An investigation by the Securities and Exchange Commission (SEC) can have substantial consequences. When the SEC conducts an investigation, the Commission can impose burdensome demands for documents and can compel witness testimony. Even if the investigation does not escalate to criminal charges or lead to a civil action, the process of the investigation alone can be costly, unpleasant, and very damaging to a reputation. If the SEC discovers potential problems during its investigation, it can refer cases to the U.S. Attorney's Office and trigger a criminal investigation. This escalates the investigation to an even more serious level.
Avoiding an SEC investigation is of paramount importance due to the unpleasantness of being investigated and the potential for serious legal action as a result of an investigation. It is important to understand the types of red flags which could potentially trigger an investigation to occur in order to ensure such behaviors are avoided.
The majority of investigations are triggered by signs of certain unlawful behaviors or by complaints from those who believe they were victimized by securities fraud. Some of the possible triggers which could result in an SEC investigation include:
- Evidence of insider trading such as an unusual pattern of stock transactions.
- Unregistered offering of securities.
- Deficiencies in accounting.
- Potentially unlawful sales practices by broker-dealers.
- Indications of a failure to supervise.
- Disclosures which appear to be misleading.
- Disclosures which appear to contain false information.
- Evidence that stock prices are being manipulated or that markets are potentially being manipulated.
These red flags can first trigger an informal investigation or Matter Under Inquiry (MUI). If the SEC has reason to suspect a violation of securities law is occurring, it will first launch this confidential type of preliminary investigation, which does not become public. The SEC cannot subpoena documents at this phase, but will rely on the individuals and entities being investigated to cooperate and provide information about the matters that are concerning to the SEC.
Although an informal investigation is described as informal, it can still progress into a formal inquiry and it is not to be taken lightly. Those who are subject to an informal investigation should have legal advice when talking with the SEC and when preparing documentation to submit to the Securities and Exchange Commission.
If the SEC determines during its informal investigation that it seems likely securities laws have been violated, the SEC will progress to a formal investigation. The SEC will then get broad subpoena powers to facilitate the conducting of a formal investigation. Senior members of the SEC enforcement division must issue a formal order for an investigation and the formal order will describe the nature and scope of the SEC investigation as well as detailing which securities laws are suspected of having been violated.