latham logo 1The SEC is the primary regulatory body charged with the enforcement of the U.S. securities laws. Most insurance and legal professionals are well-aware of the agency and familiar with its regulatory role. But in an era that has been (at least up until now) characterized by heightened enforcement activity, many of those professionals may be unfamiliar with the agency’s investigative and enforcement process and protocols. In the following guest post, Ted Carleton and Tammy Yuen of the Skarzynski Black law firm and John Sikora of the Latham & Watkins law firm provides a basic outline of the SEC’s investigative and enforcement processes, reviews some recurring D&O insurance coverage issues arising from SEC investigations and enforcement actions, highlights some of the current issues at the agency, and take a look ahead at what the change in administration may mean. I would like to thank Ted, Tammy, and John for their willingness to publish their guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Ted, Tammy and John’s guest post.



Investigations and enforcement actions by the United States Securities Exchange & Commission (the “Commission” or the “SEC”) continue to be a hot topic for the D&O insurance industry and the white collar defense bar.  Political fallout in the wake of the 2007-2008 financial crisis, and the passage of Dodd-Frank, led many to predict the dawn of a new regulatory enforcement era.  Whether those predictions ultimately proved to be accurate, since the financial crisis, the SEC has used a substantially increased budget to beef up the agency’s staffing, improve its information technology and enhance the agency’s industry expertise by hiring outside experts and forming specialty units within the Enforcement Division.   Chair Mary Jo White and Enforcement Director Andrew Ceresney, who worked together as federal prosecutors, oversaw an enforcement program that substantially increased the number of enforcement actions brought and touted numerous “first ever” cases.

With the uptick in enforcement activity, many parties and defense counsel unfamiliar with SEC enforcement encountered the agency and its enforcement staff for the first time.   The scope and process of the Commission’s activities can be confusing and opaque to practitioners who do not frequently encounter these procedures.  This article provides a basic outline of the Commission’s process and protocols with respect to investigations and enforcement proceedings, and highlights some current issues relevant to parties who may become enmeshed in a regulatory action, as well as to the D&O or other professional liability carriers who may provide insurance for the legal fees incurred in such an action.  This article also looks ahead to possible changes that may occur under the new Trump administration.

I. The Investigation Process

THE MUI—The Prologue to SEC Enforcement Actions:  The SEC investigation process begins with what is called a “matter under inquiry” or MUI.  This is also known as the “informal” investigation stage.  The primary difference between the informal and formal investigation is that during the informal investigation, the SEC staff does not have the power to compel documents and witness testimony via subpoena.

SEC staff lawyers are given broad discretion to open MUIs, which are preliminary in nature and typically involve incomplete information.  The purpose of the MUI is to gather additional facts to help the SEC staff determine whether to recommend that the Commission pursue a formal investigation.  The SEC staff generally keeps the MUI stage open for no more than two to three months—after which there is an expectation that they will determine whether further investigation is warranted.   During the MUI stage, the SEC staff will often send letters to parties whom it believes possess information relevant to the informal investigation.  As noted above, these requests for information are not made via subpoenas as the SEC staff does not have subpoena authority during the MUI stage.  Rather, the SEC staff may only compel compliance from entities regulated by the SEC such as broker-dealers and registered investment advisers (e.g., managers of mutual funds and private funds) who are required to produce many records kept in the ordinary course of their business (e.g., a broker-dealer must produce customer account statements to the SEC staff since these are required books and records).  While non-regulated recipients receiving informal requests for information from the SEC staff are not compelled to provide information, SEC-regulated entities in particular have a strong incentive to cooperate and provide whatever documents are requested beyond those kept in the ordinary course because cooperation may foster a positive relationship with the SEC staff, which can be invaluable if the regulated entity or its employees are the focus of the MUI.  During this time, SEC staff attorneys may also, and frequently do, contact individuals to request voluntary interviews.

The Formal Investigation:  A MUI becomes a formal investigation when senior members of the SEC staff approve, through a delegation of authority from the Commission, the issuance of a formal order of investigation.  Critically, it is at this stage that the staff attorney handling the MUI gains subpoena power—and can now compel the production of documents and the appearance of witnesses for sworn on-the-record testimony.   While the order may “issue”, it is not released publicly.  However, one can be certain that, once a subpoena is sent by the SEC staff, a formal order of investigation has issued.  Parties that receive a subpoena may formally request a copy of the formal order of investigation from the SEC staff, and will generally receive a copy provided they agree to certain confidentiality restrictions.

