Chapter 17
| Jurisdiction | United States |
When the 1933 Securities Act was passed, the Federal Trade Commission had authority to enforce it and to regulate issuers. When the 1934 Securities Exchange Act was passed, a question arose whether the FTC should continue its regulatory and enforcement functions or whether a new agency should be created. President Franklin Roosevelt was indifferent but was persuaded to create a new agency, the Securities Exchange Commission, to replace the FTC in those roles. The first chair was Joseph P. Kennedy, formerly Ambassador to the United Kingdom and father of President John Kennedy.
The SEC's Division of Enforcement was created in 1972; before that, the functions were handled by various operating divisions. The SEC's authority to investigate is found in Section 21 of the 1934 Securities Exchange Act.
The SEC's Organization Today
The SEC is composed of five commissioners, appointed by the president and confirmed by the Senate. The president may appoint one of the commissioners to serve as the chair; no more than three commissioners may belong to the same political party. The commissioners serve for five-year staggered terms.
There are six divisions of the SEC:
1. The Division of Corporation Finance. This division has the most contact with issuers and, among other things, reviews filings. The division also provides administrative interpretations of the federal securities statutes, provides "no-action" letters with interpretive guidance, and offers guidance on financial reporting issues.
2. The Division of Economic and Risk Analysis. This division, created in 2009, conducts internal analyses, but has little interaction with investors, registrants, or market participants.
3. The Division of Enforcement. This division pursues the commission's civil complaints and suits against violators of the securities laws and performs investigations. It has subpoena power and, with the approval of the commission, can bring civil and administrative actions against violators.
4. The Division of Examinations. This division conducts the SEC's National Exam Program through which the SEC inspects registered entities like broker-dealers and investment advisers, to ensure their compliance with the federal securities laws.
5. The Division of Investment Management. This division oversees the mutual fund, investment company, and investment adviser regulation.
6. The Division of Trading and Markets. This division oversees the broker-dealer industry and the capital markets generally, including the self-regulatory organizations, such as the stock exchanges and FINRA.
In addition to the divisions, the SEC has various offices, including the Office of Chief Accountant, the Office of International Affairs, the Office of Compliance, Inspections and Examinations, the Office of the General Counsel, and the Officer of Investor Education and Advocacy.
The SEC has only civil jurisdiction; it can sue in a federal court to seek injunctions, impose penalties, and seek disgorgement. Only the Department of Justice, through the U.S. Attorneys, can bring criminal cases, however.
The SEC can also bring administrative proceedings presided over by an SEC administrative law judge. In those cases, the SEC can seek a cease and desist order, can seek to preclude violators from serving as officers or directors of a public company, and can also seek disgorgement. Under Section 929P(a) of Dodd-Frank, the SEC can also seek penalties in administrative cases. Specifically, it can now obtain the same remedy in an administrative proceeding that it could in a federal court. It can also bring proceedings against regulated persons (e.g., accountants) to revoke or suspend registration or to impose bars or suspensions from employment. Some have argued that SEC administrative proceedings violate due process by limiting the respondent's rights (see, e.g., Stilwell v. SEC, 14 Civ. 7931 (S.D.N.Y. October 1, 2014) (subsequently settled)), but others argue that the availability of review by a federal court of appeals is sufficient to protect those rights. Administrative proceedings are posted on an SEC website,1 and the SEC's Rules of Practice and Enforcement Manual are publicly available.
The full commission hears appeals from decisions by administrative law judges. Decisions by the full commission are then appealable to a federal court of appeals. The SEC can also hear appeals from enforcement actions and disciplinary proceedings by self-regulatory organizations such as FINRA, NASD, or NYSE.
