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Many companies registered with the Securities and Exchange Commission (“SEC” or “Commission”), whether as a public company, an investment adviser, or a broker-dealer, will undergo an inquiry or a formal investigation by the SEC. Occasionally, much like the fictional Don Corleone in the movie “The Godfather,” the SEC will offer registrants “an offer [they] can’t refuse”: namely, the chance to provide information on a voluntary basis without the force and effect of a subpoena or another demand. But is a request truly voluntary if a refusal causes a formal investigation to be commenced?
<h5>Background on SEC Inquiries/Investigations and Sweeps</h5>
The SEC generally begins its informal investigative process by undertaking a preliminary inquiry, or Matter Under Inquiry (“MUI”), which provides the Staff an opportunity to determine whether the facts underlying the MUI “show that there is potential to address conduct that violates the federal securities laws.”<a href="#1">[1]</a> Generally, MUIs are closed or converted into an investigation within 60 days,<a href="#2">[2]</a> at which time, SEC staff (the “Staff”) may obtain a formal order of investigation. Once the formal order is issued, the Staff attorneys assigned to the matter are given the power to issue subpoenas. Parties to informal investigations are provided the same protections as those who are parties to formal investigations, such as those noted on Form 1661 and Form 1662, both of which provide information on, for example, the Fifth Amendment, right to counsel, going off the record, and consulting with counsel.<a href="#3">[3]</a>

The SEC also conducts “sweeps,” which generally originate in either the SEC’s Division of Examinations or Division of Enforcement. The general purpose of an SEC sweep is to gather information related to an industrywide compliance risk area. The sweep may be for the purposes of gathering information on companies’ operations, assessing the effectiveness of companies’ compliance programs, and reviewing the procedures and controls surrounding the production of documents. The sweep may be in response to information suggesting that numerous companies in an industry may have violated the securities laws. The subject line of these sweeps is usually general and references the initiative (e.g., Paycheck Protection Program Loan Recipients, Cybersecurity-Related Events) rather than a specific company.
<h5>Voluntary Requests</h5>
During an inquiry or investigation, Commission Staff may request the voluntary production of documents or information, or the voluntary creation of documents (such as chronologies).<a href="#4">[4]</a> At the outset of the Staff’s inquiry, voluntary document requests may be a way for the Commission to gather documents, data, and other information to help it “assess the merits of an investigation at its earliest stages before the staff opens an investigation or the Director [of Enforcement] approves the issuance of a formal order.”<a href="#5">[5]</a> However, the Staff may issue voluntary requests at any point.

The Staff’s decision to proceed in this informal manner is not an indication of the seriousness of its investigation. While a request for a voluntary production does not have the same force and effect as a subpoena, a failure to comply with the request may nevertheless result in various consequences. Accordingly, the use of the word “voluntary” is a misnomer in the traditional sense of the term. The Staff (1) could issue a subpoena for the same information or, perhaps, more information; (2) may become inclined to seek the testimony of company officials; and (3) may make assumptions regarding a company’s veracity, record-keeping, or compliance-related protocols. Moreover, because cooperation is significant in resolving matters, a failure to adhere to the SEC’s voluntary production request may result in the Staff being less lenient in negotiating a resolution.

Companies are placed in a more favorable position if they provide to the Staff documents and information sufficient to avoid the possibility of receiving a formal order directed specifically at the company. This is because, as stated above, the Staff is often moved by a company’s willingness to cooperate, which in turn could shape the outcome of the investigation, including its resolution. Furthermore, from an optics perspective, a formal order initiating an investigation against a specific company (as opposed to an MUI or a general sweep) could pose a threat to the company’s reputation and have market consequences because, more often than not, companies tend to disclose the existence of a formal investigation to their shareholders and in public filings.
<h5>Need to Preserve Documents</h5>
It is well established that a duty to preserve evidence, including electronically stored information (“ESI”), arises when litigation is “reasonably anticipated,”<a href="#6">[6]</a> although what constitutes reasonably anticipated and how it is applied to a specific case in a jurisdiction differ. The SEC Enforcement Manual states that “[a] duty to preserve ESI and paper records generally arises when litigation is reasonably anticipated or foreseeable, as well as when litigation is pending.”<a href="#7">[7]</a>

In addition, a knowing failure to maintain documents subject to the voluntary request by the SEC could invoke 18 U.S.C. 1519, which makes it a federal crime to “knowingly destroy ... any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States.”

Accordingly, once a company learns of the possibility of an SEC inquiry (which includes receiving a voluntary request), it should consult with qualified securities counsel to determine whether the duty to preserve evidence is triggered and, if so, what steps must be taken to comply with this duty. Counsel must then educate themselves about company-specific electronic documents and data storage processes. Thus, as soon as a company learns of an SEC inquiry, counsel and compliance personnel should focus on preservation obligations and take immediate steps to acquaint themselves with the universe of documents responsive to likely requests or inquiries. Many times, an SEC voluntary request will include a request to preserve documents and records. Astute counsel will work with the SEC to appropriately narrow this preservation request where possible. Thereafter, appropriate steps to preserve should be undertaken, such as distributing litigation holds and taking necessary action to preserve electronic and paper records.
<h5>Anticipating the Next Step</h5>
The Division of Enforcement is a powerful federal law enforcement authority that has a statutory mandate to investigate and civilly prosecute violations of the federal securities laws. Consequently, its requests for information are never for informational purposes only, no matter how “voluntary” a request may seem. At best, a voluntary request is a warning shot across the bow, and recipients are well advised to quickly conduct their own internal inquiries to ascertain any potential liability. Individual officers should also consider seeking their own counsel if their conduct is at the center of the inquiry.

The BakerHostetler Securities Enforcement Defense team is comprised of experienced individuals, many of whom have served in the SEC’s Enforcement Division headquarters, New York regional office, and Office of the General Counsel. Please feel free to contact any one of our experienced professionals if you have questions about this alert.

<em>Authorship Credit: Jon Barr, John J. Carney, Teresa Goody Guillén, and Michelle N. Tanney</em>

<hr>

<a id="1" name="1"></a>[1] U.S. Sec. &amp; Exch. Comm’n, Div. of Enforcement, Enforcement Manual (Nov. 28, 2017) at § 2.3.1.
<a id="2" name="2"></a>[2] <em>Id.</em>
<a id="3" name="3"></a>[3] <em>Id</em>. at § 3.2.3.1.
<a id="4" name="4"></a>[4] <em>Id</em>. at § 3.2.3.
<a id="5" name="5"></a>[5] <em>Id</em>.
<a id="6" name="6"></a>[6] <em>See</em>, e.g., <em>CAT3, LLC v. Black Lineage, Inc.</em>, 164 F. Supp. 3d 488, 496 (S.D.N.Y. 2016) (<em>quoting </em>Report of Advisory Committee on Civil Rules, App. B-15 (Sept. 2014)).
<a id="7" name="7"></a>[7] <em>Id</em>. at § 3.2.9.4.

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