Common Compliance Failures
How Companies Get in Trouble with the SEC
Companies get in trouble with the SEC through identifiable patterns of noncompliance: inadequate disclosure, offering violations, insider trading, and failure to maintain proper controls. Understanding these patterns is the first step in prevention.
Failure to Disclose Material Information
The most common path to SEC trouble is failure to disclose material information in public filings. Material information is any information that a reasonable investor would consider important in making an investment decision. Companies get in trouble when they omit material risks from their risk factors, fail to disclose related-party transactions, present financial results that do not conform to GAAP, or provide management commentary that paints a misleadingly optimistic picture. The gap between what management knows and what the filings disclose is where enforcement actions are born.
Conducting Unregistered Offerings
Companies that sell securities without either registering the offering with the SEC or properly qualifying for an exemption violate Section 5 of the Securities Act. This happens more frequently than most executives realize. Companies that use general solicitation in a Rule 506(b) offering, fail to verify accredited investor status in a 506(c) offering, sell to too many non-accredited investors, or integrate offerings that should have been treated separately can lose their exemption retroactively. The consequences include rescission rights for every investor in the offering and SEC enforcement action.
Internal Control Failures
Sarbanes-Oxley requires public companies to establish and maintain internal control over financial reporting. Companies that lack adequate internal controls, that override existing controls, or that fail to remediate identified material weaknesses create conditions for financial misstatement and, ultimately, enforcement action. The SEC has brought enforcement actions against both companies and individual executives for internal control failures, particularly where the failures enabled or concealed financial fraud.
Frequently Asked Questions
What is the most common way companies get in trouble with the SEC?
The most common way is through inadequate or misleading disclosure. Companies that fail to disclose material information, overstate financial performance, or omit significant risks from their filings create the conditions for enforcement action.
Can a company get in trouble for press releases?
Yes. Press releases and public statements by company officers are subject to the antifraud provisions of the securities laws. Companies have faced enforcement action for press releases containing materially misleading statements about financial performance, product development, or business prospects.
What happens when the SEC finds a violation?
When the SEC determines that a violation has occurred, it can seek civil penalties, disgorgement of ill-gotten gains, injunctive relief prohibiting future violations, officer and director bars, and other equitable relief. The SEC can pursue enforcement through administrative proceedings or by filing a civil action in federal district court. Criminal referrals to the Department of Justice are made in cases involving intentional fraud.
Questions about your specific situation?
Frederick M. Lehrer is a former SEC Enforcement Attorney with over 30 years of issuer-side securities law experience. All consultations are confidential. Flat-fee engagements.