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SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers
DISCLAIMER: Nothing in this booklet should be construed or relied upon as legal advice. Instead,
this booklet is intended to serve as a general introduction to the subject of SEC investigations and
enforcement actions.
Published by:
Orrick, Herrington & Sutcliffe LLP
All rights reserved.
Copyright © 2011 by Orrick, Herrington & Sutcliffe LLP
No part of this book may be reproduced or transmitted in any form or by any means, electronic or
mechanical, including photocopying, recording, or any information storage and retrieval system,
without permission in writing from the publisher.
George E. Greer
George E. Greer is a partner in Orrick, Herrington & Sutcliffe’s Securities Litigation and Regulatory
Enforcement Group. Mr. Greer regularly represents issuers, individuals, and major accounting firms in
SEC investigations and enforcement matters. He is named in Chambers America’s Leading Lawyers for
Business and in The Best Lawyers in America, Securities Law. He received his J.D. from Stanford Law
School in 1980.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers
www.orrick.com
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers
Table of Contents
I Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
II The Enforcement Landscape . . . . . . . . . . . . . . . . . . . . . . . . . 3
A. Source of Enforcement Authority . . . . . . . . . . . . . . . . . . . . . . . . . . 3
B. Specialized Enforcement Unit . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
C. Points of Emphasis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
D. Recent Enforcement Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
III Preparing for the New Era of SEC Enforcement . . . . . . . . . . . . . . . 8
A. Preparedness Assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1. Document retention policies . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2. IT systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3. Compliance training . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
B. First Steps Upon Learning of the Investigation . . . . . . . . . . . . . . . . . . 9
1. Take the investigation seriously . . . . . . . . . . . . . . . . . . . . . . . . 9
2. Retain experienced counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3. Investigate quickly and thoroughly. . . . . . . . . . . . . . . . . . . . . . .10
4. Preserve documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
5. Preserve the attorney-client privilege . . . . . . . . . . . . . . . . . . . . .10
6. Consider taxpayer confidentiality . . . . . . . . . . . . . . . . . . . . . . .10
7. Seek to narrow the scope of the document request . . . . . . . . . . . . . 11
8. Evaluate whether there is a duty to disclose the investigation . . . . . . . 11
IV How SEC Investigations and Enforcement Actions Work . . . . . . . . . . 12
A. The Power of the SEC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
B. The Initiation and Escalation of an SEC Investigation. . . . . . . . . . . . . . .12
1. Sources of an SEC investigation . . . . . . . . . . . . . . . . . . . . . . . .12
2. Informal inquiries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
3. Formal investigations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
4. Internal investigations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15
5. Wells notice and submission . . . . . . . . . . . . . . . . . . . . . . . . . .16
6. Action by the Commission. . . . . . . . . . . . . . . . . . . . . . . . . . . .16
C. Disclosing an SEC Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . .17
D. Civil Enforcement Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
1. Injunctive actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
2. Civil penalties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
3. Prospective relief. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
E. Administrative Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
1. Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
2. Sanctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
V Orrick Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 1
I. Introduction
The Securities and Exchange Commission (“SEC”) is focusing on municipal
bondsandtheirmunicipalissuersasneverbefore.IssuersmustbemindfuloftheSEC’s
newfocusonincreasingenforcementactivityinthemunicipalbondmarket,andbe
preparedtorespondifapproachedinanSECenforcementaction.
In recent months, the SEC has enhanced staffing and organization in its
Enforcement Division, obtained new enforcement techniques, adopted new
regulations,andmaderequestsofCongressforadditionalauthorityoverthissector.
TheSECclearlyhasmunicipalissuersonitsenforcementagenda,andthenewtools
at itsdisposal substantiallyheighten the risks formunicipal issuersand theofficials
and employees of those issuers.The vigor with which the SEC intends to pursue
investigationsisevidentfromtheformationofaspecialtyunitwithinitsEnforcement
Division that focuses on municipal securities and public pension funds, the steady
drumbeatofpublic statementsbySECofficialsdirectedat themunicipal securities
market,andrecentenforcementactions.
Of particular note, the SEC not only has a renewed interest in and greater
resourcesdevotedtoenforcementactionsrelatedtomunicipalsecurities,butitalsohas
apowerfulnewtool.AprovisionofthefederalDodd-FrankAct,passedinthesummer
of2010,permitstheSECtoimposecivilpenaltiesofupto$150,000on“anyperson”
aspartofanadministrativecease-and-desist(“C&D”)proceedingiftheCommission
findsthatthepersonviolatedanyprovisionoftheSecuritiesandExchangeActof1934
(the“1934Act”)oranyruleorregulationissuedthereunder.TheSECpreferstouse
C&Dactions, rather than suits in federal court,because aC&Daction ishandled
administrativelywithintheSEC—onits“homecourt.”Inthepast,itcouldonlyget
an injunction if it succeeded in a C&D action, and would have to go to court to
obtainmonetarypenalties.Plainly, the riskofmonetarypenalties imposed through
anadministrativeproceedingsubstantiallyincreasestherisksassociatedwithanSEC
enforcementaction.
2 Orrick, Herrington & Sutcliffe LLP
TheSEC’scurrentfocusonmunicipalsecuritiesisattributabletothesheersizeof
themarket(nearly$3trillioninoutstandingsecurities)anditsimportancetomillionsof
retailinvestors.ElaineGreenberg,thechiefoftheSEC’smunicipalsecuritiesandpublic
pensionenforcementunit,crisplystatedhermissionatapublicfinanceconferencein
SanFranciscoinOctober2010:“Ifwefindthatyouhidormisrepresentedmaterial
informationtotheseinvestors,wewillbeholdingyouaccountable....”
