SEC Subpoenas, Inquiries and Investigations

SEC SUBPOENAS, INQUIRIES AND INVESTIGATIONS

A GUIDE FOR MICRO AND SMALL CAP PUBLIC COMPANY OFFICERS, DIRECTORS, CONSULTANTS AND OTHER MARKET PARTICIPANTS, INCLUDING WITNESSES

I N T R O D U C T I O N

In the evolving and complex world of microcap public companies, even entities that operate under the strictest code of ethics, maintain a model corporate culture, possess a robust system of internal controls, and adhere to a standard of comprehensive compliance, may encounter allegations of misconduct that culminate in an investigation by the Division of Enforcement of the United States Securities and Exchange Commission (SEC).

An SEC investigation is serious and may have wide-ranging implications for the company. This book is written as a guide for public company officers and directors as they navigate through the SEC investigation process.

Even the most seasoned of organizations can find the initiation of an SEC investigation daunting. There are several ways in which a company may first learn about an investigation. It could come in the form of an unexpected phone call from SEC staff to the company's counsel, announcing the commencement of an investigation. Alternatively, a document preservation notice, voluntary request, or subpoena may be delivered without prior notice. In some instances, a company might be made aware of an ongoing investigation by a third party, such as a client, an auditor, or a vendor, who may receive a subpoena or an information request from the SEC. Regardless of the medium of delivery, an SEC investigation typically arrives unannounced, necessitating a swift and strategic response from public companies. The actions taken at the early stages of an investigation are frequently pivotal, influencing the trajectory of the investigation and the final outcome.

Given the potential severity and far-reaching consequences of an SEC investigation, it is essential for public companies to respond competently right from the onset of the investigative process. This can serve as a robust measure to prevent a possible enforcement action, mitigate potential sanctions, and enable senior management to focus on the core operational aspects of the company's business.

This Guide is designed to serve as a reliable tool for public company executives and counsels when confronted with an SEC investigation. The ability to adeptly navigate the investigative process from the onset can provide substantial advantages to the company, potentially helping it avoid an enforcement action, reduce potential sanctions, and permit senior management to maintain their focus on core business activities.

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This Guide provides an overview of key initial considerations that public companies should take into account when they are contacted by the SEC. These include:

Selection of external legal counsel, safeguarding attorneyclient privilege, and ensuring work-product protections

Identification of the behavior the SEC is scrutinizing, assessment of whether the behavior is ongoing, and evaluation of the necessity of immediate remediation

Determination of the internal stakeholders that should be informed about the potential investigation, including members of management, the Audit Committee, and the Board of Directors

Deciding when to apprise the company's independent auditors about the situation

Preservation and accumulation of relevant documents

Establishing a strategy for engaging with the SEC staff

Evaluating the necessity to inform the company's insurance carriers

Deciding whether any individuals involved will require separate legal representation and the company’s obligations in relation to indemnification

Assessing the need for public disclosure of the investigation and the requirement for a public relations strategy

Contemplating the possibility and potential implications of a concurrent criminal investigation, regulatory proceedings, or civil litigation.

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It is crucial for counsel to comprehend the process of the investigation and anticipate how it might unfold. This knowledge, coupled with an understanding of best practices, can enable counsel to effectively guide business leaders, set expectations, and prevent any unnecessary surprises or setbacks during the course of the investigation. Counsels who are well-informed and proactive can proficiently educate the management and board about the potential developments in an investigation, thereby managing expectations and minimizing any unanticipated outcomes or disappointments during what could be a lengthy investigation process.

However, it should be noted that a hasty attempt to engage the Commission, such as making a quick call explaining that the Commission's concerns must be based on a misunderstanding of the business or the facts, will seldom result in the resolution of the Commission's concerns. Moreover, attempts to contact Congress members, SEC Commissioners, or other senior SEC officials in order to halt an investigation are unlikely to succeed.

The pathway of an investigation is not always predictable, and it may not necessarily follow the complete course outlined in this guide. However, this Guide serves as a comprehensive reference, highlighting key considerations for counsels, company officers, and directors. It provides guidance in shaping the company's strategy, bearing in mind the ultimate objective of bringing the investigation to a swift and minimally disruptive conclusion for the company and its officers, directors, and employees.

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A myriad of reasons often account for the initiation of an investigation by the SEC. The SEC staff is constantly vigilant of financial markets, news reports, internet activity, and company filings to discern potential breaches of federal securities laws. The agency has specifically assigned a Financial Reporting and Audit Task Force to identify improper or fraudulent financial reporting.

In a bid to actively spot potential fraudulent activities, the SEC has invested significantly in personnel and tools for data analysis. A prime example of this proactive approach is the Corporate Issuer Risk Assessment Program (CIRA), which aids the staff in spotting atypical patterns in financial statements, thereby prompting further inquiry.

Sources of referrals for the Enforcement Division are not limited to the SEC's own divisions, such as the Division of Corporation Finance. Federal and state government agencies, including criminal law enforcement, contribute their share of referrals. Moreover, organizations like the Financial Industry Regulatory Authority (FINRA) and the Public Company Accounting Oversight Board (PCAOB), which routinely monitor trading, press releases, and M&A activities, often provide referrals to the SEC

Interestingly, public companies can also report potentially improper conduct to the SEC staff. Reasons for self-reporting could range from a mandated public disclosure of the misconduct, like a financial restatement, to a decision made out of the belief in good corporate governance by the company's senior management and board. Additionally, selfreporting could be a requirement stemming from previous governmental settlements, deferred or non-prosecution agreements, or similar circumstances. Regardless of the reason, it is critical for public companies to make thoughtful decisions regarding self-reporting.

Furthermore, the SEC maintains an internal database called the Tips, Complaints, Reports (TCR) System. This system records data obtained from sources like the SEC's website's Whistleblower Section, more traditional channels such as phone calls, letters, and referrals from other agencies. Any information gathered from these sources could potentially serve as grounds for an investigation. It is noteworthy that the Enforcement Division does not require probable or reasonable cause to initiate an investigation. Public companies do not have legal options to challenge the commencement of an investigation by the staff, who have considerable discretion in the investigation's conduct. In certain cases, particularly when overseas activities are involved, the SEC may request a company to conduct an internal investigation and report the findings before proceeding with the SEC's investigative processes.

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The SEC's Whistleblower Program and its Influence on Investigations

The whistleblower program, established under Section 21F of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), has significantly propelled enforcement investigations and actions. This program provides financial incentives to individuals who voluntarily provide the Commission with non-public information leading to an enforcement action. When such an action results in monetary sanctions exceeding $1 million, the whistleblower is eligible for an award between 10% and 30% of the total funds received by any U.S. regulator.

As of the end of Fiscal Year 2022, the SEC had awarded over $1.3 billion to 328 whistleblowers. These whistleblowers' information led to sanctions totaling more than $6.3 billion, including more than $4.0 billion in disgorgement of illicit gains and interest. Fiscal Year 2022 alone witnessed payments of approximately $229 million in whistleblower awards to 103 individuals. Despite a decrease in the dollar amount and the number of award recipients from the record-breaking 2021 levels, the Commission paid more in whistleblower awards in 2021 and 2022 individually than all the preceding years combined. Furthermore, in 2022, the Commission received over 12,300 whistleblower tips, marking the highest number of whistleblower tips in a fiscal year.

On September 23, 2020, the Commission introduced Whistleblower Rule Amendments, which became effective on December 7, 2020. These amendments aimed at boosting efficiencies around the review and processing of whistleblower award claims. The changes included:

A presumption setting awards at the maximum 30% of the collected monetary sanctions for awards under $5 million, which accounted for 90% of the awards in FY 2022.

A new summary disposition process for straightforward denials, enabling the Office of the Whistleblower to deliver an initial response to claimants more quickly.

A provision that could permanently bar claimants from the Commission’s whistleblower program if they submit three or more frivolous award claims.

The amendments also endowed the Commission with the authority to reward whistleblowers for their contributions to additional types of successful actions. The Commission can now consider deferred prosecution agreements and nonprosecution agreements entered into by the Department of Justice (DOJ) as "related actions" eligible for a whistleblower award.

In August 2022, the Commission adopted two more amendments to the rules governing its whistleblower program. The first amendment enables the Commission to reward whistleblowers in connection with non-SEC actions under additional circumstances. The second amendment affirms the Commission's authority to consider the dollar amount of a potential award to increase it but not to decrease it.

Employers who retaliate against or impede whistleblowers can face legal action from the Commission. Public companies should note the Commission's broad interpretation of the whistleblower rules' anti-retaliation provisions. As of the end of Fiscal Year 2022, the Commission has instigated 16 enforcement actions or administrative proceedings involving violations of Rule 21F-17. Section 21F also includes an antiretaliation provision, enabling a whistleblower to sue their employer in federal court for any form of harassment resulting from the employee's whistleblowing activity.

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1. 2. 3.

In an ever-changing financial landscape, the SEC adapts its areas of focus accordingly, aiming to preserve market integrity and safeguard investor interests. Public company reporting and disclosure have always been central to the SEC's mandate. However, the ongoing evolution of markets and the introduction of novel financial products have necessitated a shift in priorities.

In line with this, SEC Chair Gary Gensler and his team have pursued a vigorous and forward-looking agenda, emphasizing several new areas of focus.

Establishing Oversight on Climate and ESG Factors

Climate and environmental, social, and governance (ESG) factors have recently received significant attention from the SEC. In March 2021, the Commission announced the establishment of a dedicated task force for these areas. The ESG Task Force underscores the SEC's commitment to scrutinizing these vital aspects, further signaling the agency's intent to adapt its regulatory framework to evolving market realities.

Increasing Focus on Financial Reporting

Further, the SEC has heightened its focus on financial reporting, with special attention to issues such as loss contingencies and the recording of accruals. As financial reporting forms the bedrock of transparent and fair markets, any distortion or manipulation thereof poses severe risks. By prioritizing this area, the SEC strives to maintain the reliability and integrity of financial statements.

Emphasizing Digital Assets and Cybersecurity

Digital assets have emerged as another area under increased SEC scrutiny. The Commission has brought charges against entities and individuals in relation to unregistered or fraudulent offerings of digital asset securities. This is indicative of the SEC's recognition of the growing prevalence and impact of digital currencies in today's financial landscape. In May 2022, the Commission announced plans to nearly double the staff of its Crypto Assets and Cyber Unit with the addition of 20 new positions.

Alongside the increased focus on digital assets, the SEC has also ramped up its attention on cybersecurity. Entities have been charged for deficient cybersecurity procedures, failures in cybersecurity disclosure controls, and misleading investors about cybersecurity breaches. The rising prominence of this area can be attributed to the exponential growth in digital transactions and the corresponding risks.

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Prioritizing Market Integrity

Market integrity continues to be a prime concern for the SEC, especially with the rapid advancements in financial technology and increased market complexity. In recent times, the Commission has filed charges against indices for failures related to quality control, credit agencies for disclosure and internal control violations, and an investment platform for misleading customers about revenue. This pursuit underscores the SEC's commitment to preserving the integrity of the financial markets.

