In the first phase of a SEC investigation, the SEC may contact you and seek information on a voluntary basis, meaning you have no legal obligation to answer questions and/or provide documentation.  At this stage, the SEC typically does not have the power to subpoena documents and testimony, and thus must rely on an individual’s cooperation in order to advance its investigation.  At times, a refusal to cooperate may cause the SEC to look elsewhere for information.  However, it is not at all uncommon for the SEC, when faced with a situation where an individual refuses to voluntarily cooperate, to formally seek subpoena power so that it can legally compel that individual to produce books and records and/or to appear in an SEC Office to provide sworn (under oath) testimony.

In the scenario where the SEC serves a subpoena on an individual or entity, the SEC Subpoena will either indicate that it is seeking the production of records and/or sworn testimony.  Usually, SEC subpoenas are very broad in scope, seeking a wide range of documents and electronic communications (text messages and emails) over a period of time that may go back five years or more.   The SEC usually provides a mere two weeks to respond to the subpoena, even though years of data (both electronic and hard copy) are being requested.  It is common practice though to obtain an extension of time to start what is called a “rolling production” where certain categories of documents are prioritized and turned over first, with the remaining categories, typically the electronic communications (emails, text messages and social media postings) being handled last.

In my experience, it is critical to enlist the assistance of a computer forensic specialist at this stage who can image and preserve the electronic communications, assist in searching for relevant and responsive documents,  keep an inventory of what documents have been produced to date and provide the documents for SEC defense counsel to review and, ultimately, deliver to the SEC.  Beyond these critical functions, an additional benefit is that by delegating these functions, the client (recipient of the SEC subpoena) is largely taken out of the process of having to make determinations of what is, and what is not, responsive to the subpoena, such that the SEC cannot later claim that the client willfully withheld documents or in any manner improperly handled the response to the subpoena.

A common misconception is that responding to a SEC subpoena document request is a relatively simple and mostly logistical function (just gather the documents and hand them over).  This is absolutely not the case.  Usually, the production may include thousands of pages of documents, text messages, social media postings and emails.  It is at this stage that SEC defense counsel must review and analyze the data to determine whether the client has violated the federal securities laws and faces potential civil liability from the SEC, or even possibly criminal exposure.  (It is important to understand that while the SEC is a very powerful federal agency, it does not possess criminal authority, but can and does refer cases for criminal prosecution to the Department of Justice).

Once the SEC receives, reviews and analyzes the documents produced in response to the subpoena, it is not uncommon for the SEC to seek either clarification on the documents produced, and/or an understanding as to why certain categories of documents have not been produced.  It is also not uncommon for the SEC to issue additional subpoenas as its investigation evolves and it learns more.

After the completion of the production of documents to the SEC, the next step in the SEC investigation process typically involves the SEC taking an individual’s sworn testimony (answering questions under oath in front of a court reporter who creates a written transcript of the investigative testimony).  Pre-Covid19, the SEC would, with minor exception, obligate an individual to travel and physically appear at one of its offices to provide in person sworn testimony.  With the pandemic, however, the SEC’s practice changed, and it resorted to remote testimony via WebEx for the vast majority of its sworn testimony.  As the pandemic has faded, the SEC has begun to revert back to its old practice of requiring in-person testimony.  While there are still exceptions (usually reserved for third-party witnesses, those witnesses not deemed critical or are out of the country), the SEC in most instances now will insist on the live, physical appearance of the witness.

The SEC testimony process is the most critical phase of the SEC investigation.  It is very important for a witness to be fully prepared for the process, as well as for the anticipated subject matter and particular questions that will likely be asked.   It is in this process that a written record is created upon which the SEC will rely, in addition to other evidence and considerations, in making its decision whether to bring charges or not.  Accordingly, it is imperative that SEC defense counsel work with and prepare the client to ensure that his truthful testimony is presented in the best possible light.

There are, however, situations where a client’s truthful testimony would incriminate the client and thus it may require the client to invoke his constitutional right to remain silent (the Fifth Amendment to the United States Constitution).  In this scenario, the client is still required to appear for testimony (sometimes remotely, other times in person) to invoke the Fifth Amendment as to each and every question posed by the SEC enforcement attorney.  While the SEC is entitled to take a negative inference from an assertion of the Fifth Amendment in assessing whether to recommend charges, the invocation of the Fifth Amendment protects the client from making damaging, self-incriminating statements that can be easily used by the SEC to make its case, and can be shared with other agencies, including the Department of Justice, for purposes of criminal investigation and, potentially, criminal prosecution.

