In November of 2023, the Securities and Exchange Commission (SEC) announced that it had filed almost 785 enforcement actions throughout the past fiscal year — representing a 3% increase compared with 2022. The SEC investigates organizations for a number of reasons, and the consequences of these actions may be far-reaching. RIAs registered with the SEC, rather than with the state, may be especially cautious during an SEC investigation due to the combination of high ethical and regulatory standards RIAs are expected to meet and the potential for an investigation to raise concerns among clients, even if the SEC ultimately finds no evidence of wrongdoing. For these reasons, RIAs may wish to consult with experienced regulatory defense attorneys to consider options for defensive strategies during this uncertain period. For more information on regulatory defense, consider getting in touch with the Altitude Securities Law Office at (405) 534-4914. With a greater understanding of how SEC investigations work, RIAs can take appropriate steps to demonstrate their commitment to compliance and satisfy federal investigators.

What Is the Role of the SEC?

The stated mission of the Securities and Exchange Commission is threefold:

  • Protect investors
  • Maintain markets
  • Facilitate capital formation

The SEC enforces federal securities laws. These laws apply only to entities transacting in securities, and the term “security” has a very specific definition in the realm of finance. Examples of securities include (but are not limited to):

  • Notes
  • Stocks
  • Treasuries
  • Futures
  • Swaps
  • Bonds
  • Certificates of interest
  • Transferable shares
  • Investment contracts
  • Certificates of deposit

The Howey Test for Securities

One of the most important concepts when defining securities is the Howey Test. Although the test is somewhat complex, it states that a security must involve:

  • An investment
  • A group venture
  • Gains based on group efforts

If an investment meets these requirements, it is considered a security by the SEC. Liquidity is another important factor that helps define securities, as many non-securities are illiquid.

Not All Investments Are Securities

Although “securities” may cover a wide range of valuable assets, not all valuables – or even all investments – are securities according to SEC guidelines. Here are some examples of investments that are not securities:

  • Fine art
  • Collectibles
  • Precious metals
  • Jewels
  • Real estate
  • Commodities
  • Cryptocurrencies

Are Cryptocurrencies Securities?

Cryptocurrencies represent a subject of debate among securities regulators, and it is not entirely clear how the SEC will classify this type of investment in the future. However, the SEC has stated in the past that cryptocurrencies are not securities.

When Does the SEC Launch Investigations?

The SEC only has the authority to launch investigations into organizations that deal with securities. If the investment in question fails the Howey Test, the SEC cannot move forward with the investigation (although companies may still face actions from other regulatory agencies). Assuming that the investments pass the Howey Test, a number of alleged violations could lead to SEC investigations:

Misrepresentations

Organizations must clearly describe their investment opportunities to potential customers. Any inaccuracies, misrepresentations, or omissions may trigger SEC investigations.

Price Manipulation

The SEC investigates evidence of price manipulation. A common example of price manipulation is a “pump and dump” scheme.

Appropriation of Customer Funds

Organizations must keep customer funds separate. Any suspicious transfers could lead to SEC investigations.

Insider Trading

Insider trading is a common offense within the financial world. Trading with the benefit of insider information not revealed to the general public is generally illegal, and while RIAs have a fiduciary duty to provide their clients with the benefit of their advice, that advice cannot be based on illicitly-acquired knowledge.

Dealing in Unregistered Securities

Many securities are not registered with the SEC. While not all securities are subject to a requirement for registration, investors (and investment advisors) should approach any unregistered securities with caution. 

What Happens During an SEC Investigation?

A typical SEC investigation occurs over several phases. Because satisfying federal authorities’ requests for information takes time and effort, and at advanced stages of the investigative process may lead to reputational harm even if the firm is eventually cleared of wrongdoing, when the SEC investigates an RIA in most cases the firm’s goal will be to cooperate with authorities and SEC investigators with all of the information they need to confirm compliance as expeditiously as possible, in the hopes of making a prolonged SEC investigation unnecessary.

The Preliminary Phase

According to the SEC, all investigations begin in an informal manner. Companies are not legally obligated to provide testimony or documents at this phase of the investigation. However, the SEC expects staff to comply with any requests for information. In most cases, the investigation is private at this stage.

The Formal Investigation

In some cases, the preliminary phase confirms to investigators’ satisfaction that the firm is operating in compliance with regulatory standards. If the situation appears more ambiguous, however, then after informally attempting to gather information, the SEC may launch a formal investigation. At this stage, the SEC has the authority to issue subpoenas for testimony and documentation. During this process, the SEC may freeze accounts, issue temporary restraining orders, and provide cease-and-desist orders to stop RIAs from conducting business until the investigation has run its course.

The Wells Notice

If the formal investigation discovers sufficient evidence to charge a company with violations of applicable securities law, the SEC may issue what is known as a Wells Notice, which outlines the findings of the investigation. A Wells Notice may also lay out specific charges the SEC wishes to pursue.

Final Decisions

At the end of the investigation, the investigators will submit their findings to the SEC commissioner. The commissioner will then decide whether to refer the case to the Department of Justice.

What Should a Company Do During an SEC Investigation?

Despite their familiarity with annual audits to satisfy regulatory requirements, RIAs may understandably find themselves nervous during the course of a full SEC investigation. There are a number of defensive steps companies can take when dealing the SEC investigates:

Gather as Much Information as Possible

Companies can work with Altitude Securities to gather as much information as possible during an SEC investigation. The SEC is not the only party that should be gathering data during this process, and access to more information can help companies determine the most appropriate defensive steps.

Deal With Informal Inquiries Seriously

The term “informal investigation” is somewhat misleading in the context of an SEC investigation. Even though it is not mandatory to comply with requests for information during this preliminary stage, cooperation may make sense in some situations. On the other hand, careful consideration is important before giving the SEC access to every shred of information on the books.

Carefully Respond to a Wells Notice

If the SEC issues a Wells Notice, companies have the option to respond. When drafting their responses, companies can consider guidance from outside counsel. The SEC may refer to the specific wording of Wells Notice responses when enforcing violations.

Consider Resolving the Issue Before Charges

Sometimes it is possible to resolve the issue before the SEC officially announces its charges against a company. When available, this opportunity presents numerous advantages. Settlements can protect the reputation of the company, and they may be kept private.

Get in Touch With Altitude Securities Today

While internet research provides basic information on regulatory defense during SEC investigations, outside assistance can streamline the actual implementation of these strategies. The Altitude Securities Law Office has over 30 years of collective experience in the world of financial regulatory compliance and has assisted various investment firms, individuals, and companies throughout the years with a range of legal issues. When the SEC investigates, it is a serious matter, but the results of these actions are not clear until the investigations have been concluded. There are many defensive steps companies can take while these investigations are in progress. Reach out today by calling (405) 534-4914 to learn more.