Keeping an Eye on SPAC Transactions

Special Purpose Acquisition Company (SPAC) transactions have also come under the SEC's lens. Given their surging popularity as an alternative to traditional IPOs, this increased focus is a testament to the Commission's adaptive approach to emergent market trends.

Scrutinizing Private Equity and Hedge Fund Fees

The SEC has also escalated its vigilance over private equity and hedge fund fees. As these alternative investment vehicles continue to attract significant capital, the SEC's priority on this front aligns with its mandate to ensure fair and transparent practices in all corners of the financial markets.

Record-Keeping Violations

The Commission has reiterated its commitment to rigorous compliance standards by maintaining a close watch on recordkeeping violations. As effective record-keeping is a cornerstone of market transparency and compliance, this focus helps prevent illicit activities and ensures market participants adhere to best practices.

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Aggressive Pursuit of Gatekeepers' Liability

In its quest for greater market accountability, the SEC has begun to more assertively pursue 'gatekeepers' – including auditors, attorneys, and others who play pivotal roles in preventing financial misconduct. This renewed focus is aimed at holding these entities responsible for their essential role in maintaining market integrity.

Continued Enforcement Actions Against Individuals

Moreover, the SEC has continued its aggressive stance in investigating and charging individuals implicated in enforcement actions. The Commission also remains resolute in pursuing officer and director bars as viable remedies against individuals found culpable of financial misconduct. In Fiscal Years 2021 and 2022, more than two-thirds of newly filed enforcement actions involved at least one individual defendant or respondent, further reinforcing the SEC's commitment to individual accountability.

In conclusion, the SEC's shifting priorities reflect its adaptability and responsiveness to evolving market realities. By expanding its focus and vigorously pursuing new enforcement areas, the SEC aims to promote a robust, fair, and transparent financial landscape, reinforcing its core mission of investor protection and market integrity.

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The SEC, as the federal agency responsible for regulating and enforcing securities laws, conducts investigations under the authority of several federal statutes. The governing rules for these investigations are outlined in 17 C.F.R. § 202.5, the Enforcement Division’s Enforcement Manual, and other Commission guidance.

These investigations, often focused on public company accounting and disclosures, can be either formal or informal, each having distinct implications and protocols.

1. Understanding Formal and Informal Investigations

During preliminary inquiries or informal investigations, also known as Matters Under Inquiry (MUIs), the SEC's enforcement staff (the Staff) cannot subpoena entities or individuals. Instead, the Staff relies on voluntary cooperation to obtain necessary information. In contrast, during a formal investigation, the Staff is authorized to issue subpoenas requiring the production of documents or provision of testimony by virtue of a formal order of investigation. This formal order is not publicly accessible, but it can be requested by those asked to testify or produce documents.

2. Purpose and Implications of SEC Investigations

The primary objective of SEC investigations is to ascertain whether there have been violations of securities laws. However, the existence of an investigation should not be interpreted as a negative assessment of the entity, individual, or security involved. It is rather an indication that the Staff has identified a potential issue that warrants allocation of investigative resources. The Staff maintains the discretion to close investigations without enforcement action at any point during the investigation.

3. Key Statutes Involved in SEC Investigations

SEC investigations may involve several federal statutes, particularly when there are concurrent or parallel criminal investigations. The primary federal securities statutes involved in investigations related to public company accounting and disclosures are discussed in the sections below.

A. The Anti-Fraud Provisions

Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933 (Securities Act), constitute the central anti-fraud provisions that generally apply to misstated

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financial statements and associated false or misleading disclosures by public companies. These provisions essentially prohibit fraudulent conduct in connection with the purchase, sale, offer, or sale of any securities.

Certain provisions under the Securities Act and the Exchange Act, such as Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, necessitate proof of scienter – i.e., intentional misconduct or recklessness. In contrast, Sections 17(a)(2) and 17(a)(3) of the Securities Act do not require such a demonstration.

B. Liability Provisions

In serious cases, the Commission may levy charges of "control person" liability under Section 20(a) of the Exchange Act, "aiding and abetting" liability under Section 20(e) of the Exchange Act, and/or "causing" liability under Section 21C(a) of the Exchange Act. Both "control person" liability and "aiding and abetting" liability require a demonstration of scienter. However, for "causing" liability, the mental state depends on the primary violation: if the primary violation requires scienter, "causing" liability also requires scienter; if not, negligence is sufficient.

C. The Foreign Corrupt Practices Act Anti-Bribery Provision

Section 30A of the Exchange Act, the anti-bribery provision of the Foreign Corrupt Practices Act (FCPA), strictly prohibits bribing "foreign officials" to obtain or retain business. This provision applies to "issuers", including officers, directors, employees, agents, or stockholders acting on behalf of the issuer, and foreign companies with American Depository Receipts (ADRs) listed on a U.S. exchange.

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D. Reporting, Books and Records, and Internal Controls

Sections 13(a)(2), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Rules 13a-1, 13a-11, 13a-13, and 12b-20 thereunder, require every public company to file accurate annual, quarterly, and periodic reports with the Commission. These reports should not contain any materially false, misleading, or omitted information. They also require public companies to maintain accurate books, records, and accounts, and a robust system of internal accounting controls.

Violations of these reporting provisions can be established without showing scienter. Additionally, Rule 13a-15 requires issuers to establish and maintain an overall system of disclosure controls and procedures to ensure compliance with the Exchange Act financial reporting obligations.

E. Disclosure Controls for Individual Employees

Section 13(b)(5) of the Exchange Act and Rules 13b2-1, 13a-14, and 13b2-2 thereunder, place obligations on individual employees to maintain the accuracy of the issuer's books, records, and accounts, and to certify the completeness of information contained in the issuer's reports. These rules prohibit directors or officers from making material misstatements to accountants during the audit, review, or examination of the issuer's financial statements.

In conclusion, understanding the statutes provided herein is essential to navigate through SEC investigations and to ensure adherence to the stringent regulatory framework of securities law.

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The severity of an investigation conducted by the SEC, regardless of its formal or informal nature, mandates a diligent and serious approach from a company under its purview. Every investigation, irrespective of its initial nature, holds the potential to escalate into an enforcement action, the repercussions of which can profoundly affect a company's financial standing and reputation.

The company's attitude toward an investigation can act as a significant indicator to the SEC of its earnestness in identifying relevant facts and rectifying any errors or misconduct - factors that the SEC might evaluate while deciding on the charges and penalties to impose. A well-strategized approach, which encompasses key actions and considerations, can assist a company in setting the right tone from the very inception of an SEC investigation.

The cornerstone of a public company's response to an SEC investigation should be its sincerity and dedication to resolving the matter at hand. The SEC may view a company's commitment to fact-finding and remediation as a measure of its cooperation and willingness to comply with regulatory norms. Thus, the company's manner of handling the investigation significantly influences the SEC's assessment of the situation, and consequently, the severity of charges and penalties it may decide to pursue.

The gravity of potential enforcement actions underscores the need for a company to approach the investigation with utmost seriousness. It's not just the financial implications that are at stake, but the company's reputation may also suffer considerable damage if the charges materialize. In a business environment where reputation can significantly impact a company's relations with its stakeholders, maintaining a proactive and serious stance during an investigation becomes paramount.

To establish the appropriate tone, the company should strategize and execute a series of key actions. A crucial initial step is the understanding and acceptance that regardless of the formal or informal status of the investigation, the matter necessitates a thoughtful and earnest response. Every investigation carries the risk of leading to enforcement actions, which reinforces the need for the company to take every investigation seriously.

Building

this earnest approach towards an SEC investigation

involves several considerations. One of the critical elements in crafting this tone is to maintain an open and cooperative demeanor, showcasing a genuine desire to discover the relevant facts and address any instances of misconduct. By displaying a willingness to collaborate and rectify mistakes, the company can display to the SEC a level of commitment and seriousness that may influence the agency's determination of potential charges and sanctions.

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Through these strategic actions and an attitude characterized by earnestness and cooperation, a company can navigate an SEC investigation effectively, demonstrating its compliance with regulatory norms and commitment to rectifying any possible wrongdoing. The company's approach towards an investigation can significantly impact the outcome and can play a vital role in mitigating potential financial and reputational damage. Therefore, it is of the essence that public companies facing an SEC investigation take the matter seriously, from inception to conclusion, and demonstrate their dedication to resolving any issues that arise.

The Advantage of Engaging External Legal Representation

In the event that a company becomes aware of a potential investigation by the SEC, it should seriously contemplate the engagement of external counsel experienced in handling SEC investigations. The vast and intricate array of issues and strategic decisions that a company may encounter necessitates the guidance of a seasoned external counsel. Furthermore, the counsel's in-depth knowledge of the case details, often bolstered by conducting an internal investigation, enables them to provide an adequate defense during an SEC investigation. SEC staff are more likely to have confidence in the thoroughness of an investigation steered by an adept external counsel rather than one conducted solely by legal teams, regardless of the latter's robustness. Utilizing an external counsel not only streamlines the investigation process, minimizing potential delays but also allows the counsel to maintain their focus on their day-to-day responsibilities.

Moreover, the use of external counsel to conduct the investigation can significantly enhance the preservation of attorney-client privilege protections, which can become challenging to maintain if counsel also provides business advice along with legal counsel. It is imperative to maintain a clear separation between legal advice, which is protected under attorney-client privilege, and business counsel, which isn't afforded the same protections.

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This differentiation can often be blurry when the advice comes from counsel who are typically involved in both business and legal aspects of the organization.

The choice of experienced and reputable external counsel can also positively influence the SEC staff's perception of the company. The SEC staff may make adverse inferences against the company if it perceives the company's counsel to be employing delaying tactics or deceptive strategies. Having external counsel recognized for their professional integrity and respected for their work ethic can counter such negative assumptions and increase the credibility of the company's response to the investigation.

In circumstances where there is a high probability of criminal or other regulatory proceedings, or concurrent civil litigation, companies are well-advised to select counsel who have a proven track record in managing such parallel proceedings. These situations can present perilous waters, fraught with legal and reputational risks. An experienced counsel will understand how to navigate these risks, ensuring that the company's interests are protected, and its response to the investigation is well-coordinated across different legal forums.

In conclusion, when faced with a potential SEC investigation, a company stands to benefit significantly from engaging an external counsel well-versed in SEC proceedings. Their expertise can be invaluable in managing complex issues, maintaining privilege protections, enhancing the company's credibility, and adeptly handling parallel proceedings. The company can thus focus on its core operations while the external counsel ensures a thorough and professional response to the investigation.

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The Strategic Considerations of Publicizing an SEC Investigation

SEC investigations are generally conducted confidentially, with the SEC seldom disclosing their existence publicly, or confirming or denying that a specific company is under investigation. However, there are exceptions to this rule. In cases where an investigation results in enforcement action, the SEC will make the matter public, filing related pleadings and orders, and often supplementing these with press releases and litigation filings posted on the SEC's official website. This publicity could result in substantial media attention.

