Privately-owned businesses and individuals can be surprised to receive a subpoena from the U.S. Securities and Exchange Commission requiring them to produce extensive documents or give testimony. What does the SEC do, and how does it touch on private companies and private individuals?
The Role of the SEC in Enforcing Securities Laws
By its own description, “The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds.” To provide this oversight, the SEC interprets federal securities laws; issues rules; oversees the inspection of securities firms, brokers, and investment advisers; and enforces the federal securities laws.
The SEC brings hundreds of civil enforcement actions each year against individuals and companies for violations of the securities laws, ranging from insider trading to accounting fraud to providing false or misleading information about securities. The SEC’s Enforcement Division identifies subjects for potential investigation, recommends the commencement of an investigation, conducts the investigation, and recommends the filing of civil lawsuits by the Commission based on its investigation. Although the SEC does not itself file criminal cases, it works closely with law enforcement agencies to bring criminal cases for securities law violations where appropriate.
Ways in Which the SEC’s Reach Extends to Private Companies and Individuals
The SEC’s mission clearly reaches the country’s securities exchanges, companies who list their securities on the exchanges, and brokers and dealers who trade in those securities. But private companies and individuals can get caught up in SEC enforcement activity in several ways:
Sale of Unregistered Securities
Individuals or entities who are offering or selling “securities” may violate the federal securities laws if the securities are (1) not registered with the SEC and (2) don’t qualify for an exemption from registration. The legal definition of “securities” includes more than just stocks and bonds and picks up limited partnership interests, many general partnership interests, notes, fractional interests in oil and gas ventures, and other types of passive investments. Many people unwittingly run afoul of the federal securities
laws by offering interests in their business ventures without first confirming that the interests either are not securities or taking the steps to qualify for an exemption.
The federal securities laws prohibit selling securities (again, think of this word broadly to cover any type of passive interests in your own business or someone else’s) through false statements. These antifraud provisions apply whether the security is required to be registered or not. So, even if your securities are exempt from registration, your company could still be subject to SEC investigation for misstatements made in the course of offering or selling the securities.
Sales activity by an unregistered person
Persons raising money for someone else’s business who serve as an intermediary in the transaction and receive per transaction compensation (e.g., commissions) are subject to SEC registration requirements as brokers or dealers. This is one of the issues the SEC raised when it filed suit against Texas Attorney General Ken Paxton for his efforts to promote a computer hardware company and recruit his friends and business associates as investors for its private offering, activities for which he received company stock. Paxton was not registered as a broker with the SEC at the time of these activities.
Aiding and abetting a violation by someone who is subject to SEC regulation
A person who assists someone else in a violation of the federal securities laws can himself be swept up in an SEC enforcement action. For example, if a privately-owned business that buys products from a public company provides a false confirmation to the company’s auditors about the terms of the purchases, the private business (and any executive involved) could be subject to an SEC civil action for aiding and abetting a violation of the securities laws.
Individuals who trade in public company securities based on information that is not public can be charged with violating the securities laws if they know the information was obtained in violation of a duty of trust and confidence. This typically involves trading on tips from officers, directors, or employees of the company issuing the securities, or from the company’s lawyers, investment bankers, or the printers working on an offering.
How to Avoid Running Afoul of the SEC:
Here are some suggestions to avoid getting caught up in an SEC investigation.
First, if you are offering interests in your business to others, get your offering materials reviewed by counsel who can advise about possible registration requirements and how to qualify for an exemption. This is a classic example of the saying, “an ounce of prevention is worth a pound of cure.” Selling unregistered securities or failing to comply with the requirements for an exempt offering can result in having to return every dollar raised, not to mention statutory interest and penalties.
Second, have written back-up for all claims you are making to potential investors about the business and its prospects. This applies to both entities issuing securities and to persons helping to sell those interests. The SEC generally has five years to pursue claims, and defending what you said to potential investors is much easier if you have contemporaneous, written records.
Third, verify any information you provide to a public company with which you do business, including any confirmations you provide to their auditors.
Fourth, don’t act on or share rumors about stocks. The SEC has greatly expanded its technological capability to identify unusual trading that coincides with important announcements about public companies. Settling a civil insider trading charge with the SEC routinely requires full repayment of all profits made, plus a penalty equal to that amount; criminal charges may result in jail time as well.
Finally, if you do get an SEC subpoena someday, act immediately to preserve all relevant hard copy and electronic data and consult an attorney familiar with the SEC Enforcement Division processes. Whatever issues the SEC may be looking at, taking these key steps will help you put your best foot forward.
Mary L. O’Connor’s practice focuses on representing companies and their officers and directors in commercial litigation and arbitration, securities litigation, internal investigations, and regulatory investigations and enforcement proceedings.
During the course of her career, Mary has been named to the list of Best Lawyers in Dallas by D Magazine, and to the list of Texas Super Lawyers (a Thomson Reuters service) by Texas Monthly Magazine.