After the completion of sworn testimony and the SEC’s examination of the relevant evidence developed in the course of its investigation, the next phase of the SEC investigation involves the SEC making a decision whether to recommend charges to the Commission, or whether to close the investigation without enforcement action.

If the SEC opts to close the investigation, it may, but will not necessarily, send a “closing letter” to the individual and/or entity that received the SEC subpoena advising that, based upon the information then known, it has decided not to pursue an enforcement action.  Notably, the letter also makes clear that the letter should not be treated as an exoneration of the individual or company, and that the SEC still effectively retains the right to bring an enforcement action in the future.  While this qualifying language is far from comforting, as a practical matter in my decades of experience, I have never seen a closing letter sent in an investigation that the SEC later pursued.  In other words, a closing letter is as good as gold in the context of an SEC investigation, and is the best one can hope for after having endured the stress and costs of a SEC investigation.

In the event the SEC opts to recommend charges, it will typically issue what is known as a “Wells Notice” which is a formal, written notification to the client indicating that the SEC believes it has developed evidence to prove certain violations of the federal securities laws.  The Wells Notice will identify the particular charges, and will also identify the remedies it is seeking, such as a civil monetary penalty, disgorgement (the return of ill-gotten profits assuming the SEC can demonstrate pecuniary loss to investors) and non-monetary remedies, such as injunction against future violations of the securities laws, bars from the securities industry and officer-and-director bars.  More recently, the SEC has also been seeking “conduct based injunctions” which are designed to prohibit certain future legal conduct that are often tailored to the particular alleged illegal underlying conduct.  The SEC staff usually provides the recipient of the Wells Notice, and their legal counsel, with two weeks to respond, although that is normally subject to a reasonable extension of time.

It is at this stage that SEC defense counsel will reach out to the SEC to gain a more in-depth and detailed understanding of the SEC’s proposed charges, its legal theories, as well as details of the factual basis of its claims.  During this process it is quite common for defense counsel to ask for access to the SEC’s investigatory files, including transcripts of testimony from witnesses who testified in the investigation, as well as the documents produced in response to subpoenas issued to others.  Depending upon the particular case, the client, and to some extent, the SEC staff attorneys involved, some, all or none of the investigatory files will be made available, as it is ultimately a discretionary call by the SEC staff.  Once defense counsel has gained a thorough understanding of the material facts and legal theories of the SEC staff, and has reviewed the investigatory file materials, it is commonplace for counsel to seek to either make a written submission in response to the Wells Notice, and/or make an oral presentation, with the goal of either persuading the SEC to drop its enforcement recommendation altogether or, in the alternative, to not pursue certain charges (usually the fraud based violations) and to seek to resolve the matter on lesser charges, including on more favorable financial terms.  Thus, the Wells Notice process gives defense counsel and the client the opportunity to hit a home run and persuade the SEC staff to not pursue any charges (I have successfully done so in the past), or if required by the particular facts, discuss, negotiate and potentially come to a settlement that is practical and livable both personally and professionally.

There are times, though, that notwithstanding diligent efforts to resolve the matter at the Wells Notification stage, no settlement can be reached and, as a result, the SEC will proceed to file an enforcement action (a lawsuit) in either Federal District Court, or a proceeding in its own internal administrative tribunal (assuming it is a case not involving fraud that seeks a civil penalty, in which case under a recent United States Supreme Court decision it must be filed in Federal Court).  In either forum, a defendant (or respondent in a SEC administrative proceeding) has the right to contest the SEC’s evidence and legal theories, depose and cross-examine its witnesses, present witnesses and evidence of its own in support of its defense case, as well as make opening and closing statements.  At this stage, the SEC case is very much like any other case being litigated in the federal courts, meaning the SEC, as the plaintiff, has the legal burden to prove its civil case based upon the preponderance of evidence standard – it must show that it was more likely than not there was a violation of the federal securities laws or rules thereunder.  This standard is much less rigorous than the criminal law standard of proof beyond a reasonable doubt, thus making it far easier for the SEC to prevail in litigation.