297 Search Results

May 13, 2020 |
A Glimpse Behind the Curtain: Insights to SEC Enforcement During the Pandemic and Tips for Mitigating Investigative Risk

Click for PDF In a speech on May 12, 2020, Steven Peikin, Co-Director of the U.S. Securities and Exchange Commission’s Division of Enforcement, provided insights on the Division’s enforcement priorities in light of the pandemic, as well as how the Division is managing the investigative process under remote work conditions.[1]  The remarks provide helpful guidance on how companies and financial institutions can mitigate risk of investigative scrutiny for financial shocks resulting from the pandemic. In response to the pandemic, the Enforcement Division has formed a Coronavirus Steering Committee, comprised of leadership from the Home and Regional Offices, the specialized units and the Office of Market Intelligence, to identify areas of potential misconduct and coordinate the Division’s response to COVID-19 related issues.  The below areas of regulatory focus provide a helpful roadmap for companies and financial institutions, and reinforce the guidance we provided in our prior alert, to reduce the risk of drawing scrutiny.

  • Insider Trading and Market Manipulation: The rapid and dramatic impact of the pandemic on the financial performance of companies increases the potential for trading that could be perceived as attributable to material non-public information.  The Steering Committee is working with the Division’s Market Abuse Unit to monitor announcements in industries particularly impacted by COVID-19 and to identify potentially suspicious market movements.
  • Accounting Fraud: As with other financial crises, the pandemic is likely to expose previously undisclosed financial reporting issues, as well as give rise to rapidly evolving financial reporting and disclosure challenges.  The Steering Committee is on the lookout for indications of potential disclosure and reporting misconduct.  In particular, the Steering Committee is reviewing public filings with an eye toward disclosures that appear out of step to companies in similar industries.  The Committee is also looking for  accounting that attempts to inaccurately characterize preexisting financial statement issues as coronavirus related.
  • Asset Management: Asset managers confront unique challenges created by the pandemic, including with respect to valuations, liquidity, disclosures, and the management of potential conflicts among clients and between clients and the manager.  The Steering Committee is working with the Division’s Asset Management Unit to monitor these issues, including failures to honor redemption requests, which could reveal other underlying asset management issues.
  • Complex Financial Instruments: As with prior financial crises, the pandemic may reveal risks inherent in various structured investment products.  The Steering Committee is working with the Division’s Complex Financial Instruments Unit to monitor complex structured products and the marketing of those products to investors.
  • Microcap Fraud: The Steering Committee is working with the Division’s Microcap Fraud Task Force and Office of Market Intelligence, and has suspended trading in the securities of over 30 issuers relating to allegedly false or misleading claims related to the coronavirus.
As we discussed in our prior alert, by understanding the issues that can give rise to regulatory scrutiny, and consulting with counsel on how to navigate the unique challenges, issuers and financial institutions can both lower the risk of being in a regulatory spotlight, as well as resolve regulatory inquiries more efficiently. Speaking more broadly on the Enforcement Division’s process during the pandemic, Peikin noted that the Division staff continues to remain engaged despite the new challenges of a remote work environment.  The Division staff has been directed to work with defense counsel and others to reach reasonable accommodations concerning document production, testimony, interviews and counsel meetings, given the challenges of the pandemic, but also cautioned that the staff will need to protect potential claims and won’t agree to an indefinite hiatus in investigations or litigations.  In particular, Peikin noted that in instances where defense counsel would not agree to tolling agreements, the Division will consider recommending that the Commission commence an enforcement action, despite an incomplete investigative record, and will rely on civil discovery to further support its claims. Predictably, the pandemic has already led to a marked increase in Enforcement investigations and whistleblower tips.  Since mid-March, the Division has opened hundreds of new investigations concerning issues related both to COVID-19 as well as traditional areas of investigation.  In addition, the Division has triaged more than 4,000 whistleblower tips since mid-March, a 35% increase over the same period last year.  Since March 23, the Commission has granted nine whistleblower awards, including one for over $27 million (though these awards were clearly in the pipeline long before the pandemic).  Nevertheless, the notable increase in whistleblower complaints further reinforces the guidance in our prior alert on how companies can manage the heightened risks of whistleblowers resulting from the pandemic. In sum, Peikin noted that while there is uncertainty ahead, the Enforcement Division expects the pandemic will result in increased enforcement activity as the market decline and volatility will lead to investigations of potential past misconduct as well as potential new misconduct. ____________________ [1]   See May 12, 2020 Keynote Address: Securities Forum West 2020, available at https://www.sec.gov/news/speech/keynote-securities-enforcement-forum-west-2020.
Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic.  For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team, the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Enforcement Practice Group, or the following authors: Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Tina Samanta – New York (+1 212-351-2469, tsamanta@gibsondunn.com)   © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 12, 2020 |
How Biz Development Cos. Can Mitigate Regulatory Risks

New York partner Mark Schonfeld, of counsel Gregory Merz and associate Chris Hamilton are the authors of "How Biz Development Cos. Can Mitigate Regulatory Risks," [PDF] published by Law360 on May 11, 2020.

April 30, 2020 |
Operating Partners and/or Captive Consultants: Recent SEC Action and Six Takeaways

Click for PDF On April 22, 2020, the U.S. Securities and Exchange Commission (the “Commission”) issued a settled order finding that a middle-market private equity fund adviser failed to adequately disclose that costs relating to an internal “Operations Group” would be charged to the portfolio companies of the adviser’s fund.  In addition to finding a violation of Section 206(2) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the negligence-based anti-fraud provision, the adviser agreed to pay disgorgement of $1.7 million and a civil penalty of $200,000.[1] The order states that, although the applicable fund documents described certain fees that would be charged to portfolio companies, including “monitoring fees” and “consulting fees,” the documents failed to discuss any operations group costs or describe with any specificity any other relevant fees that would be charged by the adviser to the portfolio companies of the fund and not be subject to management fee offset.  Furthermore, the Commission found to be inadequate language that was subsequently added to the adviser’s Form ADV disclosure brochure describing potential costs relating to adviser personnel that “may”[2] be charged to portfolio companies of the fund.  The order is consistent with prior settlement orders where the Commission found disclosures inadequate for costs relating to in-house services[3] and captive consulting groups.[4] Operating partner arrangements come in a variety of forms, and it is important to distinguish captive consulting groups from other arrangements.  The recent order describes the operating partners as an “in-house ‘Operations Group’” and provides other facts that distinguish it from many third-party consultant arrangements, including that it was held out to investors as being in-house, that it serviced the adviser’s entire portfolio and that it charged fees designed to cover costs.[5]  While the order does not address third-party consultant arrangements, by including such distinguishing facts in its order the Commission suggests that those facts are relevant to its evaluation of the adequacy of disclosure.  While third-party consultant arrangements may receive somewhat less scrutiny, even those types of arrangements  can present meaningful conflicts or other issues that merit specific disclosure.[6] Given the Commission’s focus on operating partners and the variety of conflicts presented by operating partners, we encourage clients to discuss with counsel and consider the following general takeaways.

  1. Determine if the operating partners will be viewed as third-party consultants or as an in-house, captive consulting group. Ensuring independence and limiting the use of operating partners may be appropriate depending on disclosure and other factors and may reduce regulatory risk.
  2. Ensure that disclosure is adequate in view of the arrangement (specifically evaluating what costs are disclosed and can be fairly charged to funds and portfolio companies) and consider if periodic reporting of costs to investors is sufficiently comprehensive. Broad disclosures such as references to “monitoring fees” or “consulting fees” may be viewed as inadequate by the Commission.  In particular, the more “captive” the operating partners arrangement is, the more extensive and specific the disclosure regarding the arrangement should be.
  3. Consider what compliance controls are appropriate given the arrangement. Even if the operating partners are not “supervised persons” of the adviser under the Advisers Act, it may be appropriate to subject them to certain compliance controls consistent with an adviser’s responsibility to prevent the misuse of material, nonpublic information.
  4. Evaluate broker-dealer registration issues, if the arrangement includes the potential for transaction-based compensation.
  5. Generally consider other conflicts and issues presented by the arrangement and how they should be addressed (disclosure, consent, additional controls).
  6. Where costs of internal operating partners are allocated among portfolio companies or between portfolio companies and the adviser, it is important to maintain contemporaneous documentation to support the allocations.
_____________________ [1]  Monomoy Capital Management, L.P., Administrative Order No. 3-19764, the U.S. Securities and Exchange Commission (April 22, 2020) available at https://www.sec.gov/litigation/admin/2020/ia-5485.pdf. [2]  Notably, the Commission has expressed its dislike of the use of “may” in certain disclosures relating to conflicts of interest.  See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, the U.S. Securities and Exchange Commission (July 12, 2019), available at https://www.sec.gov/rules/interp/2019/ia-5248.pdf (“Similarly, disclosure that an adviser ‘may’ have a particular conflict, without more, is not adequate when the conflict actually exists.”). [3]  In 2015, the Commission found that an adviser violated Section 206(2) of the Advisers Act for failing to adequately disclose costs relating to legal and compliance services provided by in-house personnel charged by the adviser.  See Cherokee Investment Partners, LLC and Cherokee Advisers, LLC, Administrative Order No. 3-16945, the U.S. Securities and Exchange Commission (November 5 2015) available at  https://www.sec.gov/litigation/admin/2015/ia-4258.pdf. [4]  In 2018, the Commission announced settlement with an adviser concerning the way in which it allocated compensation-related expenses for employees of an internal operating partner group.  See NB Alternatives Advisers LLC, Administrative Order No. 3-18935, the U.S. Securities and Exchange Commission (December 17, 2018) available at https://www.sec.gov/litigation/admin/2018/ia-5079.pdf. [5]  The order cites the following statements from the adviser’s advertising materials: “an extensive in-house operational and financial restructuring team that drives business improvement throughout the [adviser’s] portfolio.” “The operations team is led by two operating partners…. The operating partners currently supervise a team of five portfolio company employees and 12 contractors who lead business improvement and lean manufacturing programs throughout the [adviser’s] portfolio.” [6]  On December 13, 2018, the Commissioner announced a settlement with an adviser for its failure to disclose certain in-house employee costs and arrangements with third-party consultants that gave rise to actual or potential conflicts of interest.  Notably, the arrangement with the third-party consultant included a personal loan between the consultant and a senior person at the adviser.  See Yucaipa Master Manager, LLC, Administrative Order No. 3-18930, the U.S. Securities and Exchange Commission (December 113, 2018) available at https://www.sec.gov/litigation/admin/2018/ia-5074.pdf.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Investment Funds or Securities Enforcement practice groups, or the following authors: Mark K. Schonfeld - New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Y. Shukie Grossman - New York (+1 212-351-2369, sgrossman@gibsondunn.com) C. William Thomas, Jr. - Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com) Gregory Merz - Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) Chris Hamilton - New York (+1 212-351-2495, chamilton@gibsondunn.com) Dan Li - New York (+1 212-351-6310, dli@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 26, 2020 |
SEC Enforcement Focus on Fallout from COVID-19: Insights for Public Companies and Investment Advisers During a Crisis

Click for PDF In a warning of things to come, the co-directors of the SEC Enforcement Division took the unusual step of issuing a cautionary statement on March 24, 2020, emphasizing “the importance of maintaining market integrity and following corporate controls and procedures” during this crisis. The SEC cited as examples the heightened risk of insider trading (“in these dynamic circumstances, corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances”) and the need to be mindful of disclosure controls (“protect against the improper dissemination and use of material nonpublic information”).[1] History teaches us that unprecedented market volatility, fast moving economic events, and dislocations create substantial challenges for compliance, and that there is a significant increase in the risk of an investigation. Today, this heightened investigative risk is compounded by unique challenges of remote work arrangements and the diminished ability for direct oversight and interaction. In an effort to help our clients navigate the latest enforcement challenges, we have compiled below a list of potential issues to be considered in the coming weeks in light of the SEC Enforcement Division’s notice and past experience on how the SEC has investigated matters in the midst of and following a crisis.

General Guidance

  1. Businesses should be prepared to operate under these conditions for at least the next three-to-six months.
  2. Businesses should maintain centralized communications with employees, clients, and investors, ensuring that even in the face of rapidly moving events that such communications are accurate and complete. Once statements are made, updates and modifications may become appropriate.
  3. Given the compliance and operational challenges of supervising employees and service providers remotely, it is helpful to have a plan in place for such supervision.
Business Continuity and Disaster Recovery Plans Firms should follow, and modify as necessary, their business continuity and disaster recovery plans. During and after past crises, the SEC’s Office of Compliance Inspections and Examinations, FINRA, and the CFTC have jointly and separately reviewed the business continuity and disaster recovery planning of firms, especially in the event of a problem experienced during the crisis. Material Contracts It is important to review material contracts to understand what would happen if your business or a counterparty cannot perform due to the current crisis. In particular, we recommend focusing on the (i) default, (ii) force majeure, (iii) termination and (iv) indemnification provisions in material contracts. For more information, see our alerts: Force Majeure Clauses: A 4-Step Checklist and Flowchart[2] and Coronavirus and Force Majeure: Addressing Epidemics in LNG and Other Commodities Contracts.[3] Regulatory Disclosures As always, consider if the current crisis has materially affected your business and if, when and how those events may need to be disclosed and if any recent statements need to be updated. There is an enhanced investigative risk that regulators will in hindsight review a business’ public statements and disclosures to determine whether a firm intentionally and materially overstated, understated, failed to correct prior statements, and/or made misleading or incomplete statements, in light of crisis-related events

Public Company Considerations

Fair Disclosure, Regulation FD Pursuant to Regulation Fair Disclosure (“Regulation FD”), in general, issuers cannot selectively disclose material, nonpublic information to stock analysts, investment advisors, security holders, or other market participants, and must disclose such information to that audience by means of simultaneous broad public dissemination.[4] Given that this crisis may have a short-term, material impact on an issuer’s finances and business operations, among other things, it is important to make sure that the process of communicating these developments with shareholders, analysts, media and other stakeholders is consistent with public disclosures and monitored with Regulation FD in mind. Sensitivity to the requirements of Regulation FD is critical in light of the extreme market volatility and the desire of market participants for information during the current COVID-19 crisis. Insider Trading and Trading Windows Public issuers should evaluate and potentially modify established trading windows during this crisis as rapidly evolving materials events may render historical trading windows inadequate. For example, during the exigency of evolving events, material nonpublic information may quickly arise outside of the traditional blackout periods, requiring the imposition of immediate restrictions on trading for certain groups of employees, executives and directors. Moreover, media reporting on notable stock sales by corporate executives heightens the exposure to regulatory inquiry. In limited instances, blackout periods might be shortened if it is in the best interests of the company and its shareholders to enable trading, and there is no material, nonpublic information due to uncertainty around how the situation is affecting the company; however, during a crisis such as this, care should be taken not to improperly restrict the communication of material information, particularly to directors and others that may need to know such information in order to perform their duties. Any changes to blackout periods must be based on the specific facts and circumstances, and should be communicated in writing with appropriate guidelines. As a general matter, public companies should exercise care in allowing corporate insiders to trade in its securities (both buying and selling) during the current crisis. 10b5-1 Plans Pursuant to Rule 10b5-1, corporate insiders frequently set up passive investment plans at a time when they do not have material, nonpublic information, in order to provide a mechanism to purchase and sell securities of their company when they have material, nonpublic information.[5] In a time of crisis, there is risk that any changes to such plans which continue to involve trading in the issuer’s securities will be scrutinized carefully by regulators, the media, and others as to whether they were made while in possession of material, nonpublic information about the effect of the crisis on the relevant issuer and to take advantage of such knowledge. Terminating a Rule 10b5-1 plan so as to cease any trading of securities in this time of crisis does not in and of itself violate the insider trading laws, and there may be very good reasons to do so. While the extraordinary changes in the markets and economy resulting from the COVID-19 situation may provide a basis for defending past transactions under a Rule 10b5-1 plan as having been made in good faith, terminating a Rule 10b5-1 plan may bear on the timing of any future decision to set up a new plan. Before making any changes to and/or stopping such a plan, corporate insiders and companies should consult their general counsel’s office and consider the best practices under the circumstances. Investment Adviser Considerations Insider Trading During a crisis, reminding investment professionals about the policies and procedures to prevent insider trading is critically important. There is a heightened investigative risk that communications with management and investor relations, which are a standard and proper part of an investment professional’s analyses of companies, regarding COVID-19 will be reviewed, in hindsight, for any disclosures of material, nonpublic information. There is also a heightened investigative risk that communications with political experts, members of federal and state executive branches and their agencies, and the staff of public representatives regarding ongoing executive and legislative actions, and the application of new laws and regulations, will be reviewed, in hindsight, for any disclosures of material, nonpublic information in violation of a fiduciary and/or other duty of confidentiality. Finally, there is a heightened investigative risk that communications with other asset managers regarding their analyses of the impact of COVID-19, which include communications, directly or indirectly, with management, investor relations, political experts, members of the executive branch, and staffs of public representatives, will be evaluated, in hindsight for any disclosures of material, nonpublic information. Investment Strategy Changes Certain investment strategies may be materially impaired by this current crisis or advisers may find unique opportunities outside of their traditional strategies. Under such circumstances, it is important to, among other things, review the documents governing the strategies to identify what changes fall within and outside such strategies, and what steps, if any, should be taken to make modifications to those strategies. Unique Opportunity Allocations Given market volatility during a crisis, unique investment opportunities may arise. Investment advisers may have to consider how to allocate unique opportunities amongst their funds, accounts and potential co-investors. As always, an adviser’s personnel will need to follow the adviser’s policies and procedures designed to ensure that they do not personally take investment opportunities away from funds and accounts managed by the adviser. Form ADV/Form PF Limited Relief For investment advisers, limited SEC relief for Form ADV/Form PF filing deadlines is available for those advisers experiencing crisis-related issues. Updated SEC guidance issued on March 25, 2020, provided that advisers “must notify the [SEC] staff and/or investors, as applicable, of the intent to rely on [such] relief, but generally no longer need to describe why they are relying on the order or estimate a date by which the required action will occur.” We nonetheless encourage advisers to file timely unless they are experiencing serious crisis-related issues, and to the extent an adviser must seek deadline relief, internally document reasons for failing to timely file.[6] Custody Rule Relief The SEC has not yet granted specific relief to the audited financial statement delivery requirement under the Rule 206(4)-2,[7] and advisers should try to meet their delivery requirements. Notably, in March 2010, an SEC Division of Investment Management FAQ stated that it would not recommend enforcement if an adviser “reasonably believed that the pool's audited financial statements would be distributed within the 120-day deadline, but failed to have them distributed in time under certain unforeseeable circumstances.”[8] It is not clear whether the Staff would consider this interpretive guidance to apply to a failure to deliver financial statements on time due to disruptions relating to COVID-19. Nevertheless, in the absence of relief related to the specific crisis, the Staff might be less inclined to bring an action against advisers making reasonable efforts to comply with the delivery requirement. Investor Communications Approaches will vary, but consider proactively advising investors of the steps you are taking to maintain operations and whom to contact with questions or concerns. Performance and investment risk discussions should include discussions of the impact this current crisis may have on investments. Under any approach, advisers should continue to maintain records of communications with investors and other stakeholders, together with any secondary support for information distributed. For funds raising capital or that permit redemptions, updates to offering materials may be appropriate. Selective disclosure to investors should be avoided. Valuation Throughout this crisis, advisers should continue to follow their valuation policies, and this could be a good time to remind relevant personnel of the details of such policies. While following existing policies is important, personnel should consider reassessing valuation assumptions and methodologies in consideration of the current environment. Decisions about changes to valuations relating to distressed asset sales should be made in consultation with experts and compliance.[9] Finally, we recommend taking additional time for the valuation process (i.e., starting earlier) and potentially conducting valuations more frequently. Liquidity Management Certain open-ended funds may experience a high volume of requests for redemptions, and advisers may have challenges in satisfying all requests in a timely fashion. An adviser facing this type of risk should carefully assess options under the applicable fund or account documents, including the possibility of imposing redemption gates, side pockets or suspensions. Implementing these types of measures may draw regulatory scrutiny in retrospect, and should be handled with care. If an adviser intends to seek liquidity through a related party transaction or a forced sale, the adviser should carefully consider the legal and regulatory issues that can be raised by these actions. Side Letter and Strategic Partnership Obligations Side letters or strategic partnership agreements may have notice or redemption rights that are implicated by the current crisis, and should be reviewed carefully. Crisis-Related Fund Expenses As with other expense allocation decisions, prior to allocating crisis-related expenses between funds or between a fund and an adviser, carefully consider the language in the operative fund documents. Record-Keeping After major market events in the past, the SEC has conducted sweep examinations seeking to understand how investment advisers respond to financial and operational challenges. Each adviser should maintain appropriate contemporaneous records that document how it assessed and responded to the financial and operational challenges posed by the current crisis for business continuity and to assist with responding to potential regulatory scrutiny. __________________
  1. Public Statement, “Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity” (March 23, 2020), available at, https://www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity
  2. Force Majeure Clauses: A 4-Step Checklist & Flowchart, Gibson, Dunn & Crutcher LLP (March 24, 2020) https://www.gibsondunn.com/wp-content/uploads/2020/03/force-majeure-clauses-a-4-step-checklist-and-flowchart.pdf.
  3. Coronavirus and Force Majeure: Addressing Epidemics in LNG and Other Commodities Contracts, Dunn & Crutcher LLP (February 14, 2020), available at, https://www.gibsondunn.com/coronavirus-and-force-majeure-addressing-epidemics-in-lng-and-other-commodities-contracts/.
  4. 17 CFR § Part 243 - Regulation FD, available at, https://www.govinfo.gov/content/pkg/CFR-2012-title17-vol3/pdf/CFR-2012-title17-vol3-part243.pdf.
  5. 17 CFR § 240.10b5-1 Trading “on the basis of” material nonpublic information in insider trading cases, available at, https://www.govinfo.gov/content/pkg/CFR-2013-title17-vol3/pdf/CFR-2013-title17-vol3-sec240-10b-3.pdf.
  6. Press Release, U.S. Securities and Exchange Commission, Division of Investment Management, “SEC Takes Targeted Action to Assist Funds and Advisers, Permits Virtual Board Meetings and Provides Conditional Relief from Certain Filing Procedures” (March 13, 2020), available at, https://www.sec.gov/news/press-release/2020-63; Press Release, U.S. Securities and Exchange Commission, Division of Investment Management, “SEC Extends Conditional Exemptions From Reporting and Proxy Delivery Requirements for Public Companies, Funds, and Investment Advisers Affected By Coronavirus Disease 2019 (COVID-19)” (March 25, 2020), available at, https://www.sec.gov/news/press-release/2020-73.
  7. 17 CFR § 275.206(4)-2 - Custody of funds or securities of clients by investment advisers, available at, https://www.govinfo.gov/content/pkg/CFR-2011-title17-vol3/pdf/CFR-2011-title17-vol3-sec275-2064-2.pdf.
  8. Staff Responses to Questions About the Custody Rule, U.S. Securities and Exchange Commission, Division of Investment Management (March 2010), available at, https://www.sec.gov/divisions/investment/custody_faq_030510.htm.
  9. See Accounting Standards Update No. 2011-04 (May 2011), available at, https://asc.fasb.org/imageRoot/00/7534500.pdf.

Gibson Dunn's lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm's Coronavirus (COVID-19) Response Team. Gibson Dunn lawyers regularly counsel clients on issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm's Securities Enforcement Group, or the authors: Mark K. Schonfeld - New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Reed Brodsky - New York (+1 212-351-5334, rbrodsky@gibsondunn.com) Barry R. Goldsmith - New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Gregory Merz - Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) C. William Thomas, Jr. - Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com) Mary Beth Maloney – New York (+1 212-351-2315, mmaloney@gibsondunn.com) Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Tina Samanta (+1 212-351-2469, tsamanta@gibsondunn.com) Chris Hamilton - New York (+1 212-351-2495, chamilton@gibsondunn.com) Nicholas C. Duvall - Washington, D.C. (+1 202-887-3781, nduvall@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 20, 2020 |
Delaware Supreme Court Unanimously Upholds Federal-Forum Provisions

Click for PDF In Salzberg, et al. v. Sciabacucchi (“Blue Apron II”),[1] a unanimous Delaware Supreme Court, with Justice Valihura writing, confirmed the facial validity of federal-forum provisions (“FFPs”)—provisions Delaware corporations adopt in their certificates of incorporation requiring actions arising under the Securities Act of 1933 (the “1933 Act”) to be filed exclusively in federal court. The Court’s decision emphasizes the “broadly enabling” scope of both the Delaware General Corporation Law (“DGCL”) as a whole, and of Section 102(b)(1),[2] which governs the contents of a corporation’s certificate of incorporation, in particular. Rejecting facial challenges to FFPs adopted by Delaware corporations in connection with several recent IPOs, the Court held that Section 102(b)(1) authorizes corporations to adopt provisions regulating matters within an “outer band” of “intra-corporate affairs” extending beyond the “universe of internal affairs” of a Delaware corporation. In this regard, Blue Apron II may offer Delaware corporations, their boards and advisors a valuable new tool for managing complex, multidistrict litigation related to their corporate governance. Blue Apron I and the Established Scope of “Internal Corporate Claims” Blue Apron II reversed, on de novo review, the December 2018 decision of the Delaware Court of Chancery in Sciabacucchi v. Salzberg, et al. (“Blue Apron I”).[3] In Blue Apron I, a stockholder in each of Blue Apron, Inc., Roku Inc., and Stitch Fix, Inc. sought a declaratory judgment that FFPs adopted in each corporation’s certificate of incorporation in connection with their 2017 IPOs were facially invalid as a matter of Delaware law. As detailed by Vice Chancellor Laster, the basic principles underlying the holding in Blue Apron I were developed in Boilermakers,[4] ATP Tour,[5] and DGCL § 115,[6] each of which addressed bylaws for disputes involving Delaware corporations. Relying upon these authorities, the Blue Apron I court held that, despite the broad scope of DGCL § 102(b)(1), the FFPs could not validly restrict a stockholder plaintiff’s choice of forum for actions arising under the 1933 Act because such claims were “external” to the corporations at issue based upon their similarity to “a tort or contract claim brought by a third-party plaintiff who was not a stockholder at the time the claim arose.” The Court of Chancery also concluded that Section 115 implicitly narrowed Section 102(b)(1) to restrict the authority of Delaware corporations to regulating only “internal corporate claims.” Additionally, the trial court also noted, but did not reach, an argument that FFPs are invalid as a matter of public policy, because they “take Delaware out of its traditional lane of corporate governance and into the federal lane of securities regulation” and could even be preempted by federal law providing forum alternatives. The New Frontier: Intra-Corporate Affairs and the “Outer Band” of Section 102(b)(1) In Blue Apron II, the Delaware Supreme Court reversed the Court of Chancery, holding that FFPs are facially valid because such provisions “could easily fall within either of the[] broad categories [of Section 102(b)(1)],” and “do not violate the laws or policies of this State” or “federal law or policy.” In doing so, the Supreme Court rejected the Court of Chancery’s conclusions that Section 115 implicitly narrowed Section 102(b)(1) and that, under Boilermakers and ATP Tour, “everything other than an ‘internal affairs’ claim was ‘external’ and, therefore, not the proper subject of a bylaw.” Instead of such a “binary world,” the Supreme Court held that claims involving “intra-corporate affairs” under Section 102(b)(1), such as the federal antitrust claims underlying the fee-shifting bylaws in ATP Tour and certain 1933 Act claims considered hypothetically by the Court in Blue Apron II, sit on a “continuum” of corporate affairs. At one end of the spectrum is “the more traditional realm of ‘internal affairs,’” including “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.” At the other end are “purely ‘external’ claims,” such as tort claims and commercial contract claims.  According to the Supreme Court, the scope of matters that certificates of incorporation may properly regulate under Section 102(b)(1) falls between those poles, as it set forth in Figure 1, below. The “outer band” of Section 102(b)(1), the Court explained, extends to all “[i]ntra-corporate affairs,” which is a “universe of matters” that “is greater than the universe of internal affairs matters.” This includes FFPs “regulating the fora for Section 11 claims involving at least existing stockholders [because such claims] are neither ‘external’ nor ‘internal affairs’ claims.” Figure 1: Textual Analysis of Corporate Affairs Notwithstanding the Supreme Court’s holding that federal-forum provisions are facially valid, the Court acknowledged that the extent to which such provisions will be respected and enforced going forward by Delaware courts, and, even more critically, by other state and federal courts, will depend in large part on the unique facts and circumstances of each case. Key Takeaways Blue Apron II provides valuable guidance to Delaware litigators and board advisors on best practices for adopting FFPs and other provisions governing the procedural aspects of intra-corporate litigation pursuant to Section 102(b)(1) of the DGCL:

  • In the wake of this development, Delaware corporations that have not done so already may amend their charters to require claims under the 1933 Act to be filed in federal court.[7] After Cyan was decided in 2018, the filing of 1933 Act claims in state courts increased significantly.[8] Given that such claims cannot be removed to federal court under Cyan, corporations have increasingly been mired in unnecessarily costly, and sometimes duplicative, state and federal court litigation throughout the country.
  • The Supreme Court in Blue Apron II quells “concern that if [FFPs were] upheld, the ‘next move’ might be forum provisions that require arbitration of internal corporate claims,” explicitly reasoning that “[s]uch provisions, at least from [Delaware] state law perspective, would violate Section 115 . . . .” But it is not yet clear whether practitioners will continue to push to include arbitration as an exclusive means to resolve certain intra-corporate disputes lying within the “outer bound” of Section 102(b)(1).
  • Although Delaware law prohibits Delaware corporations from adopting mandatory arbitration provisions in their certificates of incorporation or bylaws, it remains to be seen whether other states will follow suit. States competing for Delaware’s franchise might attempt to attract corporations by authorizing such arbitration provisions to minimize the burden and cost of litigation.
  • FFPs clearly benefit stockholders by minimizing wasteful multi-jurisdictional litigation over many disputes involving the corporations they own. Nonetheless, corporate directors and officers should anticipate that some stockholders may be wary of the provisions, including broader FFPs adopted or approved under Blue Apron II. This decision should serve as a reminder that corporations may be well advised to engage with key stockholders to discuss the benefits these provisions provide before their adoption.
____________________       [1]     Salzberg, et al. v. Sciabacucchi, No. 346, 2019 (Del. Mar. 18, 2020) [hereinafter “Blue Apron II”)].       [2]    8 Del. C. § 102(b)(1) (“[T]he certificate of incorporation may also contain . . . [a]ny provision for the management of the business and for the conduct of the affairs of the corporation , and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders . . . .”).       [3]   Sciabacucchi v. Salzberg, et al., 2018 WL 6719718 (Del. Ch. Dec. 19, 2018) [hereinafter “Blue Apron I”].       [4]   Boilermakers Local 154 Retirement Fund v. Chevron, 73 A.3d 934, 942, 952 (Del. Ch. 2013).       [5]    ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014).       [6]   8 Del. C. § 115 (“‘Internal corporate claims’ means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.”).       [7]   Blue Apron II does not address the applicability of an FFP to claims arising under the Securities Exchange Act of 1934 (the “1934 Act”), which unlike the 1933 Act vests exclusive jurisdiction with federal courts and does not include a bar to removing claims improperly filed in state court.  Compare 15 U.S.C. 78aa(a) (1934 Act), with 15 U.S.C. 77v (1933 Act).       [8]   Stanford L. Sch. Sec. Class Action Clearinghouse & Cornerstone Research, Sec. Class Action Filings 2019 Year in Review 4 (2020).
The following Gibson Dunn lawyers assisted in the preparation of this client update: James Hallowell, Jason J. Mendro, Brian M. Lutz, Mark H. Mixon, Jr., Sam Berman and Andrew Kuntz. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, any of the following practice group leaders and members, or the authors: James L. Hallowell - New York (+1 212-351-3804, jhallowell@gibsondunn.com) Jason J. Mendro - Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com) Brian M. Lutz - San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com) Mark H. Mixon, Jr. - New York (+1 212-351-2394, mmixon@gibsondunn.com) Securities Litigation Group: Brian M. Lutz - Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com) Robert F. Serio - Co-Chair, New York (+1 212-351-3917, rserio@gibsondunn.com) Jefferson Bell - New York (+1 212-351-2395, jbell@gibsondunn.com) Paul J. Collins - Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Jennifer L. Conn - New York (+1 212-351-4086, jconn@gibsondunn.com) Ethan Dettmer - San Francisco (+1 415-393-8292, edettmer@gibsondunn.com) Mark A. Kirsch - New York (+1 212-351-2662, mkirsch@gibsondunn.com) Monica K. Loseman - Denver (+1 303-298-5784, mloseman@gibsondunn.com) Jason J. Mendro - Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com) Alex Mircheff - Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com) Robert C. Walters - Dallas (+1 214-698-3114, rwalters@gibsondunn.com) Aric H. Wu - New York (+1 212-351-3820, awu@gibsondunn.com) Securities Enforcement Group: Richard W. Grime - Washington, D.C. (+1 202-955-8219, rgrime@gibsondunn.com) Barry R. Goldsmith - New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark K. Schonfeld - New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Securities Regulation and Corporate Governance Group: Elizabeth Ising - Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney - Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 14, 2020 |
2019 Year-End Securities Enforcement Update

Click for PDF

I.   Introduction: Themes and Notable Developments

A.   Behind and Beyond the Enforcement Numbers

This year, the SEC’s review of the performance of the Enforcement Division has de-emphasized the statistics and focused more on qualitative measures of its performance. As Chairman Clayton noted in his December testimony to the Senate Banking Committee, “purely quantitative measures alone cannot adequately measure the effectiveness of Enforcement’s work, which can be evaluated better by assessing the nature, quality and effects of each of the Commission’s enforcement actions with an eye toward how they further the agency’s mission.”[1] With that said, this fiscal year saw a spike in the number of enforcement actions – the number of standalone enforcement actions increased to 526 from 490 the prior year, and the amount of financial remedies obtained also increased to $4.3 billion from $3.9 billion the prior year. However, an unstated reason to avoid focus on statistical metrics could be that looking behind the numbers reveals that the increase is attributable to a one-time Mutual Fund Share Class Disclosure Initiative, a group of cases in which investment advisers were encouraged to self-report issues associated with the selection of fee-paying mutual fund share classes when a lower or no-cost share class of the same fund was available.  Consequently, the apparent increase is more likely an anomaly than a trend.[2] As in prior years under this administration, the SEC’s Enforcement Division this year continued to focus on cases impacting retail investors and on cyber-related cases, including initial coin offerings and other digital assets.  Given this current administration continues for at least another year, one should not expect dramatic changes in the focus of the Enforcement Division next year. After several years of a freeze on hiring, during which staffing numbers declined due to attrition, this year’s budget did provide the Enforcement Division with additional hiring authority. However, although headcount for Enforcement (as well as the Commission generally) increased slightly from the prior year, staffing is still well below its peak in 2016. One positive trend note to look for in the coming year is an increased focus on reducing the duration of investigations.  The Enforcement Division’s Annual Report notes that on average investigations that result in enforcement actions take an average of two years, and that the more complex accounting and disclosure cases take an average of three years.   This does not include investigations that do not result in any enforcement action, which can remain open even longer, leaving those subject to investigations in an indefinite state of uncertainty.  While it is encouraging that the Enforcement Division is taking steps to shorten the duration of investigations, it will remain to be seen whether the Commission is able to achieve any meaningful success in this regard.

B.   Insider Trading Developments

On December 30, 2019, the Second Circuit issued a significant opinion in United States v. Blaszczak that heightens the risk of investigation and prosecution in certain types of insider trading cases.[3] In Blaszczak, a Center for Medicare & Medicaid Services (“CMS”) employee, a “political intelligence” hedge fund consultant, and two hedge fund employees were charged in an insider trading scheme whereby confidential “predecisional” CMS information regarding planned changes to medical reimbursement rates was allegedly disclosed via the consultant to the hedge fund employees, who then directed their hedge fund to short stocks of healthcare companies that would be hurt by the reimbursement rate changes. After trial, a jury verdict found the defendants not guilty of insider trading under Title 15 (the Securities Exchange Act provision prohibiting securities fraud), which required that the defendants knew that the tipper received a personal benefit, but found the defendants guilty under Title 18 (a criminal securities fraud provision added in the 2002 Sarbanes-Oxley Act to the wire fraud statute), which did not require a personal benefit to the tipper. On appeal, the Second Circuit considered two primary issues: (1) whether the requirement in insider trading cases brought under Title 15 that the tipper receive a personal benefit and the tippee have knowledge of that personal benefit applied to the Title 18 criminal securities fraud provision; and (2) whether confidential predecisional government information constituted government “property,” a necessary element for the convictions. Reasoning that the Securities Exchange Act and Sarbanes-Oxley securities fraud provisions were rooted in different purposes, the Second Circuit refused to extend the Title 15 personal benefit requirement to the Title 18 securities fraud and wire fraud provisions. In addition, the Second Circuit, in a 2-1 decision, held that confidential government information may constitute government “property,” analogizing it to “confidential business information” that the Supreme Court had previously held to be property. The Second Circuit therefore affirmed the convictions. Blaszczak heightens the risk of DOJ investigation and prosecution in the subset of insider trading cases where there is limited-to-no-evidence of personal benefit to the tipper or the downstream tippee’s knowledge of the personal benefit. The decision makes it more likely that prosecutors will routinely bring Title 18 securities fraud and wire fraud charges in conjunction with Title 15 charges, especially given the continually evolving case law regarding what constitutes a “personal benefit.” Blaszczak also heightens the risk of both SEC and DOJ investigations in cases involving trading while in possession of a wide range of confidential executive agency information, whether obtained directly from a government employee or, as was the case in Blaszczak, from a consultant with access to government employees. For further information on the Blaszczak decision and its implications, please see our separate Client Alert, “United States v. Blaszczak: Second Circuit Ruling Heightens Risks of Insider Trading Investigations and Prosecutions.”

C.   Legislative Developments

On December 9, 2019, the US House of Representatives overwhelmingly passed the Insider Trading Prohibition Act (the “Act”), 410 to 13, which, if enacted, would codify a ban on insider trading. See H.R. 2534 116th Cong. § 16A. The Act amends the Securities Exchange Act of 1934 (15 U.S.C. § 78a et seq.), the securities fraud provisions of which courts have previously interpreted to prohibit insider trading. The Act, which is currently pending in the Senate, largely adopts existing insider trading caselaw and theories of liability. In its current form, the Act does not amend the criminal securities fraud provision 18 U.S.C. § 1348, which, similar to the Securities Exchange Act, courts have interpreted to prohibit insider trading. Section (a) of the Act would prohibit trading securities while aware of “material, nonpublic information relating to [a security], or any nonpublic information… that has, or would reasonably be expected to have, a material effect on the market price of [the security]” if the person “knows, or recklessly disregards, that such information has been obtained wrongfully” or that the transaction “would constitute a wrongful use of such information.” Id. § 16A(a). Section (b) would prohibit anyone who would be prohibited from trading under section (a) from “communicat[ing] material, nonpublic information relating to such security…to any other person if” (1) the other person trades “any security. . . to which such communication relates” or “communicates the information to another person who makes or causes such a purchase, sale, or entry,” and (2) “the purchase, sale, or entry . . . is reasonably foreseeable.” Id. § 16A(b). The Act applies to information that is “obtained wrongfully” or where use would be “wrongful.” It clarifies that “trading while aware of material, nonpublic information . . . or communicating material nonpublic information. . . is wrongful only if the information has been obtained by, or its use would constitute. . . (A) theft, bribery, misrepresentation, or espionage (through electronic or other means); (B) a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users; (C) conversion, misappropriation, or other unauthorized and deceptive taking of such information; or (D) a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, a breach of any code of conduct or ethics policy, or a breach of any other personal or other relationship of trust and confidence for a direct or indirect personal benefit (including pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend).” Id. § 16A(c)(1). In addition, the Act has a “knowledge requirement” mandating that the person “was aware, consciously avoided being aware, or recklessly disregarded that such information was wrongfully obtained, improperly used, or wrongfully communicated,” although the person is not required to know “whether any personal benefit was paid or promised.” Id. § 16A(c)(2). This is not the first time Congress has considered a statutory definition of insider trading. Advocates of such legislation argue that a statutory definition will bring clarity to an area of the law developed through decades of judicial interpretation of a general anti-fraud statute. However, since the House bill, like similar prior attempts a legislation, generally seeks to embody existing legal theories, critics argue that such attempts do little to simplify a complex and nuanced set of issues and actually risks adding vagueness and uncertainty. Moreover, despite significant support for the bill in the House, there appears to be little enthusiasm in the Senate for pursuing such legislation, particularly in the final months before the next election.