Furthermore, the Dodd-Frank Act created new whistleblower provisions that
will inevitably spur additional investigations and enforcement actions directed at
municipal issuers and their officials and employees. Mark Zehner, deputy director
of SEC’smunicipal andpublic pension fund enforcementunit, has publicly stated
that“numerous”municipalmarketparticipantshavequeriedtheSECaboutbringing
municipalbondabusestoitsattentionunderthewhistleblowerprogram.Underthe
Dodd-Frankmandatedwhistleblowerprogram, individualswho reportwrongdoing
canreceive10-30%ofSECrecoveriesofmorethan$1million.
Thishandbookisdesignedtoprovidemunicipalsecuritiesissuersandtheirstaffs
withanoverviewof:
• theissuestheSECisemphasizingasitseekstoregulatethemunicipalsecurities
marketthroughenforcementactions;
• stepstotakebothinadvanceofandattheoutsetofanSECinvestigationto
helpminimizetheriskofanunfavorableoutcome;and
• themechanicsofanSECinvestigation/enforcementaction.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 3
II. The Enforcement Landscape
A. Source of Enforcement Authority Municipal securitiesaregenerallyexempt fromthe registration requirementsof
theSecuritiesActof1933(the“1933Act”). Inaddition, the“TowerAmendment”
to the1934Actprohibits both theSECand theMunicipal SecuritiesRulemaking
Board (“MSRB”) from requiring municipal issuers to file disclosures in advance of
offeringdebt securities for sale.Municipal issuers are,however, subject to the anti-
fraudprovisionsof thesecurities laws.These laws,contained inboththe1933and
1934Acts,prohibitofferingorsaleofmunicipalsecuritiesbyuseofofferingmaterials
(normally called Official Statements) which contain materially false information or
omitmaterialinformationwhichinvestorswouldwanttoknowtomakeaninvestment
decision.Consequently,publicdisclosuresmadebymunicipalissuersinthecourseof
newofferingsofmunicipalbonds,inmakingpost-issuancereportstoinvestors,andin
someothercircumstanceswhentheyare“speakingtothemarket,”permittheSEC’s
Enforcement Division to police the municipal securities market, including issuers,
throughtheseanti-fraudprovisions1.
AlthoughtheSECisprohibitedfromdirectlyregulatingmunicipalissuers,ithas
foundanindirectwaytoaccomplishsomeofitsgoals.The1934ActgivestheSEC
theauthority to regulatedealers inmunicipal securities. In1989, theSECadopted
Rule15c2-12,whichprohibitedadealerfromunderwritingmostissuesofmunicipal
bondsunlesstheissuerstookcertainactions.ThisRulewasgreatlyexpandedin1994
sothatitindirectlymandatedmunicipalissuerstoagreetoprovidecertaincontinuing
disclosures after bonds were issued, something which is required in the corporate
marketsbutwhichhadneverbeforebeenmandated formunicipal securities. In its
currentform,Rule15c2-12makesitunlawfulforanydealertoactasa“participating
underwriter”inaprimaryofferingofmunicipalsecuritieswithanaggregateprincipal
amountof$1,000,000ormore(subjecttocertainexemptions)unless,amongother
things,theparticipatingunderwriter(a)obtainsanofficialstatementfromtheissuer,(b)
beforeofferinganybonds,obtainsarepresentationfromtheissuerthatthepreliminary
1Themostwell-knownanti-fraudprovisionisRule10b-5promulgatedunderthe1934Act.
4 Orrick, Herrington & Sutcliffe LLP
officialstatementis“nearfinal,”and(c)obtainsawrittenagreementfromtheissuer
to(i)submitannualreportsthatincludefinancialstatementsandotherfinancialand
operatinginformationabouttheissuerandthebondstoacentralwebsitemaintained
bytheMSRBand(ii)providenoticetothesamewebsiteinatimelymannernotto
exceed10businessdaysoftheoccurrenceofanyof14enumeratedevents.
Thus, of necessity, municipal issuers make extensive public disclosures in
connectionwith the issuance and saleof their securities, andnow,becauseofRule
15c2-12,onanongoingbasisafterbondsareissued.Misrepresentationsandomissions
inthosedisclosurescreateariskofliabilityunderRule10b-5andotherlaws.Asnoted,
civil penalties imposed through administrative cease-and-desist proceedings have
recentlybeenaddedtothetraditionalliabilityrisks.Section21C(a)ofthe1934Act
haslongempoweredtheSECtoissuecease-and-desistorders.Specifically,itprovides:
IftheCommissionfinds,afternoticeandopportunityforhearing,thatany
personisviolating,hasviolatedorisabouttoviolateanyprovisionofthisACT,
orany ruleor regulation thereunder, theCommissionmaypublish itsfindings
andenteranorderrequiringsuchperson...toceaseanddesistfromcommitting
orcausingsuchviolationandanyfutureviolationofthesameprovisionruleor
regulation.(emphasisadded)
TheDodd-FrankActaddedaprovisiontoSection21B,titledCivilRemediesin
AdministrativeProceedings,thatpermitstheimpositionofcivilpenaltiesincease-and-
desistproceedings.Specifically,newSection21B(a)(2)provides:
CEASE-AND-DESIST PROCEEDINGS – In any proceeding instituted
undersection21Cagainstany person,theCommissionmayimposeacivilpenalty
iftheCommissionfinds,ontherecordafternoticeandopportunityforhearing,
thatsuchperson–
(a)isviolatingorhasviolatedanyprovisionofthistitle,oranyruleorregulation
issuedunderthistitle;or
(b)isorwasacauseoftheviolationofanyprovisionofthistitle,oranyruleor
regulationissuedunderthistitle.