How Investigations Work
An SEC investigation is begun as a Matter Under Inquiry (MUI). An MUI can last sixty days. The SEC staff begins investigations privately. The staff develops facts through informal inquiry, interviewing witnesses, examining brokerage records and trading data, and other methods. In a preliminary investigation, no process is issued or testimony compelled. Then, the staff may seek a Formal Order of Investigation if it appears that the law has been or is about to be violated. Until 2009, only the SEC commissioners could issue a Formal Order of Investigation, but in that year, first as an experiment, the SEC delegated the authority to issue such orders to the head of the Enforcement Division. The delegation was made permanent the following year, after which the director began to "sub-delegate" the authority to senior officers in the division. After Donald Trump became president, the acting SEC Chair Michael Piwowar rescinded the delegation and returned the authority to the director of the Enforcement Division. On February 9, 2021, the Acting SEC Chair Allison Herren Lee restored the authority to issue Formal Orders of Investigation to the senior officers of the Division, about thirty in total, such as regional directors and associate directors. The restoration of delegation is expected to enable the investigative staff to act more swiftly in launching investigations.
Once a Formal Order is issued, the SEC staff can compel witnesses by subpoena and can compel the production of books, records, and other documents. The subpoena is not self-enforcing but can be enforced in federal district court. Witnesses can assert constitutional and attorney-client privileges.
If the SEC issues a subpoena to a third party, there is no obligation to notify the target (although it may do so). SEC v. Jerry T. O'Brien Inc., 467 U.S. 735 (1984).
The defendant has the right to make a Wells Submission.
The Wells Notice and the Wells Submission
Why is it called a Wells Notice? In 1972, SEC Chairman William Casey appointed a committee to review and evaluate the commission's enforcement policies and practices. John Wells, a partner at the New York law firm then called Royall, Koegel & Wells, was the chair. The committee made forty-three recommendations. One was that a prospective defendant should be notified of the substance of the staff's charges and probable recommendation in advance of the submission of the staff memorandum to the commission and be afforded an opportunity to submit a written statement to the staff, which would be forwarded to the commission together with the staff memorandum.
But the SEC did not adopt the Wells Committee recommendation and did not adopt a formal rule. Instead, the notice, called a Wells Notice, is given on a "strictly informal basis." Whether or not it is formal, do not take it lightly. It means that the SEC staff has carefully considered the facts and the law and is considering bringing an action. The SEC Enforcement Manual specifies what should be in a Wells Notice, including stating the specific charges being considered, affording the prospective defendant an opportunity to provide a voluntary statement (in writing or on videotape) to argue why the commission should not bring charges or to bring any other facts to the commission's attention. The notice must advise that the submission may be used by the commission in any subsequent action and that it may be discoverable by third parties. The manual also speaks to setting reasonable limitations on length (typically not to exceed forty pages).
The Wells Submission is the formal opportunity for respondents to persuade the SEC staff and the commission in writing that an enforcement recommendation is not warranted. See SEC Securities Act Release 5310 (1972). The Wells process is better suited for legal rather than factual arguments. Shorter is better. One benefit is that the commission will hear a rebuttal to the staff's recommendation. One danger is that the submission can be used in later proceedings.
Wells submissions may be admissible under Rule 801(d)(2) of the Federal Rules of Evidence. At least the SEC has taken that position. But there is an argument that Wells submissions are actually "offers of compromise" under Rule 408 of the Federal Rules of Evidence and are therefore neither discoverable nor admissible.2
Warning: Be careful; your legal theories might change and the submission might be factually or legally mistaken. Once the investigation is closed, the Freedom of Information Act may require the production of a Wells submissions, but there are exceptions and typically the respondent is provided an opportunity to object to the production of a Wells submission under FOIA.
There is no general duty for a company that has received a Wells Notice to disclose the existence of the SEC Investigation or the Wells Notice, nor is there an obligation to do so under Regulation S-K. "The securities laws do not impose an obligation on a company to predict the outcome of investigations." In re Lions Gate Entertainment Corp. Securities Litigation, 2016 WL 297722 (S.D.N.Y. Jan. 22, 2016). Once the Wells submission is received, the commission considers the staff's recommendation and can then authorize bringing of a case in federal court or an administrative action.
If it is an administrative action commenced by an Order Instituting Proceedings, the administrative law judge, who is independent from the commission...
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