United States: securities enforcement and investigations
In the United States, the Securities and Exchange Commission is the predominant governmental enforcer of the nation’s securities laws, shouldering the lion’s share of the load by bringing enforcement actions in federal court and administrative tribunals in order to deter and punish violators through civil remedies such as monetary penalties and injunctions. In addition, the Department of Justice plays a significant role, bringing criminal prosecutions in egregious cases and seeking to deter and punish wilful violators with the imposition of prison terms and, particularly in the case of institutional defendants, criminal fines. In practice, where violators’ actions give rise to both civil and criminal exposure, these two agencies frequently conduct their investigations in ‘parallel’ – a term that the agencies prefer because it suggests a legally useful degree of separateness even when the investigations often could more accurately be described as ‘joint’ – and bring their respective criminal and civil actions simultaneously. The following describes the usual course of investigations, enforcement actions and prosecutions pursued by these two federal agencies.
The Securities and Exchange Commission
Overview and organisation
Each year, the Securities and Exchange Commission (the SEC or Commission) brings a steady stream of enforcement actions addressing the key problems that it perceives in the US capital markets, including Ponzi schemes, financial reporting fraud, market manipulation, insider trading, offering fraud, disclosure inadequacies and other types of securities law violations. The SEC files in the neighbourhood of 600 to 800 enforcement actions annually, conducts thousands of investigations, obtains through settlement and litigation billions of dollars in fines and disgorgement, and halts through emergency action dozens of ongoing frauds.
Organisationally, the Commission itself consists of five appointed commissioners. Everyone else at the agency falls into the category of ‘Commission staff.’ Although, of necessity, it is the Commission’s staff that carries out the SEC’s day-to-day enforcement operations, bringing an enforcement action requires explicit Commission authority.
The arm of the Commission’s staff that investigates and prosecutes violations of the federal securities laws is the SEC’s Division of Enforcement, which is made up of more than 1,200 professionals. The Division of Enforcement is divided in part into geographically based units in the SEC’s Home Office in Washington, DC, and in its several regional offices, such as those in New York, Atlanta, Denver and San Francisco. Separately, the Division has specialised units that focus on highly specialised and complex areas of securities laws, such as the Division’s Asset Management Unit and Market Abuse Unit.
An SEC investigation is the means by which the SEC, through its staff, attempts to determine whether a person or entity has violated the securities laws and should become the subject of charges brought by the Commission to obtain civil remedies. SEC investigations are non-public, meaning that, generally, the SEC will not disclose that it is investigating an individual or entity.
The SEC has numerous sources for obtaining leads about which individuals or companies to investigate. These sources include tips from the public, and referrals from the Financial Crimes Enforcement Network (FinCEN), the Public Company Accounting Oversight Board, state securities regulators, Congress, and self-regulatory organisations such as the Financial Industry Regulatory Authority (FINRA). In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which was signed into law by President Obama on 21 July 2010, expanded the SEC’s whistleblower provisions to create incentives (including payment of money) for members of the public to provide the SEC with information that leads to successful enforcement proceedings. The SEC has created an Office of the Whistleblower to collect and distribute such information.
Once initiated, SEC investigations have two stages: ‘informal’ and ‘formal.’ The informal stage will often begin as a mere matter under inquiry (MUI), and will automatically convert into an informal investigation after 60 days, or earlier if warranted. See SEC, Division of Enforcement, Enforcement Manual 2.3.1 (4 June 2015) (the SEC Enforcement Manual). Importantly, the SEC staff does not have subpoena power at the informal investigation stage.
Through the issuance of a formal order of investigation, specific Commission staff can issue subpoenas to compel document production and witness testimony. The staff memorialises its reasons for seeking a formal order in a non-public formal order memorandum. Prior to 2009, the Commission itself issued formal orders. Since 2009, senior Enforcement staff, through authority delegated by the Commission, issue formal orders.
The investigation – during which an extensive testimonial and documentary record is usually developed – is often the main battleground in SEC enforcement practice. The goal for defence counsel is to persuade the SEC staff not to bring charges or, at a minimum, to reach a settlement that imposes the lightest possible sanctions on the client. Once the SEC has concluded after investigation that enforcement charges are appropriate, settlement is a common resolution. Procedurally, the settlement is usually accomplished in federal court by the SEC’s filing of a complaint and, simultaneously, the filing by the parties of a consent judgment, or accomplished in an administrative proceeding by the issuance of an SEC order instituting and simultaneously resolving the proceeding.
