sec investigations and enforcement actions...sec investigations and enforcement actions: a practical...

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.


www.orrick.com


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.


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.


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.


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


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.


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).


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.


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.


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.


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.


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.


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


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.


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


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


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


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.


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.”


V. Orrick Contacts

Securities Litigation and Regulatory Enforcement

Public Finance

George E. GreerSeattle [email protected]

Roger L. DavisSan Francisco [email protected]

Eileen B. HeitzlerNew York [email protected]

Pauline A. SchneiderWashington, D.C. [email protected]

Douglas E. GoePortland [email protected]

Robert P. FeyerSan Francisco [email protected]

Robert A. Fippinger New York [email protected]

Michael D. TorpeySan Francisco [email protected]

James A. MeyersWashington, D.C. [email protected]

orrick, herrington & sutcliffe llp

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