My Company Received an SEC Inquiry. First Steps

What the letter is, and what it is not

SEC investigations begin from many sources: tips and whistleblower submissions, market surveillance, referrals from other regulators or exchanges, press reports, or something found in a routine examination. Under 17 C.F.R. § 202.5, the staff usually starts with a preliminary, informal inquiry in which no process is issued and no testimony is compelled. The letter you received may ask you to produce documents or answer questions voluntarily. A second stage comes when the Commission issues a formal order of investigation, which lets designated staff issue subpoenas for documents and testimony. A letter that encloses a subpoena means a formal order exists.

Two things the letter will not tell you. It will not say who the staff considers the wrongdoer; a company often receives requests as a witness or a source of records about someone else, and the staff does not say which. And it will not become public: section 202.5 makes investigations nonpublic unless the Commission orders otherwise, and the SEC's own description says all investigations are conducted privately.

The first week

1. Preserve. Send a written preservation notice to every person and system that may hold responsive material: email, chat and messaging apps, personal phones used for work, cloud drives, accounting systems, board materials. Suspend auto-delete. Destruction after a request arrives is a separate and far worse problem than whatever the staff is looking at. The guide on litigation holds covers the mechanics.
2. One voice. Retain counsel experienced with the Division of Enforcement and route every contact through that lawyer. Officers should not call the staff attorney to "clear things up." Every statement is noted and can be used.
3. Read the request closely. Note the file name and number, the staff attorneys named, the return date, the scope of documents and the time period. Counsel will call the staff to learn the general nature of the inquiry, negotiate scope and timing, and agree on a rolling production.
4. Notify insurers. Directors-and-officers policies often treat a formal investigation or subpoena, and sometimes an informal request, as a claim or a pre-claim event that must be reported to preserve coverage for defense costs. The guide on insurance coverage for lawsuits explains the notice problem.
5. Tell the board. Directors should know, and in many situations an audit committee or a special committee should direct the response so that management is not investigating itself.

Voluntary request or subpoena

A voluntary request has no legal force, but refusing it is rarely wise. The staff can and usually does obtain a formal order, after which the same documents come by subpoena with a less cooperative relationship. Declining also forfeits any credit for cooperation. The sensible middle course is to respond, but through counsel, with scope and deadlines negotiated, with privileged material withheld and logged, and with a clear record of what was produced and when.

A subpoena must be answered or challenged. Objections to scope and burden are negotiated with the staff; a court fight over a subpoena is rare and usually lost. Testimony under subpoena is given under oath before a court reporter, with counsel present, and a witness may assert the Fifth Amendment privilege, which in a civil proceeding can carry an adverse inference.

Cooperation: what it buys and what it costs

Since the Commission's 2001 Report of Investigation known as the Seaboard report, the SEC has published the factors it weighs in deciding whether and how much to credit a company's self-policing, self-reporting, remediation and cooperation. They include how the misconduct arose and at what level, how it was detected, how quickly the company responded, whether responsible people were removed, whether the company disclosed promptly and fully, the quality of any internal investigation, whether the company shared its findings and encouraged employees to cooperate, and what controls now prevent recurrence. Credit can mean reduced penalties, narrower charges or no action against the company. The report itself says cooperation does not promise leniency.

The cost of cooperation is that an internal investigation produces findings, and sharing them can waive privilege as to what is shared and may hand a roadmap to private plaintiffs and to prosecutors. The decision is made deliberately, with the facts in hand, not in the first phone call.

Privilege and the internal investigation

Facts are not privileged; communications with counsel for the purpose of legal advice are. An internal investigation directed by counsel, with interviews conducted by lawyers who explain that they represent the company and not the employee, keeps the analysis and the interview memoranda privileged and the work product protected. An investigation run by the finance team or an outside accountant without counsel is discoverable by the SEC and by everyone who sues later. Employees should be told, in writing, that they may consult their own lawyer, and senior individuals whose conduct is in question usually need separate counsel because the company's interests and theirs diverge.

What you cannot tell employees

SEC Rule 21F-17 provides that no person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including by enforcing or threatening to enforce a confidentiality agreement. A company can ask employees to tell counsel about contacts with the staff, and can require confidentiality about privileged matters. It cannot require employees to seek permission before speaking to the SEC, cannot condition severance on silence toward regulators, and should review its standard confidentiality, separation and employment agreements for language that could be read that way. The SEC has brought stand-alone actions over such clauses.

The Wells process

If the staff decides to recommend an enforcement action, it ordinarily tells the proposed defendant first. Section 202.5(c) provides that a person involved in an investigation may submit a written statement setting out their interests and position, and that on request the staff may advise them of the general nature of the investigation, the indicated violations as they pertain to them, and the time available to submit the statement before a recommendation goes to the Commission. In practice this is the Wells notice and the Wells submission. The submission is the one structured chance to persuade the Commission not to authorize charges, to narrow them or to shape the remedy. It is also a document the SEC can use, so it is written as advocacy with that in mind. Settlement discussions typically run alongside it.

How it ends

Parallel criminal exposure is the reason individuals need their own counsel early and the reason testimony decisions are made carefully. The same conduct can also draw private suits from investors, which an enforcement settlement tends to invite. The guide on defending an investor lawsuit picks up there.

Example

Suppose a Dallas software company that raised $6 million from private investors receives a letter from the Fort Worth Regional Office asking, on a voluntary basis, for its offering documents, investor communications and bank records for a two-year period. The letter does not say why. Counsel learns from the staff that the inquiry concerns a former sales officer's statements to investors. The company preserves everything, produces on an agreed schedule, has counsel interview the current employees who dealt with that officer, and notifies its D&O carrier. The internal review finds two emails in which the officer promised returns the board never approved. The company shares a summary of facts, not the interview memoranda, removes the officer's remaining access and adopts a written approval process for investor communications. Nine months later the staff charges the former officer and sends the company a termination letter. The company's documented response, more than its luck, produced that result.

When to involve a litigator

Before you answer the letter, before anyone calls the staff and before any document is moved. The first production and the first phone call set the tone of the whole investigation. Tina Wysk represents companies, officers and investors in securities and investment matters in Dallas, including regulatory inquiries and the private litigation that follows them.