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.

Joseph Lucosky

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).

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.

Joseph Lucosky

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.

Joseph Lucosky