When a company finds itself the subject of an SEC investigation, it must consider several key strategic factors when deciding if, and when, to publicly disclose the investigation. This decision will be shaped by an assessment of the investigation's materiality, the underlying conduct being investigated, potential collateral consequences, and potential outcomes.

There is no standard rule demanding disclosure; therefore, the company must carefully analyze the facts and circumstances developed during the investigation. From this analysis, it should assess the impact these facts have on the company's previous disclosures and make materiality assessments. Should disclosure be deemed advisable or required, the company must then decide whether to make immediate disclosure in a current report on Form 8-K or to wait until the next periodic filing on Form 10-Q or Form 10-K.

Several strategic considerations could influence the timing of the disclosure. These considerations include maintaining credibility with investors and analysts, the risk of leaks, and the possibility of the SEC contacting customers or other third parties about the investigation. If a company understands the scope of the potential misconduct fully, it may decide to disclose the investigation as soon as the Staff notifies it of the investigation.

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On the other hand, a company may opt not to publicly disclose an SEC investigation unless a specific requirement necessitates it, such as Regulation S-K. However, it must be stressed that a company under investigation should never falsely deny the existence of an SEC investigation. Instead, it might consider a policy of not commenting on the investigation.

In addition to deciding whether to disclose the investigation, the company should consider how the investigation affects any pending disclosure documents or registration statements. Several regulations require public companies to disclose specific items in periodic and annual reports and registration statements that could be affected by the discovery of corporate wrongdoing. These include:

1. Item 103, Legal Proceedings, requires the disclosure of “pending” proceedings as well as proceedings “known to be contemplated by governmental authorities” against a corporation, subject to a materiality threshold.

2. Item 303, Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), requires public companies to disclose “known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” If the company “reasonably expects” the investigation to have a materially adverse effect on the company, disclosure of a pending investigation is required.

3. Item 401(f), Involvement in Certain Legal Proceedings, requires disclosure of certain legal proceedings concerning officers, directors, and nominees that are “material to an evaluation of the ability or integrity” of that person.

4. Item 503(c), Risk Factors, requires disclosure of the most significant risk factors that apply to the company.

The financial statements of a company might require disclosure if the company determines that the investigation constitutes a contingency with respect to which a loss is “probable” or “reasonably possible.” If a loss is probable and can be reasonably estimated, the applicable accounting literature requires the company to accrue a reserve.

Ascertaining whether an SEC investigation is a loss contingency that necessitates financial statement disclosure can be challenging. Thus, companies should seek expert disclosure counsel as needed and appropriate. This assessment should consider

several factors, including the underlying facts, the posture of the investigation, the likelihood that the company will be charged, likely remedies the SEC might seek, whether the company and the Staff have discussed settlement, and whether the company has made an offer of settlement.

Additionally, certifying officers such as the CEO and CFO must be aware of any relevant information that affects their certifications under the Sarbanes-Oxley Act concerning the accuracy of SEC filings, including the financial reports included in those filings.

Finally, it's important to remember that the disclosure of an investigation and any evidence of potential misconduct can result in adverse publicity and possible private litigation, such as shareholder class actions or derivative actions. Therefore, companies should prepare all employees who interact with the media on how to respond to questions from the press, analysts, and shareholders about a disclosed investigation. Communication related to the investigation should take into account public relations considerations, the risk of releasing inaccurate or misleading statements, waivers of privilege, and the guidelines of Regulation Fair Disclosure (Reg FD).

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Additionally, the company and its counsel should consider whether and when to inform third parties of the investigation, including insurance carriers, lenders, customers, and other business partners. The process of disclosure in the wake of an SEC investigation is complex and multifaceted. The need for careful consideration and strategic planning in the face of potential risks and outcomes can't be overstated. The company's reputation, financial health, and regulatory compliance depend on it.

Document Preservation and Production during SEC Investigations

Investigations initiated by the SEC frequently rely on extensive document requests to gather pertinent information. The document request can encompass a broad spectrum, ranging from physical records to electronic files and other forms of data. As soon as the investigation commences, companies are encouraged to proactively secure all relevant documents. This process involves, among other steps, the suspension of routine document destruction procedures.

The importance of proper document preservation cannot be overemphasized. Improper or even inadvertent document destruction or alteration is considered a severe offense and may lead to significant repercussions, including hefty financial penalties and incarceration.

The processes of collecting, processing, and reviewing the documents requested by the SEC can be both labor-intensive and costly. It is not uncommon for SEC document requests and subpoenas to be broad in scope and accompanied by seemingly unfeasible deadlines. Consequently, the SEC's Staff usually shows receptiveness towards negotiating both the extent and timeline of document productions.

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Such negotiations may lead to a variety of favorable outcomes for the company under investigation. For instance, they might allow for an extension in the production deadline or limit the date range or subject matter for document requests. In certain circumstances, they might even succeed in eliminating specific requests. The SEC's Staff may also be amenable to a rolling basis production of documents. Furthermore, in situations where production delays occur, it is advisable for the company's counsel to proactively reach out to the Staff with a status update, thereby reinforcing the client’s ongoing cooperation.

When investigations involve document production from foreign jurisdictions, an additional layer of complexity is introduced. Often, in investigations involving sizable document productions located outside the United States, the SEC Staff tends to depend on voluntary productions instead of subpoena-based requests. Nevertheless, when dealing with US-based public companies, the SEC may argue that the parent company has custody and control over documents located overseas. Moreover, if a US-based entity or individual declines to voluntarily produce documents situated outside the US, the SEC may resort to compulsory processes to secure these documents.

Complications may arise when legal barriers, such as the European Union’s General Data Protection Regulation (GDPR), potentially obstruct compliance with an SEC document request or investigative subpoena for materials located outside the US. If the SEC Staff believes that a company is demonstrating cooperation in an investigation, they may exhibit flexibility in accepting information in a form that complies with local law. The SEC's Enforcement Manual suggests that in certain instances, companies may be permitted to submit significant information to the staff by producing interview memoranda or reporting findings derived from sources that are otherwise restricted. Thus, companies should work closely with their legal counsel to ensure they balance compliance with local regulations and cooperation with the SEC investigation.

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Witness Interviews and Testimony in SEC Investigations

During the SEC’s investigative process, witness interviews and investigative testimony are pivotal elements. The latter is recorded under oath by a court reporter. Typically, the Staff considers soliciting witness interviews or testimony from the employees of a company once the document production phase is concluded. The Enforcement Division anticipates that a cooperating company will make every effort to ensure that its current employees are available for testimony or interviews. However, compelling non-US citizens to appear for testimony is likely to be a challenging endeavor for the Staff, unless those non-US citizens can be properly served while in the United States.

The sequence of witness testimonies, once initiated, is a crucial strategic decision. A company might persuade the Staff that a specific testimony order is the most efficient way to address their queries. Implementing such a strategy can prevent a situation where the SEC feels compelled to revert to previous witnesses based on subsequent testimonies that provide more comprehensive information.

Should the SEC request or subpoena witness testimony, it is the counsel's responsibility to ensure the witness is adequately prepared to provide accurate and effective testimony. Witnesses are entitled to be accompanied by their counsel during testimonies, and only attorneys who officially represent the witness are allowed to attend the investigative testimony. The process of witness preparation necessitates an in-depth understanding of key documents likely to be referenced during the testimony and adequate time. Counsel should scrutinize all documents pertinent to the investigative issues thoroughly and comprehend a witness's memory of critical facts. Further, witnesses should be adequately prepared for the likely questions from the Staff.

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Throughout the investigation, careful consideration should be given to potential conflict issues, including the necessity for Upjohn warnings. These warnings clarify to employees that the counsel represents the company, not the individual employee. Under certain circumstances, due to conflicts or strategic reasons, a company employee may require separate counsel, distinct from the company's representation. The Staff is particularly wary of counsel representing multiple witnesses suspected of having adverse interests. If separate representation is required for employees, the company also needs to evaluate its advancement and indemnification obligations as per governing documents. Where not obligatory, voluntary advancement and indemnification should be contemplated to ensure that the employees have competent counsel to represent their interests.

Joint representation can be a cost-effective alternative and facilitate information sharing when separate representation isn't required. In situations where individuals retain separate counsel, the company should assess the viability of common interest agreements. These agreements facilitate the sharing of privileged information between parties, preserving the confidentiality of privileged communications. However, entering into such an agreement should be carefully considered regarding its format - whether oral or writtenand the obligations imposed on the company. Common interest agreements do pose certain risks, including restrictions on the use of information obtained from another party, which may be disadvantageous in certain scenarios.

Individuals have the right to invoke the Fifth Amendment privilege against self-incrimination throughout an SEC investigation and subsequent civil enforcement actions. While the individual's decision to assert this privilege should be informed by their counsel's advice, it can have profound implications for the company in the SEC investigation and related civil litigation - particularly if a senior executive asserts this right.

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The Commission has the right to interpret an individual's assertion of this right negatively in deciding whether to proceed with an enforcement action and may request the court to do the same in subsequent enforcement proceedings.

Collaborative Engagement with SEC Staff during Investigations

The concept of cooperation with SEC Staff during investigations has taken center stage since 2001. The pivotal moment came with the release of the Seaboard Report by the SEC, which shed light on the considerations the Commission should bear in mind when evaluating whether a public company merits a reduction in charges or sanctions due to proactive measures such as self-policing, self-reporting, remediation, and cooperation. The Enforcement Cooperation Program, highlighted on the SEC's website, underscores the potential benefits of such collaboration. The range of benefits is vast, contingent on the degree of cooperation offered by the company. The SEC has demonstrated flexibility, agreeing to cease-and-desist orders, deferred prosecution agreements, non-prosecution agreements, and even offering "full passes" in cases of substantial cooperation during investigations. More often than not, the Commission acknowledges cooperation by reducing charges, penalties, or other sanctions they might have otherwise pursued. The decision to cooperate, and the manner of cooperation, are subjective judgments each company must make based on their individual circumstances.

The Seaboard Report presents an open-ended array of criteria that the Staff can consider when deciding the extent of credit to assign to self-policing, self-reporting, remediation, and cooperation. These criteria grant the Staff broad discretion to evaluate each case individually, based on its unique facts and circumstances.

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Key questions posed by the Seaboard Report for consideration include: how did the company collaborate with the Staff's investigation; what compliance procedures were in place to prevent the now uncovered misconduct; who detected the misconduct and how; was the misconduct reported to the SEC by the company, or did the SEC discover the issue independently; what actions were taken by the company upon discovering the misconduct; and what measures are in place to ensure such misconduct is unlikely to reoccur.

In a sweeping effort to further promote cooperation by individuals and companies, the SEC updated the Enforcement Manual in January 2010. This update includes instructions on how to quantify and reward cooperation by individuals and public companies. This guidance builds on the foundational principles established in the Seaboard Report, introducing a "non-exclusive" list of tools designed to facilitate and reward cooperation. These tools encompass proffer agreements, cooperation agreements, deferred prosecution agreements, non-prosecution agreements, and immunity requests. These incentives, in conjunction with whistleblower rewards available to individuals, can greatly influence the extent and manner in which public companies and individuals cooperate with the SEC.

