What information is the SEC interested in?
Every month, the SEC posts a Notice of Covered Action for cases resulting in a monetary recovery of more than $1 million. We examined the postings for the past year to determine what types of cases the SEC has pursued in the past. This is by no means an exclusive list and there are certainly types of information which will produce rewards for whistleblowers that we have not listed here. However, it does cover a wide range of misconduct and serves as an excellent representation of the scope of cases the SEC has pursued recently.
Accounting Fraud & Independent Auditors
Companies manipulating accounting standards and data are perennially a target of SEC enforcement actions. The misstatement of revenues, expenses or asset valuations in order to mislead investors, smooth earnings fluctuations or meet analyst estimates will be carefully examined. This includes improper accounting adjustments in violation of Generally Accepted Accounting Principles. They are also liable for failure to maintain sufficient internal accounting controls to prevent issues in their financial statements.
The disclosure of weaknesses in cyber security and data loss due to hacking is a relatively new area for securities law but we expect that there will be more than a few cyber security whistleblowers in the future as more companies are hacked and faced with the question of disclosure.
The Foreign Corrupt Practices Act (FCPA) prohibits gifts and improper payments to foreign government officials to obtain or retain government contracts. A public company may be found to have violated the FCPA even if the conduct is done by certain third parties or through an intermediary. It also prohibits inaccurate books and records, as well as insufficient internal controls to detect corruption and prevent it from being included in financial statements. This has been the subject of several enforcement actions and SEC representatives believe it will be a fertile ground for whistleblowing.
The SEC has prosecuted both individuals trading on inside information and individuals tipping others to material, nonpublic information who then trade. Suspicious transactions such as the purchase of call options in close proximity to earnings or merger announcements may garner close scrutiny.
Misconduct by Exchanges
The SEC also investigates violations of the rules by exchanges. They have sanctioned exchanges for failure to enforce Commission and exchange rules, inadequate investigation of compliance problems and unauthorized accommodations for member firms. When exchanges implement new businesses practices, or modify existing ones, without putting in place an exchange rule where one is required, they can also be subject to sanction.
Misrepresentations to Investors
Material misrepresentations to investors are taken seriously by the SEC. Failure to disclose material information about the company, including revenues, liabilities, assets and corporate management, are all a major problem. This is particularly true in connection with a security offering. Manipulation of financial statements through mark-to-market pricing or improper accounting adjustments are also an area where the SEC tends to protect shareholder investments. Similarly, misappropriation of investor funds for personal or business expenses is a common area of enforcement. There cannot be misrepresentations regarding the intended use of funds from an offering or the manner in which client accounts will be invested.
The SEC has been especially diligent regarding ponzi schemes following the Bernie Madoff debacle. Typically, they involve promises of extraordinary or guaranteed results while the individuals operating it pay early investors with money obtained from subsequent investors. There are many other types of fraud against shareholders which the SEC will pursue. Among the worst offenses are corporations and individuals selling fictitious securities or bank instruments to investors.
Private Equity Fees
There’s a widespread investigation of private equity firms concerning the fees and expenses they charge clients. In a 2014 speech, Andrew Bowden indicated that there are disclosure problems regarding the billing of fees and expenses to investors which are separate and distinct from the firm’s management fees.
Trading Price Manipulation
Market manipulation is a classic violation of securities laws. Unscrupulous individuals may artificially increase the price or volume of a stock in order to attract other investors. These schemes are sometimes combined with a form of microcap stock fraud where a party issues false and misleading press releases and statements to investors to pump and dump the stock. Market manipulation does not have to involve the actual execution of orders. The transmission of orders that the trader does not intend to have executed in order to influence the market through layering or spoofing is also prohibited. In other cases, traders have used limit orders to influence mark-to-market accounting in order to mask investment losses.