D.   Litigation Developments

Looming over the Enforcement Division in the coming year will a case before the Supreme Court which presents the question of whether the SEC is authorized to pursue one of its mainstay remedies -- disgorgement of so-called ill-gottten gains -- in enforcement actions in federal district court. There is no statute which expressly authorizes the SEC to obtain disgorgement in these federal enforcement actions, unlike in administrative proceedings where there is specific authority for the SEC to seek disgorgement. Rather, the securities laws enumerate certain statutorily defined penalties that the SEC may recover in appropriate circumstances. Nevertheless, historically, federal courts have ordered disgorgement as an equitable remedy.  In its 2017 decision in Kokesh, the Supreme Court held that the remedy of disgorgement constituted a penalty and therefore was subject to the 5-year statute of limitations on penalties.  The Enforcement Division estimates that as of the end of the 2019 fiscal year, the 5-year statute of limitations put beyond the SEC’s reach $1.1 billion in alleged ill-gotten gains. In a footnote to the Kokesh decision, the Court noted that the case did not present, and the Court would not decide, whether the SEC is authorized to obtain disgorgement. In November, the Supreme Court granted certiorari in Liu v. SEC, in which a defendant in an enforcement action was ordered to pay disgorgement as part of a final judgment entered by the district court. Before appealing to the Ninth Circuit, the Supreme Court decided Kokesh. The appellant argued to the Ninth Circuit that, in light of the decision in Kokesh that disgorgement is a penalty, and there is no statutory authorization for the SEC to seek disgorgement as a penalty, the SEC lacks authority to seek disgorgement. The Ninth Circuit affirmed the District Court’s disgorgement order based on pre-Kokesh precedent and the fact that Kokesh had expressly declined to address the question. The issue is now squarely before the Supreme Court. If the Supreme Court disallows disgorgement, the SEC’s enforcement program will be significantly weakened, that is, unless Congress steps in with a legislative solution to authorize the disgorgement remedy expressly.

E.   Commissioners and Senior Staffing Update

During the latter half of 2019, there were a number of leadership changes, several of which reflect the advancement of lawyers with many years of experience in the Division of Enforcement to positions of senior leadership. On July 8, Allison Lee was sworn in as the fifth Commissioner, bringing the Commission back to its full complement of five Commissioners. As we noted in our Mid-Year Alert, Commissioner Lee replaces prior Democratic Commissioner Kara Stein. Commissioner Lee previously served at the Commission for over a decade, including as counsel to Commissioner Stein, as well as a Senior Counsel in the Complex Financial Instruments Unit of the Division of Enforcement. A change in the other Democratic Commissioner, Robert Jackson, also appears to be on the horizon. For several months there have been reports that Commissioner Jackson would be stepping down soon to return to teaching at NYU Law School. (Although Commissioner Jackson’s term formally ended in June 2019, Commissioners may continue for another 18 months.) According to media reports shortly before the end of the year, Senator Chuck Schumer proposed to the White House that Caroline Crenshaw, an attorney currently working for Commissioner Jackson, be nominated as his replacement. Crenshaw has been employed at the SEC since 2013, and, like Commissioner Lee, previously worked under Democratic commissioner Kara Stein. Crenshaw is also a judge advocate in the U.S. Army Judge Advocate General’s Corps.[4] Other changes in the senior staffing of the Commission include:
  • In September, Monique Winkler was appointed Associate Regional Director in the SEC’s San Francisco Office. As Associate Regional Director, Ms. Winkler oversees the Enforcement program for the San Francisco Office. Ms. Winkler has worked at the SEC since 2008, including working in the Enforcement Division’s Public Finance Abuse Unit.
  • In October, Katharine Zoladz was appointed Associate Regional Director in the SEC’s Los Angeles Office. As Associate Regional Director, Ms. Zoladz, co-heads the Enforcement program for the Office, along with Associate Regional Director Alka Patel. Ms. Zoladz has worked at the SEC since 2010, including working in the Asset Management Unit.
  • In November, Chief Administrative Law Judge Brenda Murray retired after 50 years of federal service, including 25 years as Chief Administrative Law Judge.
  • In December, Kristina Littman was appointed Chief of the Enforcement Division’s Cyber Unit. Ms. Littman has worked at the SEC since 2010, including working in the Enforcement Division’s Market Abuse Unit and Trial Unit, and most recently, as counsel to Chairman Clayton.

F.   Whistleblower Awards and Cases

The SEC’s whistleblower program continues to provide significant financial awards to whistleblowers.   As of the end of 2019, the SEC has awarded a total of approximately $390 million to 71 individual whistleblowers.  This is a reminder of the powerful financial incentive the program provides to would-be whistleblowers.  In fiscal year 2019, the SEC received over 5,200 whistleblower tips. The size of whistleblower payments, in addition to the volume of tips coming through the whistleblower office, emphasize the importance of a company’s response to internal complaints from employees who could become whistleblowers. Maintaining a record of investigating internal complaints can put a company in a position to respond to SEC inquiries if and when the government comes calling. In the second half of 2019, the SEC granted several whistleblower awards that were significant, though not on the scale of the largest awards that have been awarded since the program began. As always, the Commission discloses little substantive information on the basis for the award. In July, the SEC announced a $500,000 award to an overseas whistleblower whose reporting helped the Commission bring a successful enforcement action.[5] In August, the SEC awarded over $1.8 million to a whistleblower whose cooperation included giving sworn testimony and reviewing documents, among other assistance in an investigation of conduct committed overseas.[6] And in November, the SEC awarded collectively $260,000 to three whistleblowers—themselves harmed investors—who jointly provided a tip that led to an enforcement action alleging a scheme targeting retail investors.[7] The Commission also brought another action for violation of the anti-retaliation provision of the whistleblower law. In November, the SEC amended its complaint in a pending enforcement action against an online auction portal and its CEO to add allegations that the defendants unlawfully sought to prohibit investors from reporting misconduct to the SEC and other governmental agencies.[8] In its original complaint against the company and its CEO, the SEC had alleged that the defendants engaged in a fraudulent securities offering based on false statements to investors and had misappropriated over $6 million of investor proceeds. According to the amended complaint, the defendants attempted to resolve investor allegations of wrongdoing by conditioning the return of investor money on the investors signing agreements prohibiting them from reporting potential securities law violations to law enforcement, including the SEC. The complaint is pending in the U.S. District Court for the Southern District of New York.

G.   Emerging Interest in Use of Big Data by Investment Managers

For years now we have been counseling clients on managing the regulatory and compliance risks arising from the use of alternative data or big data in portfolio management. The procurement and use of such data raises a number of potential compliance issues – both under the securities laws as well as data privacy laws – not unlike the risks presented by the use of other third party data sources such as expert networks. Years before regulators and prosecutors began bringing insider trading cases based on the use of expert networks, the SEC’s Compliance Examination program had begun asking investment advisers about their use of expert networks and the policies and procedures advisers employed to promote compliance with the securities laws. This year we have observed the SEC’s Examination staff adding to certain of their request lists requests for information about the adviser’s use of alternative data and related compliance policies and procedures. The Examination staff can use such information to learn about the various forms of alternative data managers are using, understand the range of compliance and diligence practices being employed, potentially formulate guidance in the form of a risk alert, or, in certain cases, refer matters to Enforcement for further investigation. The Examination staff’s heightened scrutiny also mirrors interest from other regulators, legislators and the media in this fast-evolving and potentially risky area. In sum, the focus of the Examination staff on fund managers’ use of alternative data emphasizes the importance of having in place policies and procedures for the on-boarding of big data providers, training of investment professionals in the risks, and ongoing monitoring of such providers on a periodic basis.

H.   Cryptocurrency

In the latter half of 2019, the SEC continued its cyber focus, bringing multiple enforcement actions in the cryptocurrency space, in large part centered on initial coin offerings (“ICOs”). Commissioner Peirce has been critical of the Commission’s approach to crypto-related issues, and has advocated for clarifying regulation rather than a “parade of enforcement actions” as a means to provide guidance to the market. In a speech in November 2019, Commissioner Peirce argued that, “the lack of a workable regulatory framework has hindered innovation and growth.” In particular, Commissioner Peirce advocated a “non-exclusive safe harbor period within which a token network could blossom without the full weight of the securities laws crushing it before it becomes functional.” It remains to be seen whether these views will influence that regulatory approach to offerings of crypto-currencies and other digital assets.[9] In the meantime, the parade marches on, as the discussion of recent cases below reflects. In September, the SEC settled an action against a blockchain technology company for allegedly conducting an unregistered ICO.[10] According to the SEC, the company failed to register the ICO—which had raised several billion dollars’ worth of digital assets between June 2017 and June 2018—as a securities offering and did not otherwise seek an exemption from registration requirements, in violation of the registration provisions of the federal securities laws. Without admitting or denying the SEC’s findings, the company agreed to pay a $24 million civil penalty and to a cease-and-desist order. A few weeks later, the SEC announced an emergency action against a mobile messaging company and its subsidiary in connection with an alleged unregistered ICO.[11] The SEC filed a complaint against the two companies in the Southern District of New York alleging that they failed to register their securities—digital tokens called “Grams”—and therefore also failed to provide investors with information about their investments. The SEC sought and obtained a temporary restraining order in order to stop the then-ongoing ICO. The litigation remains pending; the parties are currently engaged in discovery and additional briefing is due in January. The Court has ordered that the companies refrain from the offering, selling, or distribution of Grams until conclusion of the preliminary injunction hearing, which has been scheduled for mid-February 2020. In December, the SEC filed another action in the Southern District of New York, charging the founder of a digital-asset issuer and the issuer itself with defrauding investors in connection with an ICO.[12] The complaint alleges that the founder conducted a fraudulent unregistered securities offering, making misrepresentations to investors and failing to create a functional platform for online shopping profiles as promised would be done with funds raised in the ICO. The founder also allegedly misappropriated funds from the ICO for his own personal use, according to the SEC. The founder and company have not yet answered the SEC’s complaint. Also in December, the SEC brought settled charges against a blockchain technology company for failing to register an ICO that began after the Commission’s 2017 DAO Report was issued.[13] The company allegedly sold unregistered digital tokens to investors in the U.S. and through foreign resellers without placing restrictions on resale to U.S. investors. In settling the charges without admitting or denying the findings, the company agreed to a $250,000 penalty, a cease-and-desist order, and to return funds used to purchase tokens to investors who submit a claim.

II.   Public Company Cases

A.   Accounting Fraud and Internal Controls

The SEC brought several accounting fraud cases involving filed complaints against public companies and executives in the second half of 2019. Notably, several of the Commission’s actions against individuals were not settled, thus adding to the Enforcement Division’s litigation docket for the coming year. In July, the SEC filed a complaint in federal court in Chicago alleging that the former CEO and two former sales executives of an engine manufacturing company had committed accounting fraud by overstating the company’s revenues by nearly $25 million.[14] According to the SEC, the executives fraudulently recorded revenue on sales that were not yet complete, that the customer had not agreed to accept, and for which the company falsely inflated the price. The executives allegedly worked to conceal the fraud by misleading and withholding key information from the company’s accountants and outside auditor. The complaint sought permanent injunctions and penalties, as well as disgorgement and prejudgment interest from one of the sales executives and an officer-and-director bar and clawback of incentive-related compensation from the CEO. In September, the SEC filed a complaint in federal court in Indianapolis charging two former executives of a trucking company with accounting fraud, books and records violations, and reporting violations.[15] The complaint alleged that the former president and COO and former CFO participated in a scheme to buy and sell trucks at prices much higher than their fair market value, leading to the company overstating its income and earnings per share. According to the complaint, the executives tried to conceal the alleged overvaluing by lying to the company’s auditor about whether the prices were determined independently and their roles in the transactions. The SEC is seeking injunctions, monetary penalties, and officer-and-director bars. The company settled related accounting fraud charges in April 2019. The SEC in November charged a biotech company and three former executives with antifraud, reporting, books and records, and internal control violations for allegedly misstating revenue and attempting to cover it up.[16] The complaint alleged that the company’s former CEO and COO entered into undisclosed side arrangements with distributors that allowed the distributors to return product and conditioned payment obligations on end-user sales, leading to the company prematurely recognizing sales revenue and overstating revenue growth. According to the SEC, the two former executives, along with the CFO, covered up this arrangement for years, including by misleading outside auditors and lawyers. The company agreed to settle for a $1.5 million penalty, without admitting or denying wrongdoing; the litigation against the executives remains pending. In early December, the SEC charged a brand-management company and three of its former executives with accounting fraud.[17] According to the complaint, the former CEO and COO created fictitious revenue that caused the company to meet or beat analysts’ estimates for two quarters and allowed the executives to profit substantially on stock sales. In related charges, the SEC alleged that the company recognized false revenue and manipulated its earnings; concealed distressed finances of licensees; and failed to recognize more than $239 million in impairment charges for three brands. And it alleged that the company and its former CFO caused the company to overstate its net income by hundreds of millions of dollars by failing to recognize certain losses, disclose transactions to temporarily improve licensees’ finances, and test for impairment. Without admitting or denying the allegations, the company agreed to pay a $5.5 million penalty, while the former COO agreed to a permanent officer-and-director bar as well as disgorgement and prejudgment interest of more than $147,000 and a penalty to be determined later, and the former CFO agreed to disgorgement and prejudgment interest of almost $50,000 and a penalty of $150,000. The litigation against the former CEO remains ongoing.

B.   Misleading Disclosures

In addition to the accounting-related cases discussed above, the SEC also pursued cases based on misleading disclosures made by public companies in the latter half of the year. Misleading Metrics In August, the SEC announced settled charges against a publicly-traded real estate investment trust and simultaneously filed a complaint against four former executives, alleging that over a two-year period they fraudulently adjusted a certain non-GAAP metric in an effort to hit the company’s growth targets.[18] The complaint alleged that the executives misled investors and analysts by manipulating the company’s same property net operating income (SP NOI) metric in various ways, including by only selectively recognizing income, incorporating income the company had said was excluded, and making the company’s growth appear stronger by lowering the prior year’s SP NOI. The company paid a $7 million penalty to settle the charges without admitting or denying liability. Two of the executives also agreed to partial judgments with monetary relief to be determined in the future. In September, the SEC announced settled fraud charges against an information and media analytics firm and its former CEO for allegedly overstating revenue and misstating certain performance metrics after entering into a series of non-monetary transactions.[19] According to the SEC’s orders, the company—at the direction of the CEO—was negotiating for and exchanging sets of data without cash consideration and then recognizing inflated revenue on those non-monetary transactions based on the fair value of the data, which itself was increased. As part of the alleged scheme, the SEC contended that both the company and CEO misled investors by making false statements about the company’s customer base and product, and that the CEO lied to accountants in an effort to exceed revenue targets for seven consecutive quarters. Without admitting or denying the SEC’s findings, the company and CEO agreed to settle for a combined penalty of $5.7 million, with the CEO also reimbursing the company $2.1 million in incentive-based compensation and profits from stock sales. Executive Perks In September, the SEC settled actions against an automobile manufacturer, its former CEO, and its former director relating to charges that the company made false financial disclosures when it omitted disclosure of approximately $140 million in executive benefits.[20] The SEC alleged that the company’s CEO, with substantial assistance from the charged director and others in the company, worked to conceal more than $90 million in executive compensation from disclosure. The individuals also allegedly made efforts to increase the CEO’s retirement account by approximately $50 million each year. Without admitting or denying the charges, the company agreed to a $15 million civil penalty and, along with the individuals charged, agreed to cease and desist from future violations of the anti-fraud provisions of federal securities laws. In addition, the company’s CEO agreed a $1 million civil penalty and a 10-year officer and director bar while the director settled charges for a $100,000 penalty, a five-year officer and director bar, and a five-year suspension from practicing or appearing before the Commission as an attorney. Other Disclosures and Omissions In July, the SEC settled charges with a social media platform relating to allegations that the company made misleading disclosures regarding the risk of misuse data.[21] Specifically, the SEC alleged that for approximately two years, the company framed its data misuse disclosure as a hypothetical, staying that “data may be improperly accessed, used or disclosed,” when the company allegedly knew that a third-party had misused its users’ data. Without admitting or denying the allegations, the company agreed to pay $100 million to settle the action. In September, the SEC announced it had settled charges with a Silicon Valley-based issuer for allegedly failing to disclose a revenue management scheme in violation of the antifraud and reporting provisions of the federal securities laws.[22] The SEC alleged the issuer misled investors when it engaged in a scheme to “pull-in” sales to the current quarter in order to meet publicly-issued revenue guidance. The practice allegedly concealed from investors a decline in consumer demand, a loss of market share, and reduced future sales. Without admitting or denying the charges, the issuer agreed to pay a $5.5 million. Also in September, the SEC announced settled charges against a pharmaceutical company for allegedly failing to disclose or accrue for losses relating to a Department of Justice (“DOJ”) investigation into the company’s classification of its largest revenue and profit generating product.[23] The DOJ investigation began in 2014 and lasted nearly two years. The SEC’s complaint alleged that before October 2016 when it announced a $465 million settlement with the DOJ, the company did not adequately disclose to investors the potential losses caused by the investigation. Without admitting or denying the SEC’s allegations, the company agreed to a $30 million penalty. On the same day, the SEC settled charges against a Michigan-based automaker and its parent company for allegedly misleading investors about the number of new vehicles sold to U.S. consumers each month.[24] The SEC alleged that between 2012 and 2016, the automaker falsely reported uninterrupted monthly year-over-year sales growth in company press releases. The SEC alleged that the company’s growth streak had been broken in September 2013 and the company inflated vehicle sales by reporting fake sales and by reporting older sales as current ones. Without admitting or denying the charges, the two companies agreed to jointly and severally pay a $40 million civil penalty.

C.   Private Company Cases

Finally, the SEC brought the following financial reporting and disclosure cases against private companies in the second half of 2019: In September, the SEC announced it settled charges against a multinational direct-to-consumer sales company relating to allegedly false and misleading statements about the company’s business model in China.[25] The SEC alleged that between 2012 and 2018, the company’s quarterly and annual SEC filings inaccurately described the company’s payment structure in China as different from that used in other countries, when in fact the compensation paid in China was similar to that paid in other countries. This description, the SEC alleged, prevented investors from fully evaluating the risk to the company’s stock. Without admitting or denying the SEC’s charges, the company agreed to pay a $20 million penalty and to cease and desist from future violations of the antifraud and reporting provisions of the federal securities laws. In November, the SEC filed amended fraud charges against four former executives of a private healthcare advertising company relating to misleading disclosures about the company’s success.[26] The SEC’s amended complaint, filed in federal court in Chicago, alleges that the four former executives violated the antifraud provisions of the federal securities laws by misrepresenting the company’s successes by manipulating third-party studies on its product and by overstating the company’s revenue in its 2015 and 2016 financial statements by $14.3 million and $30 million, respectively. The SEC alleges that these misleading disclosures allowed the company to raise approximately $487 from a private offering. The SEC is seeking disgorgement, penalties, injunctive relief, and officer and director bars. The U.S. Attorney’s Office for the Northern District of Illinois and Fraud Section of the Department of Justice announced parallel criminal charges against the four former executives and against two former employees not named in the SEC action.

III.   Investment Advisers and Funds

In a November 2019 speech, Enforcement Co-Director Stephanie Avakian, outlined issues in the investment adviser area that are drawing investigative interest from the Enforcement Division.[27] Not surprisingly, the Enforcement Division views as a success its Share Class Selection Disclosure Initiative as it has resulted in 95 enforcement actions. (Commissioner Peirce has not been as complimentary and has questioned the merits of such aggregation of cases.[28]). Following on the conflict and disclosure themes of the Initiative, Director Avakian explained that the Commission is investigating other circumstances in which an investment adviser may be conflicted by financial incentives that may affect the adviser’s recommendations to clients. As examples, Director Avakian cited revenue sharing, cash sweep arrangements, and unit investment trusts (UITs) as circumstances that may present conflicts of interest and therefore are a growing focus of the Commission’s enforcement efforts. In each of these circumstances, the adviser’s financial interest could be impacted by investment choices for the client. In addition, Director Avakian discussed the Enforcement Division’s recently announced Teachers Initiative to examine the compensation and sales practices of third-party administrators of teacher retirement plans to identify potential conflicts of interest. In closing, Director Avakian emphasized that advisory firms should be proactive in identifying potential conflicts and ensuring adequate disclosure to clients. The enforcement actions discussed below from the latter half of 2019 reflect the Commission’s focus advisers’ identification, management and disclosure of conflicts of interest. In July, the SEC instituted a settled action against a Massachusetts-based investment adviser and its principal based on allegations that the company failed to disclose to clients conflicts of interest in connection with recommendations to invest in certain securities.[29] According to the SEC, the company concealed the substantial financial incentives offered to it by the company in which it invested client money, resulting in over $7 million in client investments over the course of approximately two years. The SEC further alleged that the investment adviser and its principal concealed this arrangement in its regulatory filings. Additionally, the principal misused investor funds for his personal benefit. Without admitting or denying the findings in the SEC’s order, the company and the principal agreed to pay over $1 million in disgorgement and prejudgment interest, as well as a $275,000 penalty, and the principal agreed to a permanent bar from the securities industry. In September, the SEC filed suit in federal district court in Illinois against an Illinois-based hedge fund adviser, as well as its top two executives, charging the defendants with violations of the antifraud provisions of the federal securities laws.[30] The SEC’s complaint alleges that the defendants manipulated valuation models, which artificially inflated the value of its investments, and in turn resulted in misstatements of historical performance and caused investors to overpay fees. Moreover, the SEC alleges that its exam staff discovered the valuation problems, but the defendants then endeavored to hide their actions from the company auditor and investors. The SEC seeks permanent injunctions and civil penalties. In November, the SEC filed suit in federal district court in New York against a New York-based investment adviser in connection with its alleged concealment of losses and its sale of $60 million in bogus loan assets.[31] The SEC’s complaint alleges that the investment adviser falsified its records to hide the fact that there was no repayment of defaulted loans and that any supposed new loans were fictitious. The SEC further alleges that the firm induced clients into buying these false new loan assets by providing clients with doctored documents, including a forged credit agreement. In connection with settlement, the SEC revoked the firm’s registration and the firm’s assets are preliminarily frozen. Any future monetary relief, including but not limited to disgorgement, will be determined at a later date. In December, the SEC filed suit in federal district court in Sacramento, California against a California-based investment adviser firm and its owner in connection with their alleged defrauding of hundreds of retirees by recommending certain investments without disclosing their conflicts of interest.[32] According to the SEC’s complaint, by concealing any conflicts of interest, the firm and its owner were able to reap millions of dollars in compensation and other benefits. Further, the firm owner had a radio show, in which he touted his expertise and simultaneously hid past charges brought against him by the SEC, with the effect of misleading prospective investors. The SEC’s complaint seeks injunctions, as well as disgorgement and civil penalties.

IV.   Brokers and Financial Institutions

A.   Rule Violations and Internal Systems Deficiencies

In the latter half of 2019, the SEC brought a number of cases against broker-dealers relating to inadequate SEC rule compliance and failures of internal systems. In August, the SEC brought settled charges against a New York City headquartered broker-dealer for deficient review of over-the-counter (“OTC”) securities in violation of Rule 15c2-11, which requires that a broker-dealer have a reasonable basis for believing that information made available by the issuer of the securities is accurate.[33] The SEC’s order alleged that the broker-dealer made markets in OTC securities while delegating responsibility for rule compliance to a compliance associate who had no formal training or trading experience, resulting in allegedly deficient reviews. Without admitting or denying the SEC’s findings, the broker-dealer agreed to a penalty of $250,000. In September, the SEC announced charges against two broker-dealers for providing the SEC with incomplete and deficient securities trading information known as “blue sheet data.”[34] The SEC’s order alleged that both broker-dealers provided blue sheet submissions which reflected millions of inaccurate or missing entries over a period of several years, largely due to undetected coding errors. The broker-dealers admitted the findings in the SEC’s orders and agreed to censures and penalties of $2.7 million and $1.95 million respectively to settle the charges. In December, the SEC brought settled charges with two trading firms for rule violations in connection with a tender offer.[35] Specifically, the SEC’s orders alleged that the trading firms violated the “short tender rule” in connection with a partial tender offer by tendering more shares than their net long positions in the security. The SEC’s orders alleged that, because the tender offer was oversubscribed, the trading firms’ actions resulted in the firms unfairly receiving shares in the offer at the expense of other tender offer participants. Without admitting or denying the findings, the trading firms agreed to pay disgorgement and penalties totaling approximately $300,000 and $200,000 respectively. Finally, as part of its ongoing initiative into American Depositary Receipt (“ADR”) practices (resulting in settlements exceeding $431 million), the SEC in December announced settled charges against a multi-national financial services firm relating to the handling of ADRs—U.S. securities that represent foreign shares of a foreign company and require corresponding foreign shares to be held in custody at a depositary bank.[36] The SEC’s order alleged that the firm borrowed ADRs from other brokers when it should have known that those brokers did not own the corresponding foreign shares required to support the ADRs. Without admitting or denying the findings, the firm agreed to pay nearly $4 million in disgorgement, interest, and penalties. The SEC’s order noted that the settlement represented the SEC’s fourteenth enforcement action relating to ADRs.

B.   Retail Investors

As part of its ongoing focus on protecting retail investors, in September 2019, the SEC brought settled charges against three subsidiaries of a national financial services firm for charging excessive fees and commissions on retail accounts.[37] The SEC’s order alleged that the firm (i) did not perform reviews of advisory accounts that had no trading activity for at least one year, resulting in unsuitable advisory fees being charged to these accounts; and (ii) misapplied pricing data to certain unit investment trusts (“UITs”) in advisory accounts, resulting in excess fees charged on UITs. The SEC’s order also alleged with respect to UITs that the firm made unsuitable recommendations to sell UITs prior to maturity (and to then purchase new UITs), resulting in excess commissions being charged to retail customers. Without admitting or denying the findings, the firm agreed to pay approximately $12 million in disgorgement to retail investors, and also agreed to a $3 million penalty. The SEC’s order noted that it took into account remedial efforts and cooperation undertaken by the firm.

V.   Insider Trading, Market Manipulation and Regulation FD

A.   Insider Trading

In the second half of 2019, the SEC brought a number of insider trading cases and won a trial on insider trading charges relating to a previously-filed complaint. In July, the SEC brought insider trading charges against a former accountant of a life sciences company and her close friend, seeking injunctive relief along with disgorgement and penalties.[38] The complaint alleges that the accountant leaked confidential revenue information to the friend in exchange for extravagant gifts, while the friend purchased securities using accounts held by several associates to conceal his identity. The scheme was discovered using advanced trading analytics software. The matter is being litigated, and parallel charges were filed by the U.S. Attorney’s Office for the Southern District of New York. In August, the SEC charged an investment banking analyst with insider trading, alleging that the analyst purchased securities after learning about a potential transaction his employer was advising on.[39] The complaint alleges that the analyst reaped nearly $100,000 in profits, and seeks disgorgement of the gains, plus penalties and injunctive relief. The matter is being litigated, and parallel charges were filed by the U.S. Attorney’s Office for the Southern District of New York. In August, an Atlanta federal court jury returned a verdict finding a New Jersey based securities broker liable for insider trading in advance of three transactions relating to charges that the SEC brought in 2016.[40] The broker was found guilty of violating Sections 10(b) and 14(e) of the Securities Exchange Act of 1934, as well as Rules 10b-5 and 14e-3. The jury held that the broker received information surrounding each transaction from an employee at an accounting firm, traded on the information, and passed it to a friend of his to do the same. The employee and the other trader were also charged, but previously settled their cases.[41] In December, the SEC announced a settlement with a former United States congressman, his son, and his friend.[42] The trio were charged with insider trading, and previously pleaded guilty to related criminal charges. The defendants agreed to disgorgement and injunctive relief, and the former congressman was permanently barred from acting as an officer or director of a public company. Also in December, the SEC charged a ring of five friends who are accused of repeatedly trading on confidential earnings information of a Silicon Valley cloud-computing company.[43] The group allegedly procured the information from one member’s IT administration position at the company, who used his credentials to access and pass along the information. The group used “carefully tailored cash withdrawals” to avoid detection, but were discovered using SEC data analysis tools. The matter is being litigated, and parallel charges have been filed by the U.S. Attorney for the Northern District of California. Notably in the criminal case, two of the individuals have been charged with violating 18 U.S.C. § 1348, a relatively recent securities fraud provision added by the Sarbanes-Oxley Act in 2002.[44] This charge may become more routine following the Second Circuit’s recent majority opinion in United States v. Blaszczak, which held that there is no “personal benefit” requirement in insider trading cases charged under this provision. This result is different from charges under the traditional Section 10(b) of the Exchange Act, where in Dirks v. SEC, the Supreme Court had held that tippers are only liable where they breach a fiduciary duty to the company’s shareholders, and they only breach such a duty where they “personally will benefit, directly or indirectly, from [their] disclosure. Absent some personal gain, there has been no breach of duty to stockholders.”

B.   Market Manipulation

In November, a New York federal court jury found a Ukrainian trading firm and two individuals liable for their roles in an unlawful trading scheme.[45] The SEC originally filed the complaint in March 2017. The evidence demonstrated that the defendants engaged in a “layering scheme” involving placing and canceling orders to artificially adjust a stock price. They also engaged in cross-market manipulation by buying and selling stocks to impact options prices. The jury found all three defendants liable on all counts.

C.   Regulation FD

In August, the SEC announced settled charges against a Florida-based pharmaceutical company relating to violations of Regulation FD based on its alleged sharing of material, nonpublic information with sell-side research analysts without also disclosing the same information to the public.[46] The SEC’s order alleged that on two separate occasions in 2017, the company selectively shared material information with analysts about the company’s interactions with the FDA, and that at the time of these disclosures, the company did not have policies or procedures regarding compliance with Regulation FD. The pharmaceutical company consented to the SEC’s order without admitting or denying the findings and was ordered to pay a penalty of $200,000 and cease and desist from future violations. ________________________ [1]              Testimony of Chairman Jay Clayton before the U.S. Senate Committee on Banking, Housing, and Urban Affairs (Dec. 10, 2019), available at https://www.banking.senate.gov/imo/media/doc/Clayton%20Testimony%2012-10-191.pdf. [2]              See D. Michaels, Focus on Sale of Higher-Fee Mutual Funds Fuels 30-Year High for SEC Enforcement Actions, Wall St. J. (Nov. 6, 2019), available at https://www.wsj.com/articles/focus-on-sale-of-higher-fee-mutual-funds-fuels-30-year-high-for-sec-enforcement-actions- 11573043400. [3]              2019 WL 7289753 (2d Cir. Dec. 30, 2019). [4]              Reuters, Exclusive: White House expected to nominate SEC lawyer for Democratic commissioner seat – sources (Dec. 20, 2019), available at https://www.reuters.com/article/us-usa-sec-nominations-exclusive/exclusive-white-house-expected-to-nominate-sec-lawyer-for-democratic-commissioner-seat-sources-idUSKBN1YO2CN. [5]              SEC Press Release, SEC Awards Half-Million Dollars to Overseas Whistleblower (July 23, 2019), available at https://www.sec.gov/news/press-release/2019-138. [6]              SEC Press Release, SEC Awards More Than $1.8 Million to Whistleblower (Aug. 29, 2019), available at https://www.sec.gov/news/press-release/2019-165. [7]              SEC Press Release, SEC Awards Over $260,000 to Whistleblowers for Their Help in Spotting Securities Fraud (Nov. 15, 2019), available at https://www.sec.gov/news/press-release/2019-238. [8]              SEC Press Release, SEC Charges Issuer and CEO with Violating Whistleblower Protection Laws to Silence Investor Complaints (Nov. 4, 2019), available at https://www.sec.gov/news/press-release/2019-227. [9]              Commissioner Hester M. Peirce, Broken Windows: Remarks Before the 51st Annual Institute on Securities Regulation (Nov. 4, 2019), available at https://www.sec.gov/news/speech/peirce-broken-windows-51st-annual-institute-securities-regulation. [10]             SEC Press Release, SEC Orders Blockchain Company to Pay $24 Million Penalty for Unregistered ICO (Sept. 30, 2019), available at https://www.sec.gov/news/press-release/2019-202. [11]             SEC Press Release, SEC Halts Alleged $1.7 Billion Unregistered Digital Token Offering (Oct. 11, 2019), available at https://www.sec.gov/news/press-release/2019-212. [12]             SEC Press Release, SEC Charges Founder, Digital-Asset Issuer With Fraudulent ICO (Dec. 11, 2019), available at https://www.sec.gov/news/press-release/2019-259. [13]             SEC Press Release, Issuer Settles Unregistered ICO Charges, Agrees to Return Funds and Register Tokens (Dec. 18, 2019), available at https://www.sec.gov/news/press-release/2019-267. [14]             SEC Press Release, SEC Charges Engine Manufacturing Company Executives with Accounting Fraud (July 19, 2019), available at www.sec.gov/news/press-release/2019-137. [15]             SEC Press Release, SEC Charges Trucking Executives with Accounting Fraud (Dec. 5, 2019), available at www.sec.gov/news/press-release/2019-253. [16]             SEC Press Release, SEC Charges Biotech Company and Executives with Accounting Fraud (Nov. 26, 2019), available at www.sec.gov/news/press-release/2019-243. [17]             SEC Press Release, SEC Charges Iconix Brand Group and Former Top Executives with Accounting Fraud (Dec. 5, 2019), available at www.sec.gov/news/press-release/2019-251. [18]             SEC Press Release, SEC Charges Brixmor Property Group Inc. and Former Senior Executives with Accounting Fraud (Aug. 1, 2019), available at www.sec.gov/news/press-release/2019-143. [19]             SEC Press Release, SEC Charges Comscore Inc. and Former CEO with Accounting and Disclosure Fraud (Sept. 24, 2019), available at www.sec.gov/news/press-release/2019-186. [20]             SEC Press Release, SEC Charges Nissan, Former CEO, and Former Director with Fraudulently Concealing from Investors More than $140 Million of Compensation and Retirement Benefits (Sept. 23, 2019), available at https://www.sec.gov/news/press-release/2019-183. [21]             SEC Press Release, Facebook to Pay $100 Million for Misleading Investors About the Risks It Faced From Misuse of User Data (July 24, 2019), available at https://www.sec.gov/news/press-release/2019-140. [22]             SEC Press Release, SEC Charges Silicon Valley-Based Issuer With Misleading Disclosure Violations (Sept. 16, 2019), available at https://www.sec.gov/news/press-release/2019-175. [23]             SEC Press Release, Mylan to Pay $30 Million for Disclosure and Accounting Failure Relating to EpiPen (Sept. 27, 2019), available at https://www.sec.gov/news/press-release/2019-194. [24]             SEC Press Release, Automaker to Pay $40 Million for Misleading Investors (Sept. 27, 2019), available at https://www.sec.gov/news/press-release/2019-196. [25]             SEC Press Release, Herbalife to Pay $20 Million for Misleading Investors (Sept. 27, 2019), available at https://www.sec.gov/news/press-release/2019-195. [26]             SEC Press Release, SEC Charges Former Top Executives of Healthcare Advertising Company With $487 Million Fraud (Nov. 25, 2019), available at https://www.sec.gov/news/press-release/2019-241. [27]             Speech, What You Don’t Know Can Hurt You (Nov. 5, 2019), available at https://www.sec.gov/news/speech/speech-avakian-2019-11-05. [28]             Speech, Reasonableness Pants (May 8, 2019), available at https://www.sec.gov/news/speech/speech-peirce-050819. [29]             SEC Press Release, SEC Charges Investment Adviser With Fraud (July 1, 2019), available at https://www.sec.gov/news/press-release/2019-115. [30]             SEC Press Release, SEC Charges Hedge Fund Adviser and Top Executives With Fraud (Sept. 30, 2019), available at https://www.sec.gov/news/press-release/2019-201. [31]             SEC Press Release, SEC Revokes Registration of Adviser Engaged in $60 Million Fraud (Nov. 26, 2019), available at https://www.sec.gov/news/press-release/2019-244. [32]             SEC Press Release, SEC Charges Recidivist Investment Adviser With Defrauding Retirees (Dec. 19, 2019), available at https://www.sec.gov/news/press-release/2019-274. [33]             SEC Press Release, SEC Charges Broker-Dealer with Violations of Gatekeeping Provisions Aimed at Protecting Investors (Aug. 14, 2019), available at https://www.sec.gov/news/press-release/2019-151. [34]             SEC Press Release, Two Broker-Dealers to Pay $4.65 Million in Penalties for Providing Deficient Blue Sheet Data (Sept. 16, 2019), available at https://www.sec.gov/news/press-release/2019-177. [35]             SEC Press Release, SEC Charges Broker-Dealers With Illicitly Profiting in Partial Tender Offer (Dec. 18, 2019), available at https://www.sec.gov/news/press-release/2019-268. [36]             SEC Press Release, Jefferies to Pay Nearly $4 Million for Improper Handling of ADRs (Dec. 9, 2019), available at https://www.sec.gov/news/press-release/2019-256. [37]             SEC Press Release, Raymond James Agrees to Pay $15 Million for Improperly Charging Retail Investors (Sept. 17, 2019), available at https://www.sec.gov/news/press-release/2019-151. [38]             SEC Press Release, SEC Charges Accountant and Friend in $6.2 Million Insider Trading Scheme (Jul. 10, 2019), available at https://www.sec.gov/news/press-release/2019-126. [39]             SEC Press Release, SEC Charges Investment Banking Analyst with Insider Trading (Aug. 12, 2019), available at https://www.sec.gov/news/press-release/2019-149. [40]             SEC Press Release, SEC Wins Jury Trial Against Broker Charged with Insider Trading (Aug. 14, 2019), available at https://www.sec.gov/news/press-release/2019-152. [41]             SEC Litig. Rel. No. 24554, SEC Obtains Final Judgment Against Former Accounting Firm Partner (Aug. 2, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24554.htm. [42]             SEC Press Release, Former Congressman and Two Others Settle Insider Trading Charges (Dec. 9, 2019), available at https://www.sec.gov/news/press-release/2019-257. [43]             SEC Press Release, Silicon Valley IT Administrator and Friends Charged in Multimillion Dollar Insider Trading Ring (Dec. 17, 2019), available at https://www.sec.gov/news/press-release/2019-261. [44]           DOJ Press Release, Two South Bay Residents Indicted For Securities Fraud Relating To Palo Alto Networks, Inc. (Dec. 17, 2019), available at https://www.justice.gov/usao-ndca/pr/two-south-bay-residents-indicted-securities-fraud-relating-palo-alto-networks-inc. [45]             SEC Press Release, SEC Wins Jury Trial in Layering, Manipulative Trading Case (Nov. 12, 2019), available at https://www.sec.gov/news/press-release/2019-236. [46]             SEC Press Release, SEC Charges TherapeuticsMD With Regulation FD Violations (Aug. 20, 2019), available at https://www.sec.gov/news/press-release/2019-156.
The following Gibson Dunn lawyers assisted in the preparation of this client update:  Mark Schonfeld, Tina Samanta, Amy Mayer, Jaclyn Neely, Zoey Goldnick, Erin Galliher, Zachary Piaker, Brandon Davis. Gibson Dunn is one of the nation's leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators. Our Securities Enforcement Group offers broad and deep experience.  Our partners include the former Director of the SEC's New York Regional Office, the former head of FINRA's Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California, and former Assistant United States Attorneys from federal prosecutors' offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force. Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Group, and our White Collar Defense Group. Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work or any of the following: Securities Enforcement Practice Group Leaders: Richard W. Grime - Washington, D.C. (+1 202-955-8219, rgrime@gibsondunn.com) Barry R. Goldsmith - New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark K. Schonfeld - New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Please also feel free to contact any of the following practice group members: New York Zainab N. Ahmad (+1 212-351-2609, zahmad@gibsondunn.com) Matthew L. Biben (+1 212-351-6300, mbiben@gibsondunn.com) Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Mary Beth Maloney (+1 212-351-2315, mmaloney@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Tina Samanta (+1 212-351-2469, tsamanta@gibsondunn.com) Washington, D.C. Stephanie L. Brooker (+1 202-887-3502, sbrooker@gibsondunn.com) Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tadavis@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Michael D. Celio (+1 650-849-5326, mcelio@gibsondunn.com) Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com)

November 6, 2019 |
Five Gibson Dunn Partners Recognized by Who’s Who Legal 2019 Business Crime Defence Guide

Who’s Who Legal named five Gibson Dunn partners to its 2019 Business Crime Defence Global guide. Washington DC partners Richard Grime and F. Joseph Warin were both named Global Elite Thought Leaders. Los Angeles partner Debra Wong Yang, New York partner Lawrence Zweifach and San Francisco partner Charles Stevens were also recognized. The guide was published November 1, 2019.

