David R. Chase, P.A.
Call Us Now: 800-760-0912
David R. Chase, P.A.
Call Us Now: 800-760-0912


When the SEC Comes Knocking:

One of the first things that a lawyer with the Securities and Exchange Commission Division of Enforcement learns is that there are too many cases and too few lawyers on staff. This fundamental reality – a wide disparity between the government’s available resources and its obligation to enforce the securities laws – explains in large measure the regulatory philosophy behind the SEC’s enforcement program.

Handicapped by a limited number of personnel and a budget that hopelessly lags behind the growth of the stock market, the SEC is forced to regulate by deterrence, hawking its cases to the press in order to spread the word about the agency’s work to the widest possible audience. Increasingly, however, the SEC has been using the specter of criminal prosecution as its most potent weapon in the war against securities fraud.

While the SEC has always aggressively promoted its cases for criminal prosecution, the level of its recent successes (and public profile) in doing so has been noteworthy, particularly in the area of so-called “process” violations – that is, criminal misconduct committed during the course of the investigative process.

With the SEC’s recent drive to promote publicly the criminalization of the securities laws, counsel must take affirmative steps to recognize, assess and minimize a client’s criminal exposure, particularly with respect to these “process” type violations. The following practical considerations should provide helpful guidance for counsel representing a client in an SEC enforcement investigation or proceeding where a real threat of criminal prosecution looms.

A common misconception is that the SEC possesses criminal enforcement powers. It does not. Criminal violations of the federal securities laws are prosecuted by the Department of Justice through the fraud section of its criminal division and through the various U.S. attorneys’ offices scattered throughout the country.

As suggested at the outset of this article, the SEC nonetheless has a critical role in determining whether a securities enforcement case is eventually prosecuted criminally. The agency has both formal and informal processes for referring cases to the DOJ. Typically, an enforcement case is referred informally by the SEC staff. In the course of this referral, the SEC orally “invites” the DOJ to request a copy of the SEC’s investigative files, which the DOJ can obtain almost immediately simply on its written request. As a practical matter, such requests are almost always prompted by informal communications initiated by the SEC staff.

What this means for counsel is that the time to think about criminal exposure is at the beginning of an SEC investigation. A case that would not otherwise catch the attention of the DOJ will be referred by the SEC if the staff feels or is given reason to believe that the conduct in question merits criminal investigation and prosecution.

Although no hard and fast rules exist governing which cases the SEC will likely refer to the criminal authorities – or on which matters the criminal authorities themselves will initiate an investigation – there are certain categories of cases that always run a high risk of criminal prosecution.

Historically, insider trading cases, particularly those involving regulated persons such as investment bankers or those involving professionals entrusted with special roles in the securities field, such as lawyers, carry significant criminal exposure. This may be explained, in part, by the fact that the investigation and prosecution of insider trading has consistently been a top enforcement priority of the SEC, and has in the past led to some of the agency’s highest-profile securities fraud cases (such as, the Milken, Boesky and O’Hagan enforcement cases and related DOJ prosecutions). Insider trading cases generally involve simple fact patterns and understandable legal concepts, appealing factors for prosecutors with juries to consider.

Matters involving large economic losses, usually in the millions, and significant numbers of investors, especially the elderly, will also typically draw criminal interest. Even in relatively smaller matters, counsel should be sensitive to the SEC’s propensity to refer cases involving violations by individuals possessing lengthy regulatory disciplinary histories. In these cases, the SEC may conclude that civil remedies have proven to be an ineffective deterrent and that only the imposition of criminal sanctions, including jail time, will be sufficient to prevent future violations.

If any of these types of cases have been thoroughly investigated and prosecuted by the SEC so that they can be delivered on a “silver platter” to the criminal authorities, the likelihood of referral is even greater. Finally, cases that have generated substantial local or even national press attention may create pressure on the SEC to secure criminal interest.

Whether to invoke the Fifth Amendment – It is crucial to evaluate the possibility of criminal prosecution early in order to formulate an appropriate defense. Perhaps the most important decision that confronts counsel at the outset of an SEC investigation is whether the client should assert his or her Fifth Amendment right against self-incrimination in response to an SEC subpoena seeking testimony or documents.

Where criminal exposure exists, the assertion of the Fifth Amendment is a difficult, but necessary decision, not only to prevent a client from self-incrimination, but also to prevent the creation of a record in which the client may make an actionable false statement to the SEC or commit perjury. A failure to assert the Fifth Amendment, where appropriate, not only compounds the client’s criminal exposure by virtue of committing “process” violations, but it may also irreparably destroy the client’s potential value as a cooperating government witness in the future.

The decision to invoke the Fifth Amendment must be weighed against the fact that the SEC will likely draw a negative inference from such an assertion, and the probable result that the client will buy an SEC enforcement proceeding. The cost of this decision is even greater where the client is regulated by the SEC (such as, registered investment advisers and brokers), where a suspension or bar from the securities industry can mean a loss of livelihood. Obviously, these costs pale in comparison to a loss of liberty that may result from an short-sighted decision to testify or produce documents.