SEC investigations, even after the SEC staff obtains a formal order of investigation, are fact-finding in nature and parties subject to the investigation have not been alleged to have engaged in any wrongdoing.  As a result, formal orders of investigation are typically vague and do not provide much information about any wrongful acts that may ultimately be alleged or who may have engaged in wrongdoing.   Keeping with the fact-finding nature of the investigation, the SEC staff does not identify formal targets (in direct contrast to Department of Justice Procedure which frequently involves the issuance of “target letters”) either in the formal order of investigation, the subpoena, or orally as part of discussions with counsel.  This can be critical from the defense perspective, because oftentimes only a very experienced regulatory lawyer may be able to ascertain from the subpoena and discussions with staff attorneys whether their client is likely to be in the line of fire, or merely a collateral source of information. This point is also critical to the insurance coverage practitioner, because coverage for the Commission’s undertakings is often predicated on an insured being accused of a Wrongful Act, and the SEC staff will generally be careful not to accuse an individual or entity of a wrongful act at the formal investigation stage.  This point of SEC practice may be of particular relevance to questions of coverage under many D&O forms.

The Wells Process:   As investigations ripen, the SEC staff will often invite “white paper” submissions and “pre-Wells” meetings to narrow the anticipated legal theories of liability and test the likely defenses to the staff’s theories.  A white paper or a pre-Wells meeting may head off a Wells notice if defense counsel presents strong legal arguments, new facts or compelling analysis demonstrating defects in the SEC staff’s preliminary theories.

There comes a point during the investigation process where the SEC staff may determine it has sufficient evidence to recommend formal charges against a party.  At this juncture—and at the SEC staff’s option—the staff lawyers may formally advise a party under investigation of this intent via the document commonly known as the “Wells Notice.”  The Wells Notice is not a formal charging document, but merely notice to the party that the staff has sufficient evidence to recommend that the Commission bring certain charges and seek certain relief.  The Wells Notice typically contains the following information: (1) that the SEC staff has made a preliminary determination to recommend that the Commission commence an action against the party; (2) the specific laws and regulations that the Commission believes may have been violated; (3) the items of relief the SEC staff will recommend against the party, and (4) an invitation to make a submission (a “Wells Submission”) to the Commission concerning the recommended course of action.

During the Wells process, the SEC staff may be more forthcoming about their view of the facts uncovered in the investigation and the potential areas of exposure they see for the party subject to the Wells notice.  The Wells Submission provides parties with an opportunity to highlight deficiencies in the SEC staff’s theories.  Defense counsel usually has at least one opportunity for a Wells meeting in which they can present the defense view of the case to some of the most senior staff members in the Enforcement Division.

During the course of the Wells process, the SEC staff may modify or drop the charges it included in the Wells notice and the Commission itself may decline to pursue some or all of the charges that the staff preliminarily recommended against a party based on the evidence mustered and arguments made during the Wells process.

Consent Decree Settlements:  The Commission may reach settlement terms with a party either prior to or during the Wells process.  Procedurally, this takes the form of the simultaneous filing of a civil complaint or institution of an administrative proceeding with settlement papers (the “Consent Decree”) that set forth the terms of a party’s settlement with the Commission.  The majority of these settlements are made on a “neither admit nor deny” basis and typically contain language that the Commission’s findings are “not binding on any other person or entity in this or any other proceeding.”  The language in a “neither admit nor deny” settlement generally limits the settlement’s potential res judicata effect on subsequent related civil proceedings.

The Civil Action:  If the Commission does not reach a settlement with an investigated party, civil litigation ensues.  The Commission will bring a formal complaint or order instituting proceedings alleging civil violations of the federal securities laws.  Much ink has been spilled as of late with respect to the forum the Commission chooses to bring such actions, as it has recently shown a preference to proceed before administrative law judges as opposed to United States District Courts.  Defendants have raised a number of objections to this forum selection, arguing that the deck is stacked in the Commission’s favor since the judges are appointed by the Commission and that the SEC administrative process does not afford defendants due process.  There have been several well publicized legal challenges to the SEC’s choice of the in-house administrative forum, but no court has yet overturned the SEC’s decision to pursue a case administratively rather than in federal district court.

II. Insurance Coverage Issues

What is a Claim:  A decade ago, the majority of public company D&O insurance forms did not expressly address when—if at all—an SEC investigation, whether formal or informal, was covered.  Accordingly, there was a significant amount of litigation over whether the receipt of an SEC subpoena by an Insured Person was a covered Claim.  In subsequent years, most forms have been revised or amended by endorsement to expressly articulate whether, and if so under what circumstances, coverage for receipt of a subpoena by an Insured Person is offered.  Further still, several forms and endorsements now expressly afford defense costs coverage for voluntary interviews or requests to produce documents, which will respond to attorney’s fees incurred by Insured Persons during informal investigations.