July 18, 2019 |
2019 Mid-Year Securities Enforcement Update

Click for PDF

I.  Introduction: Themes and Notable Developments

A.  Continued Focus on Protection of Main Street Investors

The first half of 2019 has seen a continuation of the Commission's emphasis on protecting the interests of Main Street investors. Chairman Clayton reiterated these themes in his testimony in May before the Financial Services and General Government Subcommittee of the U.S. Senate Committee on Appropriations.[1] In addition to the no less than 43 references to Main Street investors, the Chairman's testimony highlighted: (1) the Retail Strategy Task Force, formed in 2017, to use data-driven strategies to generate leads for investigation of industry practices that could harm retail investors, as well as (2) the mutual fund share class initiative as an example of returning funds to retail investors through a program to incentivize self-reporting and cooperation. To be sure, the Commission brought a number of enforcement actions focusing on various offering frauds, often with themes related to some form of cryptocurrency or digital asset.[2] The Chairman also noted in his Congressional testimony that the Commission's FY 2020 budget request contemplates adding add six positions to the Commission's investigations of conduct affecting Main Street investors. On June 5, 2019, the SEC adopted a set of rules intended to enhance the quality and transparency of retail investors' relationships with investment advisers and broker-dealers.[3] The new “Regulation Best Interest” requires broker-dealers to act in the best interest of a customer when making recommendations for securities transactions or investment strategies to a retail consumer. This means broker-dealers may not place the financial or other interests of the broker-dealer ahead of the customer. In order to satisfy the fiduciary obligations required by Regulation Best Interest, broker-dealers must: (1) make certain disclosures regarding any conflicts of interest; (2) exercise reasonable diligence, care, and skill in making recommendations; (3) maintain policies and procedures designed to address conflicts of interest; and (4) maintain policies designed to achieve compliance with the regulation.[4] Regulation Best Interest takes effect on September 10, 2019. Firms will have until June 30, 2020 to comply with the regulation.

B.  Full Commission and other Senior Staffing Updates

During the first six months of this year, there were a number of leadership changes, several of which reflect the advancement of lawyers with many years of experience in the Division of Enforcement to positions of senior leadership. On June 20, the U.S. Senate confirmed Allison Lee to serve as the fifth Commissioner with a term ending in 2022. Commissioner Lee was sworn in on July 8, bringing the Commission back to its full complement of Commissioners. Commissioner Lee replaces prior Democratic Commissioner Kara Stein. Commissioner Lee previously served at the Commission for over a decade, including as counsel to Commissioner Stein, as well as a Senior Counsel in the Complex Financial Instruments Unit of the Division of Enforcement. How long the full Commission will last is uncertain as there have been reports that Commissioner Robert Jackson, the only other Democratic Commissioner, may be stepping down in the near future to return to teaching and NYU Law School. Commissioner Jackson has not commented on his plans. Other changes in the senior staffing of the Commission include:
  • In June, David Peavler was appointed Director of the Fort Worth Regional Office. Mr. Peavler rejoined the SEC after serving two years as the General Counsel of HD Vest Inc. He previously worked for 15 years in the Division of Enforcement in the SEC's Fort Worth Regional Office.
  • In May, Erin Schneider was appointed Director of the San Francisco Regional Office. Ms. Schneider joined the Commission in 2005 as a Staff Attorney in the Division of Enforcement in the San Francisco Office, became an Assistant Director in the Asset Management Unit in 2012 and an Associate Director in the San Francisco Office in 2015.
  • Also in May, Adam Aderton was appointed Co-Chief of the Asset Management Unit of the Division of Enforcement. Mr. Aderton joined the Commission as a staff attorney in the Division of Enforcement in 2008, joined the Asset Management Unit in 2010, and became an assistant Director of the Unit in 2013.
More broadly, until recently, the Commission had been subject to a hiring freeze which led to an approximately 10% decline in staffing both in the Enforcement Division and the Commission overall. Under its FY 2019 budget, the Commission has been able to resume some hiring, but not sufficient to restore staffing levels to their prior levels. Accordingly, the Enforcement Division will continue to endeavor to accomplish more with less for the foreseeable future.

C.  Change to Commission Practice on Consideration of Settlement Offers with Waiver Requests

On July 3, Chairman Jay Clayton announced a change in the process by which the Commission will consider settlement offers from prospective defendants who are also seeking a waiver from a regulatory disqualification that would be triggered by the settlement.[5]  In effect, the new policy actually restores Commission practice to what it had been historically, prior to a change under the last administration, and represents a much-needed, common sense improvement to the Commission's settlement process. The issue arises when negotiating a settlement that triggers a regulatory disqualification.  The client can request a waiver from the disqualification.  However, the last administration had revoked the authority previously delegated to the regulatory divisions to decide waivers and required a party to make an unconditional offer of settlement without assurance as to whether the Commission would grant the waiver.  This meant that a party could be bound to a settlement that triggered a disqualification without assurance of receiving a waiver.  In some cases, the risk was significant. Under the new policy, the Commission will still be the decision-maker on waivers, but will consider the settlement offer and waiver request simultaneously and as a single recommendation.  Most important, if the Commission approves the settlement offer, but not the waiver, the party could withdraw the settlement offer and will not be bound by the offer. As the Chairman's statement explains:
… an offer of settlement that includes a simultaneous waiver request negotiated with all relevant divisions . . . will be presented to, and considered by, the Commission as a single recommendation from the staff. . . . [I]n a matter where a simultaneous settlement offer and waiver request are made and the settlement offer is accepted but the waiver request is not approved in whole or in part, the prospective defendant would need to promptly notify the staff (typically within a matter of five business days) of its agreement to move forward with that portion of the settlement offer that the Commission accepted. In the event a prospective defendant does not promptly notify the staff that it agrees to move forward with that portion of the settlement offer that was accepted (or the defendant otherwise withdraws its offer of settlement), the negotiated settlement terms that would have resolved the underlying enforcement action may no longer be available and a litigated proceeding may follow.
In sum, under the new procedure, parties will simply receive the same benefit as any settling party – certainty, finality and the clarity of knowing the full consequences of their offer to settle.

D.  Whistleblower Awards Continue

The Commission continued to issue significant awards to whistleblowers for providing information that led to financial recoveries in enforcement actions. As of June 2019, the SEC has awarded over $384 million to 64 whistleblowers since the program began in 2012.[6] In March, the Commission announced a pair of awards totaling $50 million to two whistleblowers (one for $37 million and another for $13 million).[7] The $37 million award was the Commission's third highest award. One of the awards was notable because the Commission finding in its order that the claimant had “unreasonably delayed in reporting the information to the commission,” and had “passively financially benefitted from the underlying misconduct during a portion of the period of delay.”[8] In May, for the first time, the SEC issued an award under a provision of the whistleblower rules which permits claims by whistleblowers who first report a tip to a company if the whistleblower also reports the same tip to the SEC within 120 days.[9] In this case, the whistleblower sent an anonymous tip to the company, as well as to the SEC. The whistleblower's report triggered an internal investigation by the company, which resulted in the company reporting its findings to the SEC, resulting in an SEC investigation and action. In calculating the award, the SEC credited the whistleblower “for the company's internal investigation, because the allegations were reported to the Commission within 120 days of the report to the company.” The whistleblower was awarded more than $4.5 million. In June, the SEC announced an award of $3 million to whistleblowers for a tip that led to the successful enforcement action related to “an alleged securities law violation that impacted retail investors.”[10] The key takeaway from these awards is that they provide powerful financial incentives to would be whistleblowers to report suspicions of misconduct – real or perceived – to the Commission staff. The financial incentives and anti-retaliation protections for whistleblowers put a premium on companies implementing a rigorous, proactive and documented response to internal complaints to protect against second-guessing by regulators and prosecutors. Last year, in Digital Realty Trust v. Somers, the Supreme Court held that Dodd-Frank's anti-retaliation measures protect only whistleblowers who report their concerns to the SEC and not those who only report internally.[11] In response to the Supreme Court's decision, on May 8, 2019, the House Committee on Financial Services passed the Whistleblower Protection Reform Act of 2019, H.R. 2515, which would extend the anti-retaliation protections in Dodd-Frank to whistleblowers who report alleged misconduct to a superior.[12]

E.  Notable Litigation Developments

There were a number of litigation developments of note during the first half of this year. In Lorenzo v. SEC, the Supreme Court held that an individual who is not a “maker” of a misstatement may nonetheless be held primarily liable under Rule 10b-5(a) and (c) for knowingly “disseminating” a misstatement made by another person.[13]  The decision refines the Court's 2011 decision in Janus v. First Derivative Traders, in which the Court held that liability under Rule 10b-5(b) for a misstatement only extent to the “maker” of a statement which is the “person or entity with ultimate authority over the statement.” The impact of the Lorenzo decision for Commission enforcement actions may be more academic than practical because the Commission has the ability to bring actions for secondary liability for aiding and abetting or causing a violation by another party.  Nevertheless, Commissioner Hester Peirce has cautioned against the Commission's use of Lorenzo to expand so-called “scheme” liability beyond the bounds of secondary liability.[14]  The practical import of the decision for private civil litigation may be more significant, since, in the absence of secondary liability, private plaintiffs may be able to craft broader allegations of primary liability against defendants based on their participation in a “device, scheme, or artifice to defraud” under Rule 10b-5(a) or an “act, practice or course of business” that “operates … as a fraud or deceit” under Rule 10b-5(c). In Robare Group, Ltd. v. SEC, the U.S. Court of Appeals for the D.C. held that a “willful” violation of Section 207 of the Investment Advisers Act of 1940 requires more than proof of mere negligence, even though negligence may be sufficient to establish a violation under Section 206(2) of the Advisers Act.  The decision represents a change from the holding in a 2000 decision by the same court in Wonsover v. SEC, which held that “willfully” means “intentionally committed the act with constitutes the violation” but does not require that “the actor…be aware that he is violating” the law.  In Robare, the court clarified that the willfulness standard could not be met by proof of merely negligent conduct. Historically, in cases in which parties settle to Commission orders finding willful violations, the settled order often contained a footnote articulating the Wonsover standard of willfulness.  Notably, despite the decision in Robare, the Commission has continued to use the Wonsover formulation.[15]  In the long term, the Commission will likely seek to reconcile the Robare and Wonsover decisions.  In the near term, the Robare decision potentially provides prospective defendants with additional arguments to oppose alleged violations of statutory provisions that require proof of willfulness, and as a consequence, to avoid forms of relief that turn on findings of willful violations. Finally, over the years, the Commission been continually challenged to conduct investigations and either resolve or commence actions in a timely manner.  In addition, all investigative and prosecutorial agencies have been subject to criticism at various times for “piling on” with seemingly duplicative investigations and enforcement actions in high profile matters.  This year, the Commission's late arrival to an already crowded regulatory party has become the subject of an unusually pointed judicial inquiry in the Commission's litigation against Volkswagen.  The Commission filed the action in March 2019, years after the company had already resolved actions by other federal and state governments as well as private civil actions.  In a quote that will likely resonate for some time to come, the court questioned the Commission's delay in bringing the action and reminded counsel that “the symbol of the SEC is the symbol … of the eagle, not a carrion hawk that simply descends when everything is all over and sees what it can get from the defendant.”  In an unusual step, the court order the Commission to file a declaration stating when the Commission learned of the facts alleged in each paragraph of the 69-page complaint.  On July 8, the Commission filed its submission which seeks to explain the various challenges the Commission faced in its investigation, including delays in obtaining evidence from abroad, that led to the timing of the agency's action.  Regardless of the outcome of this particular case, perhaps the court's commentary will lead investigative agencies to undertake a more thoughtful approach to the need to add to multi-agency investigations.

F.  Legislative Response to Supreme Court's Kokesh Decision

In 2018, in Kokesh v. SEC, the Supreme Court held that a 5-year statute of limitations applies to the Commission's ability to recover disgorgement of ill-gotten gains from defendants.  In a footnote to the unanimous decision, the Court somewhat cryptically suggested that the Commission's authority to obtain disgorgement may not be entirely without question.  In particular the Court stated that the decision was limited to the applicability of the statute of limitations, and not reaching the issue of “whether courts possess authority to order disgorgement in SEC enforcement proceedings….”  In its 2018 annual report, the Enforcement Division estimated the Kokesh decision may cause the Commission may forego up to $900 million in disgorgement claims. The issue of the SEC's ability to obtain disgorgement is a question that continues to play out in lower courts.  Thus far, the Second Circuit and district courts within the Second Circuit have upheld disgorgement awards post-Kokesh, finding disgorgement to be a proper equitable remedy.[16]  The meaning of Kokesh is also being hashed out in cases involving regulators other than the SEC, such as the CFTC.  For example, in a case from May of this year, a district court found that, contrary to the defendants' reading of Kokesh, the amount of disgorgement to be paid to the CFTC did not need to be reduced based on costs incurred by the defendants in the commission of their violations.[17] In March of this year, Senators Mark Warner (D-Va) and John Kennedy (R-La) introduced a bipartisan bill designed to address the concerns sounded by the Commission in the wake of Kokesh.  Titled the Securities Fraud and Investor Compensation Act, the bill would provide explicit statutory authority for the Commission to obtain disgorgement for gains actually received or obtained by a defendant, subject to a 5-year statute of limitations.  Of potentially greater consequence, however, the bill would also authorize the Commission to obtain restitution of losses sustained by investors caused by defendants in the securities industry, such as broker-dealers and investment advisers, and create a 10-year statute of limitations for equitable relief, including restitution, injunctions, bars and suspensions. Historically, the Commission has not sought to advance an argument for restitution in court.  It is not uncommon for the financial benefit to a defendant to be far less that the alleged harm incurred by an arguable class of victims.  Consequently, for many defendants, the risk of restitution could represent a substantial increase in the potential exposure created by an enforcement action.  As of this writing, the bill has not advanced.

G.  Litigation Challenge to the “Neither-Admit-Nor-Deny” Settlement

The “neither admit nor deny” settlement has long been a staple of the Commission's enforcement program.  Specifically, prospective defendants typically settle enforcement actions by consenting to either issuance of a Commission order containing findings, or the entry of a civil judgment based on a complaint containing allegations, to which the proposed defendant neither admits nor denies.  Under the prior administration, the Commission had adopted a policy of requiring admissions in certain exceptional cases.  Nevertheless, the neither admit nor deny formulation remained the predominant settlement formulation. Importantly, as a corollary to not being required to admit to any findings or allegations, parties are also prohibited from denying the findings or allegations.  The requirement is spelled out in a regulation adopted in 1972:
The Commission has adopted the policy that in any civil lawsuit brought by it or in any administrative proceeding of an accusatory nature pending before it, it is important to avoid creating, or permitting to be created, an impression that a decree is being entered or a sanction imposed, when the conduct alleged did not, in fact, occur. Accordingly, it hereby announces its policy not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the allegations in the complaint or order for proceedings. In this regard, the Commission believes that a refusal to admit the allegations is equivalent to a denial, unless the defendant or respondent states that he neither admits nor denies the allegations.
17 C.F.R. § 202.5(e). The requirement is also contained in the form of settlement offer executed by a settling party:
Defendant understands and agrees to comply with the Commission's policy “not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the allegation in the complaint or order for proceedings.” 17 C.F.R. § 202.5. In compliance with this policy, Defendant agrees not to take any action or to make or cause to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis. . . . .  If Defendant breaches this agreement, the Commission may petition the Court to vacate the Final Judgment and restore this action to its active docket.
In a lawsuit filed in January of this year, the Cato Institute is challenging the constitutionality of the so-called “gag rule” as a violation of a defendant's right to free speech under the First Amendment.[18]  The Cato Institute's interest in the issue is grounded on its desire to publish a manuscript by a party who settled a Commission enforcement action.  According to the Cato Institute's complaint, the manuscript describes what the author believes to be the Commission's overreach in coercing the author into a settlement despite the author's belief that the charges were without merit in order to avoid crippling litigation expenses.  The complaint alleges that the regulation and policy constitutes an unconstitutional content-based restriction on speech. Not surprisingly, the Commission filed a motion to dismiss the complaint in May, arguing, among other things, that the plaintiff's action was flawed in three key ways: (1) the Cato Institute lacked standing under Article III because it was challenging a contract reviewed, approved and entered by a district court—a contract to which the plaintiff was neither a party nor an intended beneficiary; (2) the court lacked jurisdiction on ripeness grounds because the plaintiff's claims were premised upon speculation about future events that would implicate other courts' authority, in effect asking the court to invalidate no-deny provisions in every single past consent judgment, regardless of whether all past settling defendants wanted this outcome;  and (3) the Cato Institute did not state a First Amendment claim because the no-deny provisions were negotiated provisions and were not imposed against a defendant's free will.  The Commission further asserted that there were compelling interests that would justify these no-deny provisions, such as avoiding investor and market confusion and deterring future defendants. The Cato Institute opposed the Commission's motion to dismiss, arguing that the Commission's no-deny provisions amounted to a lifetime ban on speech, and former SEC defendants who want to complain about the SEC's conduct in their cases are unable to do so because of these provisions.  The Cato Institute asserted three main arguments in response to the Commission's motion to dismiss: (1) the Cato Institute has standing as a would-be publisher because it is currently required to abstain from constitutionally protected speech; (2)  the court could adjudicate the instant claims without invading the jurisdiction of any other court; and (3) the unconstitutional-conditions doctrine applies to this matter and therefore the Cato Institute has properly pleaded a justiciable claim under the First Amendment. Needless to say, the lawsuit has had no impact whatsoever on the Commission's continued practice of settling actions on a neither-admit-nor-deny basis.

II.  Public Company Disclosure, Accounting and Audit Cases

A.  Internal Controls

In late January, the SEC announced a settlement with four public companies based on the companies' alleged failure to maintain adequate internal controls over financial reporting (“ICFR”).[19]  The SEC alleged that, although the companies disclosed material weaknesses in their ICFR, the took months or years to remedy the issues, including after SEC staff notified the companies of the issues.  Without admitting or denying the allegations, all four companies agreed to a cease and desist order and to pay civil penalties Ranging from $35,000 to $200,000.  One company, a Mexican steel manufacturer and processor, continues to remediate material weaknesses and, as part of the settlement, has undertaken to have an independent consultant to review the remediation.

B.  Company Disclosures Concerning the Business

In March, the SEC instituted a settled action against a U.S. home improvement company based on allegations that the company made misstatements regarding its products' compliance with regulatory standards.[20]  Following a media report on certain of the company's products in 2015, the company stated that third-party test results demonstrated its products were in compliance with regulatory standards.  The company also stated that individuals featured in the media reporting were not employees of the company's suppliers.  The SEC alleges that the company knew that one of its Chinese suppliers had failed third-party testing and had evidence that the individuals featured in the media reporting were employees of the company's suppliers.  Without admitting or denying the findings in the SEC's order, the company agreed to pay a $6 million penalty.  On the same day the SEC instituted its settled action, the Department of Justice announced that the company entered into a deferred prosecution agreement and agreed to pay $33 million in forfeiture and criminal fines. As discussed above in our introductory section, in March of this year, the SEC filed an unsettled complaint against a car manufacturer, two of its subsidiaries, and its former CEO for alleged misstatements concerning the compliance of the company's vehicles with emissions standards at a times when the company issues bonds and asset backed securities.[21]  The complaint alleges that the misstatements enabled the company to issue bonds as a lower interest rate than otherwise.  As discussed above, the litigation remains pending.

C.  Financial Reporting Cases

In early April, the SEC brought a settled action against the founder and former CEO of a Silicon Valley mobile payment startup based on allegations that he overstated the company's revenues and then sold shares he owned to investors in the secondary market.[22]  The former CEO agreed to settle the charges without admitting wrongdoing, agreeing to pay more than $17 million in disgorgement and penalties and to be barred from serving as an officer or director of a publicly traded U.S. company.  The SEC instituted a separate settled administrative action against the company's former CFO for based on allegations that he failed to exercise reasonable care in the company's financial statements and signed stock transfer agreements that inaccurately implied that the company's board of directors had approved the CEO's stock sales.  The CFO, who had also sold some of his shares in the company, entered into a cooperation agreement with the SEC and, in connection with his settlement, agreed to pay approximately $420,000 in disgorgement and prejudgment interest. Also in April, the SEC filed an unsettled action against the former CFO and two former employees of a publicly traded transportation company.[23]  The SEC's complaint alleges that the former CFO hid expenses and manipulated the company's finances, while the other two employees failed to write-off overvalued assets and overstated receivables at one of the company's operating companies.  The complaint also alleges that the defendants misled the company's outside auditor, causing the company to misstate financial results in periodic reports filed with the SECs.  The U.S. Department of Justice's Fraud Section also filed parallel criminal charges against the three individuals. Later in April, the SEC instituted a settled proceeding against a Silicon Valley market place lender that, through its website, sold securities linked to performance of its consumer credit loans.[24]  According to the SEC's administrative order, the company excluded certain non-performing charged off loans from its performance calculations reported to investors, and as a result, overstated its net returns.  Pursuant to the settlement, the company agreed to pay $3 million. Also in April, the SEC filed a settled action against a U.S. truckload carrier with accounting fraud, books and records, and internal control violations.[25]  The SEC's complaint alleges that the company avoided recognizing impairment charges and losses by selling and buying used trucks at inflated prices from third-parties, which enabled the company to overstate its pre-tax and net income and earnings per share in one annual and two quarterly reports.  In the settlement, the company agreed to pay $7 million in disgorgement, which is deemed satisfied by the company's payment of restitution in settlement of a parallel action brought by the Department of Justice.  This is also one of the few settled SEC actions under this administration in which the defendant admitted to the violations alleged in the SEC's complaint. In May, the SEC instituted settled administrative proceedings against a New Hampshire-based manufacturer and its former CEO based on allegations that the company misled investors regarding the company's ability to supply “sapphire glass” for Apple's iPhones.[26]  According to the SEC's orders, the company entered into an agreement with Apple to provide sapphire glass that met certain standards, but that the company failed to meet the standards required by the Apple contract, which triggered Apple's right to withhold payment and accelerate a large repayment from the New Hampshire company.  Despite Apple's exercise of this withholding and repayment, the company reported that it expected to meet performance targets and receive payment from Apple.  In settlement, the former CEO agreed to pay approximately $140,000 in disgorgement and penalties.  The company, which had since filed for, and exited from, bankruptcy as a private company, was not assessed a penalty.

D.  Cases Against Audit Firms

In February, the SEC instituted a settled administrative proceeding against a large Japanese accounting firm and two of the firm's former executives (the former CEO and the former Reputation and Risk Leader and Director of Independence) based on allegations that the firm violated certain provisions of the SEC's audit independence rules.[27]  The SEC's order alleges that the firm issued audit reports for a client notwithstanding that certain personnel within the accounting firm were aware that the client's subsidiary maintained dozens of bank accounts for employees of the accounting firm with balances that exceeded depositary insurance limits.  The SEC's order alleges that the firm's quality control system did not provide reasonable measures to help ensure the firm was independent from its audit clients.  Without admitting or denying the allegations, the firm agreed to pay a $2 million penalty.  The former executives agreed to be suspended from appearing or practicing before the SEC as accountants with a right to apply for reinstatement after two years in the case of the former CEO and one year in the case of the former Reputation Risk Leader and director of Independence, In June, the SEC instituted a settled administrative proceeding against an international accounting firm based on allegations that certain former firm personnel obtained confidential lists of inspection targets from a now former employee of the Public Company Accounting Oversight Board (PCAOB) and used the information to alter past audit work papers to reduce the likelihood of deficiencies being found during the PCAOB inspections.[28]  Last year, the SEC had previously instituted enforcement actions against the former personnel of the audit firm and the PCAOB.  The SEC's settled order against the firm also alleges that a number of the firm's audit professionals engaged in misconduct in connection with internal training exams.  Pursuant to the settlement, the firm agreed to pay a $50 million penalty, to retain an independent consultant to review and evaluate the firm's quality controls relating to ethics and integrity, and other remedial measures.  The firm also admitted the facts in the SEC's order and acknowledged that its actions violated a PCAOB rule requiring integrity.

III.  Cases Against Investment Advisers

A.  Representation Concerning Brokerage Commissions

In March, the SEC instituted a settled action against a dually registered broker-dealer and investment adviser in connection with the activity of a firm it had acquired.[29]  According to the SEC, the firm represented to advisory clients that they were receiving a discount off the firm's retail commission rates.  However, according the SEC's order, the firm did not adequately disclose that clients could have chosen other outside brokerage options at lower commission rates.  The SEC alleged that the firm charged commissions on average 4.5 times more than what clients would have paid using other brokerage options, but did not provide any additional services to advisory clients using its in-house brokerage than it did to advisory clients who chose other brokerages with considerably lower commission rates.  Without admitting or denying the findings, the firm agreed to pay approximately $5.2 million in disgorgement and prejudgment interest, and a $500,000 civil penalty.

B.  Conflicts of Interest

In March, the SEC instituted settled proceedings against a registered investment adviser and its former Chief Operating Officer, alleging they manipulated the auction of a commercial real estate asset on behalf of one client for the benefit of another client.[30]  According to the SEC, instead of identifying bona fide bidders, the COO used the firm's affiliated private fund client for one bid and assured two other bidders that they would not win if they participated.  According to the SEC, the selling client was thereby deprived of the ability to receive multiple genuine offers which could maximize its profit.  Without admitting or denying the findings in the order, the investment adviser agreed to pay approximately $83,000 in disgorgement and prejudgment interest, and a $325,000 civil penalty.  The former COO, without admitting or denying the findings in the order, agreed to pay a $65,000 civil penalty and a 12-month industry suspension.

C.  Advisory Fees

In March, the SEC filed an unsettled complaint against the former Chief Operating Officer of an investment adviser for allegedly aiding and abetting the advisory firm's overbilling of advisory clients in order to generate additional revenue and improperly inflate his own pay.[31]  The U.S. Attorney's Office for the Southern District of New York brought accompanying criminal charges on the same day the SEC action was announced. In May, the SEC announced a settled action against a now-defunct registered investment adviser in North Carolina alleging that the adviser overcharged clients for advisory fees, misrepresented the reason the adviser's custodian arrangement ended (the custodian observed irregular billing practices), and overstated assets under management in Commission filings.[32]  Without admitting or denying the findings in the SEC's order, the owner agreed to pay approximately $400,000 in disgorgement and prejudgment interest, and a $100,000 civil penalty.

D.  Misuse of Client Funds

In March, the SEC instituted a settled administrative proceeding against a Seattle-based registered investment adviser and its principal.[33]  According to the SEC, the company's principal misused more than $3 million from a private client fund to pay business and personal expenses, sent fraudulent account statements and tax documents to investors, overstated assets in the fund and falsely represented that the fund had undergone an independent audit.  The settled order provides that the investment adviser's registration is revoked, the principal is barred from the securities industry, and the company and owner are liable jointly and severally for disgorgement and prejudgment interest of approximately $1.2 million, but with an allowance for offset as to the principal by the amount of any restitution ordered against him in a parallel criminal action in which he agreed to plead guilty.

E.  Compliance Policies and Procedures

In June, the SEC instituted a settled administrative proceeding against a private fund manager and its Chief Investment Officer alleging that the manager failed to adopt and implement policies and procedures to address the risk that the traders' pricing of illiquid mortgage-backed bonds may not conform to generally accepted accounting principles.[34]    Without admitting or denying the findings in the SEC's order, the fund manager agreed to a civil penalty of $5,000,000 and the CIO agreed to pay a civil penalty of $250,000.

IV.  Cases Against Broker-Dealers

A.  Cases Concerning ADRs

The SEC continued a 2018 initiative focused on investigating practices related to American Depositary Receipts (“ADR”)—U.S. securities that represent foreign shares of a foreign company and that require foreign shares in the same quantity to be held in custody at a depositary bank.  Pre-released ADRs are issued without the deposit of foreign shares, but require that either a customer owns the number of foreign shares in equal amounts to the number of shares represented by the ADRs, or that the broker receiving the shares has an agreement with a depository bank.  The SEC settled three cases involving pre-released ADRs in the first half of 2019—one in March and two in June. In March, a broker-dealer agreed to pay more than $8 million in disgorgement and penalties to settle charges of improperly handling pre-released ADRs.[35]  According to the SEC's order, the broker-dealer improperly borrowed pre-released ADRs from other brokers when it should have known that the middlemen did not own the foreign shares required to support the ADRs.  As a result of borrowing these pre-released ADRs, there was inappropriate short selling and other improper trading activity. In June, the SEC settled with a broker-dealer subsidiary of a large bank, and the $42 million that the broker-dealer agreed to pay in disgorgement and penalties resulted in the largest recovery against a broker in connection with ADRs to date.[36]  In that matter, the broker-dealer improperly bought pre-released ADRs.  The SEC alleged that the broker-dealer falsely represented that the company or its customers owned the requisite number of foreign shares to justify pre-release transactions. A few days later in June, the SEC instituted settled proceedings against a broker-dealer.  The SEC Order alleged that, for approximately two years, the firm failed to take reasonable steps to ensure that the parties who received pre-released ADRs owned the corresponding shares.  Without admitting or denying the charges, the broker-dealer agreed to pay $7.3 million in disgorgement and penalties.[37]  The Commission noted that the firm undertook voluntary remediation efforts by discontinuing pre-release activity even before the staff began its investigation.

B.  Other Broker-Dealer Cases

The SEC also instituted several proceedings against broker-dealers unrelated to ADRs in the first half of 2019.  The SEC has filed a number of enforcement actions relating to “blank check” companies, the most recent of which was in February.  In February, the SEC announced charges against a broker-dealer, three of the firm's principals, and a transfer agent, alleging that the firm and transfer agent helped create and sell at least 19 sham companies, and that the individuals signed the false applications and failed to investigate.[38]  According to the SEC, those charged created these “blank check” companies from 2009 to 2014. In March, the SEC settled charges with a broker-dealer headquartered in California for allegedly failing to take appropriate measures to supervise one of its registered representatives, who was found to be involved in a pump-and-dump scheme.[39]  The SEC instituted proceedings in March 2018, since which time the firm undertook remedial measures such as revising its policies and procedures, and changes to senior leadership.  Without admitting or denying the charges, to settle the pending administrative proceeding, the firm agreed to pay a $250,000 penalty and be censured. In May, a Manhattan jury ruled in favor of the SEC in a case in which the SEC had charged a brokerage firm and its indirect owner and president with fraud and related charges for making material misrepresentations and omissions in a financial company's private placement offering and continuing to use the offering documents to solicit sales despite knowing they were inaccurate.[40]  The jury found the firm and individuals liable on all counts.

V.  Insider Trading Cases

A. Cases Involving Lawyers

In the first half of 2019, the SEC and Department of Justice twice brought insider trading charges against attorneys who traded on nonpublic information regarding upcoming financial disclosures.  In February, the SEC filed an unsettled insider trading action against a former senior attorney at a major technology company, alleging that he traded securities in the company after reviewing confidential information regarding upcoming earnings announcements.[41]  The SEC characterized the alleged conduct as particularly serious because the attorney's prior responsibilities included executing the company's insider trading compliance program.  The U.S. Attorney's Office for the District of New Jersey announced a parallel criminal complaint on the same day. In April, the SEC filed a partially-settled insider trading action against a former senior attorney of an entertainment company, for allegedly trading on nonpublic information after reviewing confidential drafts of an earnings release showing better than expected revenues.[42]  The attorney consented to a permanent injunction, with penalties and disgorgement to be determined by the district court.  The Department of Justice filed a parallel criminal complaint on the same day. In May, the SEC filed a settled insider trading action against a defendant who had been a houseguest of the general counsel of a company.  According to the complaint, the defendant misappropriated nonpublic information, misappropriated from the general counsel's home office, concerning a pending merger involving the general counsel's company, and then traded on the basis of that information in accounts in the name of his ex-wife and an ex-girlfriend.[43]  The defendant agreed to a settlement including a penalty of $253,000.  The SEC also named as relief defendants the defendant's ex-wife and ex-girlfriend in whose accounts he had traded.  They agreed to disgorge the alleged profits of $250,000, along with prejudgment interest.

B.  Continued Fallout from Newman Decision

In criminal insider trading cases, the impact of the Second Circuit's 2014 ruling in United States v. Newman,[44] since abrogated in part by the Supreme Court in United States v. Salman,[45] continues to have an impact.  In Newman, the Court held that, in cases against a defendant who is a downstream tippee, the government must prove the defendant knew the insider source of the information received a personal benefit in exchange for the tip in breach of their duty of confidentiality.  In June of this year, the District Court for the Southern District of New York overturned the 2012 guilty plea and conviction of a tippee in light of Newman, finding the record plea factually insufficient because “nothing in the record . . . speaks directly or indirectly to [the defendant's] knowledge of any personal benefit the corporate insiders received as a result of divulging confidential information.”[46]  By contrast, in January of this year, the Second Circuit upheld the 2012 conviction of a former executive, finding inter alia that he was not prejudiced by the pre-Newman jury instructions in that case.[47]

C.  Other Cases Involving Tipper and Tippee Liability

The SEC filed several other insider trading actions involving tipper/tippee liability.  In April, the SEC instituted a settled administrative proceedings against a respondent who purchased options in a grocery store chain after learning about its impending acquisition from his wife, who had in turn learned about it from a family member who was a corporate insider.[48]  In the settlement, the respondent agreed to pay approximately $57,000 in disgorgement and prejudgment interest. In June, the SEC obtained final judgments by consent against three defendants -- an executive and two of his friends.[49]  The executive had been entrusted by a friend, an employee at Concur Technologies, with confidential information of a forthcoming merger.  The executive then tipped one of his friends, who then tipped his brother.  The two brothers and other family members then placed short-term trades in call options in Concur, resulting in over $500,000 in profits, a portion of which they gave to their executive friend.  The three defendants agreed to pay disgorgement and prejudgment interest all of which was deemed satisfied by orders of forfeiture entered against each of the three individuals in parallel criminal actions in which they pleaded guilty and were sentenced to prison terms ranging from six to twenty-four months. Also in June, the SEC obtained consent judgments against two defendants, an executive at a pharmaceutical company and a business associate of the executive, in an insider trading case filed last year.[50]  The SEC's complaint alleged that the executive tipped the business associate regarding nonpublic negotiations of a licensing agreement, and that the business associate then tipped other defendants who traded on the information, resulting in $1.5 million in gains.  Without admitting or denying the allegations in the complaint, the pharmaceutical executive consented to a civil monetary penalty of $750,000 and a five-year officer and director bar.  The amount of monetary relief as to the business associate remains to be determined by the court.  All but one of other defendants have agreed to partial settlements with the SEC. Also in June, the SEC filed an amended complaint adding a Swiss businessman as a defendant to an insider trading case filed last year.[51]  The defendant allegedly purchased out of the money call options in the target company based on a tip regarding a pending merger from the son of a senior executive of the acquirer.  The proceeds of the transaction were previously frozen in the United States and Switzerland.  The U.S. Attorney's Office for the Southern District of New York announced a parallel criminal action against the defendant on the same day the SEC filed the amended complaint. Also in June, the SEC filed a settled insider trading action against a defendant who allegedly sold shares in an energy company after learning about a proposed secondary offering from individuals either at the company or affiliated with an investment bank that endeavored to participate in the offering.[52]  According to the complaint, after acquiring the information and before the public announcement, the defendant sold over 9,000 shares of company stock, avoiding approximately $46,000 in losses.  The defendant, without admitting or denying the allegations, agreed to pay disgorgement, prejudgment interest, and a one-time civil penalty.

D.  Trading by Insiders

In February, the SEC filed a settled insider trading action against a former employee of a biotech company, alleging he sold stock in the company after learning the FDA had recommended withdrawal of two of the company's products, thereby avoiding a loss of approximately $70,000.[53]  In the settlement, the defendant agreed to pay approximately $146,000 in disgorgement, prejudgment interest, and a civil penalty.

VI.  Cases Concerning Cryptocurrency and Cybersecurity

The SEC has focused on cybersecurity and cryptocurrency issues throughout the first half of the year.  In addition to bringing enforcement actions, in May, the SEC's Strategic Hub for Innovation and Financial Technology (“FinHub”)[54] hosted a public forum on distributed ledger technology and digital assets.[55]  The forum focused on engagement with market participants on new financial technologies, including initial coin offerings.

A.  Cybersecurity

In January, the SEC brought its first enforcement action of the year alleging that a Ukrainian hacker along with eight persons and entities engaged in a scheme to extract nonpublic information from the SEC's EDGAR filing system.[56]  The SEC alleged that by hacking into the EDGAR system, the accused were able to access documents that had been filed with the SEC, but that had not yet been released publicly, and pass the documents to traders who traded on the nonpublic information to the benefit of $4.1 million.  This action follows 2015 charges against the same hacker and other traders for engaging in a similar scheme involving hacking into newswire services for nonpublic information about impending corporate earnings announcements.  The U.S. Attorney's Office for the District of New Jersey brought accompanying criminal charges on the same day the SEC action was announced.

B.  Failure to Register Initial Coin Offerings

In February, the SEC continued its recent trend of enforcement actions against companies who fail to register an initial coin offering (“ICO”) pursuant to federal securities law.[57]  Unlike the two ICO-related actions the SEC settled last year,[58] the company at issue in February self-reported its late-2017 unregistered ICO.  The company had raised $12.7 million from the sale of these instruments after the Commission had publicly articulated its position that ICOs can constitute securities offerings.  The company agreed to fully cooperate with the investigation, to register the token offering, and to compensate any investors who request a return of funds.  Because of its self-reporting and remediation measures, the SEC did not impose a penalty.

C.  Other Offerings Involving Digital Assets

In May, the SEC obtained a temporary restraining order, asset freeze, and appointment of a receiver against several related companies engaged in an alleged international Ponzi scheme involving cryptocurrency and diamond mines.[59]  The principal is accused of using $10 million of the proceeds from an unregistered cryptocurrency offering by one of his companies to repay the investors in his previous diamond company and to fund his personal expenses. Also in May, the SEC filed a civil injunctive action charging an individual with operating a $26 million pyramid scheme.[60]  The complaint alleges that for over a year the individual conducted an unregistered securities offering where investors purchased instructional business packages as well as “points” that could be converted into a digital asset.  Investors earned more of these points through cash investments and by recruiting new investors to purchase digital assets and join the pyramid scheme. In June, the SEC filed a complaint alleging the defendant company raised $55 million from U.S. investors through an unregistered offering of a digital currency.[61]  Investors were allegedly told that the currency's value would increase when the company created a transaction service based on the currency that would be available within and without the company.  The SEC alleges these services were never offered and that the value of the currency has decreased by nearly half since it was initially offered. In June, the SEC filed an amended complaint against a company and its CEO for allegedly conducting a fraudulent IPO and for engaging in accounting fraud by recording more than $66 million in excess revenue.[62]  In connection with the original complaint filed last year, the court granted the SEC's request for preliminary relief freezing more than $27 million raised from the allegedly fraudulent offering.[63]  Also in June, the U.S. Attorney's Office for the District of New Jersey brought parallel criminal charges against the CEO.