Where the threat of criminal prosecution exists, but does not merit approaching criminal prosecutors to cut a deal, it is imperative for counsel to take affirmative steps to prevent a client from making matters worse by committing a “process” violation in the course of the SEC investigation.

Individuals under investigation by the SEC face criminal exposure not only on the substantive securities law front, but also in connection with the investigative process itself. “Process” violations include false statements to SEC staff, perjury and obstruction of justice. The important lesson to be learned about process violations is that underlying conduct that might otherwise not prompt a criminal referral by the SEC staff may nonetheless be referred if a process violation is committed by a client in the course of an SEC investigation. This fact should be communicated to clients at the earliest possible juncture of the investigation. Counsel should also ask questions of clients at the outset of a representation to determine whether any “process” violation has already occurred.

False statements – A client is at risk of committing a criminal false statement any time he or she communicates with the SEC or its staff. See 18 U.S.C. § 1001. A “statement” may be oral or written and may be made voluntarily or in response to an SEC subpoena. A statement need not be made under oath. Unfortunately, counsel often cannot guard against the committing of false statements by clients because they have occurred prior to the counsel’s representation of the client. This situation often results from the staff’s routine use of the “ambush” telephone call, that is, an unannounced contact by the SEC staff directly with individuals suspected of wrongdoing. Such calls typically occur at the beginning of an investigation.

Although the staff historically has had difficulty interesting the DOJ in bringing false-statement cases that arise during SEC investigations, that no longer appears to be the case. For example, last year the DOJ secured the jury trial conviction of Michael G. Sargent for false statements made during the course of an “ambush” telephone call from the SEC staff in connection with an insider trading investigation. See SEC v. Michael G. Sargent, et al., SEC Lit. Rel. No. 16373 (Nov. 29, 1999). The Sargent case is a particularly apt topic for discussion with clients regarding the importance of being truthful at all times with the staff, as the SEC subsequently failed to establish that Sargent had committed the underlying offense of insider trading. United States v. Sargent , Crim. No. 96-10134-JTL, 1998 WL 699060, at *1 (D. Mass. Oct. 9, 1998).

Perjury – A witness testifying falsely under oath before the SEC staff may be subject to a perjury conviction, whether the testimony is given in response to a direct question from the staff or is offered voluntarily by the witness. See 18 U.S.C. § 1621. As is the case with false statements, the SEC has increasingly had success in interesting the DOJ in prosecuting perjury cases based on false testimony before the staff. Accordingly, counsel must inform clients of the enhanced jeopardy resulting from committing perjury.

Obstruction of justice – In the context of an SEC investigation, obstruction of justice may come in the form of destruction or falsification of evidence sought by the SEC, deliberate concealment of requested or subpoenaed information, or the intimidation or influencing of witnesses. See 18 U.S.C. § 1512 (tampering with a witness). Clients should be informed that the government may bring an obstruction of justice case even when the evidence destroyed, falsified or concealed is not material to the underlying securities violations being investigated, or when the client’s attempt to destroy or falsify documents, or influence the testimony of witnesses, is unsuccessful. See U.S. v. Ruggerio , 934 F.2d 440 (2d Cir. 1991).

Counsel must thus convince the client to keep all discussions regarding the investigation limited to counsel and (if applicable) the client’s spouse. SEC investigations, particularly those with the potential for criminal prosecution, are stressful, time consuming and exact a considerable emotional toll on clients. A typical client reaction is to approach others under SEC scrutiny to “compare notes” about where the investigation is headed or what evidence the SEC has uncovered. Unfortunately, such conduct, viewed through the skeptical eyes of the SEC staff, is evidence of an intent to obstruct a lawful government inquiry.

A client’s credibility is of utmost significance in how the staff views the case and ultimately makes its charging decisions. Thus, the best way to avoid raising the specter to the SEC staff that a client may be engaged in the obstruction of justice is to prevent the problem from occurring in the first place. Counsel should admonish and re-admonish the client throughout the investigation about the importance of avoiding any appearance that he or she is trying to influence the staff’s investigation.

Walking the client through the standard litany of questions the SEC asks in testimony regarding documents and communications with other potential witnesses or key characters in the events being investigated often helps persuade clients that only bad consequences can flow from such communications.

The ramifications of engaging in conduct that may be construed as obstruction of justice by the staff are considerable. Not only does the client in these situations undermine any effort to establish credibility before the staff, the client exposes himself or herself to substantial prison time (10 years for influencing the testimony of witnesses) and an upward adjustment under the Federal Sentencing Guidelines.

One of the most important steps for counsel at the outset of any investigation is to obtain as many facts as possible to confirm the client’s understanding of the relevant facts. The reason is simple: Counsel cannot blindly allow his or her or client to walk into the SEC staff and make statements or produce documents that counsel knows do not square with demonstrable (and material) facts that can be developed by the staff.

