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.

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.

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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.

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.

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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.

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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.

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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.

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.

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