Last Updated on: 11th October 2023, 04:36 pm

The SEC, or Securities and Exchange Commission, is the main federal agency responsible for enforcing securities laws and regulating the securities industry in the United States. The SEC’s Division of Enforcement investigates potential violations of securities laws and can bring civil enforcement actions against individuals or companies found to have broken the law. But what exactly triggers an SEC investigation in the first place?There are a number of common reasons the SEC may open an investigation into a company or individual. Here’s an overview of some of the main things that can lead to an SEC investigation:

Selling Unregistered Securities

Companies that offer securities like stocks and bonds are required under the Securities Act of 1933 to register those securities with the SEC, unless an exemption applies. Selling unregistered securities when registration is required can lead to an SEC investigation and charges. The SEC wants to make sure companies provide adequate disclosures to investors about the investment.

Accounting Fraud

Public companies are required to file regular financial reports with the SEC. If the SEC suspects a company’s financial disclosures contain material misstatements or accounting fraud, it may open an investigation. Common accounting issues that can draw SEC scrutiny include revenue recognition violations, improper asset valuations, and failure to disclose material transactions or events.

Insider Trading

Trading securities based on material, non-public information is illegal under U.S. securities laws. The SEC often investigates when it suspects insider trading has occurred. This could involve a company executive trading shares based on confidential corporate information before it’s made public. Or it could be an outsider who trades on tips they received from a corporate insider.

Misleading Disclosures

When a public company files reports and press releases with the SEC, the information must be complete and accurate. If the SEC believes a company has made false or misleading statements that could impact investment decisions, it may initiate an investigation. This applies to disclosures related to financials, operations, business risks, management changes, and any other material information.

Market Manipulation

It’s against the law to manipulate the prices of securities through practices like wash trading, churning, spoofing, or pump-and-dump schemes. If the SEC identifies suspicious trading patterns or activities that seem intended to artificially inflate or deflate prices, it will often investigate to determine if market manipulation has occurred.

Stealing Client Funds

The SEC regulates broker-dealers and investment advisors and expects them to treat customer accounts and funds with the utmost care. If the SEC receives a tip or complaint that a securities firm or registered rep misappropriated client money, they will likely investigate. This could lead to charges as well as a bar from working in the industry again.

Ponzi Schemes

The SEC is on high alert for Ponzi or pyramid schemes that use money from new investors to pay earlier investors. Many recent SEC cases have involved exposing and shutting down Ponzi schemes before more people lost money. Red flags for Ponzi schemes include consistently high, unlikely returns and a focus on recruiting new investors rather than selling products or services.

Violations of Books and Records

Public companies must make and keep detailed books and records so their financial activities can be audited and monitored for wrongdoing. Intentionally keeping inaccurate books and records is a violation the SEC often investigates. This includes omitting material transactions as well as making false or misleading entries.

Failure to Supervise

Securities firms and advisors have a legal duty to properly supervise their employees and agents. If the SEC receives complaints about a brokerage or advisor failing to supervise reps who’ve broken the law, they may open an investigation into the firm itself. Senior executives who did not take adequate steps to detect and prevent violations could also face charges.

Whistleblower Complaints

The SEC has a whistleblower program that allows people to anonymously report potential securities law violations. Whistleblower tips have become a major source of SEC investigations and enforcement actions. The agency takes all credible whistleblower complaints seriously and investigates many of them.

Referrals from Other Agencies

The SEC often works jointly with other regulators and law enforcement agencies. If FINRA, the CFTC, FBI, or other agencies uncover possible securities violations during their own investigations, they routinely refer matters to the SEC for investigation.

Complaints from Investors

When investors complain to the SEC that they lost money due to potential misconduct or fraud, the agency reviews each complaint carefully. If the investor provides credible evidence of securities law violations, the SEC will likely open an investigation – especially if multiple investors file similar complaints.The SEC has broad discretion to investigate whenever it suspects material violations of securities laws have occurred. Some cases clearly warrant investigation based on strong evidence up front. In other instances, the SEC may conduct an initial informal inquiry before deciding whether to proceed with a full investigation.Companies and individuals should treat any contact from the SEC seriously, even if it’s just a request for information. In many cases, responding promptly and cooperating with SEC requests can help resolve the matter faster. But if the issues involved are complex or serious, it’s usually wise to consult with legal counsel experienced in SEC matters right away.While SEC investigations are not public, charges resulting from an investigation are made public through court filings or administrative orders. If companies or individuals settle with the SEC, they often do so without admitting or denying wrongdoing. Companies usually agree to pay fines, penalties, or restitution to harmed investors, while individuals can face industry bars, officer and director bans, fines, and disgorgement of any ill-gotten gains from the misconduct.The bottom line is that a wide range of activities can trigger an SEC investigation, from accounting issues and insider trading to Ponzi schemes and misleading disclosures. While the SEC does not disclose details of ongoing investigations, companies and individuals should engage experienced securities counsel immediately if they receive any requests from SEC staff to avoid potentially severe regulatory consequences. With the right legal guidance, some SEC investigations can be resolved favorably or even avoided entirely.