SEC Division of Enforcement: What It Is, How It Works (2024)

The Division of Enforcement of the U.S. Securities and Exchange Commission (SEC), the agency's largest, discovers, investigates, and prosecutes federal securities law violations. The division is crucial for domestic markets and is widely seen as the most critical financial watchdog worldwide.

Established in the early 1970s, the division has evolved significantly to keep up with increasingly complex financial instruments and ever-more-sophisticated and more geographically spread forms of fraud. Its work touches every corner of the investment world, from individual investors, including those contributing what they can each week to their 401(k), to major corporations and financial institutions with billions at stake in America's capital markets.

In recent years, the division's operations have shifted with technological changes, regulatory changes, new federal legislation, and landmark court decisions. Most notably, a June 2024 Supreme Court ruling in SEC v. Jarkesy restricted how the division can pursue specific enforcement actions. Below, we examine the SEC's investigative methods, litigation strategies, and the challenges it faces in the mid-2020s.

Understanding the SEC Division of Enforcement

The Division of Enforcement is the SEC's primary investigative arm, thus playing a crucial role in preserving the integrity of U.S. financial markets. To grasp its import for American financial markets, let's review its organization, core responsibilities, and enforcement methods. We can best examine these by taking a journey through the eight steps of a typical SEC investigation.

SEC Investigations From Tip to Resolution

Each SEC investigation is methodical and has similar phases, though the specifics depend on the case. The division is led by a director who reports directly to the SEC chair and is staffed by attorneys, accountants, analysts, and other specialists investigating and prosecuting securities law violations. The division operates from the SEC's headquarters in Washington, D.C., and 11 regional offices across the U.S., enabling it to take on securities violations nationwide.

Let's take you through the eight phases of a typical investigation:

1. An SEC Investigation Is Triggered

SEC investigations can be triggered by the division's market surveillance personnel, investor complaints, media reports, whistleblowers, and referrals from other SEC divisions and other agencies.

After getting an initial report, the division's staff conducts a preliminary review to determine if an investigation is warranted.

2. Informal Inquiry

If the preliminary review suggests potential violations, an informal inquiry begins. The division's staff may ask the relevant parties to produce documents and submit to interviews. No subpoena power is used at this stage—this is the time to cooperate, if possible.

3. Formal Investigation

If the informal inquiry uncovers meaningful evidence, the SEC authorizes a formal investigation. Staff then gain subpoena power to compel testimony under oath and get documents.

Once investigations are underway, SEC staff members have many tools available to them, and Gurbir S. Grewal, director of the Division of Enforcement, said they're not shy about using them. "Investor protection and enhancing public trust in our markets requires that we work with a sense of urgency, using all the tools in our toolkit," he said. Let's look at some of these tools:

Cooperating Witnesses

The SEC actively encourages those involved or aware of securities violations to cooperate. "The investigative process should be a collaborative one," said Grewal, who notes the SEC's cooperation program offers "significant incentives," including reduced penalties, deferred prosecution agreements, and non-prosecution agreements to those who contribute to the SEC's investigations.

"As numerous recent enforcement matters have shown, there are real benefits to parties that cooperate with Commission investigations," Grewal said. "These benefits can affect both the charges and the remedies the division may recommend and that the commission may ultimately impose."

The cooperation program is designed to give the SEC access to insider knowledge that the SEC can't get on its own (at least as easily), and cooperating witnesses have a central role in deepening SEC investigations. Cooperators may supply valuable documents, testify, or assist in other ways that bring to justice those who've violated securities laws.

However, Grewal is careful to set realistic expectations about what you might get with cooperation. "Now, this doesn't mean ... you'll always get to a no-penalty resolution or a declination. That's because all of this is highly fact-dependent." As in regular criminal cases, your cooperation with the SEC may be unneeded—they have all the evidence they need—or what you're willing to give up won't cut it to get the SEC to reduce the penalties it's seeking.

"There'll always be situations where some charges and remedies are necessary no matter the level of cooperation," Grewal said. "But the bottom line is this: you're likely to experience better outcomes with cooperation than without it."

