The Perils of an SEC Investigation

May 28, 2009

This week Pequot Capital Management announced that it will wind down in the wake of public disclosures that the government has reopened a previously closed investigation of potential insider trading.  The announcement is a stark reminder of the high costs that can be imposed by a pending  government investigation irrespective of the outcome and reinforces the need to (1) prevent investigations, and, if they cannot be avoided, (2) conclude them successfully and rapidly.  Lingering investigations can impair, if not threaten, the viability of an enterprise.  This is especially true for financial institutions, for whom client trust is essential and, in the present environment, fragile. 

Recent statements and actions by regulators, encouraged by Congress, make clear that government investigations of financial institutions and of financial reporting generally will increase.   Thus, the SEC recently disclosed that in the first few months of the new administration, it has issued more than twice the number of formal orders of investigation over the same period last year.  In addition, recent legislation has authorized additional funds, and the administration has requested significant budget increases, for the SEC and for federal prosecutors to devote their attention to investigations of alleged financial fraud. 

Several steps are key to avoiding an enforcement investigation or minimizing its effect.

First, compliance with the securities laws is necessary, but not sufficient.  Not all compliance issues are readily resolved; rather, many involve the exercise of judgment.  Thus, ensuring that the business has a sound compliance infrastructure, including the right tone at the top and effective internal controls and mechanisms for the detection and reporting of potential violations, will help convince skeptical regulators that judgmental decisions are appropriate and that any deviation from compliance is an aberration.  This also means periodically reevaluating and revising the compliance structure as the business grows and evolves and the risks change over time.

Second, when red flags arise, follow up to determine if a real problem exists and, if so, take appropriate remedial actions.  This includes creating and preserving a documentary record of the investigative steps taken and the remedial results obtained, so that if the government comes calling later, the company is able to demonstrate a reasonable response to the potential problem.  In particular, if you are an SEC registered firm, and subject to periodic inspection by the staff, use the examination as an opportunity to resolve potential problems before they are referred to the Enforcement Division. 

Finally, if the government commences an investigation, get ahead of the problem and assess whether it is possible to expedite a resolution.  Even with expanded resources, the government must still  focus its resources and effectively manage its caseload, creating an opportunity, under the right circumstances, to demonstrate that a full-fledged investigation is unnecessary, or at least that an early resolution is appropriate.  The key is to avoid the outcome where the investigation alone threatens the very survival of the enterprise.

Gibson, Dunn & Crutcher LLP

Gibson Dunn is one of the nation’s leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators.

Our Securities Enforcement Group offers broad and deep experience. Our partners include the former Director of the SEC’s prestigious New York Regional Office, a former Associate Director of the SEC’s Division of Enforcement, the former Director of the FINRA Department of Enforcement, the former general counsel of the PCAOB, the former United States Attorney for the Central District of California, and former Assistant United States Attorneys from federal prosecutor’s offices in New York, Los Angeles, and Washington, D.C.

Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Practice Group, and our White Collar Defense Group.

Gibson, Dunn & Crutcher attorneys are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work or any of the following: 

New York
Mark K. Schonfeld (212-351-2433, [email protected]
Lee G. Dunst (212-351-3824, [email protected])
Jim Walden (212-351-2300, [email protected])
Lawrence J. Zweifach (212-351-2625, [email protected])
Alexander H. Southwell (212-351-3981, [email protected])

Washington, D.C.
Barry R. Goldsmith (202-955-8580, [email protected])
John H. Sturc
(202-955-8243, [email protected])
K. Susan Grafton (202-887-3554, [email protected])

Los Angeles
Michael M. Farhang (213-229-7005, [email protected]
Douglas M. Fuchs (213-229-7605, [email protected])

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