VII.  Municipal Securities Cases

A.  New Actions

In March, the SEC filed a settled action against a former County Manager, alleging that he provided an unfair advantage to an investment adviser who was selected to manage county pension funds.[64]  The complaint alleges the County Manger, who allegedly had a romantic interest in an associate of the adviser, provided access to competitor's proposals, and also failed to disclose the conflict of interest in selecting the adviser.  The County Manager consented to a judgment enjoining him from further violations of the Investment Advisers Act and from involvement with the management of public pensions, the selection of underwriters and municipal advisers, and the offering of municipal securities, as well as a $10,000 civil penalty. Also in March, the SEC announced partially settled charges against the former controller of a not-for-profit college, alleging he misrepresented the college's finances in statements published in connection with its continuing disclosure obligations to investors pursuant to a bond issuance in 1999.[65]  According to the SEC's complaint, the former controller created false financial records, and his actions resulted in overstating the college's net assets by almost $34 million in the 2015 fiscal year.  The former controller agreed to a permanent injunction, with monetary relief to be determined at a later date.  In a parallel criminal action, the former controller agreed to plead guilty.  The college was not charged, in light of its cooperation and efforts to remediate the misconduct. In June, the SEC filed an unsettled action against a municipal adviser and managing partner based on allegations of breach of fiduciary duty in connection with a municipal bond offering for a public library.[66]  The complaint alleges the adviser failed to provide sufficient advice on selecting the underwriter for the offering and on pricing bonds, resulting in mispriced bonds which will cost the library additional interest over the life of the bonds.  In a related action, the SEC also instituted a settled administrative proceeding against the broker-dealer that underwrote the bonds based on allegations of a failure to act with reasonable care in underwriting the offering.  The broker-dealer agreed to a $50,000 civil penalty and to engage an independent compliance consultant.

B.  Settlements in Previously Filed Actions

In March, in an action previously filed in 2016, the SEC resolved litigation against a financial institution that had been the placement agent for a municipal bond offering intended to finance a finance startup video game company.[67]  The SEC alleged that the institution had failed to disclose that the project faced a shortfall in financing and that the institution was receiving compensation tied to the issuance of the bonds from the startup.  Pursuant to the settlement, without admitting or denying the allegations in the complaint, the financial institution agreed to pay approximately $800,000 in civil penalties.  The SEC's litigation against the lead banker on the deal is ongoing. In June, the SEC announced a settlement of a 2017 action against the Town of Oyster Bay, New York for allegedly failing to disclose an agreement to guarantee $20 million of loans to a third-party restaurant and concession stand operator in connection with certain municipal securities offerings.[68]  In addition to consenting to an injunction, the Town agreed to retain an independent compliance consultant to advise on its disclosures for securities offerings.  The litigation against the former town supervisor is continuing. __________________________     [1]  Testimony of Chairman Jay Clayton before the Financial Services and General Government Subcommittee of the U.S. Senate Committee on Appropriations, (May 8, 2019), available at https://www.sec.gov/news/testimony/testimony-financial-services-and-general-government-subcommittee-us-senate-committee.    [2]   See, e.g., SEC Charges Issuer With Conducting $100 Million Unregistered ICO, Press Rel. No. 2019-87 (June 4, 2019), available at https://www.sec.gov/news/press-release/2019-87; SEC Sues alleged Perpetrator of Fraudulent Pyramid Scheme Promising investors Cryptocurrency Riches, Press Rel. No. 2019-74 (May 23, 2019), available at https://www.sec.gov/news/press-release/2019-74; SEC Obtains Emergency Order Halting Alleged Diamond Related ICO Scheme Targeting Hundreds of Investors, Press Rel. No. 2019-72 (May 21, 2019), available at https://www.sec.gov/news/press-release/2019-72.    [3]   SEC Press Release, SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals (June 5, 2019), available at https://www.sec.gov/news/press-release/2019-89.    [4]   SECURITIES AND EXCHANGE COMMISSION, Regulation Best Interest: The Broker-Dealer Standard of Conduct, Rel. No. 34-86031 (June 5, 2019) (to be codified at 17 CFR §§ 240.15l-1, 240.17a-3, and 240.17a-4), available at https://www.sec.gov/rules/final/2019/34-86031.pdf (“Final Rule”). [5] See Statement by Chairman Jay Clayton Regarding Offers of Settlement (July 3, 2019), available at https://www.sec.gov/news/public-statement/clayton-statement-regarding-offers-settlement.    [6]   SEC Press Release, SEC Awards $3 Million to Joint Whistleblowers (June 3, 2019), available at https://www.sec.gov/news/press-release/2019-81.    [7]   SEC Awards $50 Million to Two Whistleblowers, Press Rel. 2019-42 (Mar. 26, 2019), available at https://www.sec.gov/news/press-release/2019-42.    [8]   In the Matter of the Claims for Award in connection with [redacted] Notice of Covered Action [redacted], Order Determining Whistleblower Award Claims, Rel. No. 85412 (Mar. 26, 2019), available at https://www.sec.gov/rules/other/2019/34-85412.pdf.    [9]   SEC Press Release, SEC Awards $4.5 Million to Whistleblower Whose Internal Reporting Led to Successful SEC Case and Related Action (May 24, 2019), available at https://www.sec.gov/news/press-release/2019-76. [10]   SEC Press Release, SEC Awards $3 Million to Joint Whistleblowers (June 3, 2019), available at https://www.sec.gov/news/press-release/2019-81. [11]   See Gibson, Dunn & Crutcher LLP 2018 Mid-Year Securities Enforcement Update (July 30, 2018), available at https://www.gibsondunn.com/2018-mid-year-securities-enforcement-update/. [12]   House Financial Services Committee Passes Bill to Expand Dodd-Frank Whistleblower Protection to Internal Whistleblowers (May 30, 2019), available at https://www.jdsupra.com/legalnews/house-financial-services-committee-88658/. [13]   Lorenzo v. SEC, 587 U.S. ___, No. 17-1077 (U.S. Mar. 27, 2019). [14]   See Speech by Commissioner Hester M. Peirce, “Reasonableness Pants,” (May 8, 2019), available at https://www.sec.gov/news/speech/speech-peirce-050819 (“Congress defined aiding and abetting liability to be the provision of ‘substantial assistance' to a securities law violator. It is important for us and the courts not to ascribe primary liability to every violation and thus write aiding and abetting out of the statute.”) (footnote omitted). [15]   See, e.g., Matter of Deer Park Road Management Company, LP, Rel. No. 5245 (June 4, 2019), n. 7 (“A willful violation of the securities laws means merely ‘that the person charged with the duty knows what he is doing…. There is no requirement that the actor ‘also be aware that he is violating one of the Rules or Acts.'”) (citations omitted). [16]   See, e.g., SEC v. Rio Tinto plc and Rio Tinto Limited, Thomas Albanese, and Guy Robert Elliott, No. 17 Civ. 7994 (AT), 2019 WL 1244933, at *22 (S.D.N.Y. Mar. 18, 2019) (collecting cases). [17]   CFTC v. Southern Trust Metals, Inc., 2019 WL 2295488, at *4-5 (S.D. Fla. May, 30, 2019). [18]   Cato Institute v. SEC, et al., Case 1:19-cv-00047 (D.D.C. Jan. 9, 2019). [19]   SEC Press Release, SEC Charges Four Public Companies with Longstanding ICFR Failures (Jan. 29, 2019), available at https://www.sec.gov/news/press-release/2019-6. [20]   SEC Press Release, SEC Charges Lumber Liquidators with Fraud (Mar. 12, 2019), available at https://www.sec.gov/news/press-release/2019-29. [21]   SEC Press Release, SEC Charges Volkswagen, Former CEO with Defrauding Bond Investors During “Clean Diesel” Emissions Fraud (Mar. 14, 2019), available at https://www.sec.gov/news/press-release/2019-34. [22]   SEC Press Release, SEC Charges Former CEO of Silicon Valley Startup with Defrauding Investors (Apr. 2, 2019), available at https://www.sec.gov/news/press-release/2019-50. [23]   SEC Press Release, SEC Charges Transportation Company Executives with Accounting Fraud (Apr. 3, 2019), available at https://www.sec.gov/news/press-release/2019-51. [24]   SEC Press Release, Silicon Valley Company Settles Fraud Charge for Misstating Returns to Investors (Apr. 19, 2019), available at https://www.sec.gov/news/press-release/2019-58. [25]   SEC Press Release, SEC Charges Truckload Freight Company with Accounting Fraud (Apr. 25, 2019), available at https://www.sec.gov/news/press-release/2019-60. [26]   SEC Press Release, SEC Charges Sapphire Glass Manufacturer and Former CEO with Fraud (May 2, 2019), available at https://www.sec.gov/news/press-release/2019-66. [27]   SEC Press Release, Deloitte Japan Charged with Violating Auditor Independence Rules (Feb. 13, 2019), available at https://www.sec.gov/news/press-release/2019-9. [28]   SEC Press Release, KPMG Paying $50 Million Penalty for Illicit Use of PCAOB Data and Cheating on Training Exams (June 17, 2019), available at https://www.sec.gov/news/press-release/2019-95. [29]   SEC Press Release, BB&T to Return More Than $5 Million to Retail Investors and Pay Penalty Relating to Directed Brokerage Arrangements (Mar. 5, 2019), available at www.sec.gov/news/press-release/2019-26. [30]   SEC Press Release, SEC Charges Registered Investment Adviser and Former Chief Operating Officer With Defrauding Client (Mar. 15, 2019), available at www.sec.gov/news/press-release/2019-36. [31]   SEC Press Release, SEC Charges New Jersey Man With Fraudulently Causing Advisory Firm to Overbill Clients (Mar. 28, 2019), available at www.sec.gov/news/press-release/2019-44. [32]   SEC Press Release, SEC Charges Investment Adviser With Fraud (May 28, 2019), available at www.sec.gov/news/press-release/2019-77. [33]   SEC Press Release, Investment Adviser Charged With Stealing Millions From Private Fund (Mar. 28, 2019), available at www.sec.gov/news/press-release/2019-45. [34]   SEC Press Release, Hedge Fund Adviser to Pay $5 Million for Compliance Failures Related to Valuation of Fund Assets (June 4, 2019), available at www.sec.gov/news/press-release/2019-86. [35]   SEC Press Release, Merrill Lynch to Pay Over $8 Million for Improper Handling of ADRs (Mar. 22, 2019), available at https://www.sec.gov/news/press-release/2019-40. [36]   SEC Press Release, Industrial and Commercial Bank of China Affiliate to Pay More Than $42 Million for Improper Handling of ADRs (June 14, 2019), available at https://www.sec.gov/news/press-release/2019-94. [37]   Admin. Proc. File No. 3-19205, In re Wedbush Securities, Inc. (June 18, 2019), available at https://www.sec.gov/litigation/admin/2019/33-10650.pdf. [38]   SEC Press Release, SEC Charges Broker-Dealer and Transfer Agent in Microcap Shell Factory Fraud (Feb. 20, 2019), available at https://www.sec.gov/news/press-release/2019-16. [39]   SEC Press Release, Wedbush Settles Failure to Supervise Charge (Mar. 13, 2019), available at https://www.sec.gov/news/press-release/2019-32. [40]   SEC Press Release, Jury Rules in SEC's Favor, Finds Brokerage Firm and Two of Its Executives Liable for Fraud (May 15, 2019), available at https://www.sec.gov/news/press-release/2019-70. [41]   SEC Press Release, SEC Charges Former Senior Attorney at Apple with Insider Trading (Feb. 13, 2019), available at https://www.sec.gov/news/press-release/2019-10. [42]   SEC Press Release, SEC Charges Former SeaWorld Associate General Counsel with Insider Trading (Apr. 9, 2019) available at https://www.sec.gov/news/press-release/2019-53. [43]   SEC Press Release, SEC Charges Nevada Man Who Traded on Confidential Information Taken from Lifetime Friend (May 7, 2019), available at https://www.sec.gov/news/press-release/2019-67. [44]   773 F.3d 438 (2d Cir. 2014). [45]   137 S. Ct. 420 (2016). [46]   United States v. Lee, No. 13-cr-539 (S.D.N.Y. June 21, 2019); see also Jody Godoy, Newman Cited in Tossing Ex-SAC Capital Exec's Guilty Plea, Law 360 (June 21, 2019), available at https://www.law360.com/articles/1171838/newman-cited-in-tossing-ex-sac-capital-exec-s-guilty-plea. [47]   Gupta v. United States, No. 15-2707 (2d. Cir. Jan 7, 2019) (affirming district court denial of motion to vacate conviction). [48]   Admin. Proc. File No. 3-19134, In re Yang, (Apr. 5, 2019), available at https://www.sec.gov/litigation/admin/2019/34-85525.pdf. [49]   SEC Litigation Release, SEC Obtains Final Judgments in Insider Trading Case Against Former Software Executive and Two Friends (June 12, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24499.htm. [50]   SEC Litigation Release, SEC Obtains Judgements Against Insider Trading Ring Defendants (June 11, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24498.htm. [51]   SEC Litigation Release, SEC Charges Swiss Resident in Insider Trading Case Involving Bioverativ Acquisition (June 13, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24500.htm. [52]   SEC Litigation Release, SEC Charges New Jersey Investor with Insider Trading (June 18, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24503.htm. [53]   SEC Litigation Release, SEC Settles with Biotech Insider Trader (Feb. 21, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24406.htm. [54]   SEC Press Release, FINHUB Strategic Hub for Innovation and Financial Technology (last modified June 13, 2019), available at https://www.sec.gov/finhub. [55]   SEC Press Release, SEC Staff to Hold Fintech Forum to Discuss Distributed Ledger Technology and Digital Assets (Mar. 15, 2019), available at https://www.sec.gov/news/press-release/2019-35; SEC Press Release, SEC Staff Announces Agenda for May 31 FinTech Forum (April 24, 2019), available at https://www.sec.gov/news/press-release/2019-59. [56]   SEC Press Release, SEC Brings Charges in EDGAR Hacking Case (Jan. 15, 2019), available at https://www.sec.gov/news/press-release/2019-1. [57]   SEC Press Release, Company Settles Unregistered ICO Charges After Self-Reporting to SEC, available at https://www.sec.gov/news/press-release/2019-15. [58]   See Gibson Dunn 2018 Year-End Review (Jan. 15, 2019), available at https://www.gibsondunn.com/2018-year-end-securities-enforcement-update/#_edn1; SEC Press Release, Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities (Nov. 16, 2018), available at https://www.sec.gov/news/press-release/2018-264. [59]   SEC Press Release, SEC Obtains Emergency Order Halting Alleged Diamond-Related ICO Scheme Targeting Hundreds of Investors (May 21, 2019), available at https://www.sec.gov/news/press-release/2019-72. [60]   SEC Press Release, SEC Sues Alleged Perpetrator of Fraudulent Pyramid Scheme Promising Investors Cryptocurrency Riches (May 23, 2019), available at https://www.sec.gov/news/press-release/2019-74. [61]   SEC Press Release, SEC Charges Issuer With Conducting $100 Million Unregistered ICO (June 4, 2019), available at https://www.sec.gov/news/press-release/2019-87. [62]   SEC Press Release, SEC Adds Fraud Charges Against Purported Cryptocurrency Company Longfin, CEO, and Consultant (June 5, 2019), available at https://www.sec.gov/news/press-release/2019-90. [63]   SEC Litigation Release, SEC Obtains Emergency Freeze of $27 Million in Stock Sales of Purported Cryptocurrency Company Longfin (May 2, 2018), available at https://www.sec.gov/litigation/litreleases/2018/lr24130.htm. See also Gibson Dunn 2018 Mid-Year Review (July 30, 2018), available at https://www.gibsondunn.com/2018-mid-year-securities-enforcement-update/; SEC Press Release, SEC Obtains Emergency Freeze of $27 Million in Stock Sales of Purported Cryptocurrency Company Longfin (Apr. 6, 2018), available at https://www.sec.gov/news/press-release/2018-61. [64]   SEC Press Release, SEC Charges Former Municipal Officer with Fraud in Connection with Public Pension Funds (Mar. 15, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24424.htm. [65]   SEC Press Release, SEC Charges College Official for Fraudulently Concealing Financial Troubles from Municipal Bond Investors (Mar. 28, 2019), available at https://www.sec.gov/news/press-release/2019-46. [66]   SEC Litigation Release, SEC Charges Municipal Advisor with Breaching Fiduciary Duty (June 27, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24520.htm. [67]   SEC Press Release, Court Penalizes Wells Fargo Securities for Disclosure Failures in 38 Studios Bond Offering (Mar. 20, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24428.htm. [68]   SEC Litigation Release, Town of Oyster Bay, New York, Agrees to Settle SEC Charges (June 7, 2019), available at https://www.sec.gov/litigation/litreleases/2019/lr24494.htm.
The following Gibson Dunn lawyers assisted in the preparation of this client update:  Mark Schonfeld, Amy Mayer, Lindsey Geher, Alyssa Ogden, Zoey Goldnick, Erin Galliher and Trevor Gopnik. Gibson Dunn is one of the nation's leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators. Our Securities Enforcement Group offers broad and deep experience.  Our partners include the former Directors of the SEC's New York and San Francisco Regional Offices, the former head of FINRA's Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California, and former Assistant United States Attorneys from federal prosecutors' offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force. Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Group, and our White Collar Defense Group. Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work or any of the following: New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Barry R. Goldsmith (+1 212-351-2440, bgoldsmith@gibsondunn.com) Laura Kathryn O'Boyle (+1 212-351-2304, ) Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Tina Samanta (+1 212-351-2469, tsamanta@gibsondunn.com) Washington, D.C. Stephanie L. Brooker (+1 202-887-3502, sbrooker@gibsondunn.com) Daniel P. Chung(+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Richard W. Grime (+1 202-955-8219, rgrime@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tadavis@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Michael D. Celio (+1 650-849-5326, mcelio@gibsondunn.com) Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 5, 2019 |
2018 Year-End Securities Litigation Update

Click for PDF 2018 witnessed even more securities litigation filings than 2017, in which we saw a dramatic uptick in securities litigation as compared to previous years.  This year-end update highlights what you most need to know in securities litigation developments and trends for the latter half of 2018, including:

  • The Supreme Court heard oral argument in Lorenzo v. Securities and Exchange Commission, and is set to answer the question of whether a securities fraud claim premised on a false statement that was not “made” by the defendant can be pursued as a “fraudulent scheme” claim even though it would not be actionable as a Rule 10b-5(b) claim under Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).
  • The Supreme Court granted the petition for writ of certiorari in Emulex Corp. v. Varjabedian to consider whether Section 14(e) of the Exchange Act supports an inferred private right of action based on negligent (as opposed to knowing or reckless) misstatements or omissions made in connection with a tender offer.
  • We discuss recent developments in Delaware law, including case law exploring, among other things, (1) appraisal rights, (2) the standard of review in controller transactions, (3) application of the Corwin doctrine, and (4) when a “Material Adverse Effect” permits termination of a merger agreement.
  • We review case law implementing the Supreme Court’s decisions in Omnicare and Halliburton II.
  • We review a decision from the Third Circuit regarding the obligation to disclose risk factors, and a decision from the Ninth Circuit regarding the utilization of judicial notice and the incorporation by reference doctrine at the motion to dismiss stage.

1. Filing and Settlement Trends

Figure 1 below reflects filing rates for 2018 (all charts courtesy of NERA). Four hundred and forty-one cases were filed this past year. This figure does not include the many class suits filed in state courts or the increasing number of state court derivative suits, including many such suits filed in the Delaware Court of Chancery. Those state court cases represent a “force multiplier” of sorts in the dynamics of securities litigation today. Figure 1:

Figure 1

As shown in Figure 2 below, over 200 “merger objection” cases were filed in federal courts in 2018. Building off a trend from 2017, this is nearly triple the number of such cases filed in 2016, and more than quadruple the number filed in 2014 and 2015. Note that this statistic only tracks cases filed in federal courts. Historically, most M&A litigation had occurred in state court, particularly the Delaware Court of Chancery. But as we have discussed in prior updates, the Delaware Court of Chancery announced in early 2016 in In re Trulia Inc. Stockholder Litigation, 29 A.3d 884 (Del. Ch. 2016) that the much-abused practice of filing an M&A case followed shortly by an agreement on “disclosure only” settlement is effectively at an end. This is likely driving an increasing number of cases to federal court. Figure 2:

Figure 2

2018 saw the continuation of a decline in the percentage of cases filed against healthcare companies, following the peak of such cases in 2016. The percentage of new cases involving electronics and technology companies, meanwhile, saw a significant bump, comprising 21% of all fillings in 2018. The proportion of cases in the finance sector remained roughly consistent as compared to 2017. Figure 3:

Figure 3

As Figure 4 shows, the average settlement value was $69 million in 2018, returning to a number comparable to the average in 2016 ($77 million) after a sharp decline to $25 million in 2017. Figure 5 reflects that the median settlement value also rose from $6 million in 2017 to $13 million in 2018. In any given year, of course, median settlement statistics also can be influenced by the timing of large settlements, any one of which can skew the numbers.  The statistics are not highly predictive of the settlement value of any individual case, which is driven by a number of important factors, such as (i) the amount of D&O insurance; (ii) the presence of parallel proceedings, including government investigations and enforcement actions; (iii) the nature of the events that triggered the suit, such as the announcement of a major restatement; (iv) the range of provable damages in the case; and (v) whether the suit is brought under Section 10(b) of the Exchange Act or Section 11 of the Securities Act. Figure 4:

Figure 4

Figure 5:

Figure 5

Following a decline in 2017, 2018 witnessed the return of Median NERA-Defined Investor Losses and Median Ratio of Settlement to Investor Losses by Settlement Year to $479 million, a level similar to that seen in 2015 and 2016. Figure 6:

Figure 6

2018 also saw a greater number of settlement sizes in the $10 to $50 million range, with settlements in the $20 to $49.9 million range reaching an unprecedented 24% of all settlements. Figure 7:

Figure 7

2. What to Watch for in the Supreme Court

A. Lorenzo Will Test the Reach of Janus on Who May Be Held Liable for False Statements

In our 2018 Mid-Year Securities Litigation Update, we discussed the Supreme Court’s grant of certiorari in Lorenzo v. Securities and Exchange Commission, No. 17-1077. As readers will recall, Lorenzo involves the question of whether a securities fraud claim premised on a false statement that was not “made” by the defendant can be pursued as a “fraudulent scheme” claim under Section 17(a)(1) of the Securities Act and Exchange Act Rules 10b-5(a) and 10b-5(c) even though it would not be actionable under Rule 10b-5(b) pursuant to the Court’s ruling in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011). In the decision below, the D.C. Circuit held that Lorenzo’s distribution of an email that included false statements drafted by his supervisor could not form the basis for 10b-5(b) liability under Janus, but could form the basis for “scheme” liability under 10b-5(a) and (c). Lorenzo v. Sec. & Exch. Comm’n, 872 F.3d 578, 580, 592 (D.C. Cir. 2017). Then-Judge Kavanaugh dissented from the panel opinion. In the merits brief, Petitioner (a securities broker) argued that allowing scheme liability would permit an end-run around the Court’s decision in Janus, which held that only the “maker” of a statement can face primary liability for securities fraud. Brief for Petitioner at 24. Petitioner specifically contended that the D.C. Circuit’s ruling would effectively nullify Janus, and would allow the SEC to impose liability for conduct under 10b-5(a) and (c) that is not actionable under 10b-5(b). Id. at 27-28. Petitioner also argued that the scheme liability theory adopted by the D.C. Circuit is functionally no different than aiding-and-abetting liability—a theory of liability under Section 10(b) of the Exchange Act that the Supreme Court rejected in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 177 (1994). Id. at 36. In its responsive brief on the merits, Respondent (the SEC) argued that neither Janus nor Central Bank purport to extend their holdings to claims made pursuant to Rules 10b-5(a) and (c). Brief for Respondent at 23-26, 31-33. On behalf of the SEC, the U.S. Solicitor General also argued that because the messages that contained the false statements were sent by Lorenzo, and because the transmission of the messages was necessary to the scheme, Lorenzo’s actions fall squarely within the provisions imposing scheme liability. Id. at 15-18. At oral argument on December 3, 2018, several Justices seemed troubled by Lorenzo’s argument because Janus relied on statutory text that prohibited the “making” of a false statement, but the statutory provisions under which the SEC charged Lorenzo do not include any references to the “making” of statements. Justice Alito repeatedly pressed Lorenzo’s counsel to explain why the alleged conduct did not “fall squarely within the language” of the statute. Tr. at 11. Justice Kagan expressed skepticism of Lorenzo’s theory that the various provisions of the anti-fraud statutes are “mutually exclusive,” such that misstatements can be sanctioned only under the provisions directed specifically at misstatements. Tr. at 25. Justice Gorsuch, however, appeared more accepting of Petitioner’s arguments, and pressed the government’s lawyer on how scheme liability could apply when the only fraud is the making of a false statement (a fraud claim barred by Janus on these facts). Tr. at 32-36. Justice Kavanaugh was recused because he participated in the decision below. We expect a decision in Lorenzo by the end of the 2018 Supreme Court Term in June 2019. We will continue to monitor developments in this area and report on any updates in our 2019 Mid-Year Securities Litigation Update.

B. In Emulex, the Court Will Address whether Liability May Be Imposed under Section 14(e) for Negligent Conduct

On January 4, 2019, the Supreme Court granted certiorari in Emulex Corp. v. Varjabedian, No. 18-459, to consider whether Section 14(e) of the Exchange Act supports an inferred private right of action based on negligent misstatements or omissions made in connection with a tender offer. The case arises out of the Ninth Circuit, which split with five of its sister circuits in holding that plaintiffs seeking to recover under Section 14(e) of the Exchange Act need only plead and prove negligence, not scienter. 888 F.3d 399, 405 (9th Cir. 2018). This case involves a joint press release announcing a merger between Avago Technologies Wireless Manufacturing, Inc. and Emulex Corp. The press release announced that Avago would pay a premium for Emulex stock. Documents filed with the SEC in support of the offer omitted a one-page “Premium Analysis” showing that while the premium fell within the normal range of merger premiums in comparable transactions, it was below average. A class of former Emulex shareholders filed a putative class action and alleged defendants had violated Section 14(e) by failing to summarize the Premium Analysis and to disclose that the premium was below the average for premiums in similar mergers. The district court dismissed the Section 14(e) claim for failure to plead that the misstatement or omission was made intentionally or with deliberate recklessness. The Ninth Circuit reversed the district court, noting that Section 14(e) contains two separate clauses, which each proscribe different conduct: (1) making or omitting an untrue statement of material fact and (2) engaging in fraudulent, deceptive or manipulative acts or practices. The Ninth Circuit reasoned that the first clause, on its face, does not include a scienter requirement. Although the Ninth Circuit acknowledged that five other circuits (the Second, Third, Fifth, Sixth, and Eleventh) have held that Section 14(e) requires that plaintiffs plead scienter, the Ninth Circuit believes those circuits ignored or misread Supreme Court precedent to import Rule 10b-5’s scienter requirement to Section 14(e) claims. Id. at 405. According to the Ninth Circuit, Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), found that Rule 10b-5 requires a showing of scienter because it was promulgated by the SEC, which only has the authority to regulate manipulative or deceptive devices that necessarily entail scienter. Varjabedian, 888 F. Supp. at 406. The Ninth Circuit also reasoned that the text of Section 14(e) is similar to that of Section 17(a)(2) of the Securities Act, which the Supreme Court held in Aaron v. SEC, 446 U.S. 680, 696-97 (1980), does not require a showing of scienter. Varjabedian, 888 F. Supp. at 406. The Ninth Circuit distinguished the contrary rulings in the other circuits by noting that they were either decided before Ernst & Ernst and Aaron or that they failed to follow the reasoning of those decisions and acknowledge the distinction between Rule 10b-5 and Section 14(e). Id. at 405. Emulex filed a petition for a writ of certiorari on October 11, 2018. Emulex argued that the Ninth Circuit’s decision “upset[] the statutory scheme enacted by Congress.” Petition for Writ of Certiorari at 15. Emulex further contended that the Supreme Court has not previously recognized a private right of action under Section 14(e) and declined to do so in Piper v. Chris-Craft Industries Inc., 430 U.S. 1, 24 (1977). While lower courts have inferred a private right of action, they have declined to create private rights of action for negligent conduct. Petition for Writ of Certiorari at 18-19. Emulex also argued that the circuit split “blew up” the consensus among circuit courts which had held that Section 14(e) does not support a private right of action or remedy based on mere negligence. Id. at 14. The Ninth Circuit’s decision, according to Petitioner, “creat[es] an expansive new regime at odds with the uniform view in the rest of the country.” Id. at 15. As noted, the Supreme Court granted certiorari in January 2019. We expect that the parties will submit their briefing to the Supreme Court in the spring of 2018, with oral argument to follow in the coming months. We will continue to monitor this appeal and provide an update in our 2019 Mid-Year Securities Litigation Update.

C. Pending Certiorari Petitions

There are two notable securities cases in which petitions for certiorari are pending. The first is Toshiba Corp. v. Automotive Industries Pension Trust Fund, No. 18-486, which also involves a circuit split created by the Ninth Circuit. The Ninth Circuit split from the Second Circuit in holding that the Supreme Court’s landmark decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), which held that U.S. securities laws do not apply extraterritorially, does not bar suits arising out of domestic transactions in the securities of a foreign issuer even when the foreign issuer has no role in facilitating the transaction. Also pending is First Solar Inc. v. Mineworkers’ Pension Scheme, No. 18-164, which we discussed in the 2018 Mid-Year Securities Litigation Update. Readers will recall that, in that case, the Ninth Circuit issued a per curiam opinion holding that loss causation can be established even when the corrective disclosure did not reveal the fraud on which the securities fraud claim is based. In both Toshiba and First Solar, the Supreme Court has entered orders requesting the Solicitor General to file briefs expressing the views of the United States. The government has not yet filed its brief in either case. We will continue to monitor these petitions and provide an update in our 2019 Mid-Year Securities Litigation Update if the Supreme Court grants certiorari.

3. Delaware Law Developments

A. Contractual Waiver of Appraisal Rights Enforceable under Delaware Law

In our 2018 Mid-Year Securities Litigation Update, we reported on two Court of Chancery decisions interpreting and applying new Delaware appraisal law set forth in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017). In the second half of 2018, the Court of Chancery continued implementing the Delaware Supreme Court’s directive by looking first—and primarily—to market factors to determine the fair value of a company’s stock when supported by appropriate facts. See Blueblade Capital Opportunities LLC v. Norcraft Cos., 2018 WL 3602940 (Del. Ch. July 27, 2018) (giving deal price no weight where stock thinly traded and sales process significantly flawed); In re Appraisal of Solera Holdings, Inc., 2018 WL 3625644 (Del. Ch. July 30, 2018) (giving deal price “dispositive” weight where sales process was “characterized by many objective indicia of reliability” and company’s actively traded stock had “a deep base of public stockholders”). Delaware courts also looked at appraisal mechanics in other contexts. In Manti Holdings, LLC v. Authentix Acquisition Co., the Court of Chancery enforced a provision in a stockholder agreement waiving stockholders’ right to pursue statutory appraisal for certain transactions. 2018 WL 4698255 (Del. Ch. Oct. 1, 2018). Stockholder-petitioners who had entered into the stockholder agreement lost their shares via merger. Id. at *1. Under the stockholder agreement, they had agreed “to refrain from the exercise of appraisal rights” if “a Company Sale [was] approved by the Board.” Id. at *2. That a “Company Sale” occurred was not disputed. In reaching its conclusion that the waiver was enforceable, the Court rejected as nonsensical the Petitioners’ argument that the waiver terminated upon consummation of the deal. Id. at *3. Importantly, the Court rejected the Petitioners’ argument that enforcing the Agreement “would impermissibly . . . impose a limitation on classes of stock by contract” in violation of DGCL Section 151(a), which, according to the Petitioners, requires such limits to derive from the corporate charter. Id. at *4. Reasoning that the Company entered into the agreement to “entice investment” and that the stockholders simply “took on contractual responsibilities in exchange for consideration,” the Court held that enforcing the stockholder agreement was “not the equivalent of imposing limitations on a class of stock under Section 151(a).” Id.

B. Courts Clarify MFW’s “Ab Initio” Requirement

In the second half of 2018, both the Delaware Supreme Court and the Court of Chancery clarified when the “ab initio” requirement is satisfied under Kahn v. M & F Worldwide Corp. (“MFW”), 88 A.3d 635, 644 (Del. 2014). Under MFW, a conflicted-controller transaction earns business judgment review when six elements are satisfied: (i) the procession of the transaction is conditioned ab initio on the approval of both a special committee and a majority of the minority stockholders (the “dual protections”); (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to say no definitively; (iv) the special committee meets its duty of care in negotiating a fair price; (v) the vote of the minority stockholders is informed; and (vi) there is no coercion of the minority stockholders. Id. at 645. In Olenik v. Lodzinski, the Court of Chancery held that the ab initio requirement was satisfied because the controller’s first offer, although extended after nine months of discussions, announced MFW’s dual protections “‘before any negotiations took place.’” 2018 WL 3493092, at *15 (Del. Ch. July 20, 2018) (quoting Swomley v. Schlecht, 2014 WL 4470947, at *21 (Del. Ch. 2014), aff’d, 128 A.3d 992 (Del. 2015) (TABLE)). The Court relied on settled Delaware law distinguishing between “discussions,” which were extensive in Olenik, and “negotiations,” which began only with the controller’s first offer. Id. at *16; see also Colonial Sch. Bd. v. Colonial Affiliate, NCCEA/DSEA/NEA, 449 A.2d 243, 247 (Del. 1982) (distinguishing between “negotiate,” which “means to bargain toward a desired contractual end,” and “discuss,” which “means merely to exchange thoughts and points of views on matters of mutual interest”). The Delaware Supreme Court weighed in three months later, holding in Flood v. Synutra International, Inc. that the ab initio element “require[s] the controller to self-disable before the start of substantive economic negotiations, and to have both the controller and Special Committee bargain under the pressures exerted on both of them by these protections.” 195 A.3d 754, 763 (Del. 2018). In particular, the Supreme Court affirmed the trial court’s conclusion that the controller satisfied the ab initio element by conditioning the transaction on MFW’s dual protections in “the Follow-up Letter [sent] just over two weeks after [it] first proposed the Merger, before the Special Committee ever convened and before any negotiations ever took place.” Id. at 764. Although these decisions are based on notably different facts—for example, nine months elapsed between the initial communication and the first offer in Olenik, and only two weeks passed between the initial communication and “the Follow-up Letter” in Synutra—they appear to create one rule: MFW’s “ab initio” requirement will be satisfied as long as the controller commits to MFW’s dual protections before substantive economic negotiations occur. Olenik is on appeal to the Delaware Supreme Court, which may further clarify matters.

C. Inadequate Disclosures Preclude Cleansing under Corwin

In two recent cases, the Court of Chancery concluded the Corwin doctrine did not apply. In re Xura, Inc. S’holder Litig., 2018 WL 6498677 (Del. Ch. Dec. 10, 2018) (denying Corwin motion based on seven alleged material omissions); In re Tangoe, Inc. S’holder Litig., 2018 WL 6074435 (Del. Ch. Nov. 20, 2018) (holding stockholders were not adequately informed for Corwin purposes where audited financials and the facts underlying a restatement were not disclosed). Under Corwin, the business judgment rule applies to judicial review of transactions that are not otherwise subject to the entire fairness standard so long as the transaction was “approved by a fully informed, uncoerced vote of the disinterested stockholders.” See id. at *9 (quoting Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304, 309 (Del. 2015)). Initially an appraisal proceeding, Xura morphed into a plenary action after appraisal discovery revealed questionable conduct primarily by a seller’s CEO. Xura, 2018 WL 6498677, at *1. The CEO, it was alleged, steered his company into a transaction with an interest that differed from other stockholders: self-preservation. Id. at *11. He stood to lose his job and a $25 million payout if the company was not sold. Id. at *13. The proxy statement for the deal failed to disclose the CEO’s actions relating to the sales process, leaving stockholders “entirely ignorant” of his influence over the transaction and “his possible self-interested motivation for pushing an allegedly undervalued [t]ransaction on the [c]ompany and its stockholders.” Id. Vice Chancellor Slights held that Corwin-cleansing was unavailable because the “stockholders could not have cleansed conduct about which they did not know.” Id. at *12. The stockholders in Tangoe similarly were found to be uninformed. Thirteen months before the transaction at issue, the SEC notified Tangoe that it would need to restate almost three years of its financials. Tangoe, 2018 WL 6074435, at *1. Tangoe took so long to do so that NASDAQ delisted its stock and the SEC threatened to deregister it. Id. at *2. After an activist stockholder increased its stake in the company and signaled to the board that “a proxy contest was coming,” the board began shifting its focus from restating the financials to selling the company. Id. at *1, 4-6. While it did so, it also altered its own compensation so that its members collectively would receive nearly $5 million in the event of a change of control. Id. at *5, 12-13. Throughout the sales process, the board failed to provide stockholders with audited financial statements. Although the Court pointed out that audited financial statements are not per se material, when combined with the misstatements in the company’s financial statements, among other things, the stockholders were left in an “information vacuum.” Id. at *10. The Court also found it significant that the board failed to disclose information related to the process of restating the company’s financials. Id. at *11. Accordingly, the Court held that Corwin-cleansing was unavailable because a reasonable inference could be drawn that the stockholders were not fully informed when they approved the transactions. Id. at *10-12.

D. Delaware Supreme Court Affirms MAE Ruling

On December 7, 2018, the Delaware Supreme Court affirmed the Court of Chancery’s recent post-trial ruling that a “Material Adverse Effect” (or “MAE”) permitted a buyer to terminate a merger agreement. Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d, — A.3d —-, 2018 WL 6427137 (Del. Dec. 7, 2018). Several factors contributed to the Court of Chancery’s finding that Akorn suffered an MAE. First, after Fresenius agreed to acquire Akorn, Akorn’s business “fell off a cliff”: in three consecutive quarters, it announced year-over-year declines in quarterly revenues of 29%, 29%, and 34%; in operating income of 84%, 89%, and 292%; and in earnings per share of 96%, 105%, and 300%. Id. at *21, 24, 35. Second, whistleblower letters prompted an investigation into Akorn’s product development and quality control process. Id. at *26. This investigation revealed many flaws, including falsification of laboratory data submitted to the FDA. Id. at *30-31. Third, Akorn failed to operate its business in the ordinary course post-signing, fundamentally changing its quality control and information technology functions without Fresenius’s consent. Id. at *88. On appeal, the Delaware Supreme Court held that the record “adequately support[ed]” the Court of Chancery’s determination. Akorn, Inc., — A.3d —-, 2018 WL 6427137 (Del. Dec. 7, 2018).

E. N.Y. First Department Reverses Xerox, Dissolves Injunction

As we reported in our 2018 Mid-Year Securities Litigation Update, in April 2018, the New York Supreme Court enjoined a multi-billion dollar merger of Xerox Corp. and Fujifilm Holdings Corp. (“Fujifilm”) because Xerox’s CEO, who negotiated the deal, and a majority of Xerox’s board were conflicted or lacked independence because they expected to continue serving the combined entity. In re Xerox Corp. Consolidated Shareholder Litigation, 2018 WL 2054280, at *7 (N.Y. Sup. Apr. 27, 2018). Xerox and Fujifilm appealed. In October 2018, the First Department reversed the decision unanimously “on the law and the facts,” holding that the business judgment rule applied and that the plaintiffs had failed to show a likelihood of success on their breach of fiduciary duty and fraud claims. Deason v. Fujifilm Holdings Corp., 165 A.D.3d 501 (1st Dep’t 2018). In particular, the plaintiffs “failed to show bad faith or a disabling interest on the part of the majority of the directors of Xerox” because “the possibility that any one of the directors would be named to [the combined] board alone was not a material benefit such that it was a disabling interest;” any potential conflict created by Xerox’s CEO continuing as the future CEO of the new company was acknowledged by the board; and the board “engaged outside advisers,” “discussed the proposed transaction on numerous occasions,” and the deal was not “unreasonable on its face.” Id. at 501-02. As a result, the First Department dismissed the complaints against Fujifilm and dissolved the injunctions enjoining the deal. Id. On February 21, 2019, the First Department denied the class plaintiffs’ motion for reargument or, in the alternative, leave to appeal to the Court of Appeals.