Data Analytics

While Hollywood often portrays federal bureaucrats as perpetual bumblers working off computers still running Windows '95, the SEC's Division of Enforcement consistently uncovers securities violations ranging from the remarkably brazen to the most subtle and secretive. For example, the SEC's Market Abuse Unit uses sophisticated data analysis to detect suspicious trading patterns, market manipulation, insider trading, and other crimes. The Division of Enforcement's Center for Risk and Quantitative Analytics examines massive volumes of market data to identify potential violations and determine where best to put the Division of Enforcement's resources.

"If everyday investors think that the market is rigged at their expense in favor of insiders who abuse their positions, they are not going to invest their hard-earned money in the markets," Grewal said. "We stand ready to leverage all of our expertise and tools to root out misconduct and to hold bad actors accountable no matter the industry or profession. That's what’s required to restore investor trust and confidence."

Exploiting the newest digital tools, the division has apprehended offenders ranging from the hapless husband who engaged in insider trading based on his wife's pillow talk (more below) to high-frequency trading firms that manipulated markets with complex algorithms designed to exploit microsecond advantages. They've also nabbed corporate executives who orchestrated elaborate accounting schemes and social media influencers spreading misinformation to bump up the prices of stocks they held.

Subpoenas and Document Requests

The SEC can issue subpoenas and request documents as part of its investigative process. These require investigation targets to produce emails, financial and other records, etc., which are critical when building a securities case.

Often, targets will later claim they should receive credit for cooperating with the SEC, which is similar to wanting a thank you note for paying your taxes. Handing over documents requested in a subpoena is something you're "required to do" and "is not what we consider cooperation," said Steven Peikin, former co-director of the Division of Enforcement.

Surveillance and Examinations

The SEC regularly examines and surveils registered entities, including investment advisers, broker-dealers, and public companies, to ensure compliance with securities laws and SEC regulations.“In examining for compliance with our time-tested rules, the division helps registrants understand the rules as well as ensures that markets work for investors and issuers alike," said SEC Chair Gary Gensler. "The division’s efforts [in examinations] enhance trust in our ever-evolving markets,”

These examinations can be routine or targeted based on identified risks. The Office of Compliance Inspections and Examinations uses a risk-based approach to identify areas of concern and conduct its reviews. There are three types of SEC reviews:

• Routine examinations: Regularly scheduled reviews based on a risk assessment process to ensure ongoing compliance.
• For cause examinations: Created in response to tips, complaints, or other indications of potential misconduct.
• Sweep examinations: Focused reviews on a particular issue, practice, or trend across multiple firms.

Findings from these could lead to enforcement actions if any significant violations are discovered or suspected. Here are the steps in an examination process:

1. Pre-examination planning: The SEC staff determines the scope and goals of the examination based on the target’s risk profile.
2. On-site visit: Examiners review records, interview staff, and assess compliance.
3. Document review: Review of relevant documents, including financial records, emails, trading logs, and compliance manuals.
4. Exit interview: Discussion of preliminary findings with the firm's management.
5. Deficiency letter: If deficiencies are found, the SEC may issue a letter outlining the issues and recommending corrective measures.
6. Follow-up: The SEC may conduct follow-up examinations to ensure that deficiencies have been addressed.

SEC Office of the Whistleblower

The SEC's Whistleblower Program, established under Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, funds incentives for individuals to report violations of securities laws. These funds come from SEC fines, not from targets of securities crimes or the American taxpayers.

Whistleblowers who give the SEC original, timely, and credible information that leads to a successful enforcement action are eligible for monetary awards ranging from 10% to 30% of the financial sanctions collected. This program has been instrumental in uncovering significant fraud and misconduct.

It's also netted whistleblowers rewards more reminiscent of multistate lotteries than government agencies. The SEC's Office of the Whistleblower highest award was given in 2023 and was worth almost $279 million, more than double the previous record, a $114 million award in 2020.

Awards like these, Grewal said, "reflect the tremendous success of our whistleblower program." The whistleblower's efforts led to more than $4 billion in disgorgement and interest, he said. "As this award shows, there is a significant incentive for whistleblowers to come forward."

Here's a summary of these and other tools used by the SEC Division of Enforcement:

4. Wells Notice

The SEC issues a Wells notice once it believes a violation has occurred. This formal document outlines the violations the SEC is considering and allows recipients to respond before charges are filed. The Wells notice process is unique to SEC investigations and is designed to avoid unnecessary litigation.