Under the leadership of Director Gurbir Grewal, the SEC administration has made it clear that obtaining credit for cooperation with the Staff involves more than merely responding to subpoenas and providing witnesses for testimony. In various speeches and press releases, Director Grewal has elaborated on the types of cooperation the Commission typically acknowledges. However, the SEC has consistently resisted assigning a quantifiable benefit to cooperation during settlement negotiations, unlike the Department of Justice in its FCPA Corporate Enforcement Policy, for instance.

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It is important for a company to understand that cooperation does not negate the need for counsel to negotiate with the Staff regarding requests for documents and testimony, nor does it preclude vigorous advocacy on behalf of the company. The objective of these negotiations should be to maintain an open dialogue with the Staff to comprehend their specific requirements, enabling the counsel to deliver the requested information while taking into consideration the burden of the Staff's request and its potential impact on the company. The approach to negotiations must be strategic and tactful. The reputation of the counsel plays a significant role in shaping the Staff's perception of the client during an investigation. Employing delaying tactics could lead to adverse inferences against the client by the Staff.

Early cooperation during the investigation can reap considerable benefits during the Wells process, a stage to be discussed later. The Staff will take such cooperation into account when deciding whether to grant the party access to the Staff's non-privileged investigative files. This, in turn, can equip the counsel with valuable information necessary to construct a convincing and effective Wells submission.

Balancing Attorney-Client Privilege and Attorney WorkProduct Considerations during Investigations

In the complex environment of SEC investigations, matters of attorney-client privilege and work-product considerations carry significant weight. The Seaboard Report delineates the contours of these aspects by stating that a company's decision to voluntarily disclose investigative findings is a factor to be taken into account when assessing its cooperation credit. However, the Commission also emphasized that public companies are not obligated to waive attorney-client privilege, work-product protection, or other privileges in order to earn such credit. The Enforcement Manual further explicates the SEC Staff's perspective on this matter:

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"Voluntary disclosure of information need not include a waiver of privilege to be an effective form of cooperation and a party’s decision to assert a legitimate claim of privilege will not negatively affect their claim to credit for cooperation. However . . . if a party seeks cooperation credit for timely disclosure of relevant facts, the party must disclose all such facts within the party’s knowledge"

The decision to share privileged materials with the SEC is a significant one, with potentially severe repercussions. The general rule is that voluntary disclosure to an independent third party, devoid of a shared legal interest, usually waives attorney-client privilege, even if the third party agrees not to divulge the communication to anyone else. The majority of courts have upheld that a company's disclosure of privileged materials to the SEC results in the waiver of attorney-client privilege. Such a waiver would not only apply to the SEC but also extend to other third parties, including potential civil litigants or the DOJ. The waiver, with respect to specific documents or information, would likely extend to all other communications related to the same subject matter as the disclosed communications.

Similarly, disclosure of materials protected by work-product protections to the SEC could also constitute a waiver of that protection. Work-product protections are typically waived when otherwise protected documents are either made available to an adversary, or to a third party that could potentially serve as a conduit to an adversary.

Companies frequently attempt to walk a fine line, aiming to secure cooperation credit without waiving privilege. This is often achieved by providing the Commission with oral summaries of non-privileged facts gleaned from investigation interviews. However, this approach is not without risk, as numerous cases have shown. Courts have, in certain instances, concluded that such information exchanges can result in a waiver of privilege, mandating the production of otherwise privileged interview documents, including memoranda, notes, summaries, and other related documents.

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Moreover, signing a confidentiality agreement with the SEC does not necessarily safeguard against waiver of workproduct protections or attorney-client privilege. This is due to the prevalent stance adopted by most Courts of Appeal, who have uniformly dismissed the notion that a producing party can preserve the attorney-client privilege and workproduct protection as to documents produced to an adverse government agency, merely through the use of a confidentiality agreement.

Therefore, companies must exercise considerable discretion when deciding which documents to voluntarily produce to the SEC. They are called upon to strike a delicate balance between the advantages of cooperation and the potential risks of waiving attorney work-product protections. This delicate balancing act demands a keen understanding of the legal landscape, strategic decision-making, and meticulous attention to detail to protect the interests of the company while also cooperating with the SEC. It is imperative for companies to have experienced counsel guide them through these complex and high-stakes decisions to ensure that the best possible outcomes are achieved.

Safeguarding Privileges While Keeping Independent Auditors Informed During an SEC Investigation

One of the pivotal responsibilities for a company embroiled in an SEC investigation involves appropriately informing its independent auditors about the investigation, the progress made, and key facts. This communication process is vital, as keeping independent auditors uninformed can potentially exacerbate the situation. In an SEC accounting investigation, these auditors will be invested in several issues. They will be concerned about the accuracy of the company's financial statements and the potential need for restatements, their ongoing reliance on management's representations, and whether their past audits may become subject to investigation.

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Notably, if the SEC's investigation pertains to accounting matters, independent auditors are likely to receive requests for documents and possibly even for investigative testimony. Keeping them updated facilitates the investigation and, as far as possible, ensures the company's continued issuance of audited financial statements.

However, working closely with auditors introduces potential dilemmas regarding privilege and work-product protections, necessitating a cautious balance between maintaining privileges and keeping the auditors informed. Court rulings have typically held that a company's disclosure of attorneyclient privileged information to its independent auditors results in a waiver of that privilege. Conversely, courts have generally determined that sharing work-product with auditors does not lead to a waiver of work-product protections, as the auditors are neither the company's adversaries nor conduits to its adversaries.

Suppose the company concurrently conducts an internal investigation. In that case, auditors often offer significant suggestions regarding the scope of document collection, search terms, investigative interviews, and fact-finding. In an investigation scenario, independent auditors may seek:

Comprehensive details of the document collection and data processing

The search terms used to identify relevant documents

Lists of interviewees

Key documents of potential interest

Detailed briefings on facts obtained from the document review and investigative interviews the company has conducted (including any internal investigations carried out by the board of directors or a board committee)

In certain cases, they may request the ability to conduct their own interviews

Balancing these requests against the need to preserve attorney-client privilege and work-product protections is a complex task. Nevertheless, a company can mitigate the risk of investigation delays by establishing a mechanism to supply this information to its independent auditors, thereby ensuring they are comfortable with the investigation process. This has to be done while being mindful of the potential privilege and work-product risks. This requires thoughtful and nuanced coordination between the company, its counsel, and its independent auditors.

In this delicate balancing act, it is crucial to consider that while communication with auditors is essential, one should avoid unnecessary disclosure of privileged information. A well-structured communication strategy with independent auditors can effectively maintain privileges, manage potential risks, ensure auditors are adequately informed, and consequently contribute to the overall efficiency of the SEC investigation. The path through this complex terrain requires experienced legal counsel capable of effectively negotiating these issues and safeguarding the company's best interests.

Navigating Privilege Disclosures amidst Parallel Civil Litigation and Other Governmental Investigations

In the complex landscape of an SEC investigation, a company must contemplate the potential impact of parallel civil litigation and additional regulatory investigations. The decisions pertaining to the disclosure of privileged information or work product ought to be influenced by the risks associated with these parallel proceedings. When the revelation of an investigation or the misconduct leading to the investigation (for instance, a financial restatement) precipitates a decrease in stock value, it is highly likely that shareholder class-action litigation will ensue. Such lawsuits can result in substantial potential damages.

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Though less severe but more prevalent, shareholder derivative suits also pose significant concerns. These suits are purportedly instituted in the corporation's name and do not necessitate a stock drop. Instead, the plaintiff's attorneys argue that the company should litigate against its own officers or directors for allegedly instigating the misconduct that initiated the SEC investigation. Additionally, other regulatory bodies governing the company might also commence investigations into the same conduct.

A company must remain cognizant of the fact that waivers of privilege and work-product protections in one context generally translate into waivers in all other contexts. Therefore, it is crucial to strategize with this risk in mind. Actions that might be beneficial in one forum can have severe repercussions in another. For instance, providing the SEC with detailed written presentations or PowerPoint slides on a case's facts could earn SEC cooperation credit and potentially shorten the SEC investigation's duration. However, if produced in related civil litigation, the same presentation could equip plaintiffs' lawyers with a clear strategy to navigate the worst facts, consequently increasing the settlement value of the civil litigation.

Therefore, when contemplating privilege waivers, a company must undertake a comprehensive assessment of the risks and benefits across the array of actual and potential related matters. It is not a decision to be made lightly or in isolation, but one that requires a holistic evaluation of the company's overall legal landscape. The complexities involved necessitate the guidance of experienced legal counsel who can navigate these challenging waters, maintaining a clear-eyed view of the potential ramifications across multiple legal arenas.

The overarching aim is to align the strategy with the company's broader interests, ensuring that the path taken in the SEC investigation does not inadvertently undermine its position in other litigation or regulatory matters.

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This necessitates a carefully calibrated and well-coordinated approach that contemplates the interplay between different proceedings, the potential for privilege waivers, and the broader implications for the company's legal position. It underscores the intricate challenges of dealing with SEC investigations and the profound importance of having a wellconsidered and comprehensive strategy in place.

Implementation of Remedial Measures: A Crucial Aspect of Corporate Compliance

Upon identifying potentially inappropriate or illegal conduct within a company, it is incumbent upon the organization to initiate immediate steps to mitigate any ongoing illicit activities and rectify any inaccuracies in financial statements. The SEC identifies timely and effective remediation as a critical aspect of corporate cooperation. The speed, efficacy, and breadth of remediation measures can directly influence the likelihood of enforcement action and the severity of resultant sanctions.

The plan for remediation should exhibit robustness, clearly indicating to the SEC the company's intention and proactive steps towards rectifying the identified issues. The range of remediation can encompass various actions. Notably, personnel actions are a common remedial measure in cases where there is evidence of misconduct. Remediation strategies can also include an assessment of any deficiencies in internal control by the management, and the subsequent plan of action designed by the management and the board to rectify these deficiencies, thereby preventing the recurrence of similar issues. In circumstances where a financial restatement is necessitated, the remediation process may also entail the consideration of 'clawback' of certain executive compensations. This is applicable even in situations where the executive in question was not directly involved in the misconduct. The SEC has the authority to enforce clawbacks under either Section 304 of the Sarbanes-Oxley Act or Section 954 of the Dodd-Frank Act.

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Section 304 of the Sarbanes-Oxley Act enables the SEC to reclaim certain compensation and stock profits related to restatement from CEOs and CFOs of public companies if the restatement was prompted by misconduct. As evidenced in the case of SEC v. Jensen, a unanimous decision by the Ninth Circuit panel highlighted that Section 304 permits the SEC to seek a clawback, irrespective of whether the restatement was instigated by personal misconduct of a CEO or CFO or by other forms of misconduct within the company. In simpler terms, the SEC can pursue executive compensation clawback even in situations where the executive did not play a part in triggering the need for a restatement.