4. Falsity of Opinions – Omnicare Update

As discussed in our prior securities litigation updates, courts continue to define the boundaries of Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015). The Supreme Court’s Omnicare decision addressed the scope of liability for false opinion statements under Section 11 of the Securities Act. The Court held that “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong.” Id. at 1327. An opinion statement can give rise to liability only when the speaker does not “actually hold[] the stated belief,” or when the opinion statement contains “embedded statements of fact” that are untrue. Id. at 1326–27. But in the heavily debated “omission” part of the opinion, the Court held that a factual omission from a statement of opinion gives rise to liability when the omitted facts “conflict with what a reasonable investor would take from the statement itself.” Id. at 1329. The plaintiffs’ bar predicted that this omission theory of falsity would give rise to a wave of securities litigation complaints poised to survive the pleadings phase. While the theory has indeed become commonplace in complaints, it has fared little to no better in the last half of 2018 against the exacting pleading standards generally applicable to all theories of liability under the securities laws. See, e.g., Hering v. Rite Aid Corp., 331 F. Supp. 3d 412, 427 (M.D. Pa. 2018) (finding that “Plaintiff has failed to meet the exacting pleading standard of the PSLRA” where reasonable investors would understand the statements to be estimates). One district court recently emphasized that “a general allegation that ‘Defendants had knowledge of, or recklessly disregarded, omitted facts’” is insufficient. In re Under Armour Sec. Litig., 342 F. Supp. 3d 658, 676 (D. Md. 2018) (citation omitted). Another court rejected plaintiff’s claim that defendants should have conducted an inquiry into the facts underlying their opinion, finding that “[a] blanket conclusory assertion that no investigation occurred, without more, is insufficient.” Pension Tr. v. J. Jill, Inc., 2018 WL 6704751, at *8 (D. Mass. Dec. 20, 2018). Courts have specifically grappled with whether plaintiffs met the pleading standard in cases involving a company’s general opinions on its financial condition. In Frankfurt-Tr. Inv. Luxemburg AG v. United Technologies Corp., the Southern District of New York held that “omitting even significant, directly contradictory information from opinion statements is not misleading, ‘especially’ when there are countervailing disclosures.” 336 F. Supp. 3d 196, 230–31 (S.D.N.Y. 2018). Relying on Tongue v. Sanofi, 816 F.3d 199 (2d Cir. 2016) and Martin v. Quartermain, 732 F. App’x 37 (2d Cir. 2018), the court found that statements about the company’s business and projected earnings per share were not misleading even where they failed to disclose specifics regarding a “slowdown of commercial aftermarket sales” and other potentially negative factors. Id. at 230. Plaintiff’s allegations—unlike the highly detailed allegations about test data in Sanofi and Martin—were “too scant in detail and scope” and “at a high level,” meaning that they failed to show that the alleged omissions would have a meaningful impact on a reasonable investor’s understanding of the company. Id. On the other hand, the District of Delaware found that plaintiffs met their pleading burden where they alleged that particular information omitted from a proxy statement, which recommended that shareholders vote in favor of a merger, made other specific statements about the fairness of the merger misleading. Laborers’ Local #231 Pension Fund v. Cowan, 2018 WL 3243975, at *10–12 (D. Del. July 2, 2018), reargument denied, 2018 WL 3468216 (D. Del. July 18, 2018). Because the board cited a fairness opinion in its decision to approve the merger, the court held that a reasonable investor may have thought that the company “placed confidence” in the fairness opinion and believed that it “accurately analyzed [the company’s] potential financial growth,” which “conflict[ed] with undisclosed facts or knowledge held by the board,” namely that the fairness opinion “did not incorporate acquisition based growth into its projections.” Id. at *10–11. Several courts also provided guidance for companies making opinion statements about legal and compliance risks, again highlighting the importance of context. For example, the Northern District of Illinois concluded that statements about legal compliance that were accompanied by disclosures concerning an ongoing IRS investigation would not be misleading to reasonable investors “unless they ignore[d] those disclosures.” Societe Generale Sec. Servs., GbmH v. Caterpillar, Inc., 2018 WL 4616356, at *4–5 (N.D. Ill. Sept. 26, 2018). Likewise, in Jaroslawicz v. M&T Bank Corp., the Third Circuit found that a company’s statements about its due diligence, which allegedly omitted deficiencies in its anti-money laundering compliance program, were not misleading. 912 F.3d 96, 113–14 (3d Cir. 2018). Paying close attention to the context, the court held that the statements were accompanied by sufficient facts that the company conducted a shorter period of diligence than investors may have otherwise expected. See id. at 114. In addition, the plaintiffs alleged both general negligence—insufficient to plead a violation under Omnicare—as well as that “a reasonable investor would have expected the banks to conduct a sampling of customer accounts” as part of their due diligence process. Id. The court found that a single allegation that the bank could have conducted a sampling was too weak to defeat the motion to dismiss. See id. In contrast, a Southern District of New York court found that a company’s statements regarding careful management and compliance with laws regarding its credit portfolio could be misleading because plaintiffs alleged that company was aware of particular facts suggesting the falsity of those statements. See In re Signet Jewelers Ltd. Sec. Litig., 2018 WL 6167889, at *12–13 (S.D.N.Y. Nov. 26, 2018). Noting that the pleading burden is “no small task,” the court held that plaintiffs nevertheless met their burden because they alleged “particularized and material[] facts” based on the testimony of former employees who provided information to the plaintiffs. Id. at *13. In particular, specific allegations that the company was “aware that a substantial and growing portion of its credit portfolio contained subprime loans and chose to disregard internal warnings about that fact” rendered the complaint sufficient to survive a motion to dismiss. Id. In the latter half of the year, courts also dealt with the circumstances in which a pharmaceutical company’s opinions on the safety of a drug undergoing clinical trials may give rise to liability under Omnicare. In Hirtenstein v. Cempra, Inc., the court held that the company’s statements that it believed a drug was safe was an inactionable opinion. 2018 WL 5312783, at *17–18 (M.D.N.C. Oct. 26, 2018). Plaintiffs claimed that because the company’s chief executive officer “elected to speak about [the drug’s] purportedly ‘compelling’ clinical data . . . [she] had a duty to disclose that . . . safety data showed a significant and genuine signal for liver toxicity and liver injury.” Id. at *17. The court held that the company did not have a “duty to disclose adverse events, particularly where the statements [were] couched as opinion and [did] not constitute affirmative statements that there are no safety concerns associated with the drug.” Id. at *18. These types of opinions could not be actionable, where they were “little more than vague optimistic statements regarding the safety profile of the drug.” Id. at *19. On the other hand, in SEB Inv. Mgmt. AB v. Endo International, PLC, the court found that plaintiff stated a Section 11 claim where it alleged that the company had specific knowledge of “an increasing number of serious adverse events linked to injection” of the drug at issue. 2018 WL 6444237, at *21–22 (E.D. Pa. Dec. 10, 2018). Despite the fact that the company allegedly knew about the “increased rate in injection use, [it] failed to disclose to investors that it faced a serious risk of regulatory action, including removal of the drug from the market,” forming the basis for an actionable Section 11 claim. Id.

5. Courts Continue to Shape “Price Impact” Analysis at the Class Certification Stage

Courts across the country continue to grapple with implementing the Supreme Court’s landmark ruling in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (“Halliburton II”), although the second half of 2018 did not bring any new decisions from the federal circuit courts of appeal. In Halliburton II, the Supreme Court preserved the “fraud-on-the-market” presumption—a presumption enabling plaintiffs to maintain the common proof of reliance that is essential to class certification in a Rule 10b-5 case—but made room for defendants to rebut that presumption at the class certification stage with evidence that the alleged misrepresentation had no impact on the price of the issuer’s stock. Two key questions continue to recur. First, how should courts reconcile the Supreme Court’s explicit ruling in Halliburton II that direct and indirect evidence of price impact must be considered at the class certification stage, Halliburton II, 123 S. Ct. at 2417, with its previous decisions holding that plaintiffs need not prove loss causation or materiality until the merits stage? See Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (“Halliburton I”); Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 568 U.S. 455 (2013). Second, what standard of proof must defendants meet to rebut the presumption with evidence of no price impact? As we have previously reported, the Second Circuit has addressed both of these key questions in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017) (“Barclays”) and Arkansas Teachers Retirement System v. Goldman Sachs, 879 F.3d 474 (2d Cir. 2018) (“Goldman Sachs”). Those decisions remain the most substantive interpretations of Halliburton II. Barclays addressed the standard of proof necessary to rebut the presumption of reliance and held that after a plaintiff establishes the presumption of reliance applies, defendant bears the burden of persuasion to rebut the presumption by a preponderance of the evidence. As we have previously noted, this puts the Second Circuit at odds with the Eighth Circuit, which cited Rule 301 of the Federal Rules of Evidence when reversing a trial court’s certification order on price impact grounds, see IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775, 782 (8th Cir. 2016), because Rule 301 assigns only the burden of production—i.e., producing some evidence—to the party seeking to rebut a presumption, but “does not shift the burden of persuasion, which remains on the party who had it originally.” Fed. R. Evid. 301. That inconsistency, however, was not enough to persuade the Supreme Court to review the Second Circuit’s decision. Barclays PLC v. Waggoner, 138 S.Ct. 1702 (Mem) (2018) (denying writ of certiorari). In Goldman Sachs, the Second Circuit vacated the trial court’s ruling certifying a class and remanded the action, directing that price impact evidence must be analyzed prior to certification, even if price impact “touches” on the issue of materiality. Goldman Sachs, 879 F.3d at 486. Following the Second Circuit’s decision, the district court held an evidentiary hearing and heard oral argument. In re Goldman Sachs Grp. Sec. Litig., 2018 WL 3854757, at *1-2 (Aug. 14, 2018). The court, again, certified the class. Id. On remand, plaintiffs argued that because the company’s stock price declined following the announcement of three regulatory actions related to the company’s conflicts of interest, previous misstatements about its conflicts had inflated the company’s stock price. See id. at * 2. Defendants argued the alleged misstatements could not have caused the stock price drops for two reasons, and offered expert testimony to support each. Id. at *3. First, they argued that the company’s stock price had not reacted to thirty-six prior reports commenting on company conflicts, and, therefore, the identified stock price drops could not be linked to the alleged misstatements. Id. at *3. Second, they argued that news of enforcement activities (and not a correction of earlier statements regarding conflicts and business practices) caused the identified stock price drops. Id. The court found plaintiff’s expert’s “link between the news of Goldman’s conflicts and the subsequent stock price declines . . . sufficient.” Id. at *4. The court was persuaded that the first allegedly corrective disclosure revealed new information about the conflicts, see id., and held that defendants’ expert testimony regarding alternative explanations for the stock price decline (i.e., the nature of the enforcement actions rather than the subject matter) was not sufficient to “sever” that link. Id. at *5-6. The Second Circuit has agreed to review Goldman Sachs for a second time and has ordered an expedited briefing schedule. See Order, Ark. Teachers Ret. System v. Goldman Sachs, Case No. 18-3667 (2d Cir. Jan. 31, 2019). The Third Circuit is also poised to substantively address price impact analysis at the class certification stage in the coming months in its review of Li v. Aeterna Zentaris, Inc., 324 F.R.D. 331 (D.N.J. 2018) (“Aeterna”). See Order, Vizirgianakis v. Aeterna Zentaris, Inc., No. 18-8021 (3d Cir. Mar. 30, 2018). Substantive briefing is completed in Aeterna, which invites the Third Circuit to clarify the type of evidence defendants must present, including the burden of proof they must meet to rebut the presumption of reliance and whether statistical evidence rebutting the presumption must meet a 95% confidence threshold. In certifying the class, the district court described defendants’ burden as “producing [enough] evidence . . . ‘to withstand a motion for summary judgment or judgment as a matter of law,’” Aeterna, 324 F.R.D. at 344 (quoting Lupyan v. Corinthian Colleges, Inc., 761 F.3d 314, 320 (3d Cir. 2014) and citing Best Buy, 818 F.3d at 782 and Fed. R. Evid. 301), but then observed defendants failed to prove lack of price impact with “‘scientific certainty,’” see id. at 345 (quoting Carpenters Pension Trust Fund of St. Louis v. Barclays PLC, 310 F.R.D. 69, 95 (S.D.N.Y. 2015)). The district court rejected defendants’ argument that plaintiff’s event study, which did not attribute a statistically significant price movement to the alleged misstatement, rebutted the presumption and criticized defendants for not offering their own event study. See id. at 345. We will continue to monitor developments in these and other cases.

6. The Third Circuit Explores the Requirement to Disclose Risk Factors

In late December 2018, the Third Circuit issued a decision in the latest case to address the scope of disclosure requirements for proxy solicitations under Section 14(a) of the Securities Exchange Act of 1934. In Jaroslawicz v. M&T Bank Corp., 912 F.3d 96 (3d Cir. 2018), former shareholders of Hudson City Bancorp filed suit against Hudson and M&T Bank, alleging the joint proxy soliciting votes for the merger between the two entities was materially misleading because (1) it failed to disclose certain practices that did not comply with relevant regulatory requirements, which posed significant risk factors facing the merger, as required under Item 503(c) of Regulation S-K (the “Regulatory Risk Disclosures”); and (2) these omissions rendered opinion statements regarding M&T Bank’s compliance with laws materially false and misleading (the “Legal Compliance Disclosures”). Specifically, as to the Regulatory Risk Disclosures, the proxy statement was alleged to be misleading because it did not discuss M&T Bank’s past consumer violations involving switching no-fee checking accounts to fee-based accounts. As to Legal Compliance Disclosures, the proxy statement was alleged to be misleading because M&T Bank had failed to discuss deficiencies in its Bank Secrecy Act/anti-money laundering (“BSA/AML”) compliance program until it filed a supplemental disclosure six days before the shareholder vote, when it disclosed for the first time that it was the subject of a Federal Reserve Board investigation on these programs. In interpreting the scope of disclosure under Item 503(c), which requires proxy issuers to discuss “the most significant factors that make the offering speculative or risky,” the Court explained that risk disclosures, such as the Regulatory Risk Disclosures at issue, must be “company-specific” in order to insulate an issuer from liability. Jaroslawicz, 912 F.3d at 106–08. Thus, “generic disclosures which could apply across an industry are insufficient” to protect a company in the event that a risk falling under a “boilerplate” disclosure later transpires. Id. at 108, 111. For this reason, the Court concluded that M&T Bank’s generic references to being subject to regulatory oversight were not “company-specific” risk factors that would “communicate anything meaningful” to stockholders. Id. at 111. Thus, even though the bank had ceased its alleged consumer violations, the Court found it plausible that the undisclosed “high volume of past violations made the upcoming merger vulnerable to regulatory delay.” Id. at 107. With respect to the plaintiffs’ allegations regarding BSA/AML deficiencies, the Court held that the supplemental proxy statement’s disclosure that the bank was the subject of an investigation regarding these practices, which “would likely result in delay of regulatory approval,” was “likely adequate” under Section 14(a). However, because the supplemental disclosures were issued a mere six days before the stockholder vote on the transaction, the Court concluded that the plaintiffs had adequately alleged that a reasonable investor did not have enough time to digest this relevant information. Id. at 112. Further, although the Court declined to expressly decide whether a heightened standard for pleading falsity applied to the Legal Compliance Disclosures and other claims brought under Section 14(a) of the Exchange Act, it found that the stockholders failed to allege a claim under their “misleading opinion” theory. Id. at 113. In dismissing plaintiffs’ Omnicare claims alleging that the Legal Compliance Disclosures were actionably misleading, the Court reiterated the longstanding principle that an opinion statement is not rendered misleading simply because it later “proved to be false.” Id. Crucially, the Court explained that the Legal Compliance Disclosures in the proxy statement were not plausibly alleged to be misleading because the bank adequately divulged the basis for its opinion. In particular, the proxy statement made clear that the bank had concluded it was in compliance with applicable laws based on a brief period of due diligence conducted in connection with the transaction. Id. at 114.

7. The Ninth Circuit Clarifies when Courts May Consider Documents Outside of the Pleadings on Motions to Dismiss Securities Claims

On August 13, 2018, the Ninth Circuit revisited the extent to which a court can properly consider materials outside of the four corners of the complaint in ruling on a motion to dismiss a securities claim. Khoja v. Orexigen Therapeutics, Inc., 899 F.3d 988, 994 (9th Cir. 2018). It is well settled that courts must not only accept all factual allegations in a complaint as true for purposes of deciding a motion to dismiss, but also consider “other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, [1] documents incorporated into the complaint by reference, and [2] matters of which a court may take judicial notice.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007). In the Ninth Circuit, a defendant can seek to treat a document as incorporated into the complaint “if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff’s claim.” United States v. Ritchie, 342 F.3d 903, 907 (9th Cir. 2003). The incorporation by reference doctrine allows courts to treat documents as if they are part of the complaint in their entirety, which “prevents plaintiffs from selecting only portions of documents that support their claims, while omitting portions of those very documents that weaken—or doom—their claims.” Khoja, 899 F.3d at 1002. Judicial notice, on the other hand, is explicitly permitted by Federal Rule of Evidence 201, and allows a court to take notice of an adjudicative fact if it is “not subject to reasonable dispute.” Fed. R. Evid. 201(b). In Khoja, the Ninth Circuit noted the “concerning pattern” of courts improperly using these procedures in securities cases “to defeat what would otherwise constitute adequately stated claims at the pleading stage,” and “aim[ed] to clarify when it is proper to take judicial notice of facts in documents, or to incorporate by reference documents into a complaint.” 899 F.3d at 998, 999. The district court in Khoja considered twenty-one documents quoted or referenced by the complaint, and granted the defendant’s motion to dismiss the claims plaintiff filed under Sections 10 and 20 of the Exchange Act. Id. at 997. On appeal, the Ninth Circuit reversed in part, holding that the district court had abused its discretion in taking judicial notice of at least one document and in treating at least seven documents as incorporated by reference. Id. at 1018. Regarding judicial notice under FRE 201, the Court explained that just because a document is subject to judicial notice “does not mean that every assertion of fact within that document is judicially noticeable for its truth.” Id. “‘[A] court may take judicial notice of matters of public record without converting a motion to dismiss into a motion for summary judgment,’” but “‘cannot take judicial notice of disputed facts contained in such public records.’” Id. (quoting Lee v. City of Los Angeles, 250 F.3d 668, 689 (9th Cir. 2001)). For example, in Khoja, the district court had judicially noticed a September 11, 2014 investors’ conference call transcript that was submitted with the defendant’s SEC filings. Khoja, 899 F.3d at 999. The Ninth Circuit explained that the district court could take judicial notice of the existence of the call, but could not take judicial notice of the statements in the transcript, as “the substance of the transcript ‘is subject to varying interpretations, and there is a reasonable dispute as to what the [transcript] establishes.’” Id. at 999-1000 (quoting Reina-Rodriguez v. United States, 655 F.3d 1182, 1193 (9th Cir. 2011)). Regarding incorporation by reference, the Ninth Circuit explained that a document that “merely creates a defense to the well-pled allegations in the complaint” should not automatically be incorporated by reference. Khoja, 899 F.3d at 1002. A contrary result would enable defendants to “insert their own version of events into the complaint to defeat otherwise cognizable claims.” Id. Applying these principles, the Ninth Circuit held that the district court abused its discretion by incorporating a Wall Street Journal blog post, as the complaint had quoted the post only once in a two-sentence footnote, and the quote conveyed only basic historical facts. Id. at 1003-04. The Khoja court explained that, under its prior precedent in Ritchie, a reference is not “extensive” enough to warrant incorporation by reference when the document is only referenced once, unless that “single reference is relatively lengthy.” Id. The Ninth Circuit held that the mere mention of the Wall Street Journal blog post was insufficient, especially as the document did not form the basis of any claim in the complaint. Id. at 1003. Ultimately, the Ninth Circuit held that the district court abused its discretion by incorporating by reference at least seven documents. Id. at 1018. It remains to be seen what impact Khoja will have in the Ninth Circuit, as Khoja did not eliminate a defendant’s ability to rely on documents outside the complaint at the motion to dismiss stage. 899 F.3d at 1018 (affirming district court with respect to half of the documents challenged on appeal). Nonetheless, the case may prompt other federal courts to revisit their practices of incorporation by reference and judicial notice, particularly in securities cases where such practices are common.
The following Gibson Dunn lawyers assisted in the preparation of this client update:  Jefferson Bell, Monica Loseman, Brian Lutz, Mark Perry, Shireen Barday, Lissa Percopo, Michael Kahn, Emily Riff, Mark Mixon, Jason Hilborn, Alisha Siqueira, Andrew Bernstein, and Kaylie Springer. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following members of the Securities Litigation Practice Group Steering Committee: Brian M. Lutz - Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com) Robert F. Serio - Co-Chair, New York (+1 212-351-3917, rserio@gibsondunn.com) Meryl L. Young - Co-Chair, Orange County (+1 949-451-4229, myoung@gibsondunn.com) Jefferson Bell - New York (+1 212-351-2395, jbell@gibsondunn.com) Jennifer L. Conn - New York (+1 212-351-4086, jconn@gibsondunn.com) Thad A. Davis - San Francisco (+1 415-393-8251, tadavis@gibsondunn.com) Ethan Dettmer - San Francisco (+1 415-393-8292, edettmer@gibsondunn.com) Barry R. Goldsmith - New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark A. Kirsch - New York (+1 212-351-2662, mkirsch@gibsondunn.com) Gabrielle Levin - New York (+1 212-351-3901, glevin@gibsondunn.com) Monica K. Loseman - Denver (+1 303-298-5784, mloseman@gibsondunn.com) Jason J. Mendro - Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com) Alex Mircheff - Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com) Robert C. Walters - Dallas (+1 214-698-3114, rwalters@gibsondunn.com) Aric H. Wu - New York (+1 212-351-3820, awu@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 16, 2019 |
Law360 Names Gibson Dunn Among Its Securities 2018 Practice Groups of the Year

Law360 named Gibson Dunn one of its six Securities Practice Groups of the Year [PDF] for 2018. The practice group was recognized for “[s]ecuring a landmark U.S. Supreme Court decision that opened up potential appointments clause challenges to administrative law judges who decide enforcement cases for the U.S. Securities and Exchange Commission.” The firm’s Securities practice was profiled on January 16, 2019. Gibson Dunn’s securities practice offers comprehensive client services including in the defense and handling of securities class action litigation, derivative litigation, M&A litigation, internal investigations, and investigations and enforcement actions by the SEC, DOJ and state attorneys general.

January 13, 2019 |
Gibson Dunn Named a 2018 Law Firm of the Year

Gibson, Dunn & Crutcher LLP is pleased to announce its selection by Law360 as a Law Firm of the Year for 2018, featuring the four firms that received the most Practice Group of the Year awards in its profile, “The Firms That Dominated in 2018.” [PDF] Of the four, Gibson Dunn “led the pack with 11 winning practice areas” for “successfully securing wins in bet-the-company matters and closing high-profile, big-ticket deals for clients throughout 2018.” The awards were published on January 13, 2019. Law360 previously noted that Gibson Dunn “dominated the competition this year” for its Practice Groups of the Year, which were selected “with an eye toward landmark matters and general excellence.” Gibson Dunn is proud to have been honored in the following categories:

  • Appellate [PDF]: Gibson Dunn’s Appellate and Constitutional Law Practice Group is one of the leading U.S. appellate practices, with broad experience in complex litigation at all levels of the state and federal court systems and an exceptionally strong and high-profile presence and record of success before the U.S. Supreme Court.
  • Class Action [PDF]: Our Class Actions Practice Group has an unrivaled record of success in the defense of high-stakes class action lawsuits across the United States. We have successfully litigated many of the most significant class actions in recent years, amassing an impressive win record in trial and appellate courts, including before the U. S. Supreme Court, that have changed the class action landscape nationwide.
  • Competition [PDF]: Gibson Dunn’s Antitrust and Competition Practice Group serves clients in a broad array of industries globally in every significant area of antitrust and competition law, including private antitrust litigation between large companies and class action treble damages litigation; government review of mergers and acquisitions; and cartel investigations, internationally across borders and jurisdictions.
  • Cybersecurity & Privacy [PDF]: Our Privacy, Cybersecurity and Consumer Protection Practice Group represents clients across a wide range of industries in matters involving complex and rapidly evolving laws, regulations, and industry best practices relating to privacy, cybersecurity, and consumer protection. Our team includes the largest number of former federal cyber-crimes prosecutors of any law firm.
  • Employment [PDF]: No firm has a more prominent position at the leading edge of labor and employment law than Gibson Dunn. With a Labor and Employment Practice Group that covers a complete range of matters, we are known for our unsurpassed ability to help the world’s preeminent companies tackle their most challenging labor and employment matters.
  • Energy [PDF]: Across the firm’s Energy and Infrastructure, Oil and Gas, and Energy, Regulation and Litigation Practice Groups, our global energy practitioners counsel on a complex range of issues and proceedings in the transactional, regulatory, enforcement, investigatory and litigation arenas, serving clients in all energy industry segments.
  • Environmental [PDF]: Gibson Dunn has represented clients in the environmental and mass tort area for more than 30 years, providing sophisticated counsel on the complete range of litigation matters as well as in connection with transactional concerns such as ongoing regulatory compliance, legislative activities and environmental due diligence.
  • Real Estate [PDF]: The breadth of sophisticated matters handled by our real estate lawyers worldwide includes acquisitions and sales; joint ventures; financing; land use and development; and construction. Gibson Dunn additionally has one of the leading hotel and hospitality practices globally.
  • Securities [PDF]: Our securities practice offers comprehensive client services including in the defense and handling of securities class action litigation, derivative litigation, M&A litigation, internal investigations, and investigations and enforcement actions by the SEC, DOJ and state attorneys general.
  • Sports [PDF]: Gibson Dunn’s global Sports Law Practice represents a wide range of clients in matters relating to professional and amateur sports, including individual teams, sports facilities, athletic associations, athletes, financial institutions, television networks, sponsors and municipalities.
  • Transportation [PDF]: Gibson Dunn’s experience with transportation-related entities is extensive and includes the automotive sector as well as all aspects of the airline and rail industries, freight, shipping, and maritime. We advise in a broad range of areas that include regulatory and compliance, customs and trade regulation, antitrust, litigation, corporate transactions, tax, real estate, environmental and insurance.

January 15, 2019 |
2018 Year-End Securities Enforcement Update

Click for PDF

I.   Introduction: Themes and Developments

A.   2018 In Review

The Securities and Exchange Commission, like most federal agencies, ended 2018 with a whimper, not a bang. Most staffers were furloughed as part of the federal government shutdown, a note on the SEC homepage cautioning that until further notice only a limited number of personnel would be on hand to respond to emergency situations. The shutdown curtailed the Division of Enforcement's ability to close out the year with a raft of last-minute filings, not to mention causing most SEC investigations to grind to a halt.  That said, between the December 27 shutdown and the date of this publication, the SEC did manage to institute two enforcement actions – a settlement with a car rental company for accounting errors occurring between 2012 and 2014[1]; and a settlement with a small accounting firm for failing to comply with the Custody Rule in connection with audits of an investment adviser conducted between 2012 and 2015.[2]  Given the age of the conduct, it is unclear the nature of the "emergency" requiring unpaid SEC staffers to come to work in the midst of the shutdown to release these two particular cases, though perhaps an impending statute of limitations was to blame. While the shutdown may have cut the Enforcement Division's year short, it was more than compensated for by the flurry of actions filed as the agency's September 30 fiscal year-end loomed.  Indeed, the SEC issued nearly a dozen press releases announcing enforcement actions on the last three days of the fiscal year, including several significant cases involving prominent public companies and financial institutions. The (fiscal) year-end rush appeared intended to blunt some of the criticism of the Enforcement Division's productivity in the new administration.  After filing 446 new stand-alone enforcement actions in fiscal 2017, an over 18% drop from the 548 actions filed in 2016, the docket recovered somewhat in 2018, with the SEC filing 490 new actions.[3]  (The SEC's tally of "stand-alone" enforcement actions excludes "follow-on" proceedings sanctioning individuals separately charged for violating the securities laws, and routine administrative proceedings to deregister the stock of companies with delinquent SEC filings.)  While still falling short of the final years under the prior SEC and Enforcement Division leadership, the current Division Directors were quick to note in their Annual Report that the 2015 and 2016 results were somewhat skewed by the SEC's Municipalities Continuing Disclosure (MCDC) Initiative, under which municipal securities issuers and underwriters who self-reported disclosure violations to the Division received leniency.  The initiative produced nearly 150 enforcement actions; stripped of those matters, the 2018 results actually exceeded those of recent years. The Division Directors further explained that these results were achieved notwithstanding a hiring freeze in place at the SEC since the onset of the Trump administration, and the Division's Annual Report included a plea for additional resources.  As stated in the Report, "While this achievement is a testament to the hardworking women and men of the Division, with more resources the SEC could focus more on individual accountability, as individuals are more likely to litigate and the ensuing litigation is resource intensive."  The Directors also noted the challenges posed by the Supreme Court's decision in Kokesh v. SEC, which confirmed a strict five-year statute of limitations on SEC demands for disgorgement[4], as well as the Court's more recent decision in Lucia v. SEC, which held that the SEC's method of appointing its administrative law judges violated the Appointments Clause of the U.S. Constitution and has necessitated the potential re-litigation of myriad administrative proceedings.[5] Thematically, the Enforcement Division (as well as SEC Chairman Clayton) repeatedly reiterated their focus on protecting "retail" or "Main Street" investors.  Indeed, the Division's Annual Report invoked the word "retail" no fewer than twenty-six times.  (A close second was "cyber," another Division priority, which appeared twenty-four times in the Report.)  The "retail" focus has led the SEC to highlight cases in which average investors appear to be victimized, particularly offering frauds, pump-and-dump-schemes, and misconduct by investment advisers and broker dealers directed at individual clients.  For fiscal 2018, according to the Annual Report, securities offering cases (which range from Ponzi schemes to various disclosure and registration violations in connection with securities offerings) comprised 25% of the year's enforcement actions, the largest single category.  Cases against investment advisers and investment companies were just behind at 22% of the caseload; and while the SEC continues to bring cases involving private funds and institutional investors, the lion's share of investment adviser cases fit within the SEC's "retail" focus. Despite efforts in recent years for the Enforcement Division to renew its scrutiny of public company financial reporting and disclosure – which in the past had often been the top category of SEC enforcement actions, representing a quarter or more of the docket – such cases comprised only 16% of the SEC's enforcement actions in 2018.  Rounding out the docket were cases involving broker-dealers (13%), insider trading (10%), and market manipulation (7%); FCPA cases and public finance abuse checked in at 3% of the enforcement filings apiece.

B.   Whistleblowers

The whistleblower bounty program enacted as part of Dodd-Frank continues to grow apace with each new year.  In its November 2018 annual report to Congress, the SEC's Office of the Whistleblower reported that the program had once again netted a record number of tips.[6]  A total of 5,282 whistleblower complaints were received in fiscal 2018, up nearly 18% from 2017.  (The report noted that the Whistleblower Office appears to have its share of vexatious whistleblowers who submit an "unusually high" number of tips, which are excluded from the tally.) As with enforcement cases ultimately filed by the Enforcement Division in 2018, the largest single category for tips for 2018 was offering frauds, representing 20% of all complaints; tips concerning corporate disclosures and financials were a close second, representing 19% of the complaints. The SEC has also continued to announce large award payments to whistleblowers whose tips led to successful enforcement actions.  In September, the SEC announced that it had awarded $39 million to a single whistleblower, the second highest award in the history of the program; the same investigation also resulted in a $15 million payment to a second whistleblower.[7]  However, due to the whistleblower regulations' confidentiality requirements, the nature of the enforcement action resulting in these awards is not reported. The SEC announced two additional whistleblower awards later that same month. First, the SEC reported a $1.5 million payment, while noting that "the award was reduced because the whistleblower did not promptly report the misconduct and benefitted financially during the delay."[8]  And in a second case, the SEC awarded $4 million to an overseas whistleblower, touting the important service that even those outside the U.S. can provide to the SEC.[9]  The SEC further heralded the tipster's continuing assistance throughout the course of the investigation. According to its most recent release, the SEC has now awarded over $326 million to 59 individuals under its whistleblower program.

C.   Cybersecurity and Cryptocurrency

As noted above, the SEC's Enforcement Division remains acutely focused on all things "cyber."  While this has manifested itself primarily, in recent months, on enforcement actions involving cryptocurrency and digital assets, the Division also had several noteworthy firsts in matters of cybersecurity in the latter half of the year. First, in September, the SEC brought its first enforcement action alleging violations of the Identity Theft Red Flags Rule.[10]  The SEC alleged that a broker-dealer lacked adequate safeguards to prevent intruders from resetting contractor passwords in order to gain access to personal information about certain customers.  Without admitting the allegations, the firm agreed to pay a $1 million penalty and to retain a consultant to evaluate its compliance with the Safeguards Rule and the Identity Theft Red Flags Rule. Then, in October, the Enforcement Division issued a report on its investigations of nine public companies which had been victimized by cyber fraud.[11]  According to the SEC, attackers had used fraudulent emails to pose as executives or vendors in order to dupe company personnel into sending about $100 million (in the aggregate) into bank accounts controlled by the perpetrators.  The SEC declined to charge the companies with wrongdoing, but cautioned companies that the internal controls provisions of the federal securities laws require them to ensure they have adequate policies and procedures to mitigate such incidents and safeguard shareholder assets.[12] But most of the high-tech action happened on the cryptocurrency front, with the Enforcement Division similarly touting a number of firsts.  Most of these actions related to registration-related conduct engaged in after the Commission's 2017 DAO Report, in which the Commission concluded that digital assets may be securities under the federal securities laws. In September, the SEC settled an action against a so-called "ICO superstore" and its owners for acting as unregistered broker-dealers by operating a website that permitted visitors to purchase tokens in ICOs and engage in secondary trading.[13] This was the first case in which the SEC charged unregistered broker-dealers for selling digital assets.  Collectively, the company and owners paid nearly $475,000 in disgorgement, while the owners also paid $45,000 each in penalties and consented to industry and penny stock bars and an investment company prohibition with a right to reapply after three years. The same day, the SEC found for the first time that a hedge fund manager's investments in digital assets constituted an investment company registration violation.[14]  According to the SEC, the fund falsely claimed to be regulated by and to have filed a registration statement with the SEC, and raised more than $3.6 million in four months.  It also engaged in an unregistered public offering and invested more than 40% of its assets in digital asset securities. The fund and its sole principal consented to pay a combined $200,000 penalty to settle the case. In November, the SEC settled an action against the founder of a digital token-trading platform, finding for the first time that such a platform operated as an unregistered national securities exchange.[15]  The platform in question matched buyers and sellers of digital assets, executed smart contracts, and updated a distributed ledger via the Ethereum blockchain, among other things. The founder consented to disgorge $300,000 and pay a $75,000 penalty.  The SEC noted that its investigation remains ongoing. Also in November, the SEC settled actions against two technology companies for failing to register their ICOs pursuant to federal securities laws.[16]  Both companies raised over $10 million worth of digital assets to fund their respective business ventures.  These were the first cases in which the SEC imposed civil penalties solely for ICO-related registration violations. The companies consented to return funds to investors, register their tokens as securities, file periodic reports with the SEC for at least one year, and pay $500,000 in total penalties. That same month, the SEC also for the first time brought actions against individuals for improperly promoting ICOs.  The SEC settled actions against two celebrities for their respective failures to disclose that they were being compensated for promoting upcoming ICOs on their social media accounts.[17]  The celebrities received approximately $350,000 in total for their promotions, all of which they were required to disgorge, along with $400,000 in total penalties. The celebrities also consented to a combined five-year ban on promoting any security. The second half of this year also saw the SEC crack down on ICOs claiming to be registered with the SEC.  In October, the SEC suspended trading of a company's securities after the company issued two press releases falsely claiming to have partnered with an SEC-qualified custodian for use with cryptocurrency transactions and to be conducting an "officially registered" ICO.[18]  Also in October, the SEC obtained an emergency court order halting a planned ICO that falsely claimed to be SEC-approved.[19]  On October 11, a federal judge froze the assets of the defendants—the company and its founder.  Notably, in one of the few setbacks to the SEC's aggressive enforcement program in the cryptocurrency space, the same judge subsequently denied the SEC's motion for a preliminary injunction, finding that the Commission had failed to show that the digital asset offered in the ICO was a security subject to federal securities laws.[20]  Litigation remains ongoing. Finally, September saw the SEC file a litigated action against an international securities dealer and its CEO for soliciting investors to buy and sell securities-based swaps.[21]  The SEC filed the case after an undercover FBI agent allegedly purchased securities-based swaps on the company's platform despite not meeting the required discretionary investment thresholds.  The SEC alleged that the company failed to register as a security-based swaps dealer and transacted the securities-based swaps outside of a registered national exchange.