Example Wells Notice

Above is the SEC's Wells notice to Coinbase from March 22, 2023. This officially notified the crypto exchange that the regulator was investigating Coinbase as an unregulated securities dealer, violating the Securities Act of 1933 and the Securities Exchange Act of 1934.

After receiving a Wells notice, an investigation's target can reply to the SEC with a rebuttal called a "Wells submission." This is used to explain, defend, or offer mitigating factors for the activity, with the hope of dissuading the SEC from pursuing formal charges.

While the SEC's Wells notices are usually a couple of pages long, Wells submissions can often be hundreds or more. Law firms aren't just upping their billable hours but are trying to defend the target after being given a limited view of the SEC's information; attorneys of targets often find themselves trying to hit a target they can't see. Thus, they typically try to rebut accusations factually (factual background and supporting documents and other evidence to back up the target's interpretation of events), legally (hitting on relevant laws and regulations, case history, and even previous speeches of SEC commissioners and others), and in terms of policy (arguments about the chilling effect or some such of the action on other investors; unintended consequences). The submission might also be the basis for a conference or "Wells meeting" with SEC staff.

Here's the Wells submission Coinbase provided to the SEC in April 2023. It did little to convince the agency, which filed formal charges in the case two months later.

Example Wells Submission

While Coinbase didn't get the SEC to stop charging the company, that doesn't mean all hope is lost for an investigation's target once a Wells notice is received. "The reality is that defense counsel and their client may know things that we don’t. We want to know as much as we can before we make a recommendation to the Commission," said Peikin, the former Division of Enforcement co-director. "Educating the staff on what you believe are the key facts—and explaining why, in your view, those facts don’t support an enforcement action or a particular charge or form of relief—can be effective." Less effective, he said, are approaches that call into question the professionalism of SEC staff. "A Wells meeting is simply not the place to air grievances."

The Wells process is when many choose to cooperate with the SEC. The Wells process tends to go sideways otherwise. "Wells meetings tend to be the most productive when defense counsel focuses on the most important arguments and issues in the case, as opposed to taking a blunderbuss approach that attempts to address every possible argument, fact, element, and issue," Peikin said.

The Wells process marks a crucial moment in any SEC investigation. After this point, it's much more difficult to unwind. The path is largely set toward a very costly process for all involved.

5. Commission Review

Following the Wells process, SEC staff presents its findings and recommendations to the commission. The five commissioners, appointed by the U.S. president and confirmed by the Senate, then votes on whether to go ahead with an enforcement action. The commission decides based on the investigation's findings, the Wells Submission (if one was made), and broader considerations of investor protection, SEC resources, and market integrity.

"It is ultimately the commission—not the staff—that decides whether to bring an action or to accept a settlement," Peikin said. "In every case, we think hard about what we are recommending, why we are recommending it, and—critically – how it compares to what the commission has done in past cases. This ensures that we are both fair to the parties in the case at hand and that we are sending clear, consistent messages to the public."

6. Enforcement Measures

Should the SEC commissioners vote to proceed, the SEC has two main avenues to do so:

• The SEC could file suit in federal district court
• But in most cases in recent history, it would begin administrative proceedings before an SEC administrative law judge (ALJ).

Over the last decade, just over 85% of cases have been channeled through the SEC's ALJ system. This is unsurprising, given that these numbers align with administrative actions at other federal agencies with investigatory powers like the U.S. Environmental Protection Agency and Homeland Security. However, it does give a sense of the effect the Jarkesy case will have once its effects begin to be felt in the SEC's annual numbers.

The Impact of SEC v. Jarkesy (2024)

The court's decision in SEC v. Jarkesy ruled that cases involving civil penalties for fraud must be brought in federal court, where defendants have the right to a jury trial. The court's majority opinion has reshaped the SEC's enforcement strategies, potentially impacting the efficiency and scope of its actions against securities law violators.

The case centered on George Jarkesy, a hedge fund manager accused of securities fraud. Before the Dodd-Frank Act, the SEC could only pursue administrative proceedings against entities it directly regulated, such as broker-dealers and investment advisers. Dodd-Frank expanded the agency's authority, allowing it to bring administrative actions against any individual or entity for securities law violations. The SEC increasingly used this power, pursuing Jarkesy's case through its in-house administrative proceedings.