Section 954 of the Dodd-Frank Act also stipulates conditions for clawbacks in the event of a restatement. This section applies to all current and former executive officers, extending beyond the CEO and CFO, and places the responsibility on the company to claw back incentive-based compensation that exceeds what an executive officer would have received based on accurate financial statements. It should be noted that while Section 304 is confined to restatements instigated by misconduct, Section 954 does not have this limitation. The SEC issued the final rules implementing Section 954 on October 26, 2022.

The onus of developing and implementing a thorough remediation plan falls on the company’s management. It serves as a testament to the organization's dedication to adherence to the law and regulations, its willingness to correct its past mistakes, and its commitment to enhance internal control mechanisms to prevent the reoccurrence of similar issues in the future. Companies that swiftly and effectively rectify problematic conduct may find that their remediation efforts are rewarded with reduced sanctions, a decrease in the likelihood of enforcement action, and ultimately, the restoration of public and investor trust.

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The resolution of an investigation, particularly one involving the SEC, can take several forms, each with its unique set of implications and potential impacts on a company's operations. The most advantageous outcome is undoubtedly the swift closure of the investigation without the filing of any charges. This outcome minimizes disruption to a company’s business operations and can help to preserve its reputation and standing. Such outcomes, while highly desirable, are indeed attainable and do occur.

However, even in instances where the duration of the investigation extends beyond initial expectations, a decision by the Staff to close the investigation without taking any further action should still be considered a positive outcome.

The ability of a company to demonstrate its cooperation, rectify any issues, and ensure there is no ongoing misconduct can influence the Staff's determination.

In some situations, the investigative process may be more complex and prolonged, requiring a deeper level of engagement with regulatory bodies. Following the completion of an investigation and the subsequent Wells process, if the Staff is intent on proceeding with an enforcement recommendation, the company is not left without recourse. In these circumstances, the company can negotiate the violations charged and the remedies sought in a manner that could potentially be more advantageous than the outcome of litigation.

The negotiation process often involves a thorough review of the charges and a careful assessment of the potential penalties or consequences. A company may seek to reduce the severity of the charges, limit the scope of the violations, or negotiate the type and extent of the relief sought. This process should involve collaboration between the company's legal team and the regulatory staff, with the shared goal of reaching a resolution that ensures regulatory compliance while mitigating the impact on the company's operations and reputation.

In this process, the company's legal team needs to consider the broader implications of the negotiated resolution, including potential impacts on other ongoing or future legal proceedings, the company's relationships with other regulatory bodies, and the public perception of the company. It is essential that the company's legal team is well-prepared, understands the regulatory environment, and is capable of effectively advocating for the company's interests.

While managing an investigation may pose significant challenges, the process of reaching a resolution provides an opportunity for the company to demonstrate its commitment to maintaining high standards of corporate governance, its willingness to rectify any issues that may have arisen, and its dedication to upholding the trust of its stakeholders Joseph Lucosky

Navigating this process effectively can help a company emerge from an investigation with minimal disruption to its operations and its relationships with regulators, stakeholders, and the public.

The Element of Time: Navigating the Duration and Implications of SEC Investigations

Understanding the temporal aspect of SEC investigations is crucial in devising a suitable strategy for managing them. The duration of SEC investigations is notoriously unpredictable and can be prolonged, often making the timeline a significant factor to consider. It's not uncommon for investigations, especially those related to financial disclosures, to extend over one to two years. In some extreme instances, investigations may even stretch up to five years or beyond.

This variability in timing stems from the complexities inherent in each investigation, the multiple entities involved, and the intricacies associated with legal and regulatory processes. The SEC staff have attempted to streamline the process by reducing the number of meetings between themselves and the entities involved, and by requiring entities to produce necessary documentation and responses more swiftly.

Despite these efforts, managing the timeline remains a considerable challenge. However, companies can proactively influence the pace of the investigation process by responding promptly and comprehensively to the SEC’s demands and adopting a proactive approach to internal fact-finding and legal argumentation, geared towards addressing the SEC staff's concerns effectively and efficiently.

Defending against, and cooperating with, an SEC investigation can be both financially and operationally taxing for a company. The uncertainty associated with an unresolved investigation can also have negative implications on a company’s standing in the capital markets. This uncertainty could be particularly detrimental for companies that issue securities, as it might affect investor confidence and stock performance.

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Moreover, prolonged investigations can inflict reputational damage that extends beyond the investigation period itself. It is thus in the best interests of a company to resolve any SECrelated matter as promptly as possible, especially when it deems that a response to a Wells notice may not successfully divert an enforcement action, or if it perceives such an action as inevitable.

However, a caveat to this approach is that even if a company is inclined towards a swift settlement, the SEC staff may not reciprocate this sentiment. It is often the case that the SEC staff may refrain from entering into serious settlement negotiations until they have completed their investigation into the conduct of senior officers or potentially implicated board members.

The rationale behind this is twofold: Firstly, identifying the extent of individual culpability can influence the assessment of the company's overall culpability. Secondly, there has been a noticeable trend in the SEC's approach, where they have begun to pursue charges against individuals more aggressively in enforcement actions. This shift further underscores the importance of a company taking into account the role and potential culpability of its senior management and board members in its overall investigative and resolution strategy.

The Procedure and Deliberations Pertaining to Wells Notices and Settlement Negotiations

The architecture that underpins the conclusion of an investigation directed by the SEC enforcement staff is a flexible entity. This is typically characterized by the enforcement staff persisting with their investigative and analytical endeavors until they reach a preliminary conclusion that an enforcement action recommendation against a specific party is warranted.

This critical juncture in the investigation is denoted by a formal announcement known as a Wells notice. It signifies the staff's intention to recommend enforcement action and provides an opportunity for the implicated party to respond in writing.

Upon receipt of a Wells notice, the normative procedure entails a meeting between the implicated party's counsel and the enforcement staff. This interaction aims to facilitate a thorough understanding of the staff's position and the potential enforcement recommendations under consideration. Following this meeting, the company can draft a Wells submission to the SEC outlining its stance, presenting persuasive arguments why the enforcement action should not proceed, or why a lesser charge should be preferred.

For instance, the company may argue for a resolution under a reporting violation pursuant to Section 13(a)(2) instead of proceeding under the provisions pertaining to anti-fraud. The Wells submission is generally the singular opportunity a company possesses to directly communicate and present its case to the Commission. Following the Wells submission, it is commonplace for the company's counsel to arrange a meeting with senior members of the Enforcement Division who were not directly involved in the investigation. This meeting serves as a platform to advocate for reconsideration of the staff's enforcement recommendation.

However, it is crucial to clarify that the issuance of a Wells notice does not inherently signify the filing of charges. It is a procedural measure instituted to provide the Commission with an opportunity to consider the defendant's counterarguments prior to deciding on the progression of enforcement proceedings.

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On an informal note, it is not uncommon for a party, which perceives a discrepancy in the staff's understanding of its position or anticipates an inevitable Wells call, to proactively engage the staff in discussions regarding the relative strength of their positions and potential settlement opportunities. This need not necessarily be postponed until the receipt of a Wells call. It is also not unusual for the staff to initiate inquiries into potential settlement options prior to the formal issuance of a Wells notice.

Should the enforcement staff decide to recommend an enforcement action post the Wells notice and subsequent submission from the company, a memorandum outlining this recommendation along with the Wells submission is presented to the Commission. This triggers a voting process among the Commissioners to decide whether to initiate enforcement action based on this recommendation, a decision which requires majority approval. The course of the Wells process and settlement negotiations, therefore, lies at the core of how investigations evolve and eventually conclude, underscoring their critical importance in the realm of SEC enforcement actions.

The Choice Between Settlement and Litigation

Public corporations frequently choose the path of settlement over litigation in instances where they are confronted with allegations from the SEC about potential inaccuracies in their financial declarations. This preference can be attributed to several factors beyond the simple monetary costs associated with legal proceedings.

Firstly, it is critical to recognize that any adverse determinations resulting from litigation are generally binding in subsequent private shareholder lawsuits. This could potentially open the floodgates for further legal challenges, translating to an escalation in reputational damage and financial liability for the corporation.

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The SEC, in its procedural guidelines, allows for parties to settle without conceding to the allegations or findings of misconduct raised by the Commission. However, it's important to note that, in accordance with these guidelines, the parties are not permitted to deny these allegations or findings either. The SEC's approach, in certain circumstances, may necessitate an admission from the implicated party. The ability to settle without outright admissions of wrongdoing provides corporations a valuable route to manage potential reputational risks and maintain public confidence.

Additionally, corporations that opt for settlement often have the opportunity to shape the narrative of the alleged misconduct as presented by the SEC. A firm stance of cooperation and proactive remediation can facilitate negotiations with the Commission to highlight positive aspects of the corporation's conduct. In cases where good cooperation and remediation are demonstrable, the implicated party can sometimes negotiate for positive acknowledgments in the SEC's public disclosures. This can encompass commendations of the corporation's cooperation during the SEC's investigation and the remedial actions undertaken in response to the allegations.

In contrast, individual parties facing allegations from the SEC often approach the situation differently, demonstrating a higher propensity to engage in litigation. This differential response can be attributed to the unique set of variables and risk factors that individual defendants have to consider, which may diverge significantly from those of corporate entities.

Overall, the choice between litigation and settlement is a multifaceted decision, informed by an intricate matrix of factors. The nature of allegations, the potential for reputational damage, the cost implications, and the anticipated influence on stakeholder relationships are just some of the many considerations that corporations must navigate in the face of SEC allegations.

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Classification of Enforcement Actions

The SEC is empowered to initiate enforcement actions in two distinct jurisdictions:

1. Civil Injunctive Actions in Federal District Court.

2. Administrative Proceedings overseen by the SEC’s internal Administrative Law Judges (ALJ).

A detailed exploration of these legal arenas and their implications provides a deeper understanding of the SEC's enforcement landscape.

Civil Injunctive Actions in Federal District Court

When the SEC chooses to file an enforcement action within a federal district court, it is customary for them to pursue civil monetary penalties, along with an injunction aimed at preventing future violations of federal securities laws. They may also seek other equitable remedies that the court deems appropriate given the circumstances of the case.

The process begins with the SEC lodging a complaint, a document outlining the alleged violations by the defendant. In situations where an enforcement action has been settled, the SEC files the complaint alongside the defendant's consent for the final judgment. This consent encompasses any sanctions and undertakings that have been mutually agreed upon. Once a judge approves the final judgment, it will perpetually bar the defendant from future violations and impose the agreed-upon sanctions. Notably, in a settled action, the final judgment does not contain any findings of fact or conclusions of law.

If a defendant opts to engage in litigation with the SEC, they will submit a formal answer to the complaint. This commences the litigation process within the federal district court.

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Administrative Proceedings before the SEC's Administrative Law Judges

Alternatively, the SEC may exercise its discretion to initiate an administrative proceeding instead of a federal district court action. The resolution of a settled administrative proceeding typically results in the issuance of a cease-anddesist order, analogous to a federal court injunction. This order mandates the respondent to halt and desist from committing violations of federal securities laws. Such a settled order also contains the Commission's findings of fact, legal conclusions, and imposed sanctions.