One facet of such negotiated resolutions is the SEC’s long-standing policy of entering into settlements with defendants in which those defendants neither admit nor deny their culpability. In the wake of judicial criticism of such settlements, see SEC v Citigroup Global Markets Inc, 827 F. Supp. 2d 328 (S.D.N.Y. 2011) (Rakoff, J.), the Commission has reduced the circumstances in which such ‘neither admit nor deny’ settlements will be permitted, with Chair Mary Jo White making the statement on 18 June 2013 that the SEC will now require defendants to admit the SEC’s allegations when the public interest demands it. Nevertheless, Chair White made clear that ‘neither admit nor deny’ would remain the settlement posture for most cases. And in practice, it has continued to be the posture in the vast majority of settlements.
Before bringing an enforcement action – whether for the purpose of entering a settlement of the action, or with the expectation that the action will be litigated – the Commission staff is required to obtain authorisation from the Commission to bring the action. Before doing so, however, the staff usually notifies the individuals or entities against whom it plans to recommend charges (a ‘Wells notice’) and allows them an opportunity to make a written submission (a ‘Wells submission’) to attempt to dissuade the Commission from bringing an enforcement action. See SEC Enforcement Manual 2.4. Affording a prospective defendant an opportunity to dissuade the SEC from filing charges is an important safeguard because the filing of an SEC enforcement action can cause significant and even permanent reputational and other harm even if the SEC charges later fail during litigation. Under the Dodd-Frank Act, the Commission has six months from the date of a Wells notice to commence an enforcement action. The Commission can extend that for another six-month period upon approval from the Chair.
If the staff is unpersuaded by an individual or entity’s Wells submission, it will seek the Commission’s approval to bring an enforcement action. It does so by submitting a written recommendation called an ‘action memorandum,’ which is usually an extensive document that contains legal and factual detail often comparable to a trial memorandum in civil litigation. An action memorandum explains the factual and legal bases of the recommended charges, identifies litigation risks for the Commission, and responds to any arguments the proposed defendants or respondents have raised.
When it has decided to bring an enforcement action, the Commission can either file a civil suit in federal district court, or it can bring an administrative action before one of the Commission’s own administrative law judges (ALJs). In either forum, the Commission may seek or impose a range of remedies, both monetary and injunctive.
In federal court, the SEC’s action proceeds like a normal civil suit, which means that generally – if it is not resolved by settlement – it will be decided at trial by a jury, with any resulting judgment being appealable to a United States Court of Appeals. In an administrative proceeding, by contrast, there is no jury. Instead, the ALJ acts much like a judge in a district court bench trial. His or her decision is appealable to the full Commission, which reviews it de novo, and that decision may be appealed to a Court of Appeals. Although defendants have argued that this administrative process is unconstitutional because ALJs are not appointed in the manner set out in the US Constitution’s Appointments Clause, the only US Court of Appeals to consider the issue has rejected the argument, holding that the Appointments Clause does not apply. See Raymond J. Lucia Cos. v S.E.C., – F.3d – 2016 WL 4191191 (D.C. Cir. 9 August 2016).
In the past few years, the number of enforcement actions brought by the SEC has climbed from 676 in fiscal year 2013, to 755 in fiscal year 2014, to 807 in fiscal year 2015. See SEC Announces Enforcement Results for FY 2015, at www.sec.gov/news/pressrelease/2015-245.html. These actions cover a broad range of alleged violations. In fiscal year 2015, for example, the SEC’s enforcement actions were distributed among the following categories:
|Topical category||Number of cases|
|Investment adviser, investment company||126|
|Financial fraud/issuer disclosure||135|
|Municipal securities and public pension||80|
See Select SEC and Market Data, Fiscal 2015, at www.sec.gov/reportspubs/select-sec-and-market-data/secstats2015.pdf.