There shouldbenodoubt that theSECwill seek to impose civil penalties on
municipalissuersandtheirofficialsandemployeesinadministrativeproceedingswhen
itbelievestherehavebeenmisrepresentationsoromissions.Ms.Greenbergpublicly
announcedthat intentionataNationalAssociationofBondLawyersconference in
October2010.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 5
B. Specialized Enforcement Unit In2010, theSEC formedfive specialized enforcementunits to focusonhigh-
priorityissues.Inannouncingthespecializedunits,theSECstatedthatthecombination
ofdedicatedresourcesandenhancedspecializationwillyieldmoreeffective,efficient,
and rigorous enforcement in the high priority areas. One of the specialized units
focusesonmunicipal securities andpublicpensions.Thatunit isheadedbyElaine
GreenbergandMarkZehner,bothofwhomhavepriorexperiencewithenforcement
actionsrelatedtomunicipalsecurities.
The most significant fact may be that the new unit targeting the municipal
securitiesmarkethasastaffofapproximately30lawyersspreadover10oftheSEC’s12
regionaloffices.Suchalargeinvestmentofenforcementresourceswillalmostcertainly
leadtoanincreaseinthenumberofinvestigationsandenforcementactionsdirectedat
participantsinthemunicipalsecuritiesmarket.
C. Points of Emphasis Ms.Greenberghasannouncedthat,whilethescopeofthenewunit’smandateis
broad,itwillseektoexpandtherelativelylimiteddecisionallawconcerningmunicipal
securitiesbyfocusingonfivespecificareas:
• Offeringanddisclosurefraud:Potentialmisrepresentationsandomissionsin
offeringdocuments.
• Tax or arbitrage-driven fraud: Profiting by borrowing at lower rates and
investing at higher/market rates is generally impermissible under the tax
codeandcanaffectthetax-exemptstatusofbondsforinvestors.OnMarch
2, 2010, the SEC and IRS announced the signing of a Memorandum of
Understandingdesignedtoimprovecompliance.Thetwoagencieswillwork
cooperatively through a standing Tax Exempt Bond/Municipal Securities
Committeetoidentifyissuesandtrendsrelatedtotax-exemptbonds.They
willalsoshareinformationasappropriate.
• Pay-to-play practices and public corruption:The pay-to-play rule (MSRB
RuleG-37)generallyprohibitsfirmsfromunderwritingmunicipalbondsfor
anissuerfortwoyearsaftera“municipalfinanceprofessional”involvedwith
thefirmmakes a campaign contributionofmore than$250 to an elected
officialoftheissuer.
• Fraud involving valuation and pricing: Focus on thinly traded securities
typicallyissuedbysmallmunicipalitiesandutilities.
• Public pension accounting and disclosure violations: At a June 22, 2011
6 Orrick, Herrington & Sutcliffe LLP
conferencesponsoredbythePewCenterfortheStates,Mr.Zehnerstated:
“Ithinkitisineveryone’sinterestsheretocomeupwithavoluntarymethod
ofadequatelydisclosingpublicpension-fund liabilitiesbeing facedbystate
and local governments.”The SEC’s recent enforcement action against the
StateofNewJerseyhighlightstheSEC’swillingnesstospurthatprocessalong
throughenforcementactions.
D Recent Enforcement Actions It has been approximately 18 months since the enforcement unit focusing on
themunicipalsecuritiesmarketwasformed.Althoughitsinvestigationsaregenerally
confidential, the enforcement actions settled in that period and anecdotal reports
of investigations suggest that theSEC is indeed focusingon theareas identifiedby
Ms.Greenberg.
• InMarch2010,theSECtookactionontwooccasionstoenforcecompliance
withtheplay-to-playrule:
○ The SEC issued a report of investigation warning firms that play-to-
playrulesapplytoaffiliatedprofessionals,notjusttoafirm’semployees.
ThefirminquestionunderwrotebondsissuedbytheStateofCalifornia
withintwoyearsofacampaigncontributiontotheTreasurerofCalifornia
madebythevice-chairmanofthefirm’sparent(bankholding)company.
Thecontributorwasnotadirector,officer,oremployeeofthesecurities
firmunit,buttheSECdeterminedthathefunctionallysupervisedthe
securitiesfirm.
○ The SEC filed a settled enforcement action against a securities firm
basedoncontributionsmadeby a senior vice-presidentof thefirm to
theTreasurerofMassachusettswithintwoyearsofthefirmco-managing
19 Massachusetts bond offerings.The securities firm was required to
disgorgeallearningsplusinterestandpayacivilpenalty.
• InAugust2010,theStateofNewJerseysettledclaimsthatitmisledinvestors
in $26 billion of municipal bonds by masking underfunding of its two
biggestpensionfunds.ItwasthefirstSECenforcementactionagainstastate.
Announcingthesettlement,Ms.Greenbergsaid,“Weneedtobeoutthere
sendingamessagetothemarketparticipants,especiallytheissuersofmunicipal
bondsreally,thattheyneedtobeouttheretakingseriouslytheirobligations
under the federal securities laws.”Followinganextensive investigation, the
SECfoundthatNewJersey’sbondofferingdocumentsfailedtodisclosethe
pensionplans’ assetand fundedratio informationonamarket-valuebasis.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 7
Becausethatinformationwasnotprovidedonthebasisofmarketvalue,the
offering documents effectively concealed an unfunded liability (i.e., using
currentmarketvalues,thefundedratiowaslessthan100%).