II.   Issuer and Auditor Cases

A.   Accounting Fraud and Internal Controls

In July, the SEC charged a drainage pipe manufacturer and its former CFO with reporting and accounting violations.[22]  According to the SEC, the company allegedly overstated its income before taxes from 2013-2015 as a result of insufficient internal accounting controls, improper accounting, and "unsupported journal entries directed or approved" by the former CFO.  Without admitting or denying the allegations, the company agreed to pay a $1 million penalty while the CFO agreed to pay a $100,000 penalty, reimburse the company approximately $175,000 in stock sale profits, and be barred from practicing as an accountant before the SEC. In early September, the SEC announced a settlement with a telecommunications expense management company and three members of the company's senior management related to allegedly fraudulent accounting practices.[23]  According to the complaint, the company prematurely reported revenue for work that had not been performed or for transactions that did not actually produce revenue.  The SEC also alleged that the company's former senior vice president of expense management operations falsified business records that were provided to auditors.  The company and three executives agreed to pay a combined penalty of $1.67 million to settle the allegations.  The litigated action against the senior VP of expense management operations remains pending. Later that month, the SEC charged a U.S.-based CFO of a public company in China with using his personal bank account to transfer over $400,000 in corporate funds from China to the U.S. to pay the company's U.S. expenses.[24]  The SEC's complaint alleged that he had previously engaged in the same practice for at least two other China-based public companies.  The SEC contended that the commingling of corporate and personal funds put the company's assets at risk of misuse and loss, and that the CFO had failed to implement an adequate set of internal accounting controls.  The CFO agreed to settle the charges without admitting wrongdoing, agreeing to pay a $20,000 fine and to be barred from serving as a public company officer or director for five years. Also in September, the SEC initiated enforcement actions against a business services company, its former CFO, and the company's former controller related to allegations of accounting fraud.[25]  The complaint alleged that the CFO manipulated the company's books to hide the increasing expense of its workers' compensation relative to revenue from its independent auditor.  When the company announced that it needed to restate its financial results to reflect the actual workers' compensation expenses, the stock price fell by 32%.  Without admitting or denying the allegations, the company agreed to pay $1.5 million to settle the charges, and the controller, who allegedly approved some of the CFO's accounting entries, agreed to pay $20,000 and be suspended from appearing before the SEC as an accountant for one year.  The case against the CFO is being litigated, and he has also been charged criminally by the United States Attorney's Office for the Western District of Washington.  The company's CEO, who was not charged with wrongdoing, agreed to pay the company back his $20,800 in cash bonuses received during the period of the alleged accounting violations. The following day, a pipeline construction company agreed to settle charges that it failed to implement adequate internal accounting controls, and failed to adequately evaluate its control deficiencies when assessing the effectiveness of its Internal Control over Financial Reporting ("ICFR"), after problems with its revenue recognition surfaced.[26]  According to the SEC, the company used contingent cost estimates to cover potential risks inherent in a project that could add unanticipated expenses to its total costs.  The company failed to implement adequate controls around its contingent cost estimates, despite recognizing that such estimates were critical for properly recognizing revenue.  Without admitting liability, the company agreed to pay a $200,000 civil penalty. Later in September, the SEC announced a settled action against a pharmaceutical company and its former CFO for allegedly understating the amount of inventory held by its wholesaler customers, which occurred as a result of the company flooding its distribution channel with products.[27]  According to the complaint, this created more short-term revenue at the expense of future sales.  Without admitting or denying the allegations, the company agreed to be enjoined from future violations and the former CFO agreed to pay approximately $1 million in penalties and disgorgement, be subject to an officer and director bar for five years, and to be barred from appearing before the SEC as an accountant with a right to apply for reinstatement after five years. In a November case involving the Kenyan subsidiary of a U.S.-based tobacco company, the SEC charged that managers at the subsidiary overrode existing internal controls and failed to report accounting errors to the parent company.[28]  As a result, the parent company filed materially misstated financial statements for more than four years, including errors to its inventory, accounts receivable, and retained earnings numbers.  The parent company agreed to settle the internal controls violations on a no admit/no deny basis.  The SEC imposed a cease-and-desist order, noting the company's remedial actions already undertaken, including sharing the results of its internal investigation with the SEC, hiring new accounting control positions within the African region, and implementing new internal accounting control procedures and policies. In December, the SEC filed a complaint against a multinational agricultural company and its executive chairman, alleging that they concealed substantial losses by improperly accounting for the divestiture of its China-based operating company.[29]  According to the SEC, the company overstated the value of stock received in the transaction and assigned a value of nearly $60 million to worthless land use rights.  The company agreed to pay a $3 million penalty and to cooperate with the SEC in future investigations, without admitting or denying the allegations.  Additionally, the CEO agreed to pay $400,000 and accept a five year officer and director bar. The next day, the SEC brought charges against a natural food company stemming from alleged weaknesses in the company's internal controls regarding end-of-quarter sales practices that helped the company meet its internal sales targets.[30]  According to the SEC, the company's sales personnel regularly offered incentives to customers to move inventory near quarter-end, including the right to return products that expired or spoiled prior to ultimate purchase, cash incentives, substantial discounts, and extended payment terms.  The company had failed to implement adequate controls to both detect and document these practices.  According to the SEC's press release, no monetary penalties were imposed based on the company's self-reporting to the SEC and significant remediation efforts, which included significant organizational changes and changes to its revenue recognition policies. Also in December, the SEC also instituted settled proceedings against a publicly-traded issuer of subprime automobile loan securities related to allegations that the company failed to accurately calculate its credit loss allowance from certain impaired loans and failed to segregate those loans from its general loan assets.[31]  The SEC also alleged that flaws in the company's internal controls led to its errors in calculating credit loss allowance and caused the company to restate its financial statements twice in a one-year period.  Without admitting or denying the allegations, the company agreed to pay a $1.5 million penalty. Finally, the SEC brought a settled proceedings against five separate companies for filing quarterly financial forms without having their financial statements reviewed in advance, which is a violation of Regulation S-X.[32]  The SEC announced the charges against all five companies in a single press release, and each company agreed to remedial action, including payment of penalties ranging from $25,000 to $75,000.

B.   Misleading Disclosures

Beyond the accounting-related cases discussed above, the SEC pursued an unusual number of cases based on misleading disclosures by public companies in the latter half of the year.

Misleading Metrics

Many of the disclosure cases instituted by the SEC involved the use of allegedly misleading metrics of interest to investors. In July, the SEC filed settled proceedings against an engineering and construction company related to allegations that it inflated a key performance metric and had various accounting control deficiencies.[33]  According to the SEC's order, the company's "work in backlog" metric, which measured the revenue the company expected to earn from future firm orders under existing contracts, improperly included at least $450 million from orders that the company had not received.  Additionally, the SEC alleged that the company's deficient accounting controls caused it to make inaccurate estimates of the costs to complete seven contracts, leading the company to restate its earnings.  Without admitting wrongdoing, the company agreed to pay a $2.5 million penalty. In August, the SEC separately instituted proceedings against a cloud communications company and two of its executives as well as executives at two online marketing companies related to allegations that they provided misleading numbers to investors.  In the first order, the SEC alleged that the company projected first quarter 2015 revenue of $74 million based on improperly reclassified sales forecasts when the CFO was aware of red flags that undermined confidence in that figure.[34]  Just a week before the end of the quarter, the company announced revenue projects that were approximately $25 million lower, causing the stock price to fall 33%.  Without admitting wrongdoing, the company agreed to pay $1.9 million and the two executives agreed to pay penalties ranging from $30,000 to $40,000.  In the second complaint, the SEC alleged that the former CEO and CFO of two online marketing companies, which formed a parent-subsidiary relationship in 2016, knowingly provided inflated subscriber figures.[35]  These charges arose out of a settled enforcement action the SEC brought against the companies themselves in June, in which the parent company agreed to pay a $8 million penalty.  Without admitting or denying the allegations, the two executives agreed to pay $1.38 million and $34,000, respectively. In September, the SEC announced a settled action with a payment processing company and its CEO.[36]  According to the SEC's allegations, the company materially overstated a key operating metric that caused research analysts to overrate the company's stock and promoted it in  its filings with the SEC, even though both the company and CEO had reason to know that the metric was inaccurate.  Without admitting or denying the allegations, the company agreed to pay a penalty of $2.1 million while the former CEO agreed to pay $120,000. Finally, in a relatively novel action, the SEC settled charges against a seller of home and business security services for failing to afford equal or greater prominence to comparable GAAP earnings measures in two of its financial statements containing non-GAAP measures.[37]  While the SEC has highlighted concerns about the prominence of non-GAAP metrics previously, this appears to be the first case in which that issue alone has resulted in an enforcement action.  Without admitting or denying the allegations, the company agreed to pay $100,000 to settle the matter.

Executive Perks

The SEC also brought several cases involving executive perks.  In July, the SEC announced a settlement with a chemical company related to charges that the company allegedly failed to adequately disclose approximately $3 million in perquisites given to its CEO in its 2013-2016 proxy statements.[38]  The SEC alleged that the company failed to disclose personal benefits not widely available and not integrally and directly related to an executive's job duties.  The company agreed to pay a $1.75 million penalty and hire an independent consultant to help implement new perquisite disclosure policies. Also in July, the SEC alleged that the CEO of an oil company hid approximately $10.5 million in personal loans from a company vendor and a prospective member of the board.[39]  Additionally, the SEC alleged that the CEO received undisclosed compensation and perks, and that the company failed to report more than $1 million in excess compensation in its disclosures.  Without admitting or denying the SEC's allegations, the CEO agreed to pay a $180,000 penalty and be subject to a five year bar from serving as an officer or director of a public company.  The board member also agreed to pay a penalty.

Other Disclosures

In July, the SEC instituted settled proceedings against a publicly-traded real estate investment trust and four executives, alleging that they failed to adequately disclose certain cashflow issues and the status of real property within its portfolio.[40]  The parties agreed to settle the charges without admitting or denying the allegations. In September, the SEC instituted proceedings against an industrial waste water treatment company and two senior executives, alleging that they failed to disclose to investors certain contractual contingencies that had not occurred in a material contract with Nassau, New York.[41]  To settle the allegations, without admitting or denying the SEC's findings, the company agreed to pay $133,000 in penalties, disgorgement, and pre-judgment interest and the two executives agreed to pay civil penalties of $60,000 and $35,000 respectively. Also in September, the SEC announced a settlement with SeaWorld Entertainment Inc. and its former CEO.[42]  The SEC's complaint alleged that the company and its CEO failed to adequately disclose the damaging impact a critical documentary had on the company's business.  Without admitting or denying the allegations, the company and former CEO agreed to pay $5 million in penalties and disgorgement.  A former vice president of communications also agreed to pay $100,000 in disgorgement and prejudgment interest, without admitting or denying the allegations. That same day, the SEC filed a settled action against a biopharmaceutical company, its CEO, and former CFO, related to allegations that the company failed to timely disclose questions about the efficacy of its flagship lung cancer drug.[43]  Without admitting or denying the SEC's allegations, the company and the executives agreed to the payment of disgorgement and penalties. Later that month, the SEC filed a settled action against a large drugstore chain, its former CEO, and former CFO for failing to communicate the increased risk of missing operating income projections in the wake of a corporate merger.[44]  The SEC alleged that in 2012, one of the predecessor entities had reaffirmed earlier projections despite internal projections showing an increased risk of falling short.  Without admitting or denying the allegations, the company paid a $34.5 million penalty and the two executives each agreed to pay $160,000. And at the end of September, the SEC announced a settlement with Tesla, Inc. and its CEO arising out of the CEO's tweets about plans to take the company private.[45]  The SEC alleged that the potential transaction was subject to numerous contingencies, and that the company lacked sufficient controls to review the CEOs tweets.  Without admitting or denying the allegations, the company and its CEO agreed to pay civil penalties; additionally, the CEO agreed to step down from the board and be replaced by an independent chairman, and the company agreed to install two new independent directors, implement controls to oversee the CEO's tweets, and establish a new committee of independent directors.

C.   Auditor Cases

In September, the SEC instituted proceedings against an accounting firm for improper professional conduct and violations of the securities law during the course of an audit of an information technology company.[46]   According to the SEC's complaint, the firm ignored a series of red flags concerning cash held by a related entity and provided an unqualified opinion.  The firm and two of its principals agreed to be barred from appearing before the SEC as accountants for five years, and to pay monetary penalties. In October, the SEC suspended three former accountants from a larger audit firm related to allegations that they violated auditing standards and engaged in unprofessional conduct during an audit of an insurance company.[47]  According to the SEC's order, the audit team fell behind schedule during the audit, but the senior manager directed team members to sign off on "predated" workpapers to make it appear that the audit had been completed before the company's annual report was filed with the SEC.  The SEC also concluded that the engagement partner and quality review partner failed to exercise due professional care that would have prevented these deficiencies in the audit.  Without admitting or denying the SEC's findings, the three accountants agreed to be suspended from practicing before the SEC as accountants for periods ranging from one to five years, pending applications for reinstatement. In December, the SEC instituted proceedings against an audit firm, two of its partners, and two partners from a now-defunct auditing firm, relating to "significant failures" in their audit of a company that went bankrupt after the discovery of more than $100 million in federal tax liability.[48]  According to the SEC's order, the firm identified pervasive risks of fraud in the company but failed to undertake additional steps to address the risk.  The SEC also alleged that the audit firm was not actually independent of the company due to an ongoing business relationship.  To settle the allegations, the firm agreed to  pay a penalty of $1.5 million, and hire an independent compliance consultant.  All four partners agreed to be suspended from practicing before the SEC for between one and three years, and to pay penalties ranging from $15,000 to $25,000. Finally, outside the public company audit context, the SEC charged an audit firm with failing to maintain its independence when conducting "Custody Rule" and broker-dealer audits.  The SEC alleged that the firm violated independence standards by both preparing and auditing client financial statements, accompanying notes, and accounting entries for more than 60 audits over five years.  Without admitting nor denying the allegations, the firm settled with the SEC, agreeing to pay a $300,000 penalty and to cease any engagements that fall within the purview of the SEC for one year.  If the firm later chooses to accept such engagements, it must retain an independent complaint consultant for a three-year period and comply with all of the consultant's recommendations for auditor independence.

D.   Private Company Cases

Finally, the SEC brought a number of financial reporting and disclosure cases against private (or pre-public) companies, including the following: In September, the SEC instituted settled proceedings against a seller of drones, toys, and other consumer products and its CEO related to allegations that they provided inaccurate sales information to the company's auditor, which caused its Form S-1 registration statement to overstate the company's revenue by approximately 15%.[49]  Without admitting or denying the SEC's allegations, the CEO agreed to pay a $10,000 penalty and the company agreed to withdraw its registration statement, which had never been declared effective. Also in September, the SEC instituted proceedings against a California-based medical aesthetics company and its former CEO.[50]  The SEC alleged that just days before the company was going to close a stock offering, the CEO learned that its Brazilian manufacturer's certificate to sell products in the European Union had been suspended, but concealed it from the company's General Counsel and underwriters.  After the offering closed and the suspension subsequently became public, the stock price fell by 52% and the CEO continued to misrepresent his knowledge.  The SEC settled with the company, recognizing the company's self-reporting to the SEC and extensive cooperation.  The SEC is litigating against the CEO. In November, the SEC instituted proceedings against an entertainment media company and five of its former officers and directors.[51]  According to the complaint, the company purchased downloads for its mobile app from outside marketing firms in order to boost its download ranking in the Apple App Store.  The company allegedly misrepresented to its shareholders why its app had risen in the download rankings, and continued to allegedly lie to shareholders about the growth of its downloads even after it stopped paying for downloads and its rankings plummeted.  The parties agreed to settle the charges without admitting or denying the allegations; the individuals agreed to pay penalties of varying amounts, three agreed to a permanent officer and director bar, and one agreed to a five-year bar.

III.   Investment Advisers and Funds

A.   Fees and Expenses

In November, a California-based investment adviser settled allegations that it overcharged clients by failing to apply "breakpoint" discounts as provided in its fee schedule.[52]  According to the SEC, the adviser's fee schedule entailed "breakpoints" which would decrease advisory fees as the amount of client assets under management increased.  For approximately eight years, however, the advisory fee discounts were applied haphazardly, resulting in overcharges to certain client accounts.  Without admitting the allegations, the adviser agreed to pay a penalty of $50,000.  The SEC recognized that, during the investigation, the adviser undertook remedial efforts, including reimbursements to clients of overcharged fees and modifications to its policies. In December, a formerly SEC-registered fund manager settled allegations that it misallocated expenses (such as rent, overhead, and compensation) to its business development company clients as well as failed to review valuation models that caused a client to overvalue its portfolio companies.[53]  The adviser agreed to pay approximately $2.3 million disgorgement and prejudgment interest, as well as a civil money penalty of approximately $1.6 million. Also in December, the SEC filed a settled administrative proceeding against a Milwaukee-based investment adviser and its owner/chairman in connection with alleged undisclosed fees.[54]  According to the SEC, the adviser added a sum to client transactions, which it called a "Service Charge."  Part of this "Service Charge" would go towards paying a third-party broker, while the remainder went to the adviser.  The SEC alleges that the adviser did not disclose these payments to clients.  Without admitting or denying the allegations, the investment adviser and its owner agreed to pay approximately $470,000 in disgorgement and prejudgment interest, as well as a $130,000 civil penalty. Later that month, the SEC settled with a private equity fund adviser for allegedly improperly allocating compensation-related expenses to three private equity funds that it advised.[55]  According to the SEC, firm employees charged the funds for work unrelated to the three funds, violating the mandates of the governing documents of the funds.  The alleged wrongdoing spanned four years.  The firm cooperated extensively with the SEC, and the Commission accounted for those remedial efforts in settlement.  The firm agreed to more than $2 million in disgorgement and a civil monetary penalty of $375,000.   In a similar case also filed in December, the SEC settled with a fund manager for inadequate disclosures regarding certain expense allocations, as well as the alleged failure to disclose potential conflicts of interest arising from certain third-party service providers.[56]  Without admitting or denying the SEC's allegations, the company agreed to pay $1.9 million in disgorgement and prejudgment interest and a $1 million civil penalty to settle the charges. At the end of December, the SEC settled with a private equity investment adviser in connection with allegations of improper expense allocations.[57]  According to the SEC, the investment adviser manages private equity funds and as well as co-investment funds on behalf of the company's employees.  The two types of funds invest alongside each other.  When the adviser sought to acquire certain portfolio companies, co-investors were able to provide additional capital to invest.  According to the SEC, over the course of approximately fifteen years, the adviser failed to allocate certain expenses on a proportional basis between the private equity funds and the co-investor funds.  In connection with settlement, the SEC acknowledged that, following an examination by the Commission's Office of Compliance Inspections and Examinations but prior to being contacted by the Division of Enforcement staff, the adviser proactively made full reimbursements, with interest, to affected funds.  The adviser agreed to pay a civil money penalty of $400,000. The SEC also brought a number of cases involving wrap fee programs. In August, an investment advisory firm settled allegations that it lacked policies and procedures to provide investors with sufficient information for investors to evaluate the appropriateness of their investments in the company's wrap fee programs.[58]  Without admitting or denying the allegations, the firm agreed to pay a $200,000 civil penalty and to undertake efforts to enhance its procedures.  And in September, an affiliated investment adviser settled allegations that it failed to disclose conflicts of interest in connection with wrap fee programs.[59]  According to the SEC, over the course of three years, the investment adviser recommended that its clients invest in wrap fee programs, one of which was sponsored by the investment adviser.  Without admitting or denying the allegations, the company agreed to pay a $100,000 civil penalty.

B.   Conflicts of Interest

In July, the SEC filed a settled administrative proceeding against the managing partner and chief compliance officer of a private equity fund adviser, alleging that he arranged for one of his funds to make a loan to a portfolio company, the proceeds of which were used to purchase his personal interest in the company.[60]  The SEC alleged that the manager failed to disclose the conflicted transaction to the fund's limited partnership advisory committee.  The manager agreed to pay a civil money penalty of $80,000 without admitting or denying the allegations.  The SEC's order noted that the fund ultimately did not lose any money on the transaction. In late August, the SEC instituted settled proceedings against an investment adviser in connection with alleged failures to disclose a conflict of interest relating to third-party products.[61]  According to the SEC, the adviser's retail advisory accounts were invested in third-party products that a U.S. subsidiary of a foreign bank managed.  In contravention of established practice, the adviser's governance committee did not vote on a proposed recommendation to terminate the third-party products, and instead later permitted new adviser accounts to invest in these products.  In so doing, according to the SEC, the adviser did not disclose a conflict of interest.  Without admitting or denying the allegations, the adviser agreed to pay nearly $5 million in disgorgement and prejudgment interest, as well as a $4 million penalty.

C.   Fraud and Other Misconduct

In July, the SEC charged a Connecticut-based advisory firm and its CEO with placing around $19 million of investor funds into risky investments, including into companies in which they had an ownership stake, while charging large commissions on top of those investments.[62]  The complaint further alleged that the company overbilled some of its clients by calculating fees based on the earlier value of investments that had decreased in value.  The case is being litigated. In August, a Michigan-based investment management firm and its representative settled claims that they had engaged in a cherry-picking scheme.[63]  According to the SEC, the representative disproportionately allocated profitable trades to favored accounts, including personal and family accounts, at the expense of other clients.  The firm agreed to pay $75,000, and the individual respondent agreed to pay approximately $450,000 in disgorgement and penalties and to be barred from the industry.  The following month, the SEC pursued similar cherry-picking claims against a Louisiana-based adviser and its co-founder.[64]  That case is being litigated.  According to the SEC, it was the sixth case arising out of a recent initiative to combat cherry picking. September was a particularly busy month, as the SEC settled a number of fraud-based cases with investment advisers. The SEC settled charges with two New York City-based investment advisers and their 100% owner and president.[65]  The advisers allegedly engaged in a complex scheme to conceal the loss in the value of their clients' assets by making false statements, improperly redeeming investments, and failing to disclose a variety of conflicts of interest.  To settle the charges, the advisers agreed to jointly and severally pay disgorgement of approximately $1.85 million and a civil penalty of $600,000. Also in September, the SEC charged a hedge fund adviser and its principal with running a "short and distort" scheme, taking a short position and then making a series of false statements to shake investor confidence and lower the stock price of a publicly-traded pharmaceutical company.[66]  According to the SEC, the fund used written reports, interviews and social media to spread untrue claims, driving the stock price down by more than a third.  The matter is being litigated. Later that month, the SEC settled with an asset manager, its former president, and its former CFO.[67]  The asset manager and former president were charged with fraudulently using investor funds to purchase interests in products offered by the firm's parent corporation to benefit the parent, at which the former president also worked.  The individuals were also charged with improperly adjusting fund returns to show more favorable results to investors.  No charges were pursued against the parent corporation because of its prompt reporting of the misconduct, extraordinary cooperation with the SEC, and the reimbursement of around $1 million to adversely impacted investors.  The company settled for more than $4.2 million in penalties and disgorgement.  The former president and CFO agreed to pay penalties, and the president also agreed to a three-year bar from the securities industry. Early in December, an investment company settled charges of improperly recording and distributing taxable dividends, when those monies should have been recorded as return of capital.[68]  According to the SEC, while the error was not quantitatively large, it impacted a key metric used by investors and analysts to evaluate performance.  The only sanction imposed was a cease-and-desist order.  The firm admitted that its conduct violated federal securities laws and consented to the imposition of the order.

D.   Share Class Selection

The SEC has been particularly focused on advisers which recommend mutual funds to clients without adequately disclosing the availability of less expensive share classes.  In February 2018, the Division of Enforcement announced its Share Class Selection Disclosure Initiative, under which the Division agreed not to recommend financial penalties against advisers which self-report violations of the federal securities laws relating to mutual fund share class selection and promptly return money to victimized investors.  While the SEC has yet to announce any enforcement actions resulting from the self-reporting initiative, it has filed a number of actions against advisers which did not self-report such violations. In August, the SEC filed a settled administrative proceeding against a Utah-based investment adviser and broker-dealer relating to mutual fund distribution fees, known as 12b-1 fees.[69]  According to the SEC, for more than four years, the company, in its capacity as a broker-dealer, reaped compensation in the form of 12b-1 fees due to its clients' mutual fund investments.  However, the company, in its capacity as an investment adviser, disclosed to advisory clients that it did not receive compensation from the sale of mutual funds.  In addition, the adviser recommended more expensive share classes of certain mutual funds when cheaper shares of the same funds were available.  The company agreed to pay over $150,000 to compensate advisory clients and a $50,000 civil money penalty. In mid-September, the SEC filed a settled administrative proceeding against a limited liability company in connection with 12b-1 fees.[70]  According to the SEC, for approximately three years, the adviser improperly collected 12b-1 fees from clients by recommending more expensive mutual fund share classes with 12b-1 fees when lower-cost share classes, without 12b-1 fees, were available.  Further, the SEC alleged that the adviser received, but did not disclose, compensation it received when the adviser invested its clients in certain no-transaction fee mutual funds.  The SEC acknowledged remedial acts undertaken and the company's cooperation with the Commission.  The adviser agreed to pay over $1.3 million in disgorgement and penalties. On the same day in late December, the SEC settled two additional share class selection cases.  In the first, a Tennessee-based investment adviser settled charges in connection with the recommendation and sale of higher-fee mutual fund shares when less expensive share classes were available.[71]  The SEC alleged that for a period of approximately four years, the company's president and investment adviser representative were the top two recipients of avoidable 12b-1 fees.  The investment adviser agreed to pay approximately $850,000 in disgorgement and prejudgment interest, as well as $260,000 as a civil penalty; collectively, the two individuals agreed to pay approximately $430,000 in disgorgement and prejudgment interest, in addition to $140,000 in civil penalties.  In the second case, the SEC settled charges with two investment advisers and a CEO of one of the firm on the ground that, despite the availability of less expensive share classes of the same funds, advisory clients' funds were invested in mutual fund share classes that paid 12b-1 fees to the firms' investment adviser representatives.[72]  In total, the investment advisers and CEO agreed to pay more than $1.8 million to settle the charges.

E.   Misleading Disclosures

The SEC brought a number of cases alleging misleading disclosures and omissions in the second half of 2018.  In July, the SEC announced a settlement with a California-based investment adviser and its majority owner.[73]  In the firm's written disclosures to clients, the firm allegedly made material misstatements about the firm's financial condition – most saliently, omitting to disclose the firm was insolvent during the relevant period and was operating on $700,000 in loans.  The SEC also alleged that the firm improperly withheld refunds of prepaid advisory fees from clients who requested via email to terminate their relationships.  The firm and its majority owner agreed to pay $100,000 and $50,000 respectively in civil monetary penalties to settle the charges. In August, the SEC settled two cases based on failures to disclose and misleading disclosures by investment advisers.  First, a Boston–based employee-owned hedge fund sponsor settled with the SEC over allegations of omissions, misrepresentations, and compliance failures relating to its practices which resulted in materially different redemption amounts when the fund lost value in a short period of time.[74]  The allegations included a failure to implement a compliance program consistent with the adviser's obligations under the Advisers Act, a lack of disclosure to all investors of their option to redeem their investment in the fund, and inaccurate statements concerning assets in the Form ADV filed annually with the SEC.  The firm agreed to pay a civil penalty of $150,000. Four days later, the SEC settled with four related investment adviser entities for allegedly misleading investors through the use of faulty investment models.[75]  According to the SEC, the  quantitative investment models contained errors, and after discovering the issue the firms discontinued their use but did not disclose the errors.  The entities agreed to pay $97 million in disgorgement and penalties without admitting liability.  Two individual defendants, the former Chief Investment Officer and the former Director of New Initiatives of one of the entities, were also charged and settled with civil penalties of $65,000 and $25,000 respectively. Also in August, the SEC filed a litigated case against a Buffalo-based advisory firm and principal.[76]  According to the SEC, in anticipation of an SEC imposed bar, the owner of the firm sold the firm to his son.  Yet, after the imposition of the bar, his son failed to apprise clients of the bar and made misleading statements when clients inquired about the bar.  Moreover, the father allegedly impersonated his son when on phone calls with clients. A Massachusetts-based investment manager settled with the SEC on the final day of August.[77]  The company allegedly disseminated advertisements touting hypothetical returns based on blended research strategies while failing to disclose that some key quantitative ratings were determined using a retroactive, back-tested application of the financial model.  The company agreed to pay a civil penalty in the amount of $1.9 million to settle the allegations of violating the Advisers Act by publishing, circulating, and distributing advertisements containing misleading statements of material fact. In the first week of September, the SEC settled with a private investment firm and its managing partner for allegedly failing to provide limited partners in a fund with material information related to a change in the valuation of the fund.[78]  The respondents jointly agreed to pay a civil penalty in the amount of $200,000.  A week later, the SEC filed a lawsuit against an Indianapolis-based investment advisory firm and its sole owner for omitting to disclose that the firm and its owner would receive commissions of almost 20% on sales of securities which it encouraged its clients to buy.[79]  The latter case is being litigated. In December, the SEC settled with a California-based registered investment adviser for material misstatements and omissions in its advertising materials, allegedly inflating the results and success of the back-tested performance for one of its indexes over the course of eight years.[80]  The adviser agreed to pay a civil penalty of $175,000. And in late December, the SEC brought its first enforcement action against robo-advisers for misleading disclosures.[81]  Robo-advisers provide software-based, automated portfolio management services.  In the first robo-adviser case, the company disclosed to clients that it would monitor client accounts for "wash sales," which could negate the tax-loss harvesting strategy it provided to clients.  According to the SEC, however, for approximately three years the adviser did not provide such monitoring, and wash sales took place in almost one-third of accounts enrolled in the tax-loss harvesting program.  This robo-adviser agreed to pay a $250,000 penalty.  In a separate case, a second robo-adviser agreed to settle charges that it provided misleading performance information on its website and social media.  According to the SEC, the company purported to show its investment performance as compared to robo-adviser competitors, but only included a small fraction of its client accounts in the comparison.  This adviser agreed to pay a $80,000 penalty to settle the matter.

F.   Other Investment Adviser Issues

Supervision and Oversight

In August, the SEC announced a settled action against a Minnesota-based diversified financial services company that had allegedly failed to protect retail investor assets from theft by its agents.[82]  The SEC alleged that the respondents' agents, many of whom pled guilty to criminal charges, committed fraudulent actions such as stealing client funds and forging client documents.  The company allegedly failed to adopt and implement policies and procedures reasonably designed to safeguard investor assets against misappropriation by its representatives.  The company agreed to pay a penalty of $4.5 million to settle the charges. In November, the SEC settled charges with a formerly registered investment adviser and its former CEO for negligently failing to perform adequate due diligence on certain investments.[83]  The SEC alleges that the firm failed to implement and reasonably design compliance policies and procedures which led to a failure to escalate and advise clients regarding concerns surrounding the investments, which turned out to be fraudulent.  Without admitting or denying the allegations, the firm agreed to pay a $400,000 civil penalty and the CEO agreed to a $45,000 civil penalty.

Cross-Trades

The SEC brought a handful of cases involving cross-trades between client accounts which favored one client at the expense of another.  In August, an investment adviser settled allegations that it had engaged in mispriced cross trades that resulted in the allocation of market savings to selected clients.[84]  According to the SEC, approximately 15,000 cross trades were executed at the bid price, resulting in the allocation of market savings to the adviser's buying clients, while depriving selling clients of market savings.  The SEC further alleged that the adviser cajoled broker-dealers into increasing the price of certain municipal bonds and executed cross trades at these inflated prices, thereby causing buying advisory clients to overpay in these transactions.  To settle the matter, the adviser agreed to reimburse its clients over $600,000, plus interest, and pay a $900,000 penalty.  The following month, the SEC instituted a similar settled administrative proceeding against a Texas-based investment adviser for failing to disclose two cross trades, causing its clients to sustain $125,000 in brokerage fees.[85] Also in September, the SEC brought a settled action against a Boston firm and one of its portfolio managers, alleging that they facilitated a number of pre-arranged cross-trades between advisory client accounts that purposefully benefited certain clients at the expense of others.[86]  In addition to paying a $1 million penalty, the company agreed to reimburse approximately $1.1 million to its harmed clients.  The former portfolio manager agreed to pay a $50,000 penalty and to submit to a nine-month suspension.

Testimonial Rule Violations

In July, the SEC instituted five distinct settled proceedings against two registered investment advisers, three investment adviser representatives, and one marketing consultant in connection with violations of the Testimonial Rule, which bars investment advisers from publishing testimonial advertisements.[87]  The advertisements were published on social media and YouTube.  The civil penalties ranged from $10,000 to $35,000 for each of the individuals. In September, a Kansas-based investment adviser and its president/majority owner agreed to settle charges in connection with violations of the Testimonial Rule and ethics violations.[88]  The SEC alleges that the investment adviser broadcast advertisements through the radio, and one of the radio hosts later became a client and broadcast his experience.  According to the SEC, the investment adviser contravened its policies by not monitoring the radio coverage.  The firm agreed to pay a civil penalty of $200,000.  Separately, the company's president/majority owner violated the company's code of ethics by not reporting transactions in brokerage accounts held for the benefit of his family.  He agreed to pay a civil penalty of $50,000.

Pay To Play Abuses

There were two "pay to play" cases settled on the same day in July.  In the first matter, the SEC alleged that three associates of a California-based investment adviser made campaign contributions to candidates who had the ability to decide on the investment advisers for public pension plans.[89]  Within two years of the contributions, in contravention of the Advisers Act, the investment adviser received compensation in connection with advising the public pension plans.  The investment adviser agreed to pay a civil penalty of $100,000.  In the other case, the SEC alleged that the firm's associates made contributions in a number of states, and the investment adviser similarly received payment to advise public pension plans in those states.[90]  The investment adviser agreed to pay a $500,000 civil penalty to settle the charges.

Custody Rule Compliance

The second half of the year entailed two Custody Rule cases against New York-based investment advisory firms.  Neither firm distributed annual audited financial statements in a timely fashion.  In the July matter, the SEC also alleged that the investment adviser lacked policies and procedures to preclude violations of the Advisers Act.  Without admitting or denying the allegations, the adviser agreed to pay a $75,000 civil penalty.[91]  In the September matter, the SEC also alleged that the firm violated the Compliance Rule by failing to review its policies and procedures on an annual basis.[92]  Without admitting or denying the allegations, the adviser agreed to pay $65,000 as a civil penalty.

IV.   Brokers and Financial Institutions

A.   Supervisory Controls and Internal Systems Deficiencies

In the latter half of 2018, the SEC brought a number of cases relating to failures of supervisory controls and internal systems – an increase in this area over the first half of the year.  As part of its ongoing initiative into American Depositary Receipt ("ADR") practices, the SEC brought numerous cases relating to the handling of ADRs—U.S. securities that represent foreign shares of a foreign company and require corresponding foreign shares to be held in custody at a depositary bank.  In July, the SEC announced settled charges against two U.S. based-subsidiaries, a broker-dealer and a depositary bank, of an international financial institution alleging improper ADR handling that led to facilitating inappropriate short selling and profits.[93]  Without admitting or denying the allegations, the subsidiaries agreed to pay $75 million in disgorgement and penalties.  In September, the SEC brought settled charges against a broker-dealer and subsidiary of a French financial institution; the broker-dealer agreed to pay approximately $800,000 in disgorgement and penalties without admitting or denying the findings.[94]  In December, the SEC settled charges against a depositary bank; the bank agreed to pay $38 million in disgorgement and penalties without admitting or denying the findings. [95] And finally, also in December, the SEC brought settled charges in two cases for providing ADRs to brokers when neither the broker nor its customer owned the corresponding foreign shares.  In the first December case, the SEC settled charges with a depositary bank headquartered in New York; the bank agreed to disgorgement, interest, and penalties of approximately $55 million without admitting or denying the charges.[96]  In the second case, the SEC settled charges with another depositary bank, a subsidiary of a large New York financial services firm.[97]  The SEC's order alleged that the improper ADR handling led to inappropriate short selling and dividend arbitrage.  The firm agreed to pay over $135 million in disgorgement, and penalties without admitting or denying the charges. In addition to the ADR cases, the SEC also brought supervision cases for the failure to safeguard customer information and for the failure to supervise representatives who sold unsuitable products.  In July, the SEC brought settled charges against an international investment banking firm for failing to maintain and enforce policies and procedures designed to protect confidential customer information, including the failure to maintain effective information barriers.[98]  The SEC's order alleged that traders at the bank regularly disclosed material nonpublic customer stock buyback information to other traders and hedge fund clients; the bank agreed to a $1.25 million penalty without admitting or denying the charges.  In September, the SEC announced settled charges against a New York-based broker-dealer and two of its executives for failure to supervise representatives in sales of a leveraged exchange-traded note ("ETN") linked to oil.[99]  The SEC's order alleged that the broker-dealer's representatives did not reasonably research or understand the risks of the ETN or the index it tracked.  The broker-dealer agreed to pay over $500,000 in penalties, interest, and customer disgorgement without admitting or denying the charges, and the two executives agreed to penalties as well as a 12-month supervisory suspension.  The broker who recommended the largest number of ETN sales also agreed to a penalty of $250,000. Along with the supervisory cases described above, the SEC also brought a few cases relating to internal controls.  In August, the SEC announced settled charges in two cases against a large financial institution and two subsidiary broker-dealers involving books and records, internal accounting controls, and trader supervision.[100]  The charges in one action related to losses due to trader mismarking and unauthorized proprietary trading, which the SEC alleged were not discovered earlier due to a failure to supervise.  In the second action, the SEC alleged that the bank lacked controls necessary to prevent certain fraudulent loans. The financial institution and subsidiaries agreed to pay over $10 million without admitting or denying the allegations. Also in August, the SEC initiated settled proceedings against a credit ratings agency for alleged internal controls deficiencies relating to a purported failure to consistently apply credit ratings symbols which were used in models used to rate residential mortgage backed securities.[101]  The ratings agency agreed to pay over $16 million without admitting or denying the allegations.

B.   Anti-Money Laundering

As in the first half of the year, the SEC continued to bring a number of cases in the anti-money laundering ("AML") area, all relating to the failure to file suspicious activity reports ("SARs").  The Bank Secrecy Act requires broker-dealers to file SARs to report transactions suspected to involve fraud or with no apparent lawful purpose. In July, the SEC announced the settlement with a national broker-dealer relating to the failure to file SARs on the transactions of independent investment advisers that it had terminated.[102]  The broker-dealer agreed to pay a $2.8 million penalty to settle the action, without admitting or denying the charges.  Similarly, in September, the SEC instituted a settled administrative proceeding against a New York brokerage firm for failing to file SARs relating to a number of terminated investment advisers.[103]  Without admitting or denying the allegations, the firm agreed to pay a penalty of $500,000; the SEC's Order noted that the settlement took into account remedial acts undertaken by the firm.  Also in September, the SEC settled charges against a clearing firm for failure to file SARs relating to suspicious penny stock trades.[104]  As part of the settlement, the clearing firm agreed to pay a penalty of $800,000 without admitting or denying the allegations, and also agreed that it would no longer sell penny stocks deposited at the firm. In December, the SEC brought settled charges against a broker-dealer alleging that during the period 2011-2013 it neglected to monitor certain movements of funds through customers' accounts and to properly review suspicious transactions flagged by its internal monitoring systems.[105]  The firm agreed to pay a $5 million penalty to resolve the charges, as well as a $10 million penalty to the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN) and the Financial Industry Regulatory Authority (FINRA) to resolve parallel charges.  The broker-dealer did not admit or deny the SEC's allegations except to the extent they appeared in the settlement with FinCEN. Also In December, the SEC announced settled charges against a broker-dealer for the failure to file SARs concerning over $40 million in suspicious wire transfers made by one customer in connection with a payday lending scam.[106]  The firm agreed to certain undertakings, including the hiring of an independent compliance consultant, without admitting or denying the allegations.  The U.S. Attorney's Office for the Southern District of New York also instituted a settled civil forfeiture action against the broker-dealer in which it paid $400,000; the U.S. Attorney's Office additionally entered into a deferred prosecution agreement with the firm.

C.   Market Abuse Cases

In the second half of 2018, the SEC's Market Abuse Unit was involved in bringing three cases relating to "dark pools" (i.e., private exchanges) and the use and execution of customer orders.  In September, the SEC announced settled charges against a large financial institution relating to alleged misrepresentations in connection with the operation of a dark pool by one of its affiliates.[107]  The SEC alleged that the firm misled customers relating to high-frequency trading taking place in the pool and also failed to disclose that over half of the orders routed to the dark pool were executed in other trading venues.  The firm and its affiliate agreed to pay over $12 million in disgorgement and penalties without admitting or denying the SEC's allegations. Also in September, the SEC, together with the New York Attorney General ("NYAG"), brought settled charges against an investment bank relating to the execution of customer orders by one of its desks responsible for handling order flow for retail investors.[108]  The SEC alleged that while the firm promoted the desk's access to dark pool liquidity, a minimal number of orders were executed in dark pools; additionally, the firm allegedly failed to disclose that retail customers did not receive price improvement on non-reportable orders.  The firm agreed to pay a total of $10 million ($5 million to the SEC and $5 million to the NYAG) without admitting or denying the allegations. And in November, the SEC brought charges against a financial technology company and its affiliate for misstatements and omissions relating to the operation of the firm's dark pool.[109]  The SEC alleged that the firm failed to safeguard subscribers' confidential trading information despite assuring firm clients that it would do so, and also did not disclose certain structural features of the dark pool to clients.  The firm and its affiliate agreed to pay a $12 million penalty to settle the charges without admitting or denying the allegations.

D.   Books and Records

In July, the SEC brought settled charges against a New York-based broker-dealer relating to its failure to preserve records.[110]  The SEC alleged that the broker-dealer deleted audio files after receiving a document request from the Division of Enforcement (because the department responsible for the files was unaware of the request), and also failed to maintain books and records that accurately recorded expenses.  Without admitting or denying the allegations, the firm agreed to pay a penalty of $1.25 million. In September, the SEC announced charges against a broker-dealer for providing the SEC with incomplete and deficient securities trading information known as "blue sheet data" used by the SEC in its investigations.[111]  The SEC's order alleged that approximately 29% of the broker-dealer's blue sheet submissions over a four-year time period contained deficiencies due to coding errors.  The broker-dealer admitted the findings in the SEC's Order and agreed to pay a $2.75 million penalty to settled the charges.  In December, the SEC instituted settled administrative proceedings against three broker-dealers for recordkeeping violations in another matter relating to deficient blue sheet data submissions.[112]  The SEC's Orders noted that as a result largely of undetected coding errors, the three firms submitted blue sheet data that continued various inaccuracies.  The three broker-dealers admitted the findings in the SEC's Orders and agreed to pay penalties totaling approximately $6 million.  The SEC's Orders noted the remedial efforts undertaken by the firms, including the retention of an outside consultant and the adoption of new policies and procedures for processing blue sheet requests.

