SEC Investigation Confidentiality Rules

SEC Investigation Confidentiality Rules

SEC investigation “confidentiality” is a one-way mirror. The SEC keeps your investigation secret from the public – you can’t call them and ask if you’re under investigation, they won’t confirm or deny anything to reporters. But you? You have to tell everyone who matters. Your board of directors. Your audit committee. Your independent auditors. Your D&O insurance carrier. Potentially every shareholder if the investigation is material. And here’s what nobody mentions: every third party the SEC contacts – former employees, vendors, customers – has zero duty to keep quiet. They can call a reporter the moment the SEC staff leaves. The confidentiality protects the SEC’s process. Not you.

This is the fundamental misunderstanding people have about SEC investigation confidentiality. They hear “confidential” and think it means nobody will know. Wrong. It means the SEC won’t publicly confirm or deny. That’s it. Meanwhile, knowledge of the investigation spreads through channels you can’t control. Your company’s lawyers know. Your board knows. Your auditors know – and they may force you to disclose under accounting standards. Your insurance carrier knows. Every witness the SEC interviews knows. The “confidential” investigation is simultaneously secret and common knowledge, depending on who you ask.

Research from Wharton tells the real story. Only 19% of companies disclose SEC investigations at the outset. The other 81% try to keep it quiet under the “confidentiality” umbrella. But the median stock decline is 5.73% within one year of a formal investigation opening, and 9.35% within two years. That decline happens whether you’ve disclosed or not. The market finds out. Former employees talk. Industry rumors spread. And when the Wall Street Journal finally breaks the story – like they did with Under Armour in 2019 after two years of undisclosed investigation – your stock drops 19% in a single day. Two years of confidentiality protected nothing. It just delayed the damage while multiplying the surprise.

The One-Way Mirror: Who “Confidentiality” Actually Protects

Heres what the SEC means when they say investigations are confidential. There policy is to conduct investigations on a confidential basis to “preserve the integrity of its investigative process” and to “protect persons against whom unfounded charges may be made.” Sound like protection for you? Read it again. The integrity of THERE process. Protection against UNFOUNDED charges – meaning if charges ARE founded, all bets are off. The confidentiality exists so the SEC can build there case without tipping off targets or witnesses. Its about there effectiveness, not your reputation.

The SEC cant disclose the existence or non-existence of an investigation under most circumstances. They wont confirm anything to reporters, they wont tell your competitors, and if someone calls asking if your under investigation, the answer is always “we cannot confirm or deny.” But that protection evaporates the moment enforcement action is filed. Then they issue press releases. They post everything on SEC.gov. Your name, the allegations, the details – all public. And by “public,” I mean indexed by Google forever. The confidentiality was never meant to protect you. It was meant to let them build the case without interference.

Everyone You Have to Tell About Your “Confidential” Investigation

OK so lets talk about who actualy has to know about your “confidential” SEC investigation. Becuase its alot more people then you think. Start with your board of directors – they need to know immediatly. This is a material development affecting the company. Your audit committee definately needs to know. Your general counsel probly already knows, which is why your reading this. But heres were it gets interesting: your independent auditors. The accountants who sign off on your financial statements. They need to know to, and keeping them in the dark is almost never advisable according to every major law firm that handles these cases.

Heres why the auditors matter so much. There concerned about several things when an SEC investigation is underway. Is a restatement necessary? Can they rely on managements representations? Might there prior audits become part of the investigation? Your auditors may strongly encourage you to disclose the investigation publicaly. Some will insist on it. And if they threaten to delay signing off on your SEC filings unless you disclose, you basicly have no choice. The “confidential” investigation just became public becuase your accountants made you tell everyone.

Then theres insurance. Your D&O insurance policy almost certainly requires notification of claims or circumstances that could give rise to claims. An SEC investigation qualifies. If you dont notify your carrier and later need coverage, they can deny the claim for failure to provide timely notice. So add your insurance company to the list of people who know about your “confidential” investigation. Same with outside counsel – obviously they know. Same with investor relations if your planning how to handle questions. The circle of people “in the know” expands faster then you’d expect.