• InOctober2010,theSECannouncedthatfourformerSanDiegocityofficials
agreedtopayfinancialpenaltiesforrolesinmisleadinginvestorsinmunicipal
bondsaboutthecity’sfiscalproblemsrelatedtoitspensionandretireehealth
careobligations.TheSanDiegoenforcementactionisthefirsttimetheSEC
hassecuredfinancialpenaltiesagainstcityofficialsinamunicipalbondfraud
case.Threeformerofficialswerefined$25,000eachandonewasfined$5,000.
Inannouncingtheresultoftheenforcementaction,theheadofSEC’sLos
Angelesregionalofficesaid,“Municipalofficialshaveapersonalobligationto
ensure that investorsareprovidedwithcompleteandaccurate information
abouttheissuer’sfinancialcondition.”
• InNovember2010,itwasreportedthattheSEChadissuedsubpoenasseeking
informationrelatedtobondsissuedbytheCityofBell,California(thesmallcity
neighboringLosAngelescaughtupinapublicpayandpensionscandal).Press
reports indicated that Bell may have issued $50 million in general obligation
bondstobuildasportscomplexwithoutadocumentedplanandtimeframefor
howtouseproceedsoranapparentneedforthemoney.
• RecentreportssuggesttheSEChasbeeninvestigating$600millionofBuild
America Bonds sold by the Metropolitan Water Reclamation District of
Greater Chicago in 2009. Such an investigation would be consistent with
reportsthattheSECisfocusingonBuildAmericaBondsbecausetheyarea
significantnewproduct.TheSECisreportedtohavemetseveraltimeswith
theIRStodiscussthesebonds.IftheIRSfindsthatBuildAmericaBondsdo
notcomplywithtaxrulesonissueprice,itcouldwithholdsubsidypayments
(35%ofinterestcosts).
8 Orrick, Herrington & Sutcliffe LLP
III. Preparing for the New Era of SEC Enforcement
Issuers and individuals who become targets of SEC investigations need to be
preparedtoactquickly.Officialsofpublicissuersshouldconductanassessmentofthe
entity’spreparednessundertheguidanceofexperiencedcounsel.Oncetheissuerlearns
ofaninvestigation,whetherformalorinformal,therearecertainstepsitshouldtakeas
promptlyaspossibletohelpguardagainstanunfavorableoutcome.
A. Preparedness Assessment Anassessmentofanissuer’spreparednessforthepossibilityofanSECinvestigation
shouldincludethefollowingsteps:
1. Document retention policies
Ensurethatdocumentretentionpolicesareinplaceandbeingfollowed.
Whentheissuerisnotifiedthataninvestigationhasbeencommenced,itlikely
willberequiredtoretaindocumentsthatrelatetotheinvestigation.Whilethe
scopeofdocumentsthatmustberetainedissubjecttonegotiation,enforcement
officialsroutinelytakeanexpansiveviewofwhatmustbepreserved.Issuersthat
havebeenlaxinenforcingretentionpoliciescannotsuddenlybecomevigilant
withoutriskingtheappearanceofhavingsomethingtohide.Toavoidcreating
theappearanceofhidingordestroyingevidence,issuersshouldbeconsistentin
remindingemployeesoftheimportanceoffollowingretentionpolicies.
2. IT systems
Understandtheinformationsystemsthatautomaticallypurgedocuments
andotherelectronicrecords,andestablishproceduresforstoppingthatprocess
at the inception of an investigation. Some software systems automatically
overwriteorpurgedata.Issuerdecisionmakersshouldworkcloselywiththe
IT staff tounderstand those systemsanddesignwork-arounds that canbe
immediatelyimplementediftheissuerlearnsofaninvestigation.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 9
3. Compliance training
Issuersshouldtakecaretoeducatetheresponsibleemployeesaboutthe
increasingrisksofSECinvestigationsandtheheighteneddisclosureobligations
imposed by the recent amendments to Rule 15c2-12.Those amendments
requireunderwriterstoobtaincommitmentsfromissuerstoprovidenotice
ofanexpandedlistofspecifiedeventsinatimelymannernottoexceed10
businessdays.Theenumeratedspecifiedevents range fromratingschanges
toadversetaxopinionstosubstitutionofpropertysecuringrepayment.Even
if the issuershave retained anoutside consultant to assistwith continuing
disclosurematters,iftheresponsibleemployeesarenotwellinformedofthese
noticeobligationsand/ortherearenotsystemsinplacetoensurethatthey
arepromptlyinformedoftheoccurrenceoftriggeringevents,anissuercould
easilyfailtoprovidetherequirednoticewithin10businessdays.
B. First Steps Upon Learning of the Investigation 1. Take the investigation seriously
SEC enforcement personnel may conduct informal investigations, but
theydonotconductcasualinvestigations.AnyinquiryfromSECenforcement
personnel is a serious matter with potentially significant consequences.
There is no reason for the recipient of the initial inquiry to provide any
substantiveresponsesonfirstcontact.IssuersshouldpolitelyinformtheSEC’s
enforcementpersonnelthattheywillrespondpromptlyafterconferringwith
counsel.TheSECstaffwillnotdrawanynegativeinferencesfromthatinitial
responsebecauseitisstandardoperatingprocedure.
