Preparing for Investigations by the SEC Division of Enforcement

The U.S. Securities and Exchange Commission (SEC) plays a critical role in safeguarding investors and ensuring compliance with federal securities laws. When the SEC opens a formal investigation, it is often triggered by a referral from its examination program (EXAMS) or by credible tips and referrals.

For investment advisers, an investigation can follow allegations of misconduct or violations of securities laws. During this process, cooperation, transparency, and corrective action are essential. Regulators expect firms not only to address identified issues but also to demonstrate a long-term commitment to compliance through restitution, updated policies, enhanced oversight, or improved governance practices.

This month’s Risk Management Tip outlines the SEC’s enforcement process, from investigation through potential enforcement proceedings, and highlights how advisers can prepare effectively.

The Investigation Process

Once referred to the SEC Division of Enforcement, staff determine whether to open a formal investigation. The Division is granted broad powers to compel testimony, subpoena documents, and examine records. A formal order of investigation authorizes SEC staff to act as officers of the Commission, enabling them to administer oaths, compel witness testimony, and demand production of books and records.

Cooperation Matters

The SEC encourages cooperation and provides “credit” to individuals and firms who substantially assist in an investigation. The level of credit depends on:

• Timeliness of cooperation
• Quality and completeness of assistance
• Resources saved as a result of cooperation
• Remedial steps taken (e.g., disciplining responsible individuals, enhancing internal controls, retraining staff, or hiring compliance experts)

Meaningful cooperation can reduce or even eliminate penalties. In some cases, firms that demonstrate corrective action and accountability avoid further sanctions altogether.

Role of Counsel

Retaining experienced securities counsel early in the process is vital. Counsel can:

• Communicate with SEC staff to clarify concerns
• Ensure document production is complete and accurate
• Prepare witnesses for testimony
• Assert attorney-client privilege and work product protections

Legal guidance helps firms navigate the complexities of the investigative process and reduce potential exposure.

Wells Notice and Wells Submission

If SEC staff intend to recommend enforcement action, they issue a Wells Notice. This notice outlines alleged violations and gives the recipient an opportunity to respond before the SEC proceeds.

Recipients may submit a Wells Submission—a written statement providing factual, legal, or policy reasons why enforcement action should not be taken. While optional, a Wells Submission requires careful consideration:

• Benefits: Offers a chance to influence the SEC’s decision.
• Risks: It is not privileged and may be shared with other regulators or used in related proceedings.

Deciding whether to respond requires weighing strategic pros and cons with legal counsel.

Administrative Proceedings

If the SEC pursues enforcement, it may file a civil action in federal court or initiate an administrative proceeding. Administrative proceedings begin with an Order Instituting Proceedings, which outlines the Division’s allegations.

Cases may proceed directly before the Commission or be referred to an Administrative Law Judge (ALJ). ALJs conduct hearings, rule on evidence, and issue initial decisions. The SEC can affirm, modify, or overturn these decisions.

Possible outcomes include:

• Civil penalties and disgorgement
• Suspension or revocation of licenses or registrations
• Bars from association with regulated entities
• Other sanctions designed to protect investors

Conclusion

Facing an SEC investigation is daunting, but preparation and proactive engagement can make a critical difference. By preserving documentation, engaging knowledgeable counsel, and taking corrective actions, advisers can demonstrate good faith cooperation and mitigate potential consequences.

JLG represents investment advisers, broker-dealers, advisers to private funds, investment companies and financial professionals in formal regulatory investigations.  For more information, please contact our Managing Partner, Michelle Jacko, at 619.298.2880.