Prosecutions for various investment and securities-related offenses come in many forms before different tribunals. This means that people and companies that participate in the vast array of investment transactions are subject to intense regulations and criminal statutes that can carry significant consequences.
Basic Securities Fraud Definitions
It is important to define a few terms. Chapter 78 of Title 15 of the United States Code encompasses many standards for the buying and selling of interests related to companies and investments. In simple terms, individuals and companies can be subject to severe penalties when transacting any money, note, stock, ownership interest in a venture or company, or right to receive revenue. These are the simplest tenets of securities regulation. Under Chapter 78, many civil and criminal rules and penalties exist.
Further, under 15 USC 78c, the terms “person” and “security” are more thoroughly defined. The term “person” means a natural person, company, government, or political subdivision, agency, or instrumentality of a government. The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a “security”; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
With respect to the definition of a “person” it is useful to understand that companies may be civilly and criminally liable.
The term “security” obviously has an expansive definition designed to include interests in private and publicly transacted items, whether or not they are traded on a recognized transactional stage such as the New York Stock Exchange. It is also important to recognize that this definition includes participation in private oil leases or other energy products.
Basic Crimes and Bases for Civil Liability
Securities related penalties are generally addressed under federal law in two ways: Use of general statutes (Title 18) and use of more tailored Securities Exchange Commission precepts (Title 15). The Securities Exchange Act of 1934 brought special powers to the SEC and serve as much of the basis for the overall regulatory framework related to existing securities. Title 15 sets out civil and criminal penalties for well-known stock related crimes such as pump and dump schemes and insider trading.
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Offenses Not under the Securities Exchange Act of 1934
For instance, Chief Executive Officer Jeffrey Skilling, in relation to the Enron scandal, “was convicted of conspiracy, securities fraud, making false representations to auditors, and insider trading.” U.S. v. Skilling, 638 F.3d 480 (5th Cir. 2006). The classic securities related crimes fall under Title 15 and Title 18 of the United States Code. Below is a list of often-used statutes to pursue monetary and penal repercussions related to securities fraud.
18 USC 371: Conspiracy to Defraud the United States
This statute is a catch-all that proscribes efforts by two or more persons to agree to commit any offense against the United States. Typically, prosecutors allege that persons who try to break rules that apply to fair stock exchange dealings are in violation of this law, which carries a potential of 5 years imprisonment.
18 USC 1341: Mail Fraud
This statute prohibits using any mail carrier, including the US Post Office, UPS, or FedEx, to accomplish any part of a “scheme or artifice to defraud” another person. While this statute is not specifically designed to address investment schemes, it is often used to prosecute persons who try to sell a fake security. For example, if a person garners investments promising an ownership interest in an oil well that does not exist and that person sends a prospectus to an investor via FedEx, then this offense could be basis for a 1341 case. This offense carries a fine up to $1,000,000 and 30 years imprisonment. Learn more about mail fraud.
18 USC 1343: Wire Fraud
This statute operates nearly identically to 1341 except that instead of the use of mails being the triggering factor, use of any wire supports this prosecution. In this context use of wires includes phone and Internet usage. If, using the example provided under the paragraph above, the prospectus were sent online instead of through the mails, then this statute could be used for prosecution. This crime carries the same sentence as 1341. Learn more about wire fraud.
18 USC 1348: Securities and Commodities Fraud
This statute outlaws attempts to defraud any person in connection with securities that are required to be registered on a national security exchange (such as the New York Stock Exchange or NASDAQ), or obtain by false pretenses any money in connection with such securities. Thus, this statute would not generally be used to prosecute persons selling fake or non-existent securities.
The term “security” in the financial context is similar to the term “conviction” in many state and federal legal contexts. That is, such terms mean different things depending upon the circumstance in which they are used.
1348 only applies to a special set of stocks, options, and bonds relating to issuers/companies that are required to be registered by under the Securities Exchange Act of 1934. Basically, it applies to companies listed on major exchanges.
Offenses under the Securities Exchange Act of 1934
15 USC 78b: Necessity for Regulation
This statute sets up basic requirements related to securities. However, that term is a very expansive one in this context. It does not simply apply to stocks on a national exchange. It encompasses nearly every existing security including those related to oil lease agreements, credit swaps, and options. 78b specifically outlines the SEC goal to curb “excessive speculation” and “unreasonable fluctuation” on major securities trading platforms. As a result, a litany of honest reporting requirements and the avoidance of exploitation of insider trading are prohibited.
15 USC 78u: Investigations and Actions
This provision of the Securities Exchange Act of 1934 sets a framework for civil penalties and SEC investigation powers. These powers include the capacity to bring suit against anyone in violation of any provision of the Act. This power carries with it the power to depose witnesses and engage in civil discovery.
In terms of civil fines. Infractions are broken into three tiers depending upon the type of wrongdoing. Tier 1 is limited to either $5,000 or the financial gain to the wrongdoer. Tier 2 is limited to $50,000 or the financial gain to the wrongdoer but is only applicable if the activity involved fraud, deceit, or a reckless disregard of regulatory requirement. Tier 3 is limited to $100,000 or the financial gain of the wrongdoer but is only applicable if fraud, deceit, and a risk of substantial losses to another person.
It is also significant that the specified dollar amounts above apply to natural persons, not companies. Further, if the financial gain is larger than the specified amounts then the larger amount would be the applicable limit.