E.   Individual Brokers

Finally, in addition to its cases involving large financial institutions, the SEC brought a number of cases against individual broker-dealer representatives.  In September, the SEC filed complaints against two brokers in New York and Florida for excessive trading in retail customer accounts which generated large commissions for the brokers but caused losses for their customers.[113]  The case is being litigated. Also in September, the SEC filed a complaint against a broker for a cherry-picking scheme in which the broker allegedly misused his access to an allocation account to cherry pick profitable trades for his own account while placing unprofitable trades in customer accounts.[114]  The SEC noted that it uncovered the alleged fraud using data analysis.  The case is being litigated, and the U.S. Attorney's Office for the District of Massachusetts announced parallel criminal charges. Finally, in December, the SEC settled with a self-employed trader (and entities that he owned and controlled) for violations of Rule 105 of Regulation M, which prohibits a person from purchasing an equity security during the restricted period of an offering where that person has sold short the same security.[115]  The SEC's Order alleged that the trader violated Rule 105 by effecting short sales during restricted periods and mismarking short sales as "long sales" in a total of 116 offerings.  The trader agreed to pay disgorgement, interest, and penalties total approximately $1.1 million without admitting or denying the charges

V.   Insider Trading

A.   Cases Against Corporate Insiders

Corporate Executives

July was a busy month for corporate executives accused of insider trading and tipping.  First, the SEC charged the former CEO of a New Jersey-based payment processing company and his romantic partner in an insider trading scheme that leveraged nonpublic information about the potential acquisition of his company by another payment processing company.[116]  On the CEO's instructions and with his funds, the romantic partner opened a brokerage account and used almost $1 million of the funds to purchase stock in the target company.  According to the SEC, the pair generated $250,000 in profits after the merger was announced.  The case is being litigated. The SEC also settled with a former VP of Investor Relations at a company operating country clubs and sports clubs alleged to have traded in his company's stock after learning that it was negotiating to be acquired.[117]  After receiving an inquiry from FINRA, the officer resigned from the company and retained counsel who reported the misconduct to the SEC and provided them substantiating documentation.  In return, the SEC agreed to a settlement that involved disgorgement of his profits of approximately $78,000 and a civil penalty equal to about one-half of the disgorgement amount. Later in July, the SEC sued a senior executive at a Silicon Valley tech company for allegedly short selling as well as selling stock in his company ahead of three different quarterly announcements that the company was likely going to miss its revenue guidance.[118]  According to the SEC, the executive made nearly $200,000 in profits from these trades.  Without admitting wrongdoing, the executive agreed to disgorge his profits and pay a corresponding civil penalty, and to bebarred from acting as an officer or director of a public company for five years.  The SEC noted that it had utilized data analysis from its Market Abuse Unit's Analysis and Detection Center to detect suspicious trading patterns in advance of earnings announcements over time. And at the end of July, the SEC sued a VP of Finance who learned from a senior executive at his company that a Chinese investment group might acquire the company.[119]  While preparing financial projections and conducting diligence, the VP allegedly used his spouse's brokerage account to purchase shares of his company.  When it became public that his company had rejected the Chinese investment group's offer in the hopes of receiving a higher price, the company's share increased 24%, resulting in the VP earning nearly $90,000.  Without admitting liability, the officer agreed to disgorgement of his gains and a corresponding civil penalty. In August, the SEC charged a former biotech executive and others with participating in a scheme that generated $1.5 million of profits by trading ahead of the announcement of a licensing agreement between his company and another large pharmaceutical company.[120]  According to the complaint, the executive informed a friend of the license agreement.  The friend then tipped a former day trader, who, in connection with an insider-trading ring, purchased stock and options and made $1.5 million in illegal profits when the agreement was announced and the company's stock price jumped 38 percent.  In a parallel action, the U.S. Attorney's Office for the District of New Jersey charged the day trader and four members of his group with illegal insider trading ahead of secondary public stock offerings. All five defendants have pled guilty to the parallel criminal charges; the four members of the insider-trading ring other than the trader have agreed to partial settlements with the SEC for conduct including their trading on the license agreement, with potential monetary sanctions to be determined at a later date.  The SEC is continuing a previous action against the trader for alleged insider trading ahead of the secondary stock offerings. In August, the SEC sued a former Sales VP at a cemetery and funeral home operator for allegedly benefiting from confidential information obtained through his employer.[121]  After learning about a substantial decline in sales that would necessitate a reduction in the company's distribution payments, the executive sold all of his shares in the company.  As part of a settlement, the executive agreed to pay disgorgement and a civil penalty. Also in August, the SEC settled charges against a former executive of a cloud security and services company.[122]  According to the SEC, the executive informed his two brothers, to whom he had gifted stock in the past, that the company would miss its revenue guidance, and contacted his brothers' brokerage firm to coordinate the sale of all of their stock.  When the negative news was announced, the stock price dropped significantly and the brothers collectively avoided losses of over $580,000.  Under the terms of his settlement, the former executive will be barred from serving as an officer or director of a public company for two years and will pay a $581,170 penalty. In September, the SEC brought a settled action against a former executive at a mortgage servicing company.[123]  The SEC alleged that the executive engaged in insider trading surrounding three separate events, including the resolution of litigation and a CFPB enforcement action against the company, as well as negotiations to sell the company. Without admitting or denying the allegations, the executive agreed to disgorge his ill-gotten gains of almost $65,000 and to pay a penalty equal to the disgorgement amount. In October, the SEC charged a company's former Director of SEC Reporting with trading ahead of a corporate acquisition.[124]  The complaint alleged that the individual bought call options and stock in a company targeted for acquisition by a subsidiary of the company. The matter is being litigated. In November, the acquisition of two health care networks by a large health care company led to two separate misappropriation cases.  The SEC charged a man with insider trading based on information he misappropriated from his wife, a human resources executive at the acquiring company, about the planned acquisitions.[125]  According the SEC, the man overheard his wife's phone calls while she was working at home.  The husband agreed to pay disgorgement of about $64,000 and a penalty of $72,144.  The SEC also settled an insider trading charge against a man alleged to have misappropriated information from his brother, an executive at one of the target companies.[126]  According to the SEC, the insider had shared the information in confidence at a family holiday party.  The trader agreed to pay disgorgement and penalties totaling about $40,000.

Board Members

In a high profile case involving drug trials, the SEC and DOJ filed parallel charges for insider trading against a U.S. Congressman, his son, and a host of other individuals.[127]  According to the SEC's complaint, the Congressman learned of negative drug trial results through his seat on a biotech company's board.  The Congressman allegedly provided his son the inside information, who then told a third individual.  Over the next few days, the Congressman's son, the third individual, and a number of their friends and family members sold over a million shares of the biotech company's stock, which plummeted more than 92 percent following the announcement of the negative results.  As a result of the trading, the Congressman's son and the third individual avoided approximately $700,000 in losses.  Two of the individuals sued ultimately settled with the SEC without admitting or denying the charges, agreeing to disgorge their gains totaling approximately $35,000 and to pay a matching civil penalty.  The SEC's cases against the Congressmen, his son, and a third individual are ongoing. In August, the SEC sued the son of a bank board member who learned of the bank's potential acquisition by another bank from his father prior to the acquisition's public announcement.[128]  The son realized approximately $40,000 in gains after the acquisition became public.  Without admitting or denying the charges, the son agreed to disgorge the gains and to pay a matching civil penalty.

Employee Insiders

In July, the SEC sued a former financial analyst at a medical waste disposal company and his mother for trading on inside information that the company would miss its revenue guidance.[129]  Following the company's earnings announcement, its stock fell 22%, resulting in the analyst and his mother avoiding losses and earning profits of approximately $330,000.  Both the analyst and his mother agreed to settle the case without admitting liability.  They will be required to disgorge their profits and pay a civil penalty in amounts to be later determined by the court. Also in July, in the second SEC case arising out of the Equifax data breach, the SEC charged a software engineer tasked with constructing a website for consumers who were impacted by the data breach for trading the company's stock before the data breach was publicly disclosed .[130]  The engineer was fired after refusing to cooperate with the company's investigation, though he and the SEC ultimately settled the case.  As part of that settlement, the engineer was ordered to disgorge $75,000 in profits.  The U.S. Attorney's Office also filed criminal charges against the engineer. The SEC also filed a number of cases involving corporate scientists.  In July, the SEC charged a scientist at a California biotech company for trading based on positive developments in a genetic sequencing platform.[131]  According to the SEC, the scientist traded during company trading blackouts, in a brokerage account not disclosed to his employer.  He settled the case, agreeing to disgorge approximately $40,000 in profits and paying a similar civil penalty.  In August, the SEC filed suit against a scientist who learned that his healthcare diagnostics company was about to acquire another company in a tender offer.[132]  On the date the acquisition was announced, his company's stock increased 176%.  As part of the settlement, the scientist agreed to disgorge $14,000 in profits and pay a corresponding civil penalty.  And in a third case, the SEC settled with a scientist at a pharmaceutical company for allegedly trading in advance of positive results of a clinical trial.[133]  The scientist agreed to disgorgement of $134,000, but based on her voluntarily coming forward and reporting her improper trades, the SEC agreed to a reduced penalty of $67,000. The SEC brought charges in August against an in-house attorney for a shipping company who traded on inside information that his company had entered into a strategic partnership with a private equity fund.[134]  As part of a settlement, he was ordered to disgorge nearly $30,000 in profits with a matching civil penalty. And in September, the SEC charged a former professional motorcycle racer handling promotional activities for a beverage company, as well as his father, family friend, and investment adviser, with insider trading for tipping and trading ahead of an impending deal with a large beverage company.[135]  According to the SEC, after the racer had learned a significant deal was imminent, the four individuals collectively purchased over $770,000 in stock and options, in certain instances borrowing funds for the purchases.  Following the announcement, they made over $283,000 in trading profits. Without admitting or denying the findings, the individuals agreed to disgorge ill-gotten gains and to pay civil penalties.

B.   Misappropriation by Investment Professionals and Other Advisors

Several deal advisors, including bankers, corporate advisors, and accountants, were charged with insider trading by the SEC.  In August, the SEC charged a professional football player and a former investment banker with insider trading in advance of corporate acquisitions.[136]  The SEC alleges that after meeting at a party, the player began receiving illegal tips, facilitated through coded text messages and FaceTime conversations, from the banker about upcoming corporate mergers.  The player allegedly made $1.2 million in illegal profits by purchasing securities in companies that were soon to be acquired, in one instance generating a nearly 400 percent return.  In return, he is alleged to have rewarded the analyst by setting up an online brokerage account that both men could access, by providing cash kickbacks, free NFL tickets, and an evening on the set of a pop star's music video in which the player made a cameo appearance.  The SEC action is being litigated; both men have pled guilty to related criminal charges.  In November, the SEC also charged a family friend of the banker in connection with the same scheme.[137]  The U.S. Attorney's Office announced parallel criminal charges against this individual. In September, the SEC filed insider trading charges against a corporate deal advisor for trading in securities of two China-based companies based on confidential information about their impending acquisitions.[138]  According to the SEC, the individual, who had been providing advice to the acquiring companies, opened a brokerage account in his wife's name and used that account to generate more than $79,500 in trading profits. That same executive later became a director at a Hong Kong-based investment banking firm.  In connection with advising a client on an acquisition of its rival, he was alleged to have again used his wife's brokerage account to buy high risk call options, which he sold after news of the acquisition for profits of more than $94,400. The case is being litigated. And in December, the SEC charged an individual with misappropriating information from his fiancé, an investment banker working on a merger between two airline companies.[139]   According to the SEC, the trader overheard calls his now-wife made at home on nights and weekends, purchasing call options in the target company and netting approximately $250,000 in profits.  Without admitting or denying liability, the trader agreed to disgorge his profits and pay a matching penalty. Also in December, the SEC alleged that an IT contractor working at an investment bank had traded, and tipped his wife and father, based on information he'd learned from the bank.[140] According to the SEC, the three collectively reaped approximately $600,000 in profits by trading in advance of at least 40 corporate events.  The SEC obtained a court-ordered freeze of assets in multiple brokerage accounts connected to the alleged trading. The SEC brought several cases against accountants and their tippees.  In August, the SEC brought a settled action against a CPA who learned of an acquisition through his work as an accountant providing tax advice to a private company owned by a member of one of the companies.[141]  The individual agreed to disgorge his profits of approximately $8,000 and pay a matching civil penalty. Also that month, the SEC sued a former director of a major accounting and auditing firm for trading ahead of a merger between two of the firm's clients.[142]  According to the SEC, after learning of the planned merger, the director used a relative's account to purchase call options, which increased in value by about $150,000 following announcement of the merger.  Though the director later allowed the options to expire without selling or exercising them, he did not inform his employer that he controlled the account when the relative's name appeared on a list of individuals in connection with a FINRA investigation into suspect trading.  Without admitting liability, the director agreed to pay a $150,500 penalty and to be barred from appearing and practicing before the SEC as an accountant for two years. The SEC brought several other cases involving misappropriation by industry professionals.  In July 2018, the SEC settled charges against a broker who traded ahead of a multi-billion dollar acquisition.[143]  According to the SEC, the broker misappropriated the information from a friend who was a certified public accountant providing personal tax advice to a senior executive at the company being acquired, and who had shared the information in confidence.  Without admitting liability, he agreed to disgorgement of his nearly $90,000 in profits, a comparable civil penalty, and debarment from being a broker.  And in September, the SEC settled a claim against a CPA and a doctor for allegedly trading while in possession of confidential information regarding an impending acquisition.[144]  According to the SEC, the CPA misappropriated the information from a friend who worked at one of the companies. The SEC alleges that after the CPA shared the information with the doctor, both purchased call options in the target company.  Both the CPA and doctor agreed to pay disgorgement and civil penalties.

VI.   Municipal Securities and Public Finance Cases

With the SEC's Municipalities Continuing Disclosure (MCDC) Initiative (which as noted above generated  a significant number of cases) completed, the SEC's Public Finance Abuse Unit returned to its traditionally slower pace, filing just a few cases in the latter half of the year. In August, the SEC charged two firms and 18 individuals with participating in a municipal bond "flipping" scheme (i.e. improperly obtaining new bond allocations from brokers and reselling to broker-dealers for a fee.[145]  According to the SEC, the firms and their principals used false identities to pose as retail investors in order to receive priority from the bond underwriters, and then resold the bonds to brokers for a pre-arranged commission.  The SEC also charged a municipal underwriter with taking kickbacks as part of the scheme.  Most of the parties settled (with sanctions including disgorgement, penalties, and industry bars and suspensions), but aspects of the case are being litigated as well.  The SEC filed another settled case for municipal bond flipping in December.[146] In September, the SEC instituted a settled action against a municipal adviser and its principal for failing to register as municipal advisor and failing to disclose its nonregistration to a school district to which it provided services.[147]  The firm and its principal agreed to pay about $50,000 in disgorgement and penalties, and the principal agreed to be barred from the securities industry.

[1]      Admin. Proc. File No. 3-18965, In re Hertz Global Holdings, Inc. (Dec. 31, 2018), available at www.sec.gov/litigation/admin/2018/33-10601.pdf.
[2]      Admin. Proc. File No. 3-18966, In re Katz, Sapper & Miller, LLP (Jan. 9, 2019), available at www.sec.gov/litigation/admin/2019/34-84980.pdf.
[3]      See SEC Press Release, SEC Enforcement Division Issues Report on FY 2018 Results (Nov. 2, 2018), available at www.sec.gov/news/press-release/2018-250; and accompanying Annual Report at www.sec.gov/files/enforcement-annual-report-2018.pdf.
[4]      For more on Kokesh, see Gibson Dunn Client Alert, United States Supreme Court Limits SEC Power to Seek Disgorgement Based on Stale Conduct (June 5, 2017), available at www.gibsondunn.com/united-states-supreme-court-limits-sec-power-to-seek-disgorgement-based-on-stale-conduct/.
[5]      For more on Lucia, see Gibson Dunn Client Alert, Supreme Court Rules That SEC ALJs Were Unconstitutionally Appointed (June 21, 2018), available at www.gibsondunn.com/supreme-court-rules-that-sec-aljs-were-unconstitutionally-appointed.
[6]      Whistleblower Program, 2018 Annual Report to Congress, available at www.sec.gov/files/sec-2018-annual-report-whistleblower-program.pdf.
[7]      SEC Press Release, SEC Awards more Than $54 Million to Two Whistleblowers (Sept. 6, 2018), available at www.sec.gov/news/press-release/2018-179.
[8]      SEC Press Release, Whistleblower Receives Award of Approximately $1.5 Million (Sept. 14, 2018), available at www.sec.gov/news/press-release/2018-194.
[9]      SEC Press Release, SEC Awards Almost $4 Million to Overseas Whistleblower (Sept. 24, 2018), available at www.sec.gov/news/press-release/2018-209.
[10]     SEC Press Release, SEC Charges Firm with Deficient Cybersecurity Procedures (Sept. 26, 2018), available at www.sec.gov/news/press-release/2018-213.
[11]     SEC Press Release, SEC Investigative Report: Public Companies Should Consider Cyber Threats When Implementing Internal Controls (Oct. 16, 2018), available at www.sec.gov/news/press-release/2018-236.
[12]     For further discussion, see Gibson Dunn Client Alert, SEC Warns Public Companies on Cyber-Fraud Controls (Oct. 27, 2018), available at www.gibsondunn.com/sec-warns-public-companies-on-cyber-fraud-controls/.
[13]     SEC Press Release, SEC Charges ICO Superstore and Owners with Operating as Unregistered Broker-Dealers (Sept. 11, 2018), available at www.sec.gov/news/press-release/2018-185.
[14]     SEC Press Release, SEC Charges Digital Asset Hedge Fund Manager with Misrepresentations and Registration Failures (Sept. 11, 2018), available at www.sec.gov/news/press-release/2018-186.
[15]     SEC Press Release, SEC Charges EtherDelta Founder with Operating an Unregistered Exchange (Nov. 8, 2018), available at www.sec.gov/news/press-release/2018-258.
[16]     SEC Press Release, Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities (Nov. 16, 2018), available at www.sec.gov/news/press-release/2018-264.
[17]     Admin. Proc. File No. 3-18906, In re Floyd Mayweather Jr. (Nov. 29, 2018), available at www.sec.gov/litigation/admin/2018/33-10578.pdf; SEC Admin. Proc. File No. 3-18907, In re Khaled Khaled (Nov. 29, 2018), available at www.sec.gov/litigation/admin/2018/33-10579.pdf.
[18]     SEC Press Release, SEC Suspends Trading in Company for Making False Cryptocurrency-Related Claims about SEC Regulation and Registration (Oct. 22, 2018), available at www.sec.gov/news/press-release/2018-242.
[19]     SEC Press Release, SEC Stops Fraudulent ICO That Falsely Claimed SEC Approval (Oct. 11, 2018), available at www.sec.gov/news/press-release/2018-232.
[20]     R. Todd, Judge to SEC: You Haven't Shown This ICO Is a Security Offering, The Recorder (Nov. 27, 2018), available at www.law.com/therecorder/2018/11/27/judge-to-sec-this-ico-isnt-a-security-offering/.
[21]     SEC Press Release, SEC Charges Bitcoin-Funded Securities Dealer and CEO (Sept. 27, 2018), available at www.sec.gov/news/press-release/2018-218.
[22]     Admin. Proc. File No. 3-18582, SEC Charges Pipe Manufacturer and Former CFO with Reporting and Accounting Violations (July 10, 2018), available at www.sec.gov/enforce/33-10517-s.
[23]     SEC Press Release, SEC Charges Telecommunications Expense Management Company with Accounting Fraud (Sept. 4, 2018), available at www.sec.gov/news/press-release/2018-175.
[24]     SEC Litigation Release, SEC Charges Outsourced CFO with Accounting Controls Deficiencies (Sept. 12, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24265.htm
[25]     SEC Press Release, Business Services Company and Former CFO Charged With Accounting Fraud (Sept. 20, 2018), available at www.sec.gov/news/press-release/2018-205.
[26]     Admin. Proc. File No. 3-18816, Pipeline Construction Company Settles Charges Relating to Internal Control Failures (Sept. 21, 2018), available at www.sec.gov/enforce/34-84251-s.
[27]     SEC Press Release, SEC Charges Salix Pharmaceuticals and Former CFO With Lying About Distribution Channel (Sept. 28, 2018), available at www.sec.gov/news/press-release/2018-221.
[28]     Admin. Proc. File No. 3-18891, Tobacco Company Settles Accounting and Internal Control Charges (Nov. 9, 2016), available at www.sec.gov/enforce/34-84562-sFor a description of the company's remedial measures, see www.sec.gov/litigation/admin/2018/34-84562.pdf
[29]     SEC Press Release, SEC Charges Agria Corporation and Executive Chairman With Fraud (Dec. 10, 2018), available at www.sec.gov/news/press-release/2018-276.
[30]     SEC Press Release, SEC Charges The Hain Celestial Group with Internal Controls Failures (Dec. 11, 2018), available at www.sec.gov/news/press-release/2018-277.
[31]     Admin. Proc. File No. 3-18932, SEC Charges Santander Consumer for Accounting and Internal Control Failures (Dec. 17, 2018), available at www.sec.gov/enforce/34-84829-s.
[32]     SEC Press Release, Public Companies Charged with Failing to Comply with Quarterly Reporting Obligations (Sept. 21, 2018), available at www.sec.gov/news/press-release/2018-207.
[33]     SEC Press Release, SEC Charges KBR for Inflating Key Performance Metric and Accounting Controls Deficiencies (July 2, 2018), available at www.sec.gov/news/press-release/2018-127.
[34]     SEC Press Release, SEC Charges Cloud Communications Company and Two Senior Executives With Misleading Revenue Projections (Aug. 7, 2018), available at www.sec.gov/news/press-release/2018-150.
[35]     SEC Press Release, SEC Charges Former Online Marketing Company Executives With Inflating Operating Metrics (Aug. 21, 2018), available at www.sec.gov/news/press-release/2018-161.
[36]     Admin. Proc. File No. 3-18819, SEC Charges Payment Processing Company and Former CEO for Overstating Key Operating Metric (Sept. 21, 2018), available at www.sec.gov/enforce/33-10558-s.
[37]     Admin. Proc. File No. 3-18955, In re ADT Inc. (Dec. 26, 2018), available at www.sec.gov/litigation/admin/2018/34-84956.pdf.
[38]     Admin. Proc. File No. 3-18570, Dow Chemical Agrees to $1.75 Million Penalty and Independent Consultant for Failing to Disclose Perquisites (July 2, 2018), available at www.sec.gov/enforce/34-83581-s.
[39]     SEC Press Release, SEC Charges Oil Company CEO, Board Member With Hiding Personal Loans (July 16, 2018), available at www.sec.gov/news/press-release/2018-133.
[40]     SEC Litigation Release, SEC Charges Real Estate Investment Funds and Executives for Misleading Investors (July 3, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24185.htm.
[41]     Admin. Proc. File No. 3-18770, SEC Charges Arizona Company And Two Senior Executives In Connection With Misleading Disclosures About Material Contract (Sept. 17, 2018), available at www.sec.gov/enforce/33-10550-s.
[42]     SEC Press Release, SeaWorld and Former CEO to Pay More Than $5 Million to Settle Fraud Charges (Sept. 18, 2018), available at www.sec.gov/news/press-release/2018-198.
[43]     SEC Press Release, Biopharmaceutical Company, Executives Charged With Misleading Investors About Cancer Drug (Sept. 18, 2018), available at www.sec.gov/news/press-release/2018-199.
[44]     SEC Press Release, SEC Charges Walgreens and Two Former Executives With Misleading Investors About  Forecasted Earnings Goal (Sept. 28, 2018), available at www.sec.gov/news/press-release/2018-220.
[45]     SEC Press Release, Elon Musk Settles SEC Fraud Charges; Tesla Charged With and Resolves Securities Law Charge (Sept. 29, 2018), available at www.sec.gov/news/press-release/2018-226.
[46]     Admin. Proc. File No. 3-18838, In re Lichter, Yu and Associates, Inc. et al. (Sept. 25, 2018), available at www.sec.gov/litigation/admin/2018/34-84281.pdf.
[47]     SEC Press Release, SEC Suspends Former BDO Accountants for Improperly "Predating" Audit Work Papers (Oct. 12, 2018), available at www.sec.gov/news/press-release/2018-235.
[48]     SEC Press Release, SEC Charges Audit Firm and Suspends Accountants for Deficient Audits (Dec. 21, 2018), available at www.sec.gov/news/press-release/2018-302.
[49]     Admin. Proc. File No. 3-18856, SEC Charges Drone Seller for Failing to Ensure Accuracy of Financial Statement in Advance of Planned IPO (Sept. 28, 2018), available at www.sec.gov/enforce/33-10564-s.
[50]     SEC Litigation Release, SEC Charges Medical Aesthetics Company and Its Former CEO with Misleading Investors in a $60 Million Stock Offering (Sept. 19, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24275.htm.
[51]     SEC Press Release, SEC Charges Giga Entertainment Media, Former Officers and Directors with Fraud in Pay-For-Download Campaign (Nov. 15, 2018), available at www.sec.gov/news/press-release/2018-263.
[52]     Admin. Proc. File No. 3-18901, SEC Charges San Jose Investment Adviser for Overcharging Fees (Nov. 19, 2018), available at www.sec.gov/enforce/ia-5065-s.
[53]     Admin. Proc. File No. 3-18909, Investment Adviser Settles Charges Related to Expense Misallocation and Valuation Review Failures (Dec. 3, 2018), available at www.sec.gov/enforce/33-10581-s.
[54]     Admin. Proc. File No. 3-18926, SEC Charges Milwaukee-Based Advisory Firm for Receiving Undisclosed Compensation on Client Transactions (Dec. 12, 2018), available at www.sec.gov/enforce/34-84807-s.
[55]     Admin. Proc. File No. 3-18935, SEC Charges Private Equity Fund Adviser for Overcharging Expenses (Dec. 17, 2018), available at www.sec.gov/enforce/ia-5079-s.
[56]     Admin. Proc. File No. 3-18930, SEC Settles with Investment Adviser Who Failed to Disclose Conflicts of Interest and Misallocated Expenses (Dec. 13, 2018), available at www.sec.gov/enforce/ia-5074-s.
[57]     Admin Proc. File No. 3-18958, In re Lightyear Capital LLC (Dec. 26, 2018), available at www.sec.gov/litigation/admin/2018/ia-5096.pdf.
[58]     Admin. Proc. File No. 3-18638, SEC Charges Investment Adviser for Compliance Failures Relating to Wrap Fee Programs (Aug. 14, 2018), available at www.sec.gov/enforce/ia-4984-s.
[59]     Admin. Proc. File No. 3-18730, SEC Charges Investment Adviser for Failing to Fully Disclose Affiliate Compensation Arrangement (Sept. 7, 2018), available at www.sec.gov/enforce/ia-5002-s.
[60]     Admin. Proc. File No. 3-18604, In re Michael Devlin (July 19, 2018), available at www.sec.gov/litigation/admin/2018/ia-4973.pdf.
[61]     SEC Press Release, Merrill Lynch Settles SEC Charges of Undisclosed Conflict in Advisory Decision (Aug. 20, 2018), available at www.sec.gov/news/press-release/2018-159.
[62]     SEC Press Release, SEC Charges Investment Adviser and CEO with Misleading Retail Investors (July 18, 2018), available at www.sec.gov/news/press-release/2018-137.
[63]     Admin. Proc. File No. 3-18649, In re Roger T. Denha (Aug. 17, 2018), available at www.sec.gov/litigation/admin/2018/34-83873.pdf; Admin. Proc. File No. 3-18648, In re BKS Advisors LLC (Aug. 17, 2018), available at www.sec.gov/litigation/admin/2018/ia-4987.pdf.
[64]     SEC Litigation Release, SEC Charges Investment Adviser and Senior Officers with Defrauding Clients (Sept. 20, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24278.htm.
[65]     Admin. Proc. File No. 3-18724, In re Mark R. Graham et al. (Sept. 6, 2018), available at www.sec.gov/litigation/admin/2018/ia-5000.pdf.
[66]     SEC Litigation Release, SEC Charges Hedge Fund Adviser with Short-And-Distort Scheme (Sept. 13, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24267.htm.
[67]     SEC Press Release, SEC Charges LendingClub Asset Management and Former Executives With Misleading Investors and Breaching Fiduciary Duty (Sept. 28, 2018), available at www.sec.gov/news/press-release/2018-223.
[68]     Admin. Proc. File No. 3-18912, In re KCAP Financial, Inc. (Dec. 4, 2018), available at www.sec.gov/litigation/admin/2018/34-84718.pdf.
[69]     Admin. Proc. File No. 3-18673, In re First Western Advisors (Aug. 24, 2018), available at www.sec.gov/litigation/admin/2018/34-83934.pdf.
[70]     Admin. Proc. File 3-18765, In re Capital Analysts, LLC (Sept. 14, 2018), available at www.sec.gov/litigation/admin/2018/ia-5009.pdf.
[71]     Admin. Proc. File No. 3-18952, SEC Charges Tennessee Investment Advisory Firm and Two Advisory Representatives with Steering Clients to Higher-Fee Mutual Fund Share Classes (Dec. 21, 2018), available at www.sec.gov/enforce/34-84918-s.
[72]     SEC Press Release, Two Advisory Firms, CEO Charged With Mutual Fund Share Class Disclosure Violations (Dec. 21, 2018), available at www.sec.gov/news/press-release/2018-303.
[73]     Admin. Proc. File No. 3-18607, SEC Charges Beverly Hills Investment Adviser for Improper Fees and False Filings (July 20, 2018), available at www.sec.gov/enforce/ia-4975-s.
[74]     Admin. Proc. File No. 3-18657, In re Aria Partners GP, LLC (Aug. 22, 2018), available at www.sec.gov/litigation/admin/2018/ia-4991.pdf.
[75]     SEC Press Release, Transamerica Entities to Pay $97 Million to Investors Relating to Errors in Quantitative Investment Models (Aug. 27, 2018), available at www.sec.gov/news/press-release/2018-167.
[76]     SEC Press Release, SEC Charges Buffalo Advisory Firm and Principal With Fraud Relating to Association With Barred Adviser (Aug. 30, 2018), available at www.sec.gov/news/press-release/2018-172
[77]     Admin. Proc. File No. 3-18704, In re Mass. Financial Services Co. (Aug. 31, 2018), available at www.sec.gov/litigation/admin/2018/ia-4999.pdf.
[78]     Admin. Proc. File No 3-18729, In re VSS Fund Mmgt. LLC and Jeffrey T. Stevenson (Sept. 7, 2018), available at www.sec.gov/litigation/admin/2018/ia-5001.pdf.
[79]     SEC Press Release, SEC Charges Investment Advisers With Defrauding Retail Advisory Clients (Sept. 14, 2018), available at www.sec.gov/news/press-release/2018-195.
[80]     Admin. Proc. File No. 3-18948, In re Sterling Global Strategies LLC (Dec. 20, 2018), available at www.sec.gov/litigation/admin/2018/ia-5085.pdf.
[81]     SEC Press Release, SEC Charges Two Robo-Advisers With False Disclosures (Dec. 21, 2018), available at www.sec.gov/news/press-release/2018-300.
[82]     SEC Press Release, SEC Charges Ameriprise Financial Services for Failing to Safeguard Client Assets (Aug. 15, 2018), available at www.sec.gov/news/press-release/2018-154.
[83]     Admin. Proc. File No. 3-18884, SEC Charges Advisory Firm With Due Diligence and Monitoring Failures (Nov. 6, 2018), available at www.sec.gov/enforce/ia-5061-s.
[84]     Admin. Proc. File No. 3-18636, SEC Charges Investment Adviser With Mispricing Cross Trades Between Clients (Aug. 10, 2018), available at www.sec.gov/enforce/ia-4983-s.
[85]     Admin. Proc. File No. 3-18767, In re Cushing Asset Management, LP (Sept. 14, 2018), available at www.sec.gov/litigation/admin/2018/ic-33226.pdf.
[86]     Admin. Proc. File No. 3-18844, SEC Orders Putnam to Pay $1 Million Penalty, Suspends and Fines Former Portfolio Manager for Prearranged Cross-Trades (Sept. 27, 2018), available at www.sec.gov/enforce/ia-5050-s.
[87]     Admin. Proc. File Nos. 3-18586, 3-18587, 3-18588, 3-18589, 3-18590, SEC Charges Investment Advisers and Representatives for Violating the Testimonial Rule Using Social Media and the Internet (July 10, 2018), available at www.sec.gov/enforce/3-18586-90-s.
[88]     Admin. Proc. File No. 3-18779, Investment Adviser and Its President Settle Charges for Testimonial Rule and Code of Ethics Violations (Sept. 18, 2018), available at www.sec.gov/enforce/ia-5035-s.
[89]     Admin. Proc. File No. 3-18585, In re Oaktree Capital Management, L.P. (July 10, 2018), available at www.sec.gov/litigation/admin/2018/ia-4960.pdf.
[90]     Admin. Proc. File No. 3-18584, In re EnCap Investments L.P. (July 10, 2018), available at www.sec.gov/litigation/admin/2018/ia-4959.pdf.   
[91]     Admin. Proc. File No. 3-18599, Investment Adviser Settles Charges for Custody Rule Violations (July 17, 2018), available at www.sec.gov/enforce/ia-4970-s.
[92]     Admin. Proc. File No. 3-18837, Investment Adviser Settles Charges for Custody Rule and Compliance Rule Violations (Sept. 25, 2018), available at www.sec.gov/enforce/ia-5047-s.
[93]     SEC Press Release, Deutsche Bank to Pay Nearly $75 Million for Improper Handling of ADRs (Jul. 20, 2018), available at www.sec.gov/news/press-release/2018-138.
[94]     SEC Press Release, SG Americas Securities Charged for Improper Handling of ADRs (Sept. 25, 2018), available at www.sec.gov/news/press-release/2018-211.
[95]     SEC Press Release, Citibank to Pay More Than $38 Million for Improper Handling of ADRs (Nov. 7, 2018), available at www.sec.gov/news/press-release/2018-255.
[96]     Admin. Proc. File No. 3-18933, In re Bank of New York Mellon (Dec. 17, 2018), available at www.sec.gov/litigation/admin/2018/33-10586.pdf.
[97]     SEC Press Release, JPMorgan to Pay More Than $135 Million for Improper Handling of ADRs (Dec. 26, 2018), available at www.sec.gov/news/press-release/2018-306.
[98]     SEC Press Release, SEC Charges Mizuho Securities for Failure to Safeguard Customer Information (Jul. 23, 2018), available at www.sec.gov/news/press-release/2018-140.
[99]     SEC Press Release, SEC Obtains Relief to Fully Reimburse Retail Investors Sold Unsuitable Product (Sept. 11, 2018), available at www.sec.gov/news/press-release/2018-184.
[100]   SEC Press Release, Citigroup to Pay More Than $10 Million for Books and Records Violations and Inadequate Controls (Aug. 16, 2018), available at www.sec.gov/news/press-release/2018-155-0.
[101]   SEC Press Release, SEC Charges Moody's With Internal Controls Failures and Ratings Symbols Deficiencies (Aug. 28, 2018), available at www.sec.gov/news/press-release/2018-169.
[102]   SEC Litigation Release, SEC Charges Charles Schwab with Failing to Report Suspicious Transactions (Jul. 9, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24189.htm.
[103]   Admin. Proc. File No. 3-18829, In the Matter of TD Ameritrade, Inc. (Sept. 24, 2018), available at www.sec.gov/litigation/admin/2018/34-84269.pdf.
[104]   SEC Press Release, Brokerage Firm to Exit Penny stock Deposit Business and Pay Penalty for Repeatedly Failing to Report Suspicious Trading (Sept. 28, 2018), available at www.sec.gov/news/press-release/2018-225.
[105]   Admin. Proc. File No. 3-18931, SEC Charges UBS Financial Services Inc. with Anti-Money Laundering Violations (Dec. 17, 2018), available at www.sec.gov/enforce/34-84828-s.
[106]   Admin. Proc. File No. 30-18940, Broker-Dealer Settles Anti-Money Laundering Charges (Dec. 19, 2018), available at www.sec.gov/enforce/34-84851-s.
[107]   SEC Press Release, SEC Charges Citigroup for Dark Pool Misrepresentations (Sept. 14, 2018), available at www.sec.gov/news/press-release/2018-193.
[108]   SEC Press Release, Credit Suisse Agrees to Pay $10 Million to Settle Charges Related to Handling of Retail Customer Orders (Sept. 28, 2018), available at www.sec.gov/news/press-release/2018-224.
[109]   SEC Press Release, SEC Charges ITG With Misleading Dark Pool Subscribers (Nov. 7, 2018), available at www.sec.gov/news/press-release/2018-256.
[110]   SEC Press Release, SEC Charges BCG Financial for Failure to Preserve Documents and Maintain Accurate Books and Records (Jul. 17, 2018), available at www.sec.gov/news/press-release/2018-134.
[111]   SEC Press Release, Broker-Dealer to Pay $2.75 Million Penalty for Providing Deficient Blue Sheet Data (Sept. 13, 2018), available at www.sec.gov/news/press-release/2018-191.
[112]   SEC Press Release, Three Broker-Dealers to Pay More Than $6 Million in Penalties for Providing Deficient Blue Sheet Data (Dec. 10, 2018), available at www.sec.gov/news/press-release/2018-275.
[113]   SEC Press Release, SEC Charges Two Brokers With Defrauding Customers (Sept. 10, 2018), available at www.sec.gov/news/press-release/2018-183.
[114]   SEC Press Release, SEC Uses Data Analysis to Detect Cherry-Picking By Broker (Sept. 12, 2018), available at www.sec.gov/news/press-release/2018-189.
[115]   Admin. Proc. File No. 3-18941, In the Matter of Andrew Nicoletta et al. (Dec. 19, 2018), available at www.sec.gov/litigation/admin/2018/34-84876.pdf.
[116]   SEC Litigation Release, SEC Charges Former Heartland CEO, Romantic Partner in Insider Trading Scheme (Jul. 10, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24191.htm.
[117]   SEC Litigation Release, SEC Charges Former Executive for Insider Trading (Jul. 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24186.htm.
[118]   SEC Press Release, SEC Detects Silicon Valley Executive's Insider Trading (Jul. 24, 2018), available at www.sec.gov/news/press-release/2018-142.
[119]   Admin. Proc. File No. 3-18618, SEC Charges VP of Finance with Insider Trading (Jul. 31, 2018), available at www.sec.gov/enforce/34-83742-s.
[120]   SEC Litigation Release, SEC Charges Former Pharma Executive and Others with Insider Trading (Aug. 23, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24245.htm.
[121]   Admin. Proc. File No. 3-18665, In re James T. Lentz (Aug. 22, 2018), available at www.sec.gov/litigation/admin/2018/33-10535.pdf.
[122]   SEC Litigation Release, SEC Charges Former Senior Executive At Silicon Valley Company with Insider Trading (Aug. 30, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24251.htm.
[123]   SEC Litigation Release, SEC Charges Former Vice President of Ocwen Financial Corporation with Insider Trading (Sept. 28, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24298.htm.
[124]   SEC Litigation Release, SEC Charges Ebay's Former Director of SEC Reporting with Insider Trading (Oct. 16, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24317.htm.
[125]   SEC Litigation Release, SEC Charges Husband with Insider Trading Ahead of Announcements by Wife's Employer (Nov. 8, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24340.htm.
[126]   SEC Litigation Release, SEC Charges California Software Consultant with Insider Trading (Nov. 8, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24338.htm.
[127]   SEC Press Release, SEC Charges U.S. Congressman and Others With Insider Trading (Aug. 8, 2018), available at www.sec.gov/news/press-release/2018-151; see also SEC Litigation Release, SEC Announces Settlement with Two Traders in Innate Insider Trading Case (Aug. 16, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24236.htm.
[128]   Admin. Proc. File No. 34-83795, SEC Charges California Bank Board Member's Son with Insider Trading (Aug. 7, 2018), available at www.sec.gov/enforce/34-83795-s.
[129]   SEC Litigation Release, SEC Charges Former Stericycle Financial Analyst and His Mother with Insider Trading (Jul. 24, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24212.htm.
[130]   SEC Litigation Release, Former Equifax Manager Charged With Insider Trading (Jul. 2, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24183.htm.
[131]   SEC Litigation. Release, Former Biotech Company Employee Charged with Insider Trading (Jul. 10, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24194.htm.
[132]   SEC Litigation Release, SEC Charges Scientist for Insider Trading (Aug. 1, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24221.htm.
[133]   Admin. Proc. File No. 3-18645, In re Honglan Wang (Aug. 16, 2018), available at www.sec.gov/litigation/admin/2018/34-83857.pdf.
[134]   Admin. Proc. File No. 3-18655, SEC Charges Former In-House Counsel with Insider Trading (Aug. 21, 2018), available at www.sec.gov/enforce/34-83896-s.
[135]   SEC Press Release, SEC Charges Former Professional Motorcycle Racer, his Investment Adviser, and Others With Insider Trading (Sept. 27, 2018), available at www.sec.gov/enforce/34-84304-s.
[136]   SEC Press Release, SEC Charges NFL Player and Former Investment Banker With Insider Trading (Aug. 29, 2018), available at www.sec.gov/news/press-release/2018-170.
[137]   SEC Press Release, SEC Charges Family Friend of Former Investment Banker With Insider Trading (Nov. 2, 2018), available at www.sec.gov/news/press-release/2018-251.
[138]   SEC Litigation Release, SEC Charges Acquisition Advisor with Insider Trading (Sept. 14, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24269.htm.
[139]   SEC Litigation Release, SEC Charges Husband of Investment Banker with Insider Trading (Dec. 17, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24375.htm.
[140]   SEC Press Release, SEC Halts Alleged Insider Trading Ring Spanning Three Countries (Dec. 6, 2018), available at www.sec.gov/news/press-release/2018-273.
[141]   SEC Litigation Release, SEC Charges Certified Public Accountant with Insider Trading (Aug. 21, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24240.htm.
[142]   Admin. Proc. File No. 3-18652, Former Director At Major Accounting Firm Settles Insider Trading Charges (Aug. 20, 2018), available at www.sec.gov/enforce/34-83889-s.
[143]   Admin. Proc. File No. 3-18574, In re Michael Johnson (July 6, 2018), available at www.sec.gov/litigation/admin/2018/34-83602.pdf.
[144]   Admin. Proc. File No. 3-18858, In re Unal Patel (Sept. 28, 2018), available at www.sec.gov/litigation/admin/2018/34-84315.pdf.
[145]   SEC Press Release, SEC Files Charges in Municipal Bond "Flipping" and Kickback Schemes (Aug. 14, 2018), available at www.sec.gov/news/press-release/2018-153.
[146]   Admin. Proc. File No. 3-18936, SEC Charges Former Municipal Bond Salesman with Fraudulent Trading Practices (Dec. 18, 2018), available at www.sec.gov/enforce/33-10587-s.
[147]   Admin. Proc. File No. 3-18803, SEC Bars Head of Unregistered Municipal Advisory Firm for Failing to Disclose Material Facts to School District (Sept. 20, 2018), available at www.sec.gov/enforce/34-84224-s.