To use the most basic insider-trading example, if a client insists in preparation that he or she never communicated with a person he or she had reason to believe was an insider to a proposed merger transaction, counsel must obviously try to confirm the accuracy of that statement. In order to accomplish this task, counsel must attempt to check records within the client’s custody, such as telephone and cellular-phone records, credit-card statements, expense reports and hotel bills.

A more delicate, but critical investigative step, is to try to communicate with counsel for the alleged insider (or other relevant potential witnesses) through the use of the joint defense privilege. Finally, if counsel develops information that is inconsistent with the client’s understanding of relevant facts, counsel must confront the client, assist the client’s memory-retrieval process, and, if necessary, gently remind the client of the consequences of failing to testify truthfully before the SEC staff.

Nonetheless, counsel will rarely be able to confirm in every respect a client’s understanding of the relevant facts. Experience and a good dose of common sense are often the only guides counsel will have in assessing whether or not a client is on the verge of committing a “process” violation. If counsel believes that a client is about to commit such a violation, counsel should strongly consider advising the client to assert his or her Fifth Amendment right against self-incrimination.

In cases where the threat of criminal prosecution is particularly acute or imminent, counsel must make the critical decision as to whether to try to cut a deal with the prosecutors or the SEC. Generally, if counsel believes the client has serious criminal exposure and can provide substantial assistance as it relates to others involved in the investigation or imminent SEC litigation, the best opportunities lie with the criminal authorities and not with the SEC.

The SEC can do very little for a client in this regard. As previously stated, it cannot confer criminal immunity because it does not possess criminal powers. Its granting of civil immunity – which is rarely done and difficult to obtain – is usually of little value without a corresponding grant of some form of meaningful criminal immunity.

Furthermore, the SEC cannot bind the criminal authorities through its settlements, leaving the door wide open for criminal prosecution after having expended the time and resources to resolve the SEC’s civil case. Additionally, unlike the Federal Sentencing Guidelines, there is no formal mechanism by which your client can be rewarded for his or her cooperation and assistance against others in the SEC action. Accordingly, due to their power to grant immunity and reward cooperation, counsel is usually better off by knocking first on the door of the criminal authorities.

Should you file a Wells submission? – In a case with no apparent criminal exposure, the Wells submission is one of the most useful steps in the SEC enforcement process. A Wells submission provides a prospective defendant prior to the institution of an enforcement action the opportunity to present a persuasive case to the senior officials in the Enforcement Division and the commission itself that the investigating staff reached the wrong conclusions regarding liability, or made incorrect charging decisions. Although difficult to achieve, a successful Wells submission can result in a decision by the SEC to decline prosecution altogether or, in the alternative, to seek lesser charges (that is, nonfraud-based claims).

Where a client faces potential criminal exposure, and has consequently asserted his or her Fifth Amendment right against self-incrimination in the investigation in response to subpoenas for testimony and documents, a different view of the Wells submission process should be used. In almost all instances, a client who has asserted the Fifth Amendment during the investigative stage should refrain from attempting a Wells submission. Not only will the commission and senior officials in the Enforcement Division do little more than ignore the submission, the client risks making statements that can be construed as waiving his or her Fifth Amendment assertion.

Counsel should also keep in mind that Wells submissions are admissible evidence and will be provided to the DOJ in the course of the informal or formal referral process. At this juncture of a case, a client’s monetary resources can typically be better used toward a settlement rather than in futile pursuit of an unlikely positive outcome.

Where the threat of criminal prosecution exists, but does not merit approaching criminal prosecutors to cut a deal, a client must consider how to resolve a case brought first by the SEC. Often the best approach after receiving a Wells submission is to approach the SEC about settling the case as quickly as possible. A decision to litigate with the SEC should not be taken lightly, as the staff will in that situation be more likely to refer the case to criminal authorities, if it has not already been referred, or to increase the pressure on criminal authorities to indict. Although a strategy to quickly settle does not always produce the best possible result with the SEC, it may effectively dampen any interest in bringing the same case criminally.

Where to settle an SEC case – After counsel has reached the conclusion that the client should seek to settle with the SEC, thought should be given regarding where (such as, in which federal district court) the settlement will be filed. Often overlooked in this process is the fact that the SEC staff will very often agree to file its complaint, the client’s consent and the proposed final judgment order in the District Court for the District of Columbia, where the SEC is located and where the U.S. attorney’s office rarely brings securities fraud cases.

If possible, counsel should avoid agreeing to file settlement papers in those districts such as the Southern District of New York and the Southern District of Florida, which have the expertise and institutional will to pursue criminal securities fraud cases.

The SEC’s recent concerted effort to use the criminal authorities to further deter securities violations has dramatically raised the stakes in their enforcement proceedings. Counsel must be sensitive to this new reality by not only evaluating the nature and extent of the client’s criminal exposure early on and reacting accordingly, but also by taking affirmative steps to ensure that the client does not become his or her own worst enemy during the investigatory process.

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