And thats just the people YOU tell. The SEC is contacting witnesses seperately. Former employees. Current employees. Vendors. Customers. Business partners. Anyone who might have relevent information. None of these people have any confidentiality obligation. The SEC wont swear them to secrecy. There free to discuss the investigation with anyone they want, including the press. Your former CFO gets a subpoena, mentions it to a former collegue, that collegue mentions it at an industry conference, and suddenly everyone in your sector knows the SEC is looking at you. So much for confidentiality.

Heres the kicker. Item 103 of Regulation S-K requires disclosure of “material pending legal proceedings known to be contemplated by government authorities.” Item 303 requires disclosure of “known trends or uncertainties” that could have material impact. If your SEC investigation is material – and many are – you might have an affirmative duty to disclose it in your next 10-K or 10-Q. The “confidential” investigation becomes a required disclosure item. You didnt leak it. The securities laws forced your hand.

Theres also ASC 450 to worry about. Thats the accounting standard that addresses disclosure of “loss contingencies.” If the SEC investigation could result in material losses – fines, penalties, disgorgement – your auditors will push for disclosure under ASC 450. The confidentiality you thought you had gets overridden by accounting standards. People think there keeping the investigation quiet, but the regulatory framework dosent actually let you do that if the stakes are high enough.

The Third-Party Problem: Why Your Secret Is Already Out

Lets be very clear about the third-party issue becuase this is were most peoples understanding of confidentiality falls apart. The SEC conducts investigations by talking to witnesses. Alot of witnesses. These witnesses include current employees, former employees, customers, vendors, counterparties, analysts, anyone who might have relevent information. The SEC dosent require these witnesses to sign NDAs. They dont swear them to secrecy. Every single witness is free to discuss there interaction with SEC staff with anyone they want.

Think about what this means practicaly. The SEC contacts a former employee who left on bad terms. That person has zero loyalty to your company. They answer the SECs questions, then call a reporter they know. Or they post on LinkedIn that “regulators are looking into interesting things at my former employer.” Or they just tell friends in the industry, and the information spreads from there. You have no control over this. None. The confidentiality you think exists is actually a fiction maintained only at the SECs discretion – and the SEC isnt silencing witnesses.

Ive seen cases were companies thought there investigation was completly confidential, then discovered that half there industry already knew about it. How? Former employees talked. Vendors who recieved document requests talked. Customers who got contacted talked. By the time the company realized the investigation was common knowledge, the damage to there reputation was already done. They just didnt know it yet. The “confidential” investigation had been an open secret for months.

The Insider Trading Trap Nobody Warns You About

Heres something genuinly terrifying that most people dont consider. Knowledge of your companys SEC investigation is almost certainly material nonpublic information. MNPI. The same category of information that triggers insider trading liability. Which means the moment you learn your under SEC investigation – and you decide not to disclose it publicaly – you may have created an insider trading trap for yourself and everyone else who knows.

Think about it. You know about the investigation. The investigation is material – if disclosed, it would affect the stock price. You havent disclosed it. Now you want to sell some stock. Can you? The answer isnt clear, and thats the problem. Wharton research found that in many cases, undisclosed SEC investigations “provide insiders with a considerable information advantage, which many insiders appear to exploit for personal gain.” Translation: people are trading on knowledge of there own companys investigation, and the SEC notices.

So now your in a trap. You can disclose the investigation and watch your stock drop (22% in one case, just from disclosing an SEC subpoena in a 10-Q). Or you can not disclose, sit on the MNPI, and risk insider trading charges if anyone who knew about the investigation traded during the quiet period. This is the confidentiality trap nobody warns you about. Your trying to keep the investigation confidential, but the confidentiality itself creates additional legal exposure. The disclose-or-abstain rule that governs officers and directors means you either tell the market or you dont trade. There is no third option.