2. Retain experienced counsel
The issuer shouldthenseekguidance fromcounselwithexperience in
SEC enforcement matters. SEC investigations invariably spawn new risks
beyond any preexisting disclosure issue (e.g., the risk of an incomplete
document production or a misstatement caused by the target’s inadequate
investigationofthefacts).TheyalsopresentopportunitiestoshapetheStaff ’s
viewsthroughthesubstanceoftheresponse,referencetowhattheSEChas
done in other matters, and cooperation. Counsel with experience in SEC
investigationscanhelpnavigatetheserisksandopportunitiessoastoobtain
thebestpossibleoutcome.Bondcounsel,disclosurescounsel,orunderwriters
counselmayhaveampleexperiencewithdisclosuresbutinsufficientexperience
withSECinvestigationsandenforcement.
10 Orrick, Herrington & Sutcliffe LLP
3. Investigate quickly and thoroughly
The issuer, with assistance from counsel, should promptly gather and
analyzerelevantfacts.Providinglessthanaccurateandthoroughinformation
totheSEC,nomatterhowwellintentioned,willnotendwell.Sucherrors
cancreateheightenedsuspicionsandleavetheimpressionthattheissueror
itsofficialsandemployeesarenotrespectfulofthelawsand/ortheregulators.
Amongotherthings,theissuershouldinterviewemployeeswithknowledgeof
theunderlyingeventsorinformationtoensurethat,iftheyarelaterexamined
bytheSEC,theirstatementswillbeconsistentwiththeinformationsupplied
totheSECbytheissuer.
4. Preserve documents
Actimmediatelytopreservealldocuments,bothhardcopyandelectronic.
Theuniverseofdocuments thatmustbepreserved canoftenbenarrowed
throughnegotiationwiththeSEC’sstaff.Untilthoseparametersareagreedto
andmemorialized,thebestcourseistopreserveeverythinginordertoavoid
anyriskthattheSECwillinterpretthelossofdocumentsasthedestruction
ofevidence.
5. Preserve the attorney-client privilege
FromthemomentaninquiryfromtheSECisreceived,theissuershould
takecaretopreservetheprivilegednatureofitscommunicationswithcounsel,
includingtheprivilegednatureoftheinternalinvestigation.Retainingoutside
counselattheoutsetcanhelpachievethatprotection.Employees,especially
senior officials, should be cautioned that communications not involving
counselmaybediscoverable.The issuermaydecide towaive theattorney-
clientprivilegeaspartofanefforttocooperatewiththeSEC,withthehope
thatsuchcooperationwillpersuadetheSECnottoinitiateanenforcement
actionor tobemore lenient.But, sharingprivileged informationwith the
SECshouldbeachoiceaftercarefuldeliberation,nottheunfortunateproduct
offailingtotakeadequatestepstoprotecttheprivilege.
6. Consider taxpayer confidentiality
The SEC sometimes asks the issuer to waive restrictions on the IRS
disclosingtaxpayer informationsothattheIRScancommunicatewiththe
SEC.Suchwaivermaynotalwaysbewise,andissuersshouldconsultwith
counselbeforedoingso.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 11
7. Seek to narrow the scope of the document request
The initial document request from the SEC is often quite broad and
burdensome.Thecostofproducingdocumentscanbestaggering.Recipients
ofdocumentrequestsshouldseektolimittheburdenandcostbynegotiating
with the SEC to narrow the scope of the document request. Experienced
counselwillknowwhatfeaturesofthedocumentrequestwillbemostcostly,
thepointsonwhichtheStaffmightbeflexible,andhowtonegotiatenarrowing
thedocumentrequests.
8. Evaluate whether there is a duty to disclose the investigation
Inmanyinstances,therewillnotbedutytodisclosethefactornatureofan
SECinvestigation.But,issuersshouldnotsimplyassumethatthereisnosuch
duty. For example, the investigation may surface information that casts prior
disclosures indoubtor the cost of responding to the investigationmay cause
financialperilfortheissuer.Consequently,issuersshouldconsultwithcounselto
determinewhetheranSECinvestigationisamaterialeventwarrantingdisclosure.
12 Orrick, Herrington & Sutcliffe LLP
IV. How SEC Investigations and Enforcement Actions Work
A. The Power of the SEC CongresshasvestedtheSECwithbroadauthoritytoconductinvestigationsinto
possibleviolationsofthefederalsecuritieslawsandtodemandproductionofevidence
relevanttosuchinvestigations.TheSEC’sauthorityincludesthepowertosubpoena
witnesses,administeroaths,andcompeltheproductionofbooksandrecords.
InOctober2008,theSECmadeitsEnforcementManualavailableonitswebsite.
ThemanualisausefulresourceforentitiesandindividualstargetedbytheSEC.
B. The Initiation and Escalation of an SEC Investigation 1. Sources of an SEC investigation
SECinvestigationsmayspringfromanyofalargenumberofdifferent
sources. Often, investigations grow out of examinations by the Staff of
periodic public disclosures. Complaints from members of the public are
yetanothercommonsourceofSECinvestigations. In thepastdecade, the
financialpresshasbecomeapotentsourceofleadsfortheSEC,asbusiness
journalistsnowconductaggressiveinvestigationsevenbeforetheStaffisaware
ofcertainconduct.Likewise,tipsbyinternalwhistleblowershaveprompted
manyinvestigations.Whistleblowercomplaintsarelikelytoescalateinlight
ofthe“bounties”madeavailablebyDodd-Frank.Finally,referralsfromother
governmentagenciesarealsoacommonsourceofSECinvestigations.