15 USC 78u-1: Civil Penalties for Insider Trading
This provision allows a civil penalty upon controlling persons within an entity participating in a national exchange of the greater of either 3 times the profit gained or $1,000,000.
15 USC 78i: Manipulation of Security Prices
This provision relates to “pump and dump” schemes. These schemes are depicted in films such as Boiler Room and Wolf of Wall Street. Basically, these schemes are designed to create high trading volume in low-priced “penny” stocks on the promise that such stocks have tremendous upside potential and value. However, it the schemers who tout this purported value with the understanding that they’ll dump their position as soon as the price rises. Thus, price escalations are based upon high trading activity as opposed to any demonstrated value. Typically, once the stock price gets high, schemers dump their positions and the stock falls to a low price or zero, leaving investors, who are unaware of the false inflation, high and dry. This is the basis for directors and large stockholders to have trading restrictions in their positions. 78i outlaws pump and dump schemes.
15 USC 78j: Manipulative and Deceptive Practices
This provision makes it a federal crime to break any other requirement under the Securities Exchange Act of 1934. This includes failure to report the financial health and condition of a company on a major exchange and Insider Trading. Under Sarbanes Oxley and the Securities Exchange Act of 1934, companies are not allowed to inflate profit reports or deflate loss reports. Further, managers, control persons, and executives are not allowed to share information that is sensitive regarding their organization. Efforts to share this information or act upon it are considered insider trading and are illegal because they give an unfair advantage to insiders and their beneficiaries. More significant is the fact such practices put odd lot (or regular) investors at a market disadvantage.
15 USC 78ff: Penalties
This statute sets the penalty range for persons who “willfully” violate any provision of the Securities Exchange Act of 1934 and for those who “willfully” provide false information regarding any required reporting for companies under the Act.
Important Defense Considerations in Securities Fraud Cases
For people and companies facing the challenges of an SEC, US Postal Inspector, FBI, State Securities Board, or Homeland Security investigation related to any type of securities fraud, time and thoroughness are paramount considerations.
These cases often involve extensive data and records. They also involve a large number of potential witnesses. Unfortunately, law enforcement officials may draw a conclusion that wrongdoing took place on a small amount of records or a lone disgruntled employee. Thus it is important that records are compiled and analyzed quickly. It is also important to identify and evaluate the person or persons that spawned the investigation.
If the Government has a misunderstanding as to how a company attracts investment or keeps its own records, it could draw a false conclusion. Misunderstandings must be corrected.
It is equally important that the Government receives an accurate understanding as to how a company works and which responsibilities are assigned to various employees. If certain members of a company break certain rules it does not mean that all employees have done so.
Defense professionals need to not only to compile, understand, and organize company structures and records, they also need to obtain other professionals that can provide accurate forensic accounting to establish an accurate money flow and information that is beneficial to any targeted employee or person.
In situations where prosecutions do not target a company or corporation, these considerations are equally important to protect individuals.
Of most importance, these prosecutions require a high mental state where the Government must prove that a person knowingly committed fraud. This means that the person had to establish an intent to misrepresent information and to steal.
Under the Securities Exchange Act of 1934, to gain a conviction, the Government needs to establish “willfulness.” This means that only persons who know they are breaking the law when they engaged in fraud, can be convicted. This is important because all investigation by defense attorneys must be conducted with that understanding. Efforts to establish that clients were not knowingly breaking the law are critical.
This level of diligence is also applicable to SEC civil investigations. Fines under the Act are significant and can have a devastating reputational impact upon a company, not to mention a seriously threatening the company’s solvency. Once again, thorough reviews of documents and interviews with employees can help shape the narrative for the Government and justify a lowering of any applicable fine, or the avoidance of a fine altogether.
As with all criminal defense, during a federal investigation it is not only important for the defense to conduct their own investigation as stated above, it is also important to try to make contact with prosecutors and begin reviewing any discovery the Government makes available as well as make efforts to persuade the Government that it misunderstands the facts, or at the least, the scope of any wrongdoing.
Ultimately, securities fraud investigations are complex and the Government has a myriad of tools to impose significant fiscal, reputational, and liberty consequences to individuals and companies.
United States Sentencing Guidelines
Guidelines applicable to the Title 18 offenses are sentenced under 2B1.1. Learn more about 2B1.1 Sentencing.
With respect to the Securities Act of 1934 (18 USC 78), most cases are also dealt with under USSG 2B1.1. This means that the intended or actual loss involved with the fraud or failure to honestly report an asset the driving factor. However, certain offenses committed by persons “in a position of public trust with official responsibility for carrying out a government program or policy,” could be subject to USSG 2C1.1. This means that the starting offense level, before adding levels based upon intended or actual loss, could be as high as 12 or 14 instead of 6 or 7 as would be the case under 2C1.1. This is important because directors, managers, and control persons have significant authority and the Government may very well make the case that they are persons in positions of public trust based upon their duties to standards under SEC guidelines and various federal securities acts.
By itself, an increase for abuse of trust can add years of imprisonment. Also, it is important to recognize that securities cases rapidly accumulate loss numbers based on the number of persons purportedly negatively affected in certain stock fraud allegations. Ultimately, these prosecutions can carry significant sentences and steep fines.
If you or your business are under investigation for securities fraud, call us immediately to discuss how our former federal prosecutors can assist you. You can also contact us online: