SEC Crackdown Increasingly Centers Around Negligence Charges

Responding to the public outcry over corporate scandal, the Securities and Exchange Commission has been aggressively filing complaints against individuals and corporations for several years. Historically, SEC complaints have alleged intentional fraud - in other words, that the accused engaged in intentional misconduct leading to investor loss. However, by increasingly bringing cases based on negligence rather than intentional fraud, the SEC is potentially sweeping more individuals and entities into its enforcement web.

An Overview of the SEC's Stance on Enforcement Actions for Negligence

Negligence is defined as the failure to exercise the care that a reasonably prudent person would have exercised in similar circumstances. From an enforcement standpoint, the chief difference between traditional fraud and negligence charges is that a negligence allegation does away with the need to prove wrongful intent.

Formerly, negligence charges were used as a second resort by the SEC, often levied in addition to claims of intentional or reckless fraud. This strategy could provide an out for the accused, allowing them to settle their cases by admitting to the lesser negligence charges in return for other allegations being dropped. However, negligence is no longer taking a back seat in SEC enforcement actions.

"Simply avoiding Ponzi scheme-style outright fraud is not enough to avoid enforcement action," Kenneth Lench, the SEC's structured and new products enforcement unit chief said in a recent interview with the Wall Street Journal. "Firms and executives have a duty of care. Failure to check properly that investors are being provided with fair and accurate information could, under some circumstances, be a breach of that duty, even if there's no intent to defraud them."

As reported by Bloomberg Business Week, SEC enforcement director Rob Khuzami added that his agency will follow through on negligence cases where investors lose money and there is "a deviation from the appropriate standard of care." According to Khuzami, this does not, however, mean that the SEC intends to bring enforcement actions when questionable conduct constitutes an honest mistake.

More Negligence Cases Widen the SEC Enforcement Net

Will the new focus on negligence lead to more SEC enforcement actions? All signs point to yes. Simply put, negligence is easier to prove than intentional fraud, and Securities Act provisions pertaining to negligent violations cover a wider array of conduct.

The trend seems to already be playing out in the real world. In addition to several high-profile negligence cases peppering the headlines in recent months, in 2011 the SEC increased the total number of enforcement actions to 735, up from 677 in 2010. In the first few months of 2012, there is no indication that this year will see any kind of slowdown.

What Is the Impact on Businesses and Brokers?

For business owners and corporate officers, the shift toward negligence prosecutions has important implications. Borderline cases that may not have resulted in an enforcement action in years past could now end up in court. It is important for all businesspeople to remember exercising due care can decrease the odds of a negligence claim and a strong internal compliance program can minimize the risk of SEC enforcement. In light of the new focus on negligence, practical recommendations for those subject to SEC regulation include:

  • Ensure that adequate resources are dedicated to compliance so that any SEC demands can be met with a prompt, accurate response
  • Identify areas of the business most at risk for Securities Act violations and test information gathered about such risk areas for inconsistencies
  • Ascertain whether known trends reported in a prior periods have changed, and if so, whether those changes should affect shareholder disclosures and financial statements
  • Periodically test compliance safeguards

What Is the Impact on Investors?

For shareholders and other investors, the trend toward more negligence enforcement generally should be a good thing; it means those charged with responsibly for managing investments will be subject to greater scrutiny.

However, investors cannot always totally rely on the SEC to protect their investments. While negligence cases are easier to prove than intentional fraud, they also carry lower penalties. If a misrepresentation or omission or some other negligent act led to your investment losses, you may wish to file your own lawsuit or arbitration claim.

The benefits of pursing your own legal action are twofold: you may further discourage sloppy broker or corporate behavior, and you may be able to recoup some or all of your losses. The involvement of an SEC action for negligence could help your case: it can alert you to irregular activity, serve as a warning sign that may encourage the defendant to settle and reveal evidence that may not have otherwise come to light.

If you fear misconduct by the officers or agents charged with managing your investment, you may have legal recourse. Whether your suspicions were aroused by an SEC investigation or something else, you owe it to yourself to make sure your trust is not being abused. If you believe you have been a victim of broker or brokerage firm negligence, get in touch with a securities fraud attorney to explore your options.

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