Category Archives: Compliance

Knowledge Base: Aren’t Public Companies Required To Disclose SEC Investigations?

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Back in 2000 I pioneered using the Freedom of Information Act (FOIA) as a research tool with the SEC. Through the years we discovered countless undisclosed SEC probes and helped thousands of professional investors learn to interpret those that are disclosed. In fact, SEC comment letters are now posted now to the internet for free largely a result of my early efforts with the FOIA (This is the letter I sent to the SEC (link is external) in 2004 on that proposal.).

I’ve personally met with untold numbers of sophisticated investors and spoken at professional gatherings across the country about what we learned from our FOIA work and how SEC investigations really work.

This is my first in a series of articles I plan to post on things you as an investor need to know when it comes to SEC activity. If you like them, please let me know and I will gladly write more.

I leave you with kind wishes,

John P. Gavin, CFA
Founder and CEO
Probes Reporter, LLC
feedback@probesreporter.com
Or click here to use our online Contact Us form

Let’s start with some basic knowledge you need to have when it comes to SEC investigations —

  • Public companies are not technically required to disclose the existence of all SEC probes. Consistently, I hear investors say they thought otherwise.
     
  • When a public company discloses the existence of SEC activity of any kind it is likely because they felt the situation was serious enough it HAD to be disclosed.
     
  • Public companies hate talking about anything bad. Never forget that.

 

Public companies are not technically required to disclose the existence of all SEC probes.

Time and again, I am amazed to find out how few people actually know that public companies are not “required” to disclose when they have an SEC investigation. This is because public companies are only required to disclose matters that they deem “material”.

The consequences of undisclosed SEC investigations can be severe. We also know some SEC investigations go nowhere, so we are not necessarily critical of a company for not disclosing all the probes they have – or that we discover though our FOIA work.

Here’s the problem: Management, who could have self-serving reasons for not disclosing an investigation, gets to be the judge of what is and isn’t material. It’s not at all hard to imagine investors having a view that differs from management on these judgment calls.

The volume of undisclosed SEC activity we find, sometimes at just one company, is so high we find it hard to believe all of those management teams involved did not judge anything sufficiently material to warrant disclosure. But it happens.

Unless the SEC steps in and forces a company to disclose certain information (and that can take months or even years) the company gets to decide whether you need to know, what you need to know, and when you get to know it.

Feels a bit unbalanced, don’t you think? But that’s the way it is. So how do you protect yourself? Read on.

 

When a public company discloses the existence of SEC activity — of any kind — it is likely because they felt the situation was serious enough it HAD to be disclosed.

Trust that! Trust that they know this is a serious problem. That’s almost certainly why they disclosed.

Once, after speaking at a CFA breakfast meeting, a person who identified himself as an attorney experienced in such matters came up to me and said that management’s perception of the exposure being serious is the only reason a company will disclose an SEC probe. It was a strong view I couldn’t corroborate on my own. But I will tell you I wasn’t surprised.

In short, whenever a company discloses something bad, you can trust that the act of disclosure itself tells you that management judged the matter serious. This is true no matter how soothing the words or assurances are.

Also, keep in mind that Wall Street analysts are generally not a good source for helping you to interpret SEC probes that are disclosed.

Just as I’ve been amazed at how few people knew companies don’t have do disclose their SEC investigations, I’ve been equally surprised at just how misinformed even professional investors are when it comes to interpreting SEC matters.

For many reasons, they also tend to shy away from pressing a company too hard on an SEC exposure (though we would recommend otherwise).

 

Public companies hate talking about anything bad. Never forget that.

Public companies love happy talk. Wall Street analysts do too. As a result in our experience we’ve found that means most companies will not tell something bad that is impacting them until it becomes serious: Often too late for you to avoid losing money.

This often includes disclosure – or failure to disclose – SEC investigations. Even then, they may use spin and clever word choice to minimize the impact of the bad news. Never forget that.

 

Computer Forensics Help Fall Accused Insider Trader

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Guest Contributor: Mark S. Enslin

A former Bristol-Myers finance executive pleaded guilty earlier this year to an insider trading charge, admitting to buying stock options in a biotech company that Bristol-Myers was preparing to buy. As part of the plea, the executive agreed to forfeit $311,361 in allegedly illegal profits, and he now faces a maximum of 20 years in prison and $5 million fine when he is sentenced later this year.

