The SEC’s Market Manipulation Investigation Is Expanding: What Hedge Funds, Broker/Dealers and Other Large Institutional Investors Should Know

September 24, 2008

On Friday, September 19, 2008, the Securities and Exchange Commission announced a "sweeping expansion" of its ongoing investigation of possible manipulation of the price of equity securities of financial institutions,[1] to determine whether certain market participants engaged in illegal activity to enhance the value of short positions.  SEC Chairman Christopher Cox stated that the investigation will look into the activity of investors with significant short positions in equity markets and positions in credit default swaps.  This expansion, according to Chairman Cox, supplements ongoing SEC investigations concerning the origination and securitization of sub prime mortgage loans, the involvement of credit rating agencies and insurers in the securitization process, and the sale of mortgage-backed investments to investors.

On September 23, many newspapers reported that the Federal Bureau of Investigation has opened preliminary investigations of activity at four major businesses which either received government assistance or filed for bankruptcy protection and was continuing investigations about mortgage related issues at twenty six other companies nationwide.

Coming in the midst of market turmoil, the Commission’s September 19 announcement stated that it had approved a formal order of private investigation authorizing its Division of Enforcement to subpoena documents and require witnesses to testify.  It also announced that FINRA and NYSE Regulation examiners would be onsite at broker/dealers to review short-selling activity.  On September 22, the Commission issued orders under Section 21(a)(1) of the Securities Exchange Act of 1934 requiring written statements from market participants regarding market positions, compliance with existing short sale rules, and details of all information shared or received about specified financial institutions.  The Commission’s use of this tool – one that has not been broadly used for several years — represents a significant escalation of its enforcement efforts in this area.  Letters requesting these sworn statements have already been issued with relatively short return dates.

Market participants who receive requests for sworn written statements, trading information and other data should consider the following points:  

1.  Preserve Documents and Data.   

Recipients of the SEC’s Section 21(a)(1) order are being asked to preserve all documents pertaining to the specified financial institutions.  Penalties for failing to preserve documents and data requested by a government agency such as the SEC can be severe.  Prompt steps should be taken to preserve requested documents and data.  The failure to preserve and produce documents and data can damage an institution’s credibility with the government even if it does not result in civil or criminal government action.

Document demands by the SEC, self regulatory organizations or other government agencies may appear burdensome and create difficult compliance issues particularly in the age of electronic documents.   Many of those burdens can be alleviated through dialogue with the Commission Staff.  Thus, recipients of subpoenas or orders requiring written statements should preserve the requested documents and data first and then negotiate the scope and schedule of production or relief from the need to continue burdensome preservation requirements that may otherwise adversely affect business operations.

2. Be Precise and Accurate in Responses. 

Section 21(a)(1) responses are statements that are made under oath "by a senior officer, managing partner or director" of the recipient and are subject to the criminal penalties for perjury and for making false statements to the federal government.   The Commission may share the responses with the Congress or other agencies of government.  The responses may also have to be provided in private civil litigation and be admissible as evidence and could become public.  It is therefore essential that information provided is accurate and complete.   Reponses to questions posed by the government should not be the based on guesswork or speculation but instead on a careful analysis of the recipient’s records and data and after gathering the relevant facts from all relevant sources.  If additional time is needed to respond, then consider requesting an extension of the due date from the SEC and working out a reasonable timetable within which the information may be supplied.  If there are limits on the ability to provide information or other qualifications, they should be clearly noted in the response. 

3. Obtain Legal Assistance.

Recipients of subpoenas or orders requiring statements regarding the facts and circumstances of the investigation should obtain the assistance of counsel.  A Section 21(a)(1) order calls for, in effect, a "mini" internal inquiry.  Counsel can assist in gathering the data and documents needed to respond, preserve appropriate evidentiary privileges and the rights of the recipients, negotiate the contours and timing of the response with the SEC staff, and can advise the recipient on the legal issues presented and possible legal exposure.  Due care and precision in one’s initial responses can help avoid later difficulties.  Public outcry in times of economic stress sometimes leads to claims of illegal behavior, when, in fact, no violation of law has occurred.  The government sometimes finds that an initial belief that illegal conduct has occurred proves to be unfounded. 

Care and accuracy in responding to investigative demands for information establishes the foundation of credibility upon which facts demonstrating legitimate activity can be based.


  [1]   "SEC Expands Sweeping Investigation of Market Manipulation," September 19, 2008, available at

Gibson, Dunn & Crutcher LLP

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn attorney with whom you work,
John H. Sturc (202-955-8243, [email protected]),
Barry R. Goldsmith (202-955-8580, [email protected]) or
K. Susan Grafton (202-887-3554, [email protected])
in the firm’s Washington, D.C. office,
or any of the following: 


New York

Jonathan C. Dickey (212-351-2399, [email protected])
Lee G. Dunst (212-351-3824, [email protected])
Robert F. Serio – New York (212-351-3917, [email protected]
James A. Walden (212-351-2300, [email protected])

Washington, D.C.

Michael Bopp (202-955-8256, [email protected]
Amy L. Goodman (202-955-8653, [email protected])
F. Joseph Warin (202-887-3609, [email protected])

 Los Angeles

Thomas E. Holliday (213-229-7370, [email protected])
Marcellus A. McRae (213-229-7675, [email protected])
James J. Moloney (949-451-4343, [email protected])
Wayne W. Smith (949-451-4108, [email protected])
Debra Wong Yang (213-229-7472, [email protected]

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