In its 6-3 decision siding against the SEC, Chief Justice John G. Roberts Jr., writing for the majority, stated, "A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator." Associate Justice Sonia Sotomayor, in her dissent, emphasized the decision's impact. Whatever her legal analysis, there was little doubting her prognosis: "The majority's decision... effects a seismic shift," not just for the SEC but "in this court's jurisprudence." She argued that requiring civil penalties to be tried before a jury in federal court would have "momentous consequences," extending beyond the SEC to other agencies.

The SEC v. Jarkesy ruling has far-reaching implications for all federal regulatory agencies, fundamentally altering securities law enforcement. While the full impact awaits interpretation by lower courts in the mid-2020s, most commentators agree it will hamper the SEC's ability to pursue enforcement actions against fraudulent actors, of which there never seems to be a shortage in the financial world. The decision comes at a critical time, with the SEC still clearing away a mountain of pandemic-related frauds and a 50% increase in crypto-fraud charges in 2023.

Cary Coglianese, professor at the University of Pennsylvania Carey Law School, agreed with other legal analysts that the shift could be significant. "If we're dealing with situations where we're just revoking licenses or the like, that can go a lot more quickly" through administrative processes, he said. "The penalties would be another matter, and I suspect we'll see a shift and probably a decrease in the number of civil penalty actions that the SEC is pursuing. There's already a bottleneck there."

Coglianese said this decision, combined with other recent rulings like the June 2024 Loper Bright Enterprises v. Raimondo case, which ended the "Chevron deference" to regulators' expertise, is causing widespread uncertainty. He said, "All this stuff is kind of chaos because it is shifting a real settled understanding of how we operate as a government."

For his part, SEC Chair Gary Gensler has tried to sound ready to do the work to keep chaos at bay. "If the courts adjust, we adjust," he told the Financial Times. Nevertheless, taking stock of recent SEC court defeats, he reached for an investing metaphor that depicted dark times ahead. "I'm also a guy that grew up in markets... You still try to move forward in a down market."

7. Resolution

Under the Jarkesy ruling, cases that meet both of the following must now go to federal court:

1. Civil penalty cases for violations involving fraud: insider trading, market manipulation,
2. Cases where the SEC seeks monetary penalties for legal breaches like fraud.

Here are the cases the SEC should still be able to handle through administrative proceedings, Coglianese told Investopedia:

• Cases where the SEC seeks to ban someone from the securities industry (e.g., revoking securities licenses).
• Cases that don't include fines beyond disgorgement.
• Enforcement actions that don't involve fraud.

Given this, here are the potential outcomes of SEC cases and the likely forums for their adjudication:

8) Ongoing Monitoring

The SEC doesn't "just bring cases and walk away," said Stephanie Avakian, former co-director of the Division of Enforcement. "We continue to monitor compliance with our orders and take action when we see violations." "Monitoring compliance," current Director Grewal said, isn't just about remediation, though, but "ensures that wrongdoers are held accountable."

Here's what's typically involved:

• Independent consultants: The SEC may require the appointment of independent monitors to oversee compliance with court orders and settlements and report back to the agency.
• Compliance reports: Defendants are typically required to submit periodic reports detailing their adherence to the agreed-upon terms if there was a settlement or ordered by a federal court or ALJ.
• Certification of compliance: Executives or board members might be required to certify their company's compliance with the settlement terms or court orders.
• Verification of remedial efforts: The SEC will verify that any required remedial actions, such as internal control improvements or corporate governance changes, have been put in place.
• Follow-up investigations: The SEC is typically quick to start up investigations should they have concerns about the former defendant's follow-through.
• Penalty for non-compliance: If the SEC finds that a defendant has failed to follow the terms of a settlement or court order, it will seek additional penalties.

Recent Developments for the SEC Division of Enforcement

The Securities and Exchange Commission's Division of Enforcement has kept an aggressive stance in recent years, focusing on emerging areas like cryptocurrency and cybersecurity. In fiscal year 2023, the SEC filed 784 enforcement actions (501 were stand-alone, not follow-on cases), 3% above 2022. These cases resulted in almost $5 billion in financial remedies, the second-highest amount in the SEC's history.

Here are the major areas that the SEC has been focused on:

Cybersecurity and Disclosure

Cybersecurity has become a major focus for the SEC's Division of Enforcement. In 2023, the SEC took groundbreaking action in this area by charging SolarWinds, a software company, and its chief information security officer with fraud and failing to maintain proper internal controls related to their cybersecurity practices and disclosures.