This relatively innocuous insider trading case is interesting for at least two reasons. First, it’s a good reminder that insider trading remains a high priority for the SEC and other regulators. In fact, over the past three years, the SEC has filed more insider trading cases than in any three-year period in the agency’s history. Many of these actions involved registered representatives, hedge fund managers, corporate insiders, and other financial professionals who conspired in various forms to trade on non-public information.

The second interesting aspect of this case is what investigators revealed was one of their key pieces of evidence: they were able to trace the fact that the executive had run a series of Internet searches on insider trading detection just prior to some of his trades, including a review of an article entitled “Ways to Avoid Insider Trading.” Technology continues to evolve at an astounding pace, and the effects of that evolution on the securities industry will continue to be significant. When the SEC is able to utilize such technology on the back end to apprehend those who violate the securities laws, it’s only a matter of time before the SEC and other regulators will expect those in supervisory positions to utilize that same technology on the front end to attempt to stop the violations before they occur. Supervision of Internet usage, so called “social media” websites, and other electronic media remains a “hot button” issue and will only continue to grow in importance.

SEC Examination 2014 Priorities

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What Compliance Officers Should Expect from SEC Exams in 2014

If there is one thing that keeps compliance officers up at night, it is that dreaded message from the SEC, “We have decided to conduct an examination of your firm, and please do not treat this as an adversarial proceeding, rather we are here trying to learn about your firm, and we are here to help.” Hardly comforting given the many recent referrals from Enforcement, and the fact that Enforcement lawyers now routinely accompany SEC examiners to on-site inspections.

Recently, the SEC published its 2014 Examination Priorities giving broker-dealers and advisers guidance on areas of concern.

Examination Priorities for Both Brokers and Advisers

System-wide, the SEC will continue to focus on policies around fraud detection and prevention, corporate governance including the control environment and “tone at the top”, conflicts of interest, enterprise risk management, technology and supervision of IT systems.  The SEC will closely examine dual registrants and incentives to firms when customers choose to open accounts at dual registrants as an advisory client or brokerage client. The SEC also will scrutinize how advisers and brokers are addressing new laws and regulations, and sales and marketing practices related to retirement products such as IRAs and 401(k) plans. These broad areas affect nearly every adviser and broker-dealer, and all firms should be prepared for an SEC exam in these areas.

Examination Priorities Specifically for Investment Advisers and Investment Companies

Adviser Core Risks

Still stung by the failure to detect Madoff, for advisers, the SEC will continue to examine custody of client assets and compliance with the custody rules, paying particular attention to advisers that fail to realize that they have custody through non-conventional methods such as check-writing authority or powers of attorney.

Another core risk for advisers is conflicts of interest in business practices such as best execution, soft dollars, and agency/principal transactions. Examiners will scrutinize undisclosed compensation arrangements, allocation of investment opportunities, controls and disclosure when an adviser manages both performance-based accounts and traditional fee accounts, valuation of illiquid securities and higher risk products that are sold to retail and elderly investors. The SEC will review the accuracy of advisers’ performance advertising. Advisers that have wrap-fee programs should expect a review of fiduciary duties and controls to monitor wrap fee conflicts of interest, best execution and trading away from the wrap sponsor. Finally, the SEC will continue to review disclosure and compliance issues related to payments by advisers to distributors, solicitors and other intermediaries.

Areas of Focus for New Advisers Including Hedge Fund and Private Equity Fund Managers

New advisers that have not been examined in the last three years, including hedge and private equity fund managers, should expect a visit from the SEC in 2014. The SEC plans to look closely at new advisers’ marketing and sales practices, portfolio management including compensation methodologies, conflicts of interest and safety of client assets, and valuation particularly with respect to hard-to-value illiquid securities and their relationship to portfolio manager compensation.

Increasingly Aggressive Examinations

There is little doubt that the market and regulatory failures of the Great Recession has led to increasingly aggressive and skeptical examinations by the SEC. This creates compliance and reputational risks for firms. The 2014 exam priorities, although quite extensive, nevertheless provide a helpful guide for compliance professionals in determining where to devote finite compliance resources.