Defending securities actions requires strategy in navigating a tricky process and qualified answers at critical decision points during an SEC investigation.

Defending securities actions on behalf of clients requires strategy in navigating a tricky process, which can be unique in each situation. If you are interested in this topic, you likely already have some idea of the lay of the land from a regulation of federal securities standpoint.

When it comes to civil enforcement, we are primarily concerned with the SEC bringing action in a U.S. District Court or Administrative proceeding. District Courts, in general, provide defendants with a fairer fight by virtue of the presider, a neutral Article III Judge. In the Administrative forum, however, Administrative Law Judges are appointed and compensated through the SEC and the success rates by the SEC in these proceedings is high.

SEC actions can arise from a routine investigation of regulated persons or companies or from an investigation of either regulated or non-regulated parties. There are many triggers for an investigation. Many clients get worked up over the question of what started an investigation when they should be more concerned with how to handle the investigation. Because at the end of the day, once an exam or investigation has started, it can take on a life of its own and go off in all kinds of directions.

Once an exam begins, the SEC will ask for all manner of documents, and this is where a routine exam can quickly pivot in scope to areas wildly beyond any initial questions. Similarly, informal voluntary requests for documents can do the same.

That said, the most common violation of the securities laws that lead to and become the subject of an action is misrepresentations or omissions in connection with the offer and sale of securities. With more Main Street investor money being held by and managed by investment advisors, we are also seeing more allegations concerning violations of fiduciary duties that all investment advisors and investment advisor representatives owe to their clients.

Decision Point 1: Cooperating with an SEC Investigation

In the voluntary request for documents circumstance, the first decision a party faces is to cooperate or not. Getting off on a negative foot with the SEC would seem to never be a good idea, but on the other hand, the SEC cannot compel the release of documents until the Commission has issued a formal order. For regulated entities and persons facing an exam, compliance is not voluntary.

The decision to comply at this early stage will be based on the specific facts and circumstances, and the scope of the requests and types of materials requested. As with most stages of an SEC examination or investigation, the decision will need to be made without clearly knowing what cards the SEC may be holding.

If a party decides not to volunteer information, the SEC can obtain an order initiating a formal investigation naming officers and entities. This formal order provides the SEC with the power to issue subpoenas for documents and to compel sworn testimony. At this formal stage, there’s no question about whether a party should or should not comply. It must.

Decision Point 2: How to Respond

But now there’s a new decision point; the question becomes how to respond. Study the request with a qualified attorney to try to understand the scope of the investigation. There are often clues in the particular requests. In addition, ask the SEC for more clarification. But know that most SEC lawyers will not confide in you about what they are fishing for.

Before any documents are released to the SEC, certain procedures should be followed: every page should be electronically stamped and indexed for easy retrieval and ability to identify what has been produced for later reference. This is not insignificant. Since the SEC Divisions do not share staffing, there is a good chance a party will be asked to submit the same documents a second time to the enforcement division as were initially submitted to the examination staff.

Decision Point 3: Wells Process

The next decision point may be around the Wells process. After initiating an investigation, the SEC may issue a Wells Notice, which states that the SEC believes there’s been some violation of the federal securities laws and cites which laws. This is a fairly nebulous, boilerplate notice that recites statutory provisions that the SEC suspects have been violated without any factual description. The SEC may describe such facts in a subsequent meeting or Webex call that give rise to the violations of securities laws they identified in the notice.

It’s at this point that the party faces another decision point, how to respond.

Decision Point Four: Responding to the Wells Process

Lawyers tend to have a knee-jerk reaction that, of course, we respond to these outrageous claims of violations of the federal securities laws in a robust, brief-like writing. But the substantial expense associated with putting together a comprehensive response needs to be weighed in terms of the value proposition.

There are any number of investigations where the SEC sends a Well notice and decides not to move forward with an action. If a lawsuit or Administrative proceeding is likely, then a thoroughly researched and written response negating various components of what the SEC disclosed as potential violations is justified. But, again, the cards the SEC holds are not all on the table.

In some cases, it is better to face the complaint head on in a forum, especially when potential settlements come to light that reduce risk and cost from the client’s perspective. District Court and Administrative forums can be an opportunity for the client to tell their side of the story, which can have the effect of significantly reducing the extent of the allegations in the complaint. Clients have a tendency to just want to get on with the fight so they at least have the chance to defend and tell their side.

Throughout this process, the defense attorney is trying to sort out and evaluate the strength of the SEC’s allegations. A related decision is whether to disclose a formal investigation to shareholders, investors, business partners and others, which is a topic for another day.

When settlement is an option, the type of settlement to pursue is based on a wide variety of factors including the nature of the securities violations that the SEC alleges and the status of the proposed defendants.

• Does the violation touch on the sale of securities that were sold by our clients?
• Will state Commissioners bring similar claims?
• If a client settles with the SEC, are they opening the floodgates to the potential for private investor claims?

When facing decision points like these during an SEC inquiry or enforcement action, reach out to a qualified and experienced securities attorney.