Federal Securities Fraud: SEC Enforcement and Criminal Prosecution
Quick Overview
A guide to federal securities enforcement, covering SEC investigations, insider trading, market manipulation, Ponzi schemes, and the intersection of civil and criminal securities proceedings. Includes defense strategies and the role of whistleblowers.
Table of Contents
Federal Securities Enforcement Framework
How Securities Laws Are Enforced
The Securities Exchange Act of 1934 and SEC Rule 10b-5 are the primary tools for combating securities fraud. Rule 10b-5 makes it unlawful to employ any device, scheme, or artifice to defraud, make untrue statements of material fact, or engage in any act that operates as a fraud in connection with the purchase or sale of any security.
Insider trading is prosecuted under the misappropriation theory established in United States v. O'Hagan (1997) and the classical theory from Chiarella v. United States (1980). The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for civil penalties of up to three times the profit gained or loss avoided.
The SEC's Division of Enforcement investigates potential violations through formal and informal investigations. Formal orders of investigation grant subpoena power to compel testimony and document production. The SEC can bring civil enforcement actions in federal court or through administrative proceedings before an administrative law judge.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 significantly expanded the SEC's enforcement toolkit, including the whistleblower program under Section 21F, which provides financial incentives for individuals who report securities violations that lead to successful enforcement actions exceeding $1 million.
Defense Strategies in Securities Cases
Responding to SEC Investigations and Criminal Charges
Early engagement with SEC staff during the investigation phase can influence the outcome. Wells submissions—written arguments presented before the SEC decides whether to file charges—provide an opportunity to present the defense's version of events and argue against enforcement action.
Parallel proceedings present unique challenges when both the SEC and DOJ are investigating the same conduct. Defense counsel must carefully navigate the Fifth Amendment implications of civil discovery while criminal proceedings are pending, as testimony in SEC proceedings can be shared with criminal prosecutors.
Challenging materiality is a common defense in securities fraud cases. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. Expert testimony from financial analysts can help establish that the alleged misrepresentation was not material.
The SEC's whistleblower program has become a significant source of enforcement referrals. Companies should implement robust internal compliance programs and reporting mechanisms to identify and address potential violations before they are reported to the SEC.
External Resources & References
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