In recent years, the SEC has increasingly preferred administrative proceedings, particularly in litigated matters. In Fiscal Year 2021, for example, roughly 48% of the actions brought by the SEC were standalone administrative proceedings. These internal tribunals, presided over by SECemployed ALJs, offer speed and efficiency with reduced discovery when compared to federal court proceedings.

This increased usage of administrative proceedings has gained widespread attention and has been the subject of constitutional challenges. On July 13, 2016, the SEC announced updates to its rules of practice governing these administrative proceedings, providing additional opportunities for depositions and adding flexibility to the timeline for specific administrative proceedings.

However, recent legal developments have somewhat curtailed the SEC's use of administrative proceedings in litigated matters. In 2018, the Supreme Court ruled that SEC's administrative law judges are "officers of the United States," making them subject to the Appointment Clause of the Constitution. In a more recent development, on May 18, 2022, the Fifth Circuit opined that the SEC violated the Seventh Amendment's right to a jury trial by bringing defendants before administrative law judges, arguing that Congress had unconstitutionally delegated legislative powers to the SEC.

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Importantly, the Supreme Court has agreed to hear a similar challenge to the constitutionality of these tribunals. This has effectively resulted in the SEC limiting the use of administrative proceedings to settled matters and follow-on proceedings for specific types of relief.

In conclusion, the SEC's enforcement actions may manifest in either federal district courts or administrative proceedings, depending on various factors. Each type of forum carries its unique benefits and constraints, influencing the SEC's decision to employ them and the potential outcomes for defendants.

The Intersection of Civil and Criminal Investigations

While the SEC operates within the realm of civil enforcement, it does not have the jurisdiction to initiate criminal proceedings. This power resides with the Department of Justice (DOJ). That being said, the relationship between these two agencies is far from mutually exclusive. Particularly in cases that involve potential violations of anti-fraud statutes or the Foreign Corrupt Practices Act (FCPA), it is not uncommon for the SEC and DOJ to conduct parallel investigations. This confluence of civil and criminal investigations forms a significant aspect of the overall enforcement landscape.

Under its mandate, the SEC is empowered to refer a matter to the DOJ for potential criminal prosecution. Such referrals typically occur when the SEC encounters egregious violations during its civil investigations, or when the nature of the potential misconduct necessitates both civil and criminal sanctions. When an SEC investigation uncovers possible criminal misconduct, the commission may recommend the DOJ initiate a parallel criminal investigation.

It is important to note that information acquired by the SEC during its investigations can and often is shared with the DOJ. This inter-agency information sharing forms part of the cooperative framework between the SEC and DOJ in enforcing securities laws. Therefore, the possibility of a criminal investigation should not be dismissed during an SEC investigation.

Companies under an SEC investigation should maintain awareness that their responses, including any documents provided or statements made, could potentially be shared with the DOJ. This possibility should be a key consideration in shaping the strategic decisions a company makes during an SEC investigation. These strategic decisions can encompass a wide array of aspects, from the level of cooperation with the SEC to the tactical approach in providing requested information.

While the SEC and DOJ operate under distinct mandates, their joint efforts underscore a unified front against securities law violations. As such, a company involved in an SEC investigation should not underestimate the potential for parallel criminal investigations and must prepare accordingly. This preparation should involve considering all potential outcomes, including the possible transition from a civil to a criminal investigation, and planning strategies that factor in this broad enforcement landscape. Understanding and navigating this complex interplay between the SEC's civil investigations and the DOJ's criminal jurisdiction is crucial for any company under scrutiny for potential violations of securities laws.

The Evolving Landscape of Monetary Penalties

Over the past decade and a half, the SEC has progressively adopted a more assertive stance in imposing significant monetary sanctions. In a notable address in 2013, then-SEC Chair, Mary Jo White, emphasized the vital role of robust monetary penalties in a successful enforcement strategy.

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This approach has since been endorsed by her successors and the Commission’s enforcement personnel, and the trend toward more substantial monetary sanctions shows no signs of abating.

Recently, under the leadership of Director Grewal, the SEC has cautioned about an impending rise in monetary penalties. This new direction signifies a heightened emphasis on the SEC’s punitive role. Furthermore, the Enforcement Division has declared its intention to step away from a strict adherence to historical precedents when determining monetary sanctions. Rather, each investigation will be appraised on its own merits, indicating a more dynamic and case-by-case approach to enforcement.

In Fiscal Year 2022, this policy shift was clearly evident. The SEC ordered an unprecedented total of over $6.4 billion in monetary sanctions, including penalties and disgorgement. This record-breaking figure underscores the SEC’s escalating commitment to leverage significant financial penalties as a deterrent for securities law violations.

While the cumulative amounts of monetary sanctions often garner the most attention, it is important to understand that these sanctions are not monolithic. They are composed of three separate segments: civil penalties, disgorgement, and prejudgment interest. Each of these components is distinct and carries its own set of considerations for those involved in the SEC's enforcement actions.

Civil penalties are fines imposed by the SEC as punishment for violating securities laws. The level of these penalties can vary significantly depending on the nature and severity of the violation, the harm caused to investors, and the benefits accrued by the violator.

Disgorgement represents the repayment of ill-gotten gains. Under this mechanism, the SEC requires violators to surrender the profits they realized from their illegal activities. Disgorgement serves to deprive violators of the financial benefits of their misconduct, thereby removing the incentive for such behavior.

Prejudgment interest is the third component of monetary sanctions. It represents the interest accrued on the disgorged amount from the time of the violation until the judgment is rendered. This aspect of monetary sanctions ensures that violators do not profit from the time value of money gained through illegal activities.

The specific components proposed by the Enforcement Division in a particular case can affect the legal counsel’s ability to negotiate the total sanction. Understanding the composition of the proposed sanction, and the distinct factors considered in determining each component, can be instrumental in formulating a response strategy. The evolving landscape of monetary penalties highlights the increasing financial implications of securities law violations and underscores the importance of compliance with regulatory requirements.

A Deep Dive into Civil Penalties

The SEC possesses both the authority and discretion to modulate penalties according to the severity of securities law violations. This customization of penalties is achieved through a three-tiered system that categorizes violations based on their gravity.

1. Tiers of Penalties: An Overview

The SEC categorizes penalties into three distinct tiers based on the severity of violations:

- First Tier: This category encompasses all types of violations, irrespective of their severity or the underlying conduct.

- Second Tier: This level is assigned to violations that involve "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement." Essentially, these are breaches that involve intentional or grossly negligent misconduct.

- Third Tier: This is the highest level of penalties, reserved for the most severe violations. These include actions that involve "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" and that either "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons or resulted in substantial pecuniary gain" for the violator.

2. Calculating Maximum Penalties: A Dual Approach

The calculation of maximum penalties within each tier follows two alternative methodologies. The first method is applicable in both administrative and civil actions, allowing for a "per violation" calculation. Here, the penalty amount escalates by tier, reflecting the severity of the violation.

The second method, applicable only in civil actions, ties the penalty to the "gross amount of pecuniary gain" to the defendant resulting from the violation(s). This method is designed to ensure that the violator does not profit from their misconduct.

3. Understanding the Maximum Penalties

As of January 2022, the maximum penalties under the Securities Act of 1933 / Securities Exchange Act of 1934 for each tier in both types of actions are outlined in the table below:

It's crucial for companies to understand that, despite the statutory guidelines, the SEC does not strictly adhere to a formulaic approach when determining an appropriate penalty. This is especially true during settlement negotiations. The SEC is often swayed by public opinion and pressure to impose high penalties for violations of federal securities laws Nevertheless, the SEC can use the statute to justify high penalties.

4 Number of Violations and Potential Penalties

In terms of the number of violations, the SEC has considerable latitude. Each misstated entry in a company's books and records can be charged as a separate violation, potentially leading to an accumulation of violations and corresponding penalties.

If the pecuniary gain from the violations is sufficiently large, the per-violation amounts become insignificant in civil actions.

5. Parallel Criminal Resolutions

In cases where there are parallel criminal resolutions resulting in a criminal fine for the same conduct, the SEC typically, but not always, waives any civil monetary penalty. This practice illustrates the SEC's recognition of the financial impact of overlapping sanctions and its willingness to coordinate with other enforcement bodies.

In conclusion, navigating the SEC's civil penalty structure is a complex process requiring a detailed understanding of the tier system, penalty calculation methodologies, and the SEC's discretionary powers. Through diligent compliance and risk management efforts, companies can mitigate the risk of penalties and ensure adherence to securities laws.

Disgorgement and Prejudgment Interest in Securities Violations

The SEC typically advocates for the repayment, or disgorgement, of profits obtained unlawfully in addition to the application of prejudgment interest calculated from the date of the violation. Prior to 2017, the SEC maintained that disgorgement was a restorative measure, and as such, was not subjected to the standard five-year statute of limitations. This position was challenged by the Supreme Court's 2017 ruling, stating that an order for disgorgement in an SEC enforcement action should be classified as a "penalty," thereby placing it within the purview of the five-year limitation period relevant to other civil penalties.

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The landscape evolved further in 2020 when the Supreme Court stipulated that the SEC could request disgorgement as a form of “equitable relief,” provided it stays within “the parameters of traditional equity practice." This ruling temporarily constrained the SEC's ability to seek disgorgement. However, the regulatory environment took another shift with the intervention of Congress.

On January 1, 2021, the National Defense Authorization Act (NDAA) was passed, overriding a presidential veto. This pivotal legislation expressly granted the SEC the ability to seek disgorgement for violations of federal securities laws. Furthermore, it extended the statute of limitations for disgorgement awards and other equitable remedies in certain fraud-centric cases from five years to a ten-year window.

Specifically, Section 6501 of the NDAA amends Section 21(d) of the Exchange Act, making it clear that the SEC, in actions filed in federal district court, has the right to seek “disgorgement … of any unjust enrichment by the person who received such unjust enrichment as a result of [a] violation” of the securities laws. The new provision diverges from the Exchange Act provision examined by the Supreme Court as it does not expressly necessitate that the relief be “for the benefit of investors.”

In addition, Section 6501 introduces extended limitation periods for disgorgement and other equitable relief measures. While the standard limitations period for disgorgement remains at five years, any violation that obligates the SEC to establish “scienter” or intent including infractions of Section 10(b) of the Exchange Act, Section 17(a)(1) of the Securities Act of 1933, and Section 206(1) of the Investment Advisers Act of 1940 now sees the limitations period for disgorgement extended to 10 years from the most recent date of misconduct. This elongated 10-year limitations period also applies to other “equitable remedies,” such as injunctions and sanctions like industry bars and suspensions, in both scienter and non-scienter actions.