2. Informal inquiries
SECproceedingsusually begin as “informal investigations” or “informal
inquiries.”Attheinformalinquirystage,theSEC’sStaffhasnotyetsoughtthe
authoritytoissuesubpoenasforcompellingdocumentsandtestimony.Instead,
itusuallyaskswitnessestogivetestimonyandprovidedocumentsvoluntarily.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 13
a. Informal inquiries typically are not publicly disclosed
TheSECisauthorized toconductan informal inquiry inprivate.
Only very rarely will the SEC disclose the pendency of an informal
inquiry,whichmeansthatprivateplaintiffsmaybekeptinthedarkas
longasaninquiryremainsinformal.
b. Document and testimonial discovery in informal inquiries
In connection with an informal inquiry, the Staff nearly always
requests a voluntary production of documents. Indeed, an informal
inquiry very often commences with a letter attaching a request for
documents. Given that informal inquiries are often exploratory fact-
finding exercises focused on several areas of reported or suspected
misconduct, the Staff ’s document requests are often broader and less
specificthanthoseinprivatelitigation.
It is also common for the Staff to request creation of various
documentsorcompendiumsofinformationanddata.Forexample,the
Staffmayrequest thesubmissionofachronologyofevents,complete
withtheidentitiesofparticipantsatanymeetings.Thepreparationof
suchdocumentsmustbehandledwithcare.
Afterdocumentproductionhascommenced,theStaffwillcommonly
requestwitnessinterviewsand/ortestimony.Iftheprospectivewitness
canpersuadetheSECthatatranscriptwoulddisadvantagehimorthe
Staff,theStaffmayagreetoconductitsinterviewswithoutatranscript.
c. Conclusion of an informal inquiry
Where documents and testimony provided to the Staff do not
indicatea securitiesviolation, the subjectofan informal inquirymay
simplyneverhear from theStaff again regarding the inquiry.That is
alsothecaseif,underthecircumstances,itisquestionablewhetherany
violationoccurredandthesubjectoftheinquiryactedinacooperative
andcrediblemanner.Generally,iftheStaffdecidesthatitwillnotpursue
theinquirybeyondtheinformalstage,thesubjectoftheinquirywillnot
receiveanyformalnotification.
Incontrast,aninformalinquirymayconcludebecausetheStaff is
convinced,without theneed for additional evidence, that a securities
violationoccurred. In such a case, theStaffmaydecide to “skip” the
formalinvestigationstagealtogetherandrecommendtotheCommission
thatitcommenceanadministrativeproceedingagainstallegedviolators
14 Orrick, Herrington & Sutcliffe LLP
orfileacomplaint infederalcourtseekinginjunctiverelief.TheStaff
mayalsoreferthesuspectedviolationtotheDepartmentofJusticefor
initiation of criminal proceedings against alleged violators. In recent
years, it is becoming somewhat more common for the Staff to skip
directly froman informal inquiry to an administrative, injunctive, or
criminalproceeding.
3. Formal investigations
TheStaffmayescalateaninformalinquiryintoaformalinvestigationifit
believesthatasubpoenaisnecessarytoobtaindocumentsortestimonyfrom
thesubjectoftheinvestigationorfromthirdpartiesthatwillnotorcannot
voluntarilycomplywithaninformalrequestforinformation.
a. Formal order of investigation
The Staff cannot initiate a formal investigation—and enjoy the
concomitant powers to issue subpoenas and require oaths—until the
Commission issues a formal order of investigation. A formal order of
investigationwillbeissuediftheCommissionbelievesthataviolationof
thefederalsecuritieslawsisoccurringorhasoccurred.Mostimportantly,a
formalorderwilloftendescribe—albeitvaguely—thegeneralsubjectmatter
oftheformalinvestigation.Thismayprovidethetargetofaninvestigation
withthefirstwrittenindicationofthenatureofasuspectedviolation.
b. Contents of a formal order
A formal order is a brief document outlining suspected statutory
and regulatory violations. A formal order will not provide much (if
any)detailregardingtheStaff ’sevidenceorthebasesfortheStaff ’slegal
theories.Theorderwill generally contain four sections: (1) thePublic
Official Files section, which refers to information contained in the
Commission’spublicfiles;(2)theStaffReportsection,whichpresents,in
ahighlyconclusoryform,thefactsthenknowntotheStaff,aswellasthe
securitieslawsthattheStaffsuspectshavebeenorarebeingviolated;(3)
thePurposeandOrdersectionliststheviolationsthatmayhaveoccurred
orareoccurring;and(4)theAuthorizedStaffsectionliststhemembersof
theStaffwhoareauthorizedtoadministeroathsandtoissuesubpoenas.
c. Guidelines governing formal inquiries
Formalinvestigationswillremainnonpublicinalmostallcases.The
Staffmay,however,shareinformationwithothergovernmentalagencies.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 15
Ifaskedforinformationregardingasuspectedinvestigation,theStaffwill
neitherconfirmnordenytheexistenceofaninvestigation.Nevertheless,
occasionallytheexistenceofaformalinvestigationisleakedbypersons
withinthesubjectentity,soitmaybeappropriatetodeveloparesponse
planinanticipationofsuchaleak.
Pursuant to the SEC’s Rules Relating to Investigations, witnesses
in formal investigations receive a number of procedural protections.
Amongthemoreimportantprotectionsareawitness’srighttoreview
theformalorder,toreviewatranscriptofhisorherowntestimony,and
tobeaccompaniedbycounselwhilegivingtestimony.