What remains largely unaddressed by these changes in policy language is the question of coverage for an Insured Entity.  Historically, D&O coverage was limited to coverage for Insured Persons to the extent they were indemnified by the Company.   Entity coverage was later added, but, in the public company context, was restricted to a specific subset of claims, Securities Claims, which were typically limited to Claims alleging a violation of a securities law or rule.


Against this background, most forms do not afford the Insured Entity stand-alone coverage for any Investigation-stage proceeding against the Company.  Rather, such coverage is generally afforded—often by endorsement—if and only if, and only so long as, the investigation simultaneously proceeds against an Insured Person.  This is consistent with the historical scope of D&O insurance, which was to provide broad coverage for Insured Persons for Wrongful Acts, but limited entity coverage in the form of Securities Claim coverage.

Interrelated Claims:  Because SEC investigations can have a very broad scope, the SEC may issue informal and formal requests for information to many different parties seeking a wide range of information.  Because of the secrecy that surrounds SEC and other government investigations, it can be difficult to know what potential wrongful acts the SEC is investigating.  Thus, it is not uncommon for a single entity to get multiple requests for information from the SEC over the course of many years.  If, and when, an investigation develops into a Claim, it may be difficult to determine the date of Claim and whether the Claim is related to an earlier request for information.

III. Current Enforcement Trends & Related Observations

With the change in presidential administration will come a change in the composition of the five-member SEC Commission.   Chair White will be replaced as Chairman by an individual appointed by President Trump.  Trump has nominated Jay Clayton, a corporate transactional lawyer in private practice with Sullivan & Cromwell.  Clayton’s enforcement priorities are a complete unknown, but many commentators have noted that he has no governmental work experience, and will be the first Commissioner without such experience since the late 1970s.  What is certain is that Clayton will, in turn, name a new director of SEC Enforcement.  While it is unclear what Clayton’s appointment means for SEC enforcement, it is reasonable to anticipate a rollback of Chair White’s “broken windows” approach, in which the SEC brought a high number of enforcement actions involving smaller infractions in the hopes of preventing larger violations from occurring.  This approach did not gain much traction in public opinion.  Further, as the number of SEC registrants sued for relatively minor offenses mushroomed, it lessened the impact of an individual SEC enforcement action.  In place of “broken windows,” we may see the agency emphasize individual accountability and retreat from imposing eye-popping penalties on large corporations.

New SEC leadership will review the recent performance of the Enforcement Division not only to determine what could be improved, but also what has worked well.  One way that the SEC has generated results in the last several years is by using a carrot and stick approach to encourage SEC registrants to self-report violations in areas where there may be a large number of registrants deviating from the applicable laws and regulations.

A striking example of this tack was the Municipalities Continuing Disclosure Cooperation initiative (MCDC), in which the SEC brought over 140 actions against municipal issuers and underwriting firms in connection with municipal bonds, an area in which there was previously little enforcement activity.  The SEC offered standardized settlement terms to municipal securities underwriters and issuers that self-reported violations related to continuing financial disclosures required of the issuers of municipal bonds.  The alternative to self-reporting under the MCDC—the stick–was potentially serious SEC exposure for violating the antifraud provisions of the federal securities laws.  The SEC announced the MCDC in March 2014 and by September 2016, the agency had brought more than 140 settled enforcement cases against issuers and underwriters.  Because each case was brought separately and not part of a single action, the MCDC results provided a significant boost to the total number of enforcement actions brought by the SEC, which is a key metric by which the agency measures itself.

After the success of the MCDC, the SEC targeted several other areas for self-reporting sweeps, including private equity fees and expenses and the customer protection rule that applies to broker-dealers, which requires broker-dealers to maintain a reserve of funds or qualified securities that is at least equal in value to the net cash owed to its customers.  While the SEC has not announced the results of these self-reporting sweeps, expect the agency’s new leadership to consider ways to continue the growth in the total number of enforcement cases and avoid reporting a significant decline in this key metric.

Other success stories that are likely to continue under new leadership include the staff’s improved industry expertise, the use of data analytics to spot anomalies that could signal misconduct and the increased cooperation between the exam and enforcement staff when investigating investment advisers and broker-dealers.   These initiatives, while largely unreported in the press, have resulted in increased efficiency at the SEC.

While the new SEC leadership will put its own stamp on the enforcement program, it is unlikely to send the enforcement staff into hibernation.  Enforcement is the facet of the SEC’s operations that draws the most public attention, and the area for which the agency’s leadership will be held accountable by the public, the industry and the SEC’s Congressional overseers.