Disclose or Don’t: Both Paths Lead to Lawsuits

So what happens if you disclose the investigation? Stock drops. In one documented case, a company disclosed recieving an SEC subpoena in its Form 10-Q, resulting in a 22% drop in stock price. Shareholders sue. They claim the investigation must mean something is wrong. They want to recover there losses. You now face SEC investigation PLUS shareholder litigation, and you havent even been charged with anything yet.

What happens if you dont disclose? If the investigation turns out to be material and it later becomes public – through media reports, through SEC enforcement, through third-party leaks – shareholders sue anyway. They claim you hid material information. They point to the trading that happened while insiders knew. They want damages. Under Armour learned this when the Wall Street Journal broke news of a two-year SEC investigation they hadnt disclosed. Stock dropped 19% in a day. Lawsuits followed. Two years of confidentiality gave them nothing but delayed litigation.

This is why the decision to disclose or not disclose is so difficult. Neither path is safe. Disclosing can cause immediate stock decline and litigation. Not disclosing can result in worse litigation later plus potential insider trading exposure. The research shows companies are roughly evenly split – 19% disclose at the outset, 44% disclose by conclusion, meaning more then half never voluntaraly disclose at all. But the outcomes for non-disclosers arent necessarily better. The market adjusts either way, eventually.

The Under Armour Lesson: Two Years of Confidentiality, 19% Stock Drop in One Day

Under Armour provides the clearest example of what “confidentiality” actually means in practice. The SEC began investigating the companys accounting practices. The company kept it confidential. For more then two years, no public disclosure. The investigation remained a secret – or so they thought. Then in November 2019, the Wall Street Journal published an article revealing the investigation. Stock dropped 19% in a single day.

Two years of confidentiality. Two years of not telling shareholders. Two years of executives knowing about an investigation that could materially affect the company. And then one news article erased any benefit the confidentiality might have provided. The stock drop was actually worse then it might have been with early disclosure, becuase now it came with the additional revelation that management had known for two years and said nothing. Confidentiality didnt protect anyone. It just made the eventual disclosure more damaging.

If your relying on investigation confidentiality to protect your company or your reputation, the Under Armour case should give you pause. The SEC wont tell the press about your investigation. But they dont need to. Former employees will talk. Vendors will talk. Eventually, a reporter will connect the dots. And when they do, your stock drops just as hard as if youd disclosed yourself – except now you also look like you were hiding something.

What “Confidential” Actually Means for Your Investigation

So what does SEC investigation confidentiality actually give you? Not much, when you think about it carefully. The SEC wont confirm your investigation to random callers. They wont issue press releases until enforcement action is filed. They wont tip off your competitors directly. Thats the entire scope of the protection. Meanwhile, you have to notify your board, your auditors, your insurance company. Witnesses can talk to anyone. Accounting and securities rules may force disclosure. Your own knowledge creates insider trading risk.

The confidentiality also comes with a warning nobody reads. Form 1662, which the SEC provides to every witness, explicitly states that information gathered “may be shared with criminal law enforcement agencies, both federal and state.” So the SEC investigation is confidential from the public, but not from the Department of Justice, not from state attorneys general, not from other regulators. The same documents and testimony you provide in the “confidential” civil investigation can end up in a criminal prosecution file.

If your facing an SEC investigation, understand what confidentiality actually means. It means the SEC wont publicize the investigation until they file charges. Thats all. It dosent mean nobody will find out. It dosent mean you can keep trading your stock. It dosent mean your auditors wont force disclosure. It dosent mean witnesses will stay quiet. The “confidentiality” is narrower then it sounds, and the consequences of misunderstanding it – insider trading exposure, shareholder litigation, surprised board members – are severe. Get legal counsel who understands these dynamics before making any decisions about what to disclose and when.