The subject of an SEC investigation is entitled to the same
testimonialprivilegesasduringajudicialproceeding,includingFourth
and Fifth Amendment protections against unreasonable searches and
self-incrimination. The attorney-client privilege likewise exists in
connectionwithanSECinvestigation.
d. Conclusion of a formal inquiry
TheStaffmayconcludeaformalinvestigationbyeitherdetermining
thatnoactionisappropriateorbyrecommendingtotheCommission
thatenforcementproceedingscommence.IftheStaffrecommendsno
action,theStaffgenerallywillinformthesubjectofthatdetermination.
IftheStaffbelievesthattheinvestigationshouldresultinenforcement
action, it will draft an action memorandum to the Commission
recommendingthattheCommissiontakeaction.Therecommendation
willsetforththegroundsfortherecommendationandwillrecommend
acourseofactionandaremedy.Finally,theStaffwillalsoforwardtothe
CommissionanyWells submission (discussedbelow)providedby the
proposedrespondentsordefendants.
4. Internal investigations
Itcanbeinanissuer’sinteresttorespondtonoticeofanSECinvestigation
by institutingan internal investigation.Atan issuer’s request, theStaffmay
defer its investigationpending the completionof the internal investigation,
providedtheissueragreestoforwardtheresultsofitsinvestigationtotheStaff.
AnissuercangreatlyexpediteresolutionoftheStaffinvestigation,andthereby
avoidthecostanddisruptionofaStaffinvestigation,byutilizingthisprocess.
An issuer that launches an internal investigation may also curry favor
withtheStaffbyshowingitswillingnesstocooperate.TheCommissionand
16 Orrick, Herrington & Sutcliffe LLP
theStaffoftenconsidersuchcooperationindeterminingwhatremedy,ifany,
toimpose.
5. Wells notice and submission
Where the Staff believes that it will recommend to the Commission
thatchargesbebroughtagainstthesubjectofaninvestigation,theStaffwill
usuallyissuea“Wellsnotice.”AWellsnoticeinvitespersonsinvolvedinan
investigation topresent a statement to theCommission setting forth their
interestsandpositions.
a. No right to receive a Wells notice
TheWellssubmissionpracticeisexactlythat—apracticeorcustom
that isnotrequiredunder law.Nocourthasheldthatthesubjectsof
SECinvestigationshaveadueprocessrighttoreceiveaWellsnotice(or
thesubsequentopportunitytomakeaWellssubmission).
b. Whether to make a Wells submission
MostpotentialrespondentsanddefendantschoosetomakeaWells
submission,perhapsbecausetheStaffandtheCommissionersappearto
evaluatethesesubmissionswithcare.AfterevaluatingaWellssubmission,
theStaffmayverywellalteritsrecommendationstotheCommission,
includingdroppingcertainindividualsfromorreducingtheseverityof
theproposedaction.Moreover,becauseaWellssubmissionaccompanies
the Staff ’s recommendation to the Commission, the submission may
have a positive anddirect impact on theCommission itself. In some
circumstances, strategic considerations may argue against making a
Wellssubmission.
c. Content of a Wells submission
A Wells submission is essentially a legal brief that highlights the
hurdlesthatanactionbytheCommissionwouldface.TheCommission
hasstatedthatthemosthelpfulWellssubmissionsaddressquestionsof
lawandpolicy,ratherthanarguingfactualmatters.
6. Action by the Commission
WhereanactionhasbeeninvestigatedbytheStaffandrecommendedto
theCommission,theStaff ’sopinionandrecommendationsareconsolidatedin
an“actionmemo”totheCommission.Thismemosetsfortharecommended
courseofaction—enforcement,litigation,noaction,orsettlement—thatthe
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 17
Commissionwillusually adopt.Theactionmemomarks thebeginningof
theCommissionprocess:atwo-tothree-monthperiodofconsiderationthat
determinesthefateoftheinvestigation.TheCommissionconductsaclosed
meetingtoconsidertheStaff ’ssuggestionsandtodecideeithertodonothing,
tocommencecivillitigation,ortocommenceanadministrativeproceeding.
WhiletheCommissiondoesnothavethepowertobringacriminalsuit,it
mayreferthemattertotheDepartmentofJusticeorstateandlocalauthorities
forprosecution.
C. Disclosing an SEC Investigation TheSEC’sformalinvestigativeproceedingsarenormallyconductedprivatelyto
avoidunwarrantedinjurytothereputationsofthepersonsbeinginvestigated.Section
21ofthe1934ActdoesauthorizetheCommissiontopublishinformationconcerning
violationsituncoversduringthecourseofitsinvestigations.Courtshavesustainedthe
Commission’srighttoinvestigatesubjectsprivatelyandpublicly.
WhileitusuallyrunsinthefavorofapartyunderSECinvestigationtorefrain
from disclosing the existence or nature of an investigation—if for no reason other
than to keep the plaintiff ’s bar at bay until the investigation is concluded—where
the investigation (or matter being investigated) is material, the party may need to
discloseitorpotentiallyfaceadditionalpenaltiesandlitigation.Additionally,whether
determinedtobematerialornot,theexistenceofaninvestigationmustnotbefalsely
deniedbyanissuer’sofficials.
