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The Rising Stakes of Enforcement Proceedings Brought by the Securities and Exchange Commission
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The era of the more business friendly Securities and Exchange Commission (“SEC”) of former Chairman Harvey Pitt has come to an end in the wake of Sarbanes-Oxley and the Enron-WorldCom corporate implosions. In fact, the total fines levied by the SEC have skyrocketed from $44 million in 2001 to more than $1 billion in both 2003 and 2004. During the same period, the number of enforcement actions initiated because of alleged abuses in the areas of financial reporting and accounting have increased by more than 70 percent. See Tim Reason, The Limits of Mercy, CFO, April 2005, at 61, 62.This increase in the number and severity of enforcement actions being brought by the SEC appears to be a policy shift for the agency in general. Companies and individuals that fail to respond to this shift in corporate oversight and accountability may join the growing ranks of those facing SEC enforcement penalties through its enforcement process.

The SEC’s enforcement process includes both informal and formal investigations. Most begin as informal investigations and may or may not lead to a formal investigation. Informal investigations can be initiated by the staff of the SEC’s Division of Enforcement (the “staff”) without prior approval by the SEC, but they offer several distinctions over a formal investigation. For one, an informal proceeding will often allow the company or individual greater control over the investigation’s timing and scope. Further, it is more likely that an informal investigation will be closed, without an enforcement action, if the facts support such a result. There may also be less of a need to publicly disclose an informal investigation. Finally, the staff does not have the power to subpoena testimony or documents in an informal investigation, and instead requests cooperation from the company or individual under investigation.

In contrast, formal investigations can only be commenced after the staff secures a formal order of investigation through an application to the SEC. However, obtaining such an order is relatively routine. Generally, a good faith belief that an investigation is warranted is sufficient to secure the order. Unlike its informal counterpart, a formal investigation provides the staff with the power to subpoena information. As such, the staff has the ability to compel a company or individual under investigation, as well as third parties (such as former employees and accountants), to provide testimony and documents. If a formal investigation does commence, the company or individual under investigation, or their legal counsel, should request a copy of the formal order issued as it will provide the investigation’s general scope.

Increasingly, the SEC has been more aggressive against those companies or individuals deemed uncooperative with the testimony and document production aspect of the investigation process. In an October, 2001 release, the SEC set out a list of 13 factors it will consider in determining whether, and how much, to credit self-policing, self-reporting, remediation and cooperation including, but not limited to, the extraordinary step of taking no enforcement action, bringing reduced charges, seeking lighter sanctions, or including mitigating language in documents the SEC uses to announce and resolve enforcement actions. (SEC release 34-44969 may be found at Therefore, it is important that the voluntary or compelled testimony and document production aspect of the investigation be closely overseen by the company or individual under investigation, as well as their legal counsel.

If the SEC determines that violations of securities law have occurred during its informal or formal investigation, it can also bring civil enforcement proceedings in federal court or before an administrative law judge. If criminal conduct is present, the matter can also be referred to the Department of Justice. A number of remedies are available to the SEC in these civil enforcement proceedings, including: injunctive relief; monetary penalties; administrative cease-and-desist orders; disgorgement; and the prohibition of individuals from acting as officers or directors of public companies.

Appropriate cooperation with SEC investigations, seeking timely legal advice and understanding the enforcement process are important steps in an attempt to avoid substantial penalties, but such strategies will never guarantee a successful outcome. As always, the best course of action is for companies and individuals to attempt to ensure that violations do not occur in the first place through sound legal counsel, internal controls and a commitment to accounting and auditing independence and integrity.

If you have any questions regarding the above issues, the Securities Team at Greenebaum Doll & McDonald pllc, which includes a former member of the SEC’s Division of Enforcement, is here to assist you or your company.

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