Joseph Lucosky

As per established jurisprudence on disgorgement, it only needs to be a reasonable estimate of a defendant’s unlawfully acquired gains. Once the SEC presents a prima facie case that the proposed amount approximates these gains, the burden of proof shifts to the defendant to show that the disgorgement amount is unjustified. This becomes particularly relevant in cases involving fraudulent financial statements or misleading SEC filings, where courts may order defendants to disgorge any profits realized due to inadequate disclosure. Quantifying such profits can be complex, often requiring the deployment of forensic experts to counter the SEC's claims.

The courts have the discretion to award prejudgment interest on disgorgement. This period typically starts with the date of the unlawful profit and ends with the entry of judgment. Prejudgment interest can significantly boost the amount the SEC recovers, particularly because there could be a considerable time gap between the occurrence of the conduct that led to the alleged violation of the securities laws and the time a court enters a judgment.

Evolution of Settlement Admissions within the SEC's Framework

Over the years, the SEC has historically allowed defendants to settle cases without an admission or denial of the commission’s allegations, findings, or conclusions. However, this 'neither admit nor deny' stance has undergone a series of modifications in recent years, marking a significant shift in the SEC's approach to settlements.

The first notable change was initiated in early 2012 when the SEC decided to abolish the 'neither admit nor deny' terminology in instances where there had already been admissions or determinations of fact in related criminal cases. Consequently, in situations involving concurrent criminal convictions, or non-prosecution or deferred-prosecution agreements incorporating admissions or acknowledgment of criminal conduct, the SEC refrained from incorporating the standard 'neither admit nor deny' phrasing.

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Instead, they opted to specify the nature of the criminal conviction, or the details of the non-prosecution or deferredprosecution agreement within the settlement documentation. Initially, this policy adjustment did not require additional admissions beyond those already acknowledged in the criminal proceedings.

This policy underwent further modification in June 2013 when then-Chair Mary Jo White announced an expansion of the range of settlements where admissions might be required. Alongside this announcement, a new policy was instituted, necessitating admissions in cases displaying egregious conduct or causing widespread investor harm. An internal memorandum from the co-directors of the Enforcement Division identified three criteria to help determine the necessity of admissions:

"Misconduct that has caused significant harm to numerous investors or put investors or the market at risk of substantial harm."

"Egregious intentional misconduct."

"Instances where the defendant has unlawfully impeded the commission's investigative processes."

Despite acknowledging that the majority of cases would continue to be resolved without requiring admissions, the memo emphasized that in certain situations, it may be necessary for defendants to admit their wrongdoing to ensure accountability, even if it potentially delays resolution.

During the Trump Administration, the SEC, although not officially declaring a policy shift, saw its Enforcement Division predominantly revert to its traditional approach. This reversion resulted in a significant decrease in the number of cases requiring admissions of guilt in SEC enforcement actions.

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Joseph Lucosky

In contrast, the Biden Administration, led by Director Grewal, has signaled a return to requiring admissions in select matters. In an October 2021 statement, Director Grewal indicated that admitting wrongdoings serves as a strong accountability measure. In his words, “When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law, and so, in an era of diminished trust, we will, in appropriate circumstances, be requiring admissions in cases where heightened accountability and acceptance of responsibility are in the public interest.”

Expounding further, Director Grewal highlighted the deterrent value of public admissions, stating, “Admissions, given their attention-getting nature, also serve as a clarion call to other market participants to stamp out and self-report the misconduct to the extent it is occurring in their firm.” This strategic direction underlines the SEC's evolving approach towards achieving transparency and accountability in securities law enforcement.

Ramifications of a Settlement with the SEC

The consequences of concluding a settlement with the SEC extend beyond the immediate implications. Such resolutions may induce various collateral effects, with their severity and extent being contingent on the distinct circumstances and terms of the resolution. Each scenario is inherently unique, and therefore the resultant collateral outcomes will correspondingly vary.

Settling an enforcement action with the SEC is not merely about concluding an uncomfortable chapter; it can also be the precursor to a range of secondary, or collateral, consequences. While the resolution of the immediate matter before the SEC is paramount, it is equally essential to remain mindful of these potential subsequent ramifications.

Joseph Lucosky

This awareness facilitates a holistic approach to negotiation and decision-making, with a comprehensive understanding of the full spectrum of potential implications.

Public corporations, in particular, should be attuned to these collateral outcomes owing to their potentially significant impact. These effects could potentially reverberate across various facets of the business, affecting its regulatory status, relationships with business partners, and reputation among investors and the public. It is imperative to consider these factors while contemplating a settlement with the SEC.

In summary, while achieving a resolution with the SEC is a crucial step for public corporations embroiled in enforcement actions, it is not the end of the journey. It is merely the first step in a longer path that could be fraught with further obstacles in the form of collateral consequences. Understanding and anticipating these potential outcomes is crucial for mitigating their impact and ensuring the corporation's continued stability and success.

The Ripple Effect of SEC Settlements on Subsequent Litigation

Public companies' resolutions with the SEC have traditionally had particular characteristics that can have a pronounced impact on subsequent litigation proceedings. A detailed examination of these implications can reveal how an SEC settlement can potentially set a precedent, shaping the trajectory of further litigation involving similar issues.

Historically, public companies have been able to settle SEC enforcement actions without admitting or denying the Commission’s allegations, findings, or conclusions. This approach allows companies to resolve the enforcement action while maintaining a neutral stance regarding the substance of the allegations.

Joseph Lucosky

In such cases, there is no legal determination or verdict regarding the SEC's claims' merits. Therefore, a settlement reached under these circumstances typically has no preclusive effect, meaning that the fact of settlement does not legally prevent a company from disputing the same issues in subsequent legal proceedings, such as securities class actions.

However, recent legal developments have instigated a shift in this norm, prompting closer examination of the potential consequences of SEC settlements in subsequent litigation. Some recent court decisions have explored the possibility of admitting certain aspects of the SEC settlement into evidence in later legal proceedings. These decisions have underscored the potential evidentiary value of SEC settlements, thereby questioning the traditionally held view that SEC settlements have no bearing on future litigation.

A significant factor influencing the admissibility and preclusive effect of SEC settlements in subsequent litigation is whether the company was required to make admissions as part of the settlement. Should a company be obligated to admit to any wrongdoing to achieve resolution with the SEC, such an admission could be admitted as evidence in subsequent litigation. Moreover, such an admission could potentially have a preclusive effect, effectively barring the company from arguing a contrary position in future litigation.

This potential preclusive effect has significant implications for the company's litigation strategy and potential settlement value in any future litigation. A prior admission of wrongdoing could potentially compromise the company's defensive position in future litigation, thereby impacting its prospects of achieving a favorable resolution. Furthermore, such an admission could also influence the settlement value of subsequent litigation, potentially leading to larger settlement demands from plaintiffs who may view the prior admission as strengthening their case.

Joseph Lucosky

In conclusion, the potential impact of SEC settlements on subsequent litigation underscores the need for public companies to approach SEC enforcement actions with a comprehensive and forward-looking litigation strategy. Companies must consider not only the immediate implications of an SEC settlement but also its potential ripple effects on subsequent litigation. This holistic approach can enable companies to navigate the complexities of SEC enforcement actions and subsequent litigation more effectively, minimizing potential legal risks and exposure.

Compliance with Disclosure Obligations Following an SEC Settlement for Public Companies

The nature of the Securities and Exchange Commission (SEC) settlements mandates transparency, which can lead to a series of ensuing public disclosures for companies, especially those that are publicly traded. These disclosure obligations largely hinge on the violations that prompted the resolution.

Upon reaching a settlement with the SEC, the public company is subject to public disclosure requirements concerning the terms and conditions of the resolution. The release of this information follows the principle of public access to crucial regulatory information, particularly in cases that involve public entities. However, the obligation to disclose is not limited to the settlement details; it may activate a series of further disclosure obligations relating to the company's operations, particularly within its SEC filings.

Notably, if the SEC settlement involves the entry of an injunction or administrative order against a public company, it may trigger additional disclosure requirements, especially under Regulation S-K.

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This regulation, which governs non-financial statement disclosure requirements for public companies, could necessitate the disclosure of pertinent information concerning legal proceedings, the financial condition of the company, and management's discussion and analysis of the firm's financial performance. The extent of these additional disclosure obligations will depend largely on the nature and severity of the violations that led to the SEC settlement.

These disclosures contribute to fostering an environment of transparency and trust among shareholders, potential investors, and the general public. Accurate and timely disclosure enables these stakeholders to understand the implications of the SEC settlement for the company's operations and future prospects.

Despite the regulations guiding these disclosure obligations, a company needs to exercise due diligence when deciding what to disclose about the SEC settlement. The task of determining the appropriate and accurate public disclosure of the settlement is complex and calls for a careful balancing act. On one hand, the company must comply with the legal obligations to disclose certain aspects of the settlement. On the other hand, the company must also consider the potential implications of these disclosures for its reputation, its relationship with stakeholders, and its competitive position in the market.

In conclusion, while an SEC settlement brings closure to an enforcement action, it also opens up a new chapter of compliance with disclosure obligations for a public company. The company must navigate these obligations carefully, ensuring it balances the need for transparency with the potential impact of the disclosures on its operations and stakeholder relationships. A prudent approach to disclosure can go a long way in maintaining the trust of stakeholders while safeguarding the company's interests in the aftermath of an SEC settlement.

Joseph Lucosky

Implications on Automatic Shelf Registration Statements for Well-Known Seasoned Issuers Following SEC Settlement

For public companies, the ability to file shelf registration statements as a Well-Known Seasoned Issuer (WKSI) can provide significant advantages. However, a settlement with the SEC can have implications on this ability, particularly in relation to a company's classification as an "ineligible issuer".

To provide some context, a WKSI enjoys the privilege of filing shelf registration statements that are instantly effective without undergoing review by the SEC Staff. Rule 405 of the Securities Act stipulates the criteria for maintaining this WKSI status. According to the rule, an issuer or a WKSI cannot be an "ineligible issuer" to retain this privilege.

An ineligible issuer is defined as an issuer, or whose subsidiaries, within the three years prior to the evaluation date, has been subjected to a judicial or administrative decree or order. This includes a settled claim or order involving allegations or violations of, or prohibiting future violations of, the federal securities laws' anti-fraud provisions. Thus, a WKSI may lose its privileged status following an SEC settlement, depending on the nature of the allegations and violations involved.

However, the regulation provides a pathway for an issuer to seek an exemption from ineligible issuer status. To secure this waiver, the issuer must establish "good cause" by demonstrating that it is not necessary for it to be considered an ineligible issuer given the circumstances. The concept of "good cause" involves an analysis of the issuer's unique situation and the implications of denying the waiver on its operations.

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In terms of the administrative aspect, the SEC has vested the Division of Corporation Finance with the authority to grant waivers from ineligible issuer status. The Division, while considering a waiver, takes into account several factors including who within the issuer was responsible for the misconduct, the remedial measures implemented by the issuer, and the impact of denying a waiver on the issuer's operations.

However, the process of obtaining a waiver and demonstrating "good cause" has become increasingly stringent, especially if the underlying conduct implicating the issuer involves a violation that required the presence of "scienter" or an intention to deceive, manipulate, or defraud.