D. Civil Enforcement Actions TheCommissionisempoweredtobringawidevarietyofcivilenforcementactions.
1. Injunctive actions
Section 20(b) of the Securities Act gives the Commission authority
tobring an action to enjoin anyperson engaged inor about to engage in
anyactorpracticethatviolatesanyprovisionoftheAct.Insomeinstances,
defendants (without admitting the alleged violations) may consent to the
entry of the injunction. Defendants may contest a preliminary or final
injunction,however,byarguingthattheyhavenotviolatedtheActand/or
thatanyfurtherviolationisimprobable.
2. Civil penalties
The Commission may seek a monetary penalty against any person in
violationofthefederalsecuritieslawsoraCommissioncease-and-desistorder.
Thatincludesnotjusttheissuer,butindividualssuchasofficialsandstaffof
18 Orrick, Herrington & Sutcliffe LLP
theissuer.AsevidencedbythepenaltiesimposedontheSanDiegoofficials
inthematterdescribedabove,theriskofmonetarypenalties isnot justa
theoreticalriskforindividuals.Moreover,undercurrentCommissionpolicy,
a defendant must agree to seek no tax benefit or insurance benefit for a
penaltypayment.
There are six factors that the Commission considers to determine
whether a fine is in the public interest: (1) whether the act in question
involves“fraud,deceit,manipulation,ordeliberateorrecklessdisregardof
a regulatory requirement”; (2) resultingharmtootherpersons; (3)extent
ofunjustenrichment;(4)degreeofrecidivism;(5)theneedto“detersuch
personsandotherpersonsfromcommittingsuchactsoromissions”;and(6)
otherconsiderationsasjusticemayrequire.
3. Prospective relief
Aspartofasettlement,theCommissionwilloftenrequirethatacompany
agreetoan“undertaking”—aparticularizedprospectiveaction—designedto
ensurethattheissuercannotandwillnotcommitthesameviolationagain.
E. Administrative Proceedings TheCommissionhastheauthoritytoitselfadjudicatecertainallegedviolations
ofthesecuritieslawsafteranadministrativehearingontherecord.
1. Process
a. Conduct of hearings
Once initiated, a formal proceeding is usually tried before an
Administrative Law Judge (“ALJ”), an independent Commission
employee.Theproceedingisconductedinamannersimilartoanon-jury
trial,witheachoftherespondentsabletopresentevidenceandtestimony
and to cross-examine witnesses. Unlike a trial, however, a proceeding
beforetheCommissionaffordstherespondentsnorighttodiscoveryand
proceedsatamuchfasterpaceunderlooserevidentiarystandards.Atthe
proceeding’sconclusion,theALJfilesan“initialdecision.”
b. Appeal to the Commission
After issuance of the ALJ’s initial decision, respondents may file
apetitionforaCommissionreviewortheCommissionmayordera
reviewonitsowninitiative.TheCommissionthenrendersjudgment
onthebasisofsubmittedmaterials.Itmaymodifytheinitialdecision
inanyway,evenincreasingtheinitialsanctions.
SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers 19
c. Appeal to United States Court of Appeals
Once a final order has been entered, parties may appeal the
Commission’sdecisiontoeithertheUnitedStatesCourtofAppealsfor
the District of Columbia or the circuit in which the appealing party
residesorhasitsprincipalplaceofbusiness.
2. Sanctions
a. Cease-and-desist orders
The Commission has broad authority to administratively enter
cease-and-desistordersthatrestrainviolationorthreatenedviolationof
the securities laws by any person. If the Commission finds “that any
personisviolating,hasviolated,orisabouttoviolateanyprovision”of
theSecuritiesAct,theExchangeAct,oranyruleorregulationadopted
thereunder, it may enter an order directing the respondent “to cease
anddesist fromcommittingor causing suchviolationandany future
violation.”The order may also direct the respondent to take specific
steps“toeffectcompliance . . .withinsuchtime”astheCommission
mayorder.Ifacease-and-desistorderisviolated,theCommissioncan
initiateaproceedinginanappropriatefederaldistrictcourttoimposea
civilpenalty.
b. Monetary penalties
Asnotedabove,theDodd-FrankActconferredontheCommission
theauthoritytoimposeamonetarypenaltyonmunicipalissuersandtheir
officialsandemployeesinconnectionwithadministrativecease-and-desist
proceedings. The Dodd-Frank Act added a provision to Section 21B,
titled Civil Remedies in Administrative Proceedings, that permits the
impositionofcivilpenaltiesincease-and-desistproceedings.Specifically,
the new Section 21B(a)(2) provides that the Commission may impose
acivilpenaltyagainstanypersonwho“isviolatingorhasviolatedany
provisionof[theExchangeAct],oranyruleorregulationissuedunder
[theExchangeAct]”orwhoisorwas“acauseoftheviolation.”
20 Orrick, Herrington & Sutcliffe LLP
V. Orrick Contacts
Securities Litigation and Regulatory Enforcement
Public Finance
George E. GreerSeattle Office206-839-4403ggreer@orrick.com
Roger L. DavisSan Francisco Office415-773-5758rogerdavis@orrick.com
Eileen B. HeitzlerNew York Office212-506-5235eheitzler@orrick.com
Pauline A. SchneiderWashington, D.C. Office203-339-8483paschneider@orrick.com
Douglas E. GoePortland Office503-943-4810dgoe@orrick.com
Robert P. FeyerSan Francisco Office415-773-5886bobfeyer@orrick.com
Robert A. Fippinger New York Office212-506-5260rfippinger@orrick.com
Michael D. TorpeySan Francisco Office415-773-5932mtorpey@orrick.com
James A. MeyersWashington, D.C. Office202-339-8487jmeyers@orrick.com
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