The SEC can seek in federal court, and impose in administrative proceedings (AP), a host of civil remedies (but not, of course, criminal sanctions). The following chart summarises the principal remedies available to the SEC:
|Statutory injunction||Enjoins defendant from committing future violations of securities laws||Available when SEC proves violation of the securities laws and likelihood of future violations||Federal court|
|Disgorgement||Defendant gives up illegal profits||Equitable remedy available for most violations||Federal court and AP|
|Civil monetary penalties||Monetary fines set forth in various statutes||Intended to deter defendant from committing future violations||Federal court and AP cease-and-desist proceedings|
|Officer and director bar||Bars individual from serving as officer or director of public companies||SEC must prove that defendant committed fraud and is unfit to serve as an officer or director||Federal court and AP cease-and-desist proceedings|
|General equitable remedies||Court has wide latitude to fashion remedies for protection of investors||Equitable relief created by case law now codified by Sarbanes-Oxley Act||Federal court|
|Sanctions against regulated individuals or entities||Examples: revoking broker-dealer registration; barring individuals from associating with broker-dealers, investment advisers, investment companies; imposing limitations on professional activities||Available when respondent has wilfully violated or willfully aided and abetted a violation of the federal securities laws and the remedy is in the public interest; also available in other circumstances such as when respondent is convicted of certain crimes or subject to statutory injunction||AP|
|Penny stock bar||Bars defendant from participating in penny stock offerings||Often sought in small cap stock manipulation and Ponzi scheme cases||Federal court and AP|
|Discipline against accountants and attorneys||SEC may bar an accountant or an attorney from practising before the SEC||Remedy available when, for example, an accountant engages in ‘improper professional conduct’||AP|
|Cease-and-desist order||SEC orders respondent to cease and desist from causing or committing future violations||Available when respondent commits or causes securities law violation; SEC needs to show some likelihood of future violation||AP cease-and-desist proceedings|
Cooperation or lack thereof
In determining what actions to bring and what remedies to seek, the SEC and its staff have repeatedly said that they will give credit when companies and their counsel cooperate in investigations and act responsibly when faced with the discovery of misconduct. In a policy statement, the Commission has explained that ‘[c]ooperation by individuals and entities in the Commission’s investigations and related enforcement actions can contribute significantly to the success of the agency’s mission’ and that the Commission possesses ‘a wide spectrum of tools […] for facilitating and rewarding cooperation by individuals, ranging from taking no enforcement action to pursuing reduced charges and sanctions in connection with enforcement action.’ 17 C.F.R. section 202.12 (19 January 2010).
By the same token, for well more than a decade, the Commission has exercised its discretion to seek or impose enhanced monetary penalties and other remedies when it perceives a lack of cooperation by defendants or their counsel. For example, in SEC v Brightpoint, Inc, Lit. Rel. No. 18340, 2003 SEC LEXIS 2165 (11 September 2003), where the SEC charged AIG with selling an insurance product that the SEC believed was a sham designed to enable policy-holding companies to record phantom receivables, the SEC insisted on a US$10 million civil penalty from AIG and explained in its press release that the penalty not only reflected ‘the gravity of [AIG’s] misconduct [… but also] the fact that, in the course of the Commission’s investigation, AIG did not come clean [… and instead] withheld documents and committed other abuses […] compounding its overall misconduct[.]’
The Department of Justice
Overview and organisation
The federal securities laws provide for criminal penalties for wilful violations. 15 U.S.C. section 78ff. Responsibility for prosecuting criminal violations of the securities laws falls to the United States Department of Justice (the Department or DOJ). More specifically, such prosecutions are typically brought by the Department’s Fraud Section in Washington, DC, or by one of the Department’s 93 geographically based United States Attorney’s Offices – including the United States Attorney’s Office for the Southern District of New York, which has outsized importance in this field due to its jurisdiction over Manhattan, the nation’s de facto financial capital.
Sources of investigations
The information that leads the DOJ to open a criminal securities investigation can come from any of a number of sources. Likely the most common source is a referral from the SEC, which has a statutory mandate to ‘transmit such evidence as may be available concerning such acts or practices as may constitute a violation of any provision of [the securities laws …] to the Attorney General, who may, in his discretion, institute the necessary criminal proceedings[.]’ 15 U.S.C. section 78u(d)(1). Investigations are also frequently opened on the initiative of federal law enforcement agencies, like the Federal Bureau of Investigation, which devotes significant resources to the investigation of white-collar crime generally, and securities and commodities fraud specifically. See FBI, What We Investigate, White Collar Crime, at www.fbi.gov/investigate/white-collar-crime. Finally, media outlets like the Wall Street Journal often serve as sources of leads by publishing articles that expose potential criminal wrongdoing and attract the attention of prosecutors. See, for example, Susan Pulliam, Jean Eaglesham & Rob Barry, Insider-Trading Probe Widens, Wall St. J., 11 December 2012, at A1 (reporting that the ‘Manhattan US attorney’s office has launched a broad criminal investigation’ concerning matters ‘cited in a recent Wall Street Journal article’).
Information sharing between the DOJ and SEC
When a criminal investigation is opened based on a referral from the SEC, the first thing federal prosecutors will generally do is request and obtain access to whatever evidence has been and continues to be collected by the Commission. See SEC Enforcement Manual 5.1. This interagency access request is not public and, absent more, the subject of an SEC investigation will not necessarily know – but would frequently be wise to consider – that federal prosecutors may be monitoring the results of the Commission’s investigation with an eye toward bringing criminal charges.