In summary, an SEC settlement can have far-reaching implications on a WKSI's ability to file automatic shelf registration statements due to the potential for the company to be classified as an "ineligible issuer". While there are pathways for a company to seek exemption from this status, the process requires a compelling demonstration of "good cause", which has become increasingly difficult in recent times. Consequently, issuers must carefully consider these potential consequences when navigating the regulatory landscape surrounding SEC settlements.

Regulatory Restrictions on Certain Offerings Following an SEC Settlement

One of the crucial aspects of a company's relationship with the SEC revolves around the offerings of securities under Rule 506 of Regulation D. This rule authorizes a company to raise unlimited capital, provided the securities are sold only to accredited investors and up to 35 additional purchasers who meet sophisticated investor criteria. However, an SEC settlement can have significant implications on a company's ability to avail itself of this rule due to certain disqualification provisions.

Joseph Lucosky

According to the provisions of the Dodd-Frank Act, the SEC was mandated to establish disqualification regulations applicable to the offerings and sales of securities under Rule 506. Under these regulations, a company's eligibility to rely on Rule 506 can be negated if certain individuals or entities, such as directors and officers who partake in the offering, have experienced a disqualifying event. Notably, disqualifying events encompass a range of incidents, including enforcement orders issued by the SEC or court judgments related to antifraud provisions of the federal securities laws, where intent to deceive, manipulate or defraud was present.

However, it is important to note that these disqualification provisions do not render a company permanently ineligible to conduct offerings under Rule 506. The regulation outlines a process through which a company can apply to secure an exemption from disqualification. Specifically, Regulation D allows a company to be exempted from disqualification if the regulatory order, which triggered the disqualification, includes a written statement indicating that the disqualification "should not arise."

In essence, a company has the opportunity to negotiate with the SEC to include such a statement in the regulatory order, thereby preventing the disqualification from taking effect. Furthermore, Regulation D offers another recourse for issuers, where they may seek a waiver by demonstrating "good cause." The waiver indicates that denying the exemption is not necessary under the circumstances. To make this request, the company must apply to the Division of Corporation Finance within the SEC.

The process of granting these waivers has been a topic of debate within the SEC and among legislators. The primary point of contention pertains to the appropriate standard for granting these waivers and the circumstances under which a company should be permitted to continue conducting offerings under Rule 506 following a disqualifying event.

Joseph Lucosky

It is also worth mentioning that the SEC retains the discretion to impose conditions on these waivers, thereby ensuring that the company meets certain regulatory requirements despite the waiver.

In conclusion, an SEC settlement can potentially disqualify a company from conducting offerings under Rule 506 of Regulation D. However, the regulations provide pathways for the company to seek exemption from this disqualification. Despite the controversy surrounding the granting of waivers, they represent an important mechanism that can allow a company to continue its capital-raising activities in the aftermath of an SEC settlement.

Implications on Safe Harbor for Forward-Looking Statements Following an SEC Settlement

The safe harbor provisions for forward-looking statements, as provided in Section 27A of the Securities Act and Section 21E of the Exchange Act, play a significant role in enabling issuers to communicate their financial expectations and business strategies to the public. These provisions offer protection from private litigation alleging that certain forward-looking statements were materially false or incomplete. However, an SEC settlement can potentially impact an issuer's ability to avail itself of these safe harbors.

Forward-looking statements are an essential tool for issuers as they allow for the communication of future plans, projections, and strategies. However, they can be a subject of contention if they turn out to be materially false or incomplete. To provide some degree of protection to issuers, the Securities Act and the Exchange Act contain safe harbor provisions which grant immunity from private litigation in such cases.

However, these provisions do not extend to all issuers indiscriminately. Specifically, an issuer cannot take advantage of the safe harbor provisions if, within the three years preceding the forward-looking statement, it has been subject to a judicial or administrative decree or order arising from a government action. This includes prohibitions on future violations of anti-fraud provisions of the securities laws or determinations that the issuer violated the anti-fraud provisions of the securities laws.

These restrictions effectively serve as deterrents against fraudulent activities, ensuring issuers maintain the highest level of integrity and transparency in their dealings. Nonetheless, the securities laws provide a mechanism for disqualified issuers to regain their eligibility for the safe harbor provisions.

Specifically, a disqualified issuer may apply to the Commission for an exemption, allowing it to once again avail itself of the safe harbor provisions. This ensures that issuers have the opportunity to demonstrate their commitment to compliance and regain the protections offered by these provisions.

In conclusion, the ability to use the safe harbor provisions for forward-looking statements can be significantly impacted by an SEC settlement. However, the securities laws provide a pathway for disqualified issuers to regain this crucial protection, highlighting the importance of maintaining strict adherence to the securities laws and regulations.

Final Thoughts

Engaging with an SEC investigation is an intricate, financially draining, and time-intensive endeavor. These proceedings necessitate an acute understanding of the investigative process, awareness of the potential risks, and knowledge of the strategic challenges a public company may encounter. Such comprehension enables public company executives and counsel to steer through these complex processes and minimize unnecessary disruption to everyday business operations.

SEC investigations, by their very nature, are complex. They involve an intricate mesh of rules, regulations, and statutes that require a depth of understanding and appreciation. To navigate this complexity, public company executives and counsel must arm themselves with a comprehensive understanding of the investigative process. They must be familiar with each step of the process, from the initiation of an investigation to its conclusion, including the potential outcomes and ramifications of the investigation.

Furthermore, SEC investigations can have a significant financial impact. They often necessitate substantial legal costs, regulatory fines, and potential reputational damage that can impact a company's bottom line. Moreover, they can be extremely time-consuming, drawing away resources from the company's normal business operations. Therefore, it is of utmost importance for executives and counsel to understand these potential financial implications and strategically manage them to minimize their impact.

Joseph Lucosky

Beyond the procedural and financial aspects, executives and counsel must also understand the potential strategic issues that an SEC investigation can raise. These can include understanding the implications of settlement negotiations, managing public relations and shareholder relations during an investigation, and understanding the impact of an investigation on future business opportunities. Strategically navigating these issues can help a company avoid unnecessary missteps and ensure that the investigation proceeds as smoothly and efficiently as possible.

In conclusion, the process of dealing with an SEC investigation is a multifaceted one, involving understanding the complexities of the investigation process, appreciating the potential financial and time implications, and strategically navigating the associated issues. By understanding these aspects, public company executives and counsel can ensure that they are well-prepared to manage an SEC investigation effectively, thereby minimizing disruption to business operations and moving the investigation towards resolution in a prompt and efficient manner.

Joseph Lucosky

Mr. Lucosky has a broad multidisciplinary practice that includes extensive experience in litigation and dispute resolution, regulatory investigations (including FINRA and SEC matters), negotiated mergers and acquisitions; domestic and cross-border investments/joint ventures; the representation of private equity; venture capital and other private investment funds, placement agents and underwriters; securities offerings; private and public financings (including secured and unsecured lending); bankruptcy transactions; real estate matters; and various other types of commercial transactions.

Joseph M. Lucosky is the founding and managing partner of Lucosky Brookman LLP and oversees both the transactional and litigation departments.

In addition, he counsels corporate boards, board committees (including special committees) as well as being a personal adviser to many entrepreneurs, business leaders and corporate executives. He has counseled clients on significant litigation, regulatory and transactional matters across a number of industry sectors.

Mr. Lucosky has extensive experience with each stage of the corporate life cycle: start-up, expansion, management transition and exit. In addition to advising private corporations, he regularly advises publicly traded companies on a broad range of activities including, listing applications, stock trading issues, corporate governance matters and Sarbanes-Oxley compliance.

Mr. Lucosky also regularly assists public company management in compliance with Securities Act and Exchange Act regulations, including with their periodic corporate filings (on Forms 10-K,10-Q, 8-K and Proxy Statements), as well as, other regulatory and national exchange filing requirements with the SEC, FINRA, OTC Markets (including the OTCQX), NASDAQ and NYSE. He has also participated in many international transactions with dual listings on certain London, Toronto, Frankfurt, Australian and Hong Kong Exchanges.

Additionally, he has counseled clients on numerous international and cross-border transactions, commercial agreements and joint ventures including in the United Kingdom, France, Germany, China, Russia, Africa, Canada, Italy, Lichtenstein, Brazil, Middle East, Israel, Australia, Greece, Switzerland, South Africa, Ireland, New Zealand and many more.

On the investor side, Mr. Lucosky regularly represents, placement agents, underwriters, private investment funds in evaluating, structuring and negotiating both debt, equity and convertible investments for public and private companies in all phases of the corporate life cycle (from start-up through exit).

Joseph Lucosky

Mr. Lucosky works closely with his clients as both an attorney and trusted business adviser, helping them find both costeffective and practical solutions to complex business law issues. Clients appreciate not only his practical advice but also his accessibility and constant communication and his willingness to share his extensive rolodex to make introductions to sources of capital.

A member of the American Bar Association, Mr. Lucosky is a member of the Committees on Mergers and Acquisitions, Corporate Governance and Middle Market Businesses. He is also a member of the New Jersey State Bar Association Business Law Section– Securities and Corporate Practice/Governance Committee; the New York State Bar Association- Securities Regulation Committee; and is a Corporate Governance Fellow at the National Association of Corporate Directors.

In addition, Mr. Lucosky was appointed by the Supreme Court of the State of New Jersey to the District VIII Ethics Committee and was selected in 2012 by the New Jersey Law Journal as a “New Leader of the Bar” (one of the 40 Best Attorneys under the age of 40).

Mr. Lucosky is also an active supporter of numerous charitable organizations. He is a member of the Board of Directors and serves on the Nominating and Governance Committee for the Save a Child’s Heart Foundation, an international humanitarian project that performs life-saving cardiac surgery for children from developing countries. In addition, Mr. Lucosky is also the Chairman of the Board of Directors of the Lucosky Brookman Charitable Foundation which donates time, money and resources to numerous charitable organizations including Save A Child’s Heart, The Williams Syndrome Foundation, OutRun 38, Make-A-Wish, St. Jude Children’s Research Hospital, the Catholic Charities of America and many more.

Joseph Lucosky

Prior to forming Lucosky Brookman, Mr. Lucosky was both a partner and counsel with a New Jersey-based corporate securities law firm. Mr. Lucosky also practiced for almost 8 years in New York City at both Seward & Kissel LLP where he represented dozens of companies, hedge funds and private equity funds in various public and private corporate finance transactions throughout the Americas, Europe and Asia, and Cahill Gordon & Reindel LLP where he represented Fortune 500 companies and bulge bracket investment banks in a wide array of equity and debt securities transactions, bank financings and mergers and acquisitions.

He graduated from Rutgers University with a B.S. degree in Accounting and received his Juris Doctor from Brooklyn Law School where he graduated cum laude and was the Senior Notes and Comments Editor of the Brooklyn Law Review, a member of the Moot Court Honor Society and a Carswell Scholar. He is a member of both the New York and New Jersey bars.

Joseph Lucosky