This case was significant because it was the first time the SEC accused a company of intentional or reckless fraud (known legally as scienter-based fraud) in a cybersecurity matter. By bringing this case, the SEC sent a clear message that it will hold companies and their executives responsible for misconduct related to cybersecurity, especially when they mislead investors about their cybersecurity measures and risks.

Here's a table on the difference between scienter and non-scienter fraud, an important distinction since many SEC cases turn on whether the higher burden of proof (providing intent) is required:

SEC Enforcement and Crypto

A notable trend has been the SEC's increased focus on cryptocurrency-related violations. In 2022, the SEC announced a significant expansion of its Crypto Assets and Cyber Unit, nearly doubling its staff to 50. Despite still filling these positions throughout 2023, the SEC nevertheless ramped up its crypto-related enforcement actions.

The agency brought 46 such actions in 2023, a 53% increase from 2022, targeting crypto exchanges, intermediaries, and individuals for alleged fraud and unregistered offerings. High-profile cases included charges against major exchanges Binance and Coinbase for operating without registration. This signaled the SEC's impatience with crypto proponents seeking access to regulated markets while avoiding SEC regulations.

There has been internal division within the SEC over this. Commissioners Hester Peirce and Mark T. Uyeda have criticized the SEC's crypto-related policies, advocating for rulemaking and guidance over enforcement. In their dissents, they've likened the SEC's decade-long struggle with digital currencies to a campy soap opera, complete with fictional dialogue. More seriously, they've called the SEC's standards for classifying crypto as securities "opaque and arbitrary," arguing that this creates an "untenable" environment for crypto assets. They contend that the commission's actions haven't protected investors but instead "intimidated innovators and entrepreneurs."

Bringing Insider Trading Out of the Shadows

The SEC Division of Enforcement, formed in the early 1970s in part to focus resources on combating insider trading, has been expanding its enforcement reach in this area.

For example, the SEC has started bringing more cases for violations of rules on internal controls—the policies and procedures meant to ensure correct financial reporting and compliance with laws—even when there weren't clear accounting or disclosure problems.

For instance, Charter Communications (CHTR) was fined $25 million for violating internal control requirements related to stock buybacks. The company's board had approved buybacks only if they complied with SEC Rule 10b5-1, which guards against trading based on material nonpublic information. However, Charter included "accordion" provisions allowing alterations to buyback plans after they were in effect, potentially enabling insider-based timing. The SEC deemed this a violation of the board's authorization.

The SEC has also pursued "shadow trading." This involves using material nonpublic information about one company to trade in the securities of a related company, such as a competitor. In the landmark case SEC v. Panuwat, Matthew Panuwat, a former Medivation executive, was found guilty in April 2024 of using confidential information about his company's acquisition to trade in Incyte Corporation (INCY) securities, a comparable company in the same industry.

In light of its win, Grewal, the division's director, pushed back against media coverage that tended to depict its crackdown on shadow trading as based on a new interpretation of insider trading laws. "There was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple."

Despite setbacks elsewhere in the courts, scholars consider this one of the SEC's most consequential wins in years, perhaps decades. The precedent, novel or not, expands the scope of prosecutable insider trading cases. This newfound vigor shows the SEC's willingness to flex its regulatory muscles. It could also help demonstrate the SEC's transformation from what critics long depicted as a slumbering watchdog to an agency with the "stamina" to "not weary of the fight."

The Bottom Line

The SEC Division of Enforcement serves as the watchdog of the U.S. securities markets, helping to ensure compliance with securities laws and protect investors from fraud and misconduct. The division uses its various tools—a successful whistleblower program, cooperation incentives, and advanced data analytics—to detect and investigate violations. The division's efforts result in an average of 700 to 800 enforcement actions annually, from administrative proceedings and settlements to civil actions and criminal prosecutions in federal court.

By collaborating with other regulatory and law enforcement agencies, the SEC Division of Enforcement extends its reach locally and internationally to tackle complex, often cross-jurisdictional cases. Ultimately, the SEC Enforcement Division plays a critical role in maintaining investor confidence and ensuring the fair and orderly operation of the financial markets, contributing to the overall health and stability of the U.S. economy.