Access, however, is not necessarily a two-way street, because criminal prosecutors have investigative tools that are not available to the Commission, the results of which cannot be shared with the Commission staff. For example, where the necessary statutory criteria are met, the DOJ has the authority to execute judicially authorised wiretaps on suspects’ telephones and other communications devices. The results of these wiretaps can be used in a criminal prosecution, but cannot be shared with the SEC. See SEC v Rajaratnam, 622 F.3d 159, 174 (2d Cir. 2010). Similarly, any documents or testimony obtained through the use of grand jury subpoenas are subject to the grand jury secrecy requirements of Rule 6(e) of the Federal Rules of Criminal Procedure and cannot be shared with the Commission by federal prosecutors. Functionally, however, prosecutors and Commission staff working on parallel investigations will often simply agree at the outset that any relevant documents will be obtained through administrative subpoenas issued by the Commission, rather than through grand jury subpoenas, so that both agencies will have access to the results.
One tool reserved to criminal law enforcement authorities, the results of which can be shared with the Commission, is the search warrant. This tool may soon take on greater importance based on a bill passed by the House of Representatives that would require a judicially issued warrant before investigators could obtain an individual’s emails or other electronic communications from an internet service provider. As SEC Chair White observed in a May 2016 op-ed piece in the New York Times, ‘as a civil law enforcement agency, the SEC cannot obtain warrants: That authority rests with criminal law enforcement authorities.’ See ‘Privacy Rules Shouldn’t Handcuff the S.E.C.’, at www.nytimes.com/2016/05/13/opinion/privacy-rules-shouldnt-handcuff-the-sec.html. Absent an amendment requested by Chair White to give the SEC warrant-like powers to obtain electronic communications, the Commission could obtain such communications only where criminal law enforcement authorities supplied them to the Commission in the context of a parallel investigation.
‘Parallel’ versus ‘joint’ investigations
Even when they are investigating the same potential violations at the same time, in close communication, using the same documents, and interviewing witnesses together, the DOJ and the SEC are careful to describe their investigations as ‘parallel,’ rather than ‘joint.’ See, for example, SEC Enforcement Manual 5.2.1. The position that the investigations are distinct – despite being simultaneous and coordinated – serves at least two important purposes for the DOJ.
First, it reduces the likelihood that federal prosecutors will be charged with legal responsibility for knowing what exculpatory material might reside in the SEC’s files. Federal prosecutors have a constitutional obligation to be aware of any exculpatory information in the files of the ‘prosecution team,’ and to provide that exculpatory information to a charged defendant. If that prosecution team includes the SEC – that is, if the SEC and DOJ are investigating jointly, rather than in parallel – the prosecutors would assume a duty to review information in the SEC’s files and produce any exculpatory material therein. Criminal defendants often seek exactly that, and in at least one case a federal judge rejected the notion that the SEC and DOJ were investigating in parallel, rather than jointly, and ordered federal prosecutors to obtain and review the SEC staff’s memoranda of 44 jointly conducted witness interviews in order to ensure that any exculpatory material in those memoranda was disclosed to the criminal defendant. U.S. v Gupta, 848 F. Supp. 2d 491 (S.D.N.Y. 2012) (Rakoff, J.).
Second, the notion that the SEC and DOJ are acting separately permits federal prosecutors to argue that prior, often self-serving investigative testimony given by an individual who later invokes his or her Fifth Amendment privilege not to testify cannot be introduced by a criminal defendant at trial. Defendants in several recent securities fraud trials have argued that such testimony is admissible under Rule 804(b)(1) of the Federal Rules of Evidence, which permits the introduction of prior testimony where it is offered against ‘a party’ who had an opportunity and motive to cross-examine the witness when the earlier testimony was taken. In opposing such arguments – thus far with success – federal prosecutors have contended, among other things, that they are not the same ‘party’ as the SEC for purposes of the prior testimony because the SEC was conducting its investigation in parallel with the DOJ, but not jointly. See U.S. v Martoma, 2014 WL 5361977 (S.D.N.Y. 2014) (Gardephe, J.).
