As the U.S. Securities and Exchange Commission (SEC) steps up its investigations into possible fraud and other accounting irregularities at publicly-traded companies, organizations that understand the factors involved in the launch and life cycle of an SEC investigation may be better prepared and possibly positioned for healthier outcomes, should they become the focus of an SEC investigation.

At the close of the fiscal year in September 2014, the number of SEC investigations dramatically increased by 46 percent, resulting in 99 accounting fraud actions. Reasons for the upsurge include new whistleblower protections and incentive programs, expanded media coverage of businesses, and the growing use of quantitative data analytics by the SEC’s Financial Reporting and Audit Task Force to detect possible instances of fraud.

More of the same can be expected in future. SEC Chair Mary Jo White, who spent much of her career at the SEC in its enforcement division, has pledged to put more resources towards detecting accounting irregularities and strenuously policing such activity. “I have focused much of my career not only on pursuing wrongdoers, but also on deterring wrongdoing,” Chair White commented to the Council of Institutional Investors in 2013.

It All Starts With Awareness

When the SEC is notified by a whistleblower or the Commission’s data analytics systems of a possible violation, this triggers a Memorandum Under Inquiry or MUI. This preliminary investigation fosters an informal request for information from the company under scrutiny. In many cases, the MUI may simply be a routine matter, i.e. nothing to fret about.

After the information is provided (or not provided) to the SEC, the Commission may determine to undertake a formal order of investigation of the target company, with broad subpoena power to compel the provision of all requested information, documents, and responses by witnesses and other parties to questions under oath.

During the course of its investigation, a so-called Wells Notice (named after former SEC Chair John Wells) may be issued, indicating that the SEC has determined that it may bring a civil action against the company. The notice provides the target with time to explain and provide information as to why it believes this enforcement action is unnecessary.

Once the Wells Notice has been issued, (the target company has the opportunity to present a response). At that point, the SEC may decide to take civil or administrative action against the company.  In cases where it is determined that the violation was willful, the Commission may refer the case to the Department of Justice for criminal prosecution.

For the most part, companies found to have violated the law are permitted to settle the matter financially without an avowed admittance or denial of the allegations, unless a large number of investors were harmed by its actions or the company’s conduct was otherwise egregious. Consequently, most matters reach settlement.

Individuals who sign a cooperation agreement with the SEC’s Division of Enforcement and provide it with substantial assistance are given credit for the effort, limiting actions against the person.   In some cases, the SEC may agree to forego prosecution of the individual altogether.

Financial Risk Mitigation – The Role of Insurance 

While many insurance brokers and corporate risk managers are cognizant of the SEC’s recent efforts to combat accounting fraud, the process by which an SEC investigation launches and proceeds is complex and expertise on this subject is less commonplace. Such expertise is important considering the heightened level of legal and settlement expense associated with such investigations.

Knowledge of the process by which an SEC investigation launches and proceeds is of particular use when assembling an insurance program of diverse policy coverages, terms and conditions. In recent years, as the SEC has increased its oversight and enforcement of accounting fraud, the property and casualty insurance industry has responded with new insurance solutions that transfer elements of these risks.

Different insurance policy coverages, terms and conditions come into play to transfer some of the financial risks of target entities and their board directors and executive officers. For instance, financial errors and omissions (E&O) liability insurance provides legal and indemnity expense reimbursement coverage for companies that cooperate with the regulatory investigation. Financial errors and omissions (E&O) liability insurance also provides coverage for regulatory actions arising out of services to clients, the consequence of more stringent regulations like Sarbanes-Oxley and the Dodd-Frank Act.

Public company directors and officers (D&O) liability insurance typically provides defense expenses and indemnity coverage for insured persons named in a formal SEC investigation. Public company D&O insurance can also cover formal investigations against an entity, for example, when the SEC also identifies insured persons by name in its formal order of investigation or when there is a concurrent shareholder securities class action.  Private company D&O insurance provides similar coverage to the insured persons of non-public companies. In both cases, the insurance picks up the cost of defending against a securities claim (including any formal regulatory proceeding brought by the SEC).

For insurance brokers and company risk managers, the utility of these insurance coverages to transfer the costs of cooperating with the SEC in its investigation cannot be understated. Today’s dynamic regulatory environment insists upon dynamic insurance coverages.



Any discussion of coverage herein is summary only. Coverage depends on the actual facts of each claim and the terms, conditions, and exclusions of the issued policy. Please refer to the issued policy to determine all terms, conditions and exclusions of coverage.  In the event of a conflict, the terms and conditions of the policy prevail. All coverages described in this document may be offered by one or more of the property and casualty insurance company subsidiaries of The Hartford Financial Services Group, Inc. Coverage may not be available in all states or to all businesses. Possession of these materials by a licensed insurance producer does not mean that such producer is an authorized agent of The Hartford. To ascertain such information, please contact your state Department of Insurance or The Hartford at 1-888-203-3823. All information and representations herein are as of August 2015.

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