Several related issues also comprise part of the efforts made by the SEC and DOJ to maintain separateness and protect certain procedural advantages that the DOJ has in criminal cases. For one, although the DOJ may not use the SEC as its stalking horse, see U.S. v Scrushy, 366 F. Supp. 2d 1134 (N.D. Ala. 2005) (Bowdre, J.), and will typically neither direct the SEC to take investigative testimony nor participate in framing specific questions when the SEC chooses on its own to take such testimony, federal prosecutors generally feel free to request that the SEC refrain from taking a witness’s testimony when such testimony might be counter-productive in the criminal case (such as when prosecutors view the witness as someone who might be convinced to cooperate with the criminal investigation). The SEC typically honours such requests.
Another example is that, although Commission staff often participate jointly in witness interviews conducted by prosecutors and FBI agents, the resulting interview memoranda prepared by the FBI are frequently made available to the Commission staff only to review and take notes from, but not to copy or place in their own files. The reason is that, in a criminal case, such witness interview memoranda are protected from disclosure to a criminal defendant until at or shortly before trial, see 18 U.S.C. section 3500, but those same memoranda, if present in the SEC’s files, might be obtained earlier by a defendant through the more liberal civil discovery rules that would apply in a parallel civil action brought by the SEC. Thus, the Commission staff is only permitted to take notes from FBI interview memoranda, with the expectation that those notes would contain the SEC staff attorney’s mental impressions and thus be protected from disclosure pursuant to the attorney work-product privilege.
When the DOJ determines after investigation to bring charges in a securities case, it will typically do so under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78j(b), the general securities anti-fraud provision. A criminal violation of that section carries a potential penalty of 20 years in prison. However, most securities law violations also violate other sections of the Federal Criminal Code, including the prohibitions on mail and wire fraud, which also carry prison sentences of up to 20 years. It is common to see prosecutors include those charges in a securities fraud indictment as well.
In instances of parallel investigations by the DOJ and the SEC, the two agencies will typically coordinate the filing of charges, returning the DOJ’s criminal indictment on the same day that the SEC’s civil complaint is lodged. Promptly thereafter, however, a stay of the civil case is often obtained. The reason for this, once again, is to ensure that the defendant cannot obtain discovery in the civil case to which he or she would not be entitled in the criminal case, such as the opportunity to take the pretrial depositions of the witnesses against him or her.
Another reason why the SEC typically agrees to forestall its own case in favour of allowing the criminal prosecution to proceed first is that a criminal conviction, if obtained, will generally resolve any dispute as to the defendant’s liability in the SEC’s civil case, leaving the SEC with little to do except negotiate with the defendant for an appropriate civil penalty. Thus, although the DOJ’s and the SEC’s cases against a defendant are independent of one another, the SEC has a vested interest in the success of the criminal prosecution, and Commission staff typically contribute significantly to the prosecutors’ efforts, either in a consulting role or through temporary appointments as Special Assistant United States Attorneys to work directly on prosecuting the criminal case, including at trial.
A final topic worth discussing is the role of cooperation in criminal proceedings. Like the SEC, the DOJ recognises the value of cooperation by culpable individuals and entities. Indeed, as to individuals, recognition of that value is written directly into the criminal code and the United States Sentencing Guidelines, each of which provides procedures for cooperating defendants to obtain leniency at sentencing by providing ‘substantial assistance’ to law enforcement authorities, generally in the form of providing information about and testifying against other culpable individuals. See 18 U.S.C. section 3553(e); U.S.S.G. section 5K1.1.
For corporations and other business entities, the issue is somewhat more complex. The expectation for corporate cooperation has traditionally been less that the corporation must provide assistance in the prosecution of others, but, rather, that a corporation can obtain leniency by being cooperative in the investigation of itself. See generally US Attorneys’ Manual, section 9-28.000, Principles of Federal Prosecution of Business Organizations. In September 2015, however, Deputy Attorney General Sally Yates issued a memo entitled, ‘Individual Accountability for Corporate Wrongdoing’ (the ‘Yates Memo’, available at www.justice.gov/dag/file/769036/download). In the Yates Memo, the Deputy Attorney General announced that, henceforth, ‘In order for a company to receive any consideration for cooperation under the Principles of Federal Prosecution of Business Organizations, the company must completely disclose to the Department all relevant facts about individual misconduct.’ While there has been some debate about whether the Yates Memo worked a significant practical change, or merely struck a note of emphasis concerning existing practice, there can be no disputing that in the context of violations of the securities laws, corporations seeking leniency on account of cooperation are now required to disclose not only any relevant facts surrounding the corporation’s own misconduct, but also any relevant facts surrounding the misconduct of any of its officers, directors or employees. From a practical standpoint, the result may be that in responding to a criminal investigation into potential violations of the federal securities (or other) laws, the interests of a corporation and those of its officers and directors will more regularly diverge.