The following Gibson Dunn lawyers assisted in the preparation of this client update:  Marc Fagel, Amy Mayer, Andrew Paulson, Tina Samanta, Elizabeth Snow, Craig Streit, Collin James Vierra, Timothy Zimmerman and Maya Ziv. Gibson Dunn is one of the nation's leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators. Our Securities Enforcement Group offers broad and deep experience.  Our partners include the former Directors of the SEC's New York and San Francisco Regional Offices, the former head of FINRA's Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California, and former Assistant United States Attorneys from federal prosecutors' offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force. Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Group, and our White Collar Defense Group. Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work or any of the following: New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Barry R. Goldsmith (+1 212-351-2440, bgoldsmith@gibsondunn.com) Laura Kathryn O'Boyle (+1 212-351-2304, ) Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Tina Samanta (+1 212-351-2469 , tsamanta@gibsondunn.com) Washington, D.C. Stephanie L. Brooker (+1 202-887-3502, sbrooker@gibsondunn.com) Daniel P. Chung(+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Richard W. Grime (+1 202-955-8219, rgrime@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tadavis@gibsondunn.com) Marc J. Fagel (+1 415-393-8332, mfagel@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Michael D. Celio (+1 650-849-5326, mcelio@gibsondunn.com) Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 29, 2018 |
SEC Imposes Civil Penalties for ICO Registration Violations; Suggests a Path for Future Compliance

Click for PDF On November 16, 2018, the Securities and Exchange Commission (SEC) announced settled charges in its first cases imposing civil penalties solely for registration violations related to initial coin offerings (ICOs).[1]  The SEC brought charges against CarrierEQ Inc. (AirFox) and Paragon Coin Inc. (Paragon) for their respective ICOs conducted in 2017 on the basis that (i) the digital tokens sold in those ICOs were securities under Section 2(a)(1) of the Securities Act of 1933 (Securities Act) and (ii) those securities were neither registered nor exempt from registration under Section 5 of the Securities Act. Both AirFox and Paragon issued unregistered tokens in spite of an earlier warning from the SEC that certain tokens, coins or other digital assets can be considered securities under the federal securities laws and, consequently, issuers who offer or sell such securities must register the offering and sale with the SEC or qualify for an exemption.[2]  The cases follow the SEC's first non-fraud registration case, Munchee, Inc., in which the SEC halted a coin sale by means of cease-and-desist order and no monetary penalties were imposed. In 2017, AirFox raised approximately $15 million worth of digital assets to finance its development of a token-denominated "ecosystem," and Paragon raised approximately $12 million worth of digital assets to develop and implement its business plan related to the cannabis industry. After reviewing the nature of these tokens, the SEC concluded that they were securities under the Howey test, thereby making those offerings subject to the requirements of Section 5 of the Securities Act and related rules. The resolution of these charges has been suggested as a "model for companies that have issued tokens in ICOs . . . to seek to comply with the federal securities laws," according to Steven Peiken, Co-Director of the SEC's Enforcement Division.  The remedy has three parts.  First, both Airfox and Paragon agreed to pay monetary penalties of $250,000 each.  Second, in a nod to the statutory remedies provided by Section 12(a)(1) of the Securities Act, both companies agreed to distribute a "claim form" to their respective investors whereby purchased tokens could be exchanged for the amount of consideration paid plus interest and, for those investors no longer in possession of their purchased tokens, damages.  The  "claim form" approach was agreed to over another potential remedy used by other companies in the past, a "rescission offer" in which the companies would offer to repurchase issued tokens and, in the event an investor declined that offer, such investor would hold freely tradable tokens.  Third, perhaps most significantly, both companies agreed to register the tokens as securities under the Exchange Act and file periodic reports with the SEC, thereby granting investors the disclosure protections of the securities laws in deciding whether to put their securities.  It is likely that compliance with this regime will likely impose significant compliance burdens, particularly on smaller issuers.  It remains to be seen whether other ICO issuers who have conducted unregistered securities offerings will opt for this remedy following discussions with the SEC.


[1]   See SEC Release No. 10574 and Release No. 10575.
[2]   See Report of Investigation Pursuant To Section 21(a) Of The Securities Exchange Act of 1934: The DAO (Exchange Act Rel. No. 81207) (July 25, 2017)). See also www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?List=f3551fe8-411e-4ea4-830c-d680a8c0da43&ID=297&Web=97364e78-c7b4-4464-a28c-fd4eea1956ac.
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long, Alan Bannister, Nicolas Dumont, and Jordan Garside. Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm's Financial Institutions, Capital Markets or Securities Enforcement practice groups, or the following: Financial Institutions and Capital Markets Groups: Arthur S. Long - New York (+1 212-351-2426, along@gibsondunn.com) J. Alan Bannister - New York (+1 212-351-2310, abannister@gibsondunn.com) Nicolas H.R. Dumont - New York (+1 212-351-3837, ndumont@gibsondunn.com) Stewart L. McDowell - San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Securities Enforcement Group: Marc J. Fagel - San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Mark K. Schonfeld - New York (+1 212-351-2433, mschonfeld@gibsondunn.com)
© 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 1, 2018 |
U.S. News – Best Lawyers® Awards Gibson Dunn 132 Top-Tier Rankings

U.S. News – Best Lawyers® awarded Gibson Dunn Tier 1 rankings in 132 practice area categories in its 2019 “Best Law Firms” [PDF] survey. Overall, the firm earned 169 rankings in nine metropolitan areas and nationally. Additionally, Gibson Dunn was recognized as “Law Firm of the Year” for Litigation – Antitrust and Litigation – Securities. Firms are recognized for “professional excellence with persistently impressive ratings from clients and peers.” The recognition was announced on November 1, 2018.

October 17, 2018 |
SEC Warns Public Companies on Cyber-Fraud Controls

Click for PDF On October 16, 2018, the Securities and Exchange Commission issued a report warning public companies about the importance of internal controls to prevent cyber fraud.  The report described the SEC Division of Enforcement's investigation of multiple public companies which had collectively lost nearly $100 million in a range of cyber-scams typically involving phony emails requesting payments to vendors or corporate executives.[1] Although these types of cyber-crimes are common, the Enforcement Division notably investigated whether the failure of the companies' internal accounting controls to prevent unauthorized payments violated the federal securities laws.  The SEC ultimately declined to pursue enforcement actions, but nonetheless issued a report cautioning public companies about the importance of devising and maintaining a system of internal accounting controls sufficient to protect company assets. While the SEC has previously addressed the need for public companies to promptly disclose cybersecurity incidents, the new report sees the agency wading into corporate controls designed to mitigate such risks.  The report encourages companies to calibrate existing internal controls, and related personnel training, to ensure they are responsive to emerging cyber threats.  The report (issued to coincide with National Cybersecurity Awareness Month) clearly intends to warn public companies that future investigations may result in enforcement action. The Report of Investigation Section 21(a) of the Securities Exchange Act of 1934 empowers the SEC to issue a public Report of Investigation where deemed appropriate.  While SEC investigations are confidential unless and until the SEC files an enforcement action alleging that an individual or entity has violated the federal securities laws, Section 21(a) reports provide a vehicle to publicize investigative findings even where no enforcement action is pursued.  Such reports are used sparingly, perhaps every few years, typically to address emerging issues where the interpretation of the federal securities laws may be uncertain.  (For instance, recent Section 21(a) reports have addressed the treatment of digital tokens as securities and the use of social media to disseminate material corporate information.) The October 16 report details the Enforcement Division's investigations into the internal accounting controls of nine issuers, across multiple industries, that were victims of cyber-scams. The Division identified two specific types of cyber-fraud – typically referred to as business email compromises or "BECs" – that had been perpetrated.  The first involved emails from persons claiming to be unaffiliated corporate executives, typically sent to finance personnel directing them to wire large sums of money to a foreign bank account for time-sensitive deals. These were often unsophisticated operations, textbook fakes that included urgent, secret requests, unusual foreign transactions, and spelling and grammatical errors. The second type of business email compromises were harder to detect. Perpetrators hacked real vendors' accounts and sent invoices and requests for payments that appeared to be for otherwise legitimate transactions. As a result, issuers made payments on outstanding invoices to foreign accounts controlled by impersonators rather than their real vendors, often learning of the scam only when the legitimate vendor inquired into delinquent bills. According to the SEC, both types of frauds often succeeded, at least in part, because responsible personnel failed to understand their company's existing cybersecurity controls or to appropriately question the veracity of the emails.  The SEC explained that the frauds themselves were not sophisticated in design or in their use of technology; rather, they relied on "weaknesses in policies and procedures and human vulnerabilities that rendered the control environment ineffective." SEC Cyber-Fraud Guidance Cybersecurity has been a high priority for the SEC dating back several years. The SEC has pursued a number of enforcement actions against registered securities firms arising out of data breaches or deficient controls.  For example, just last month the SEC brought a settled action against a broker-dealer/investment-adviser which suffered a cyber-intrusion that had allegedly compromised the personal information of thousands of customers.  The SEC alleged that the firm had failed to comply with securities regulations governing the safeguarding of customer information, including the Identity Theft Red Flags Rule.[2] The SEC has been less aggressive in pursuing cybersecurity-related actions against public companies.  However, earlier this year, the SEC brought its first enforcement action against a public company for alleged delays in its disclosure of a large-scale data breach.[3] But such enforcement actions put the SEC in the difficult position of weighing charges against companies which are themselves victims of a crime.  The SEC has thus tried to be measured in its approach to such actions, turning to speeches and public guidance rather than a large number of enforcement actions.  (Indeed, the SEC has had to make the embarrassing disclosure that its own EDGAR online filing system had been hacked and sensitive information compromised.[4]) Hence, in February 2018, the SEC issued interpretive guidance for public companies regarding the disclosure of cybersecurity risks and incidents.[5]  Among other things, the guidance counseled the timely public disclosure of material data breaches, recognizing that such disclosures need not compromise the company's cybersecurity efforts.  The guidance further discussed the need to maintain effective disclosure controls and procedures.  However, the February guidance did not address specific controls to prevent cyber incidents in the first place. The new Report of Investigation takes the additional step of addressing not just corporate disclosures of cyber incidents, but the procedures companies are expected to maintain in order to prevent these breaches from occurring.  The SEC noted that the internal controls provisions of the federal securities laws are not new, and based its report largely on the controls set forth in Section 13(b)(2)(B) of the Exchange Act.  But the SEC emphasized that such controls must be "attuned to this kind of cyber-related fraud, as well as the critical role training plays in implementing controls that serve their purpose and protect assets in compliance with the federal securities laws."  The report noted that the issuers under investigation had procedures in place to authorize and process payment requests, yet were still victimized, at least in part "because the responsible personnel did not sufficiently understand the company's existing controls or did not recognize indications in the emailed instructions that those communications lacked reliability." The SEC concluded that public companies' "internal accounting controls may need to be reassessed in light of emerging risks, including risks arising from cyber-related frauds" and "must calibrate their internal accounting controls to the current risk environment." Unfortunately, the vagueness of such guidance leaves the burden on companies to determine how best to address emerging risks.  Whether a company's controls are adequate may be judged in hindsight by the Enforcement Division; not surprisingly, companies and individuals under investigation often find the staff asserting that, if the controls did not prevent the misconduct, they were by definition inadequate.  Here, the SEC took a cautious approach in issuing a Section 21(a) report highlighting the risk rather than publicly identifying and penalizing the companies which had already been victimized by these scams. However, companies and their advisors should assume that, with this warning shot across the bow, the next investigation of a similar incident may result in more serious action.  Persons responsible for designing and maintaining the company's internal controls should consider whether improvements (such as enhanced trainings) are warranted; having now spoken on the issue, the Enforcement Division is likely to view corporate inaction as a factor in how it assesses the company's liability for future data breaches and cyber-frauds.


   [1]   SEC Press Release (Oct. 16, 2018), available at www.sec.gov/news/press-release/2018-236; the underlying report may be found at www.sec.gov/litigation/investreport/34-84429.pdf.
   [2]   SEC Press Release (Sept. 16, 2018), available at www.sec.gov/news/press-release/2018-213.  This enforcement action was particularly notable as the first occasion the SEC relied upon the rules requiring financial advisory firms to maintain a robust program for preventing identify theft, thus emphasizing the significance of those rules.
   [3]   SEC Press Release (Apr. 24, 2018), available at www.sec.gov/news/press-release/2018-71.
   [4]   SEC Press Release (Oct. 2, 2017), available at www.sec.gov/news/press-release/2017-186.
   [5]   SEC Press Release (Feb. 21, 2018), available at www.sec.gov/news/press-release/2018-22; the guidance itself can be found at www.sec.gov/rules/interp/2018/33-10459.pdf.  The SEC provided in-depth guidance in this release on disclosure processes and considerations related to cybersecurity risks and incidents, and complements some of the points highlighted in the Section 21A report.

Gibson Dunn's lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work in the firm's Securities Enforcement or Privacy, Cybersecurity and Consumer Protection practice groups, or the following authors:

Marc J. Fagel - San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Alexander H. Southwell - New York (+1 212-351-3981, asouthwell@gibsondunn.com)

Please also feel free to contact the following practice leaders and members:

Securities Enforcement Group:

New York Barry R. Goldsmith - Co-Chair (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark K. Schonfeld - Co-Chair (+1 212-351-2433, mschonfeld@gibsondunn.com) Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Laura Kathryn O'Boyle (+1 212-351-2304, ) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Washington, D.C. Richard W. Grime - Co-Chair (+1 202-955-8219, rgrime@gibsondunn.com) Stephanie L. Brooker  (+1 202-887-3502, sbrooker@gibsondunn.com) Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Marc J. Fagel - Co-Chair (+1 415-393-8332, mfagel@gibsondunn.com) Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tdavis@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com) Privacy, Cybersecurity and Consumer Protection Group: Alexander H. Southwell - Co-Chair, New York (+1 212-351-3981, asouthwell@gibsondunn.com) M. Sean Royall - Dallas (+1 214-698-3256, sroyall@gibsondunn.com) Debra Wong Yang - Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com) Christopher Chorba - Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Richard H. Cunningham - Denver (+1 303-298-5752, rhcunningham@gibsondunn.com) Howard S. Hogan - Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com) Joshua A. Jessen - Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com) Kristin A. Linsley - San Francisco (+1 415-393-8395, ) H. Mark Lyon - Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Shaalu Mehra - Palo Alto (+1 650-849-5282, smehra@gibsondunn.com) Karl G. Nelson - Dallas (+1 214-698-3203, knelson@gibsondunn.com) Eric D. Vandevelde - Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com) Benjamin B. Wagner - Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com) Michael Li-Ming Wong - San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com) Ryan T. Bergsieker - Denver (+1 303-298-5774, rbergsieker@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 2, 2018 |
M&A Report – Fresenius Marks a Watershed Development in the Analysis of “Material Adverse Effect” Clauses

Click for PDF On October 1, 2018, in Akorn, Inc. v. Fresenius Kabi AG,[1]  the Delaware Court of Chancery determined conclusively for the first time that a buyer had validly terminated a merger agreement due to the occurrence of a "material adverse effect" (MAE). Though the decision represents a seminal development in M&A litigation generally, Vice Chancellor Laster grounded his decision in a framework that comports largely with the ordinary practice of practitioners. In addition, the Court went to extraordinary lengths to explicate the history between the parties before concluding that the buyer had validly terminated the merger agreement, and so sets the goalposts for a similar determination in the future to require a correspondingly egregious set of facts. As such, the ripple effects of Fresenius in future M&A negotiations may not be as acute as suggested in the media.[2]

Factual Overview

On April 24, 2017, Fresenius Kabi AG, a pharmaceutical company headquartered in Germany, agreed to acquire Akorn, Inc., a specialty generic pharmaceutical manufacturer based in Illinois. In the merger agreement, Akorn provided typical representations and warranties about its business, including its compliance with applicable regulatory requirements. In addition, Fresenius's obligation to close was conditioned on Akorn's representations being true and correct both at signing and at closing, except where the failure to be true and correct would not reasonably be expected to have an MAE. In concluding that an MAE had occurred, the Court focused on several factual patterns:
  • Long-Term Business Downturn. Shortly after Akorn's stockholders approved the merger (three months after the execution of the merger agreement), Akorn announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 84% and 96%, respectively. Akorn attributed the declines to the unexpected entrance of new competitors, the loss of a key customer contract and the attrition of its market share in certain products. Akorn revised its forecast downward for the following quarter, but fell short of that goal as well and announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 89% and 105%, respectively. Akorn ascribed the results to unanticipated supply interruptions, added competition and unanticipated price erosion; it also adjusted downward its long-term forecast to reflect dampened expectations for the commercialization of its pipeline products. The following quarter, Akorn reported year-over-year declines in quarterly revenues, operating income and earnings per share of 34%, 292% and 300%, respectively. Ultimately, over the course of the year following the signing of the merger agreement, Akorn's EBITDA declined by 86%.
  • Whistleblower Letters. In late 2017 and early 2018, Fresenius received anonymous letters from whistleblowers alleging flaws in Akorn's product development and quality control processes. In response, relying upon a covenant in the merger agreement affording the buyer reasonable access to the seller's business between signing and closing, Fresenius conducted a meticulous investigation of the Akorn business using experienced outside legal and technical advisors. The investigation revealed grievous flaws in Akorn's quality control function, including falsification of laboratory data submitted to the FDA, that cast doubt on the accuracy of Akorn's compliance with laws representations. Akorn, on the other hand, determined not to conduct its own similarly wide-ranging investigation (in contravention of standard practice for an FDA-regulated company) for fear of uncovering facts that could jeopardize the deal. During a subsequent meeting with the FDA, Akorn omitted numerous deficiencies identified in the company's quality control group and presented a "one-sided, overly sunny depiction."
  • Operational Changes. Akorn did not operate its business in the ordinary course after signing (despite a covenant requiring that it do so) and fundamentally changed its quality control and information technology (IT) functions without the consent of Fresenius. Akorn management replaced regular internal audits with "verification" audits that only addressed prior audit findings rather than identifying new problems. Management froze investments in IT projects, which reduced oversight over data integrity issues, and halted efforts to investigate and remediate quality control issues and data integrity violations out of concern that such investigations and remediation would upend the transaction. Following signing, NSF International, an independent, accredited standards development and certification group focused on health and safety issues, also identified numerous deficiencies in Akorn's manufacturing facilities.

Conclusions and Key Takeaways

The Court determined, among others, that the sudden and sustained drop in Akorn's business performance constituted a "general MAE" (that is, the company itself had suffered an MAE), Akorn's representations with respect to regulatory compliance were not true and correct, and the deviation between the as-represented condition and its actual condition would reasonably be expected to result in an MAE. In addition, the Court found that the operational changes implemented by Akorn breached its covenant to operate in the ordinary course of business. Several aspects of the Court's analysis have implications for deal professionals:
  • Highly Egregious Facts. Although the conclusion that an MAE occurred is judicially unprecedented in Delaware, it is not surprising given the facts. The Court determined that Akorn had undergone sustained and substantial declines in financial performance, credited testimony suggesting widespread regulatory noncompliance and malfeasance in the Akorn organization and suggested that decisions made by Akorn regarding health and safety were re-prioritized in light of the transaction (and in breach of a highly negotiated interim operating covenant). In In re: IBP, Inc. Shareholders Litigation, then-Vice Chancellor Strine described himself as "confessedly torn" over a case that involved a 64% year-over-year drop-off in quarterly earnings amid allegations of improper accounting practices, but determined that no MAE had occurred because the decline in earnings was temporary. In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., Vice Chancellor Lamb emphasized that it was "not a coincidence" that "Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement" and concluded the same, given that the anticipated decline in the target's EBITDA would only be 7%. No such hesitation can be found in the Fresenius opinion.[3]
  • MAE as Risk Allocation Tool. The Court framed MAE clauses as a form of risk allocation that places "industry risk" on the buyer and "company-specific" risk on the seller. Explained in a more nuanced manner, the Court categorized "business risk," which arises from the "ordinary operations of the party's business" and which includes those risks over which "the party itself usually has significant control", as being retained by the seller. By contrast, the Court observed that the buyer ordinarily assumes three others types of risk—namely, (i) systematic risks, which are "beyond the control of all parties," (ii) indicator risks, which are markers of a potential MAE, such as a drop in stock price or a credit rating downgrade, but are not underlying causes of any MAE themselves, and (iii) agreement risks, which include endogenous risks relating to the cost of closing a deal, such as employee flight. This framework comports with the foundation upon which MAE clauses are ordinarily negotiated and underscores the importance that sellers negotiate for industry-specific carve-outs from MAE clauses, such as addressing adverse decisions by governmental agencies in heavily regulated industries.
  • High Bar to Establishing an MAE. The Court emphasized the heavy burden faced by a buyer in establishing an MAE. Relying upon the opinions that emerged from the economic downturns in 2001 and 2008,[4]  the Court reaffirmed that "short-term hiccups in earnings" do not suffice; rather, the adverse change must be "consequential to the company's long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months." The Court underscored several relevant facts in this case, including (i) the magnitude and length of the downturn, (ii) the suddenness with which the EBITDA decline manifested (following five consecutive years of growth) and (iii) the presence of factors suggesting "durational significance," including the entrance of new and unforeseen competitors and the permanent loss of key customers.[5]
  • Evaluation of Targets on a Standalone Basis. Akorn advanced the novel argument that an MAE could not have occurred because the purchaser would have generated synergies through the combination and would have generated profits from the merger. The Court rejected this argument categorically, finding that the MAE clause was focused solely on the results of operations and financial condition of the target and its subsidiaries, taken as a whole (rather than the surviving corporation or the combined company), and carved out any effects arising from the "negotiation, execution, announcement or performance" of the merger agreement or the merger itself, including "the generation of synergies." Given the Court's general aversion to considering synergies as relevant to determining an MAE, buyers should consider negotiating to include express references to synergies in defining the concept of an MAE in their merger agreements.
  • Disproportionate Effect. Fresenius offers a useful gloss on the importance to buyers of including "disproportionate effects" qualifications in MAE carve-outs regarding industry-wide events. Akorn argued that it faced "industry headwinds" that caused its decline in performance, such as heightened competition and pricing pressure as well as regulatory actions that increased costs. However, the Court rejected this view because many of the causes of Akorn's poor performance were actually specific to Akorn, such as new market entrants in Akorn's top three products and Akorn's loss of a specific key contract. As such, these "industry effects" disproportionately affected and were allocated from a risk-shifting perspective to Akorn. To substantiate this conclusion, the Court relied upon evidence that Akorn's EBITDA decline vastly exceeded its peers.
  • The Bring-Down Standard. A buyer claiming that a representation given by the target at closing fails to satisfy the MAE standard must demonstrate such failure qualitatively and quantitatively. The Court focused on a number of qualitative harms wrought by the events giving rise to Akorn's failure to bring down its compliance with laws representation at closing, including reputational harm, loss of trust with principal regulators and public questioning of the safety and efficacy of Akorn's products. With respect to quantitative measures of harm, Fresenius and Akorn presented widely ranging estimates of the cost of remedying the underlying quality control challenges at Akorn. Using the midpoint of those estimates, the Court estimated the financial impact to be approximately 21% of Akorn's market capitalization. However, despite citing several proxies for financial performance suggesting that this magnitude constituted an MAE, the Court clearly weighted its analysis towards qualitative factors, noting that "no one should fixate on a particular percentage as establishing a bright-line test" and that "no one should think that a General MAE is always evaluated using profitability metrics and an MAE tied to a representation is always tied to the entity's valuation." Indeed, the Court observed that these proxies "do not foreclose the possibility that a buyer could show that percentage changes of a lesser magnitude constituted an MAE. Nor does it exclude the possibility that a buyer might fail to prove that percentage changes of a greater magnitude constituted an MAE."
Fresenius offers a useful framework for understanding how courts analyze MAE clauses. While this understanding largely comports with the approach taken by deal professionals, the case nevertheless offers a reminder that an MAE, while still quite unlikely, can occur. Deal professionals would be well-advised to be thoughtful about how the concept should be defined and used in an agreement.

   [1]   Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018).
   [2]   See, e.g., Jef Feeley, Chris Dolmetsch & Joshua Fineman, Akorn Plunges After Judge Backs Fresenius Exit from Deal, Bloomberg (Oct 1, 2018) ("'The ruling is a watershed moment in Delaware law, and will be a seminal case for those seeking to get out of M&A agreements,' Holly Froum, an analyst with Bloomberg Intelligence, said in an emailed statement."); Tom Hals, Delaware Judge Says Fresenius Can Walk Away from $4.8 Billion Akorn Deal, Reuters (Oct. 1, 2018) ("'This is a landmark case,' said Larry Hamermesh, a professor at Delaware Law School in Wilmington, Delaware.").
   [3]   The egregiousness of the facts in this case is further underscored by the fact that the Court determined that the buyer had breached its own covenant to use its reasonable best efforts to secure antitrust clearance, but that this breach was "temporary" and "not material."
   [4]   See, e.g., Hexion Specialty Chems. Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008); In re: IBP, Inc. S'holders Litig., 789 A.2d 14 (Del. Ch. 2001).
   [5]   This view appears to comport with the analysis highlighted by the Court from In re: IBP, Inc. Shareholders Litigation, in which the court determined that an MAE had not transpired in part because the target's "problems were due in large measure to a severe winter, which adversely affected livestock supplies and vitality." In re: IBP, 789 A.2d at 22. In this case, the decline of Akorn was not the product of systemic risks or cyclical declines, but rather a company-specific effect.

The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Andrew Herman, Saee Muzumdar, Adam Offenhartz, and Daniel Alterbaum. Gibson Dunn's lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm's Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker - Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman - Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover - Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman - New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne - Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Mark D. Director - Washington, D.C./New York (+1 202-955-8508/+1 212-351-5308, mdirector@gibsondunn.com) Andrew M. Herman - Washington, D.C./New York (+1 202-955-8227/+1 212-351-5389, aherman@gibsondunn.com) Eduardo Gallardo - New York (+1 212-351-3847, egallardo@gibsondunn.com) Saee Muzumdar - New York (+1 212-351-3966, smuzumdar@gibsondunn.com) Mergers and Acquisitions Group / Litigation: Meryl L. Young - Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz - San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu - New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins - Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang - Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz - Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz - New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 10, 2018 |
Private Funds and the Clayton SEC: Out From Under the Microscope?

San Francisco partner Marc Fagel is the co-author of "Private Funds and the Clayton SEC: Out From Under the Microscope?" [PDF] published in the July/August 2018 issue of Practical Compliance & Risk Management For the Securities Industry.

July 30, 2018 |
2018 Mid-Year Securities Enforcement Update

Click for PDF

I.  Significant Developments

A.  Introduction

For a brief moment in time, after several years with as many as 3 of the 5 commissioner seats vacant, the SEC was operating at full force, with the January 2018 swearing in of newest commissioners Hester Peirce and Robert Jackson.  This situation was short-lived, as Commissioner Piwowar, a Republican appointee with a deregulatory bent who had pulled back on certain enforcement powers, stepped down at the beginning of July.  While the president has named a potential replacement, the Senate has not yet held confirmation hearings; with Democratic Commissioner Kara Stein also set to leave the agency sometime later this year, the Senate may defer consideration until both the Republican and Democratic nominees have been named.  The vacancy could cause the Commission, which has already split on several key rulemakings, to defer some more controversial regulatory initiatives and even some enforcement actions which pose thornier policy questions. Meanwhile, the most noteworthy Enforcement-related event came with the Supreme Court's Lucia decision, in which the Court held that the agency's administrative law judges have been unconstitutionally appointed, resolving a technical but significant legal issue which has dogged the SEC's administrative proceedings for several years.  As discussed further below, the decision throws a wrench in the works for the Enforcement Division, which until the past couple years had been litigating a growing number of enforcement actions in its administrative forum rather than in federal court. In terms of enforcement priorities, the SEC has continued to pursue a relatively small number of significant public company cases; despite a push in recent years to increase its focus on accounting fraud, few new actions were filed in the first half of 2018.  In contrast, the Division filed a surprisingly large number of cases against investment advisers and investment companies, including advisers to individual retail clients, private fund managers, and mutual fund managers. And the SEC's concentration on all things "cyber" continued to make headlines in the initial months of 2018.  The SEC rolled out guidance on appropriate cybersecurity disclosures, and filed its first (and to date only) case against a public company for allegedly failing to report a data breach to investors on a timely basis.  Additionally, the SEC continues to institute enforcement actions in the cryptocurrency space, though is focus remains primarily on outright frauds, leaving ongoing uncertainty as to the regulatory status of certain digital assets.

B.  Significant Legal Developments

On June 21, 2018, the Supreme Court ruled in Lucia v. SEC that the SEC's administrative law judges (ALJs) were inferior officers of the United States for purposes of the Constitution's Appointments Clause, and that the SEC had failed to properly appoint its ALJs in a manner consistent with the Clause.[1]  (Mr. Lucia was represented by Gibson Dunn before the Supreme Court.)  After several years in which the SEC had increasingly filed contested proceedings administratively rather than in federal district court, the agency reversed course in the face of mounting court challenges to the constitutionality of its ALJs (who had been appointed by a government personnel office rather than by the commissioners themselves).  Even with the reduced number of pending, litigated administrative proceedings, the SEC still faces the prospect of retrying dozens of cases which had been tried before improperly-appointed ALJs.  As this report went to press, the SEC had yet to determine how it would handle these pending cases, or how or when it would go about appointing ALJs to hear litigated administrative proceedings going forward. Even with Lucia resolving the primary legal question which had been floating about in recent years, other questions about the legality of ALJs may continue to complicate administrative proceedings, and thus for the time being the SEC has determined to pursue most litigated cases in court.  (Though the SEC continues to bring settled administrative proceedings, as such settled orders are issued by the Commission itself rather than by an ALJ.) Another Supreme Court decision that curtailed SEC enforcement actions, SEC v. Kokesh, continues to impact the enforcement program.  As detailed previously, in June 2017 the Supreme Court overturned a lower court ruling that required the defendant to disgorge $34.9 million for conduct dating back to 1995.  The Supreme Court found that disgorgement was a form of penalty and was therefore subject to a five-year statute of limitations.[2]  In March 2018, on remand, the Tenth Circuit determined that the statute of limitations still did not bar the SEC's action since the "clock" restarted with each act of misappropriation.[3]  Moreover, notwithstanding Kokesh, the issue of whether SEC actions seeking injunctive relief or other non-monetary sanctions (such as industry bars) are governed by the five-year statute remains hotly contested.  In a May 2018 speech, Co-Enforcement Director Steven Peiken noted that the SEC continues to maintain that injunctive relief is not subject to the five-year statute of limitations under Kokesh, and admonished parties that the staff would not forgo pursuing actions based on such arguments.[4]  However, the issue is far from settled, and just this month a district court came to a different conclusion.[5] In June, the Supreme Court granted a petition of certiorari filed by Francis V. Lorenzo, an investment banker who copied and pasted his boss's allegedly fraudulent email into a message to his clients and who the D.C. Circuit found liable for fraud as a result[6].  Mr. Lorenzo has argued that, based on the Supreme Court's 2011 decision in Janus Capital Group Inc. v. First Derivative Traders, he should not be considered the "maker" of the allegedly fraudulent statements.  Mr. Lorenzo's petition asserts that the D.C. Circuit decision allows the SEC to avoid the requirements of Janus by characterizing fraud claim as "fraudulent scheme" claims.  A circuit split exists as to whether a misstatement alone can form the basis of a fraudulent scheme claim.

C.  Whistleblower Developments

The first half of 2018 saw the SEC's largest whistleblower bounties to date, as well as some related rulemaking proposals which could potentially cap such awards.  As of April, the SEC reported that it had paid more than $266 million to 55 whistleblowers since 2012.[7] In March, the SEC announced its highest-ever whistleblower awards, paying a combined $50 million to two individuals and an additional $33 million to a third.[8]  While the SEC may not disclose the identities of whistleblowers, their counsel subsequently publicly disclosed that the awards were paid in connection with a $415 million SEC settlement with a major financial institution alleged to have misused customer cash.[9]  In its Order granting the awards, the Commission declined to grant awards to additional putative whistleblowers and, in doing so, clarified the standard for finding that a tip "led to" the success of a particular action.[10]  For a tip to "significantly contribute[] to the success of an . . . action" and entitle the whistleblower to an award, the "information must have been 'meaningful,'" i.e., must "'make a substantial and important contribution' to the success of the . . . action."  The Commission declined to adopt a more flexible standard. In a separate action the following month, the SEC awarded $2.2 million to a former company insider.[11]  The SEC noted that the $2.2 million award was paid under the 120-day "safe harbor" rule, which provides that, when a whistleblower reports to another federal agency and then submits the same information to the SEC within 120 days, the SEC will treat the information as having been submitted on the day it was submitted to the other agency.  A week later, the SEC announced a $2.1 million award to a former company insider whose tips had led to "multiple" successful enforcement actions.[12] In addition to developments relating to award payments, the first half of 2018 also included a Supreme Court decision affecting the rights of whistleblowers pursuant to anti-retaliation protections.  In Digital Realty Trust, the Court overturned the Ninth Circuit's decision (described in our 2017 Year-End Update) and found that Dodd-Frank's anti-retaliation measures protect only whistleblowers who report their concerns to the SEC and not those who only report internally.[13] Finally, in a late June open meeting, the Commission voted to propose various amendments to its whistleblower program.[14]  In response to the record-breaking award noted above, the proposed rules would give the SEC discretion to limit the size of awards in cases resulting in monetary sanctions greater than $100 million (which, given a permissible award size of 10-30% of money collected by the SEC, would effectively create a $30 million award cap).  Other proposed amendments include:
  • allowing awards based on deferred prosecution agreements and non-prosecution agreements entered into in criminal cases;
  • permitting awards made when the Commission reaches a settlement outside the context of a judicial or administrative proceeding;
  • allowing the SEC to bar individuals from later seeking awards after they submit false or frivolous claims;
  • and, in response to Digital Realty, requiring a whistleblower to submit information in writing to receive retaliation protection.

D.  Cybersecurity and Cryptocurrency

In 2017, the SEC touted cybersecurity as a major enforcement priority and created a dedicated "Cyber Unit" to investigate and prosecute cyber-related threats.  The SEC's cyber-focus continued in the first half of 2018 with its February release of interpretive guidance on public companies' disclosure obligations regarding cybersecurity risks and incidents.[15]  The Guidance, which reaffirms and expands upon the SEC Division of Corporation Finance's existing guidance on the topic from 2011, encourages companies to adopt "comprehensive policies and procedures related to cybersecurity," and to consider how their insider trading policies address trading related to cybersecurity incidents.  While not creating any bright-line rules, it discusses that the "materiality of cybersecurity risks and incidents depends upon their nature, extent, and potential magnitude," as well as "the range of harm that such incidents could cause," including "harm to a company's reputation, financial performance, and customer and vendor relationships, as well as the possibility of litigation or regulatory investigations or actions."  The SEC further noted that the existence of an ongoing internal or external investigation into an incident "would not on its own provide a basis for avoiding disclosures" of an otherwise material incident.  As discussed further below, the Guidance was followed two months later by the SEC's announcement of its first enforcement action against a company arising out of a data breach. Regarding the continuing proliferation of digital (or "crypto") currencies, the staff of the SEC's Divisions of Enforcement and Trading and Markets issued a statement in March reinforcing that digital platforms that trade securities and operate as an "exchange," as defined by the federal securities laws, must register as a national securities exchange or operate under an exemption from registration.[16]  The statement also outlines a list of questions that potential investors should consider before deciding to trade on such platforms.  The statement came on the heels of a litigated enforcement action charging a bitcoin-denominated platform, BitFunder, and its founder with operating an unregistered securities exchange, defrauding users by misappropriating their bitcoins and failing to disclose a cyberattack, and making false and misleading statements in connection with an unregistered offering of securities.[17]  In a parallel criminal case, the U.S. Attorney's Office charged BitFunder's founder with perjury and obstruction of the SEC's investigation. The SEC also brought a handful of initial coin offering (ICO) enforcement actions in the first half of 2018.  In January, the SEC obtained a court order halting an ICO it characterized as "an outright scam," which had raised $600 million in just two months by claiming to be the world's first "decentralized bank" and falsely representing that it had purchased an FDIC-insured bank.[18]  In April, the SEC charged two co-founders of a financial services start-up with orchestrating a fraudulent ICO by falsely claiming to offer a debit card backed by major credit card companies that would allow users to convert cryptocurrencies into U.S. dollars.[19]  The U.S. Attorney's Office for the Southern District of New York brought parallel criminal actions against the co-founders, and the SEC later charged a third co-founder with fraud after discovery of text-messages revealing fraudulent intent.[20]  Then, in May, the SEC obtained a court order halting an ICO by a self-proclaimed "blockchain evangelist" who had fabricated customer testimonials and misrepresented having business relationships with the Federal Reserve and dozens of companies.[21] Additionally, in April, the SEC obtained a court order freezing over $27 million in proceeds raised by Longfin Corp. after the company and its CEO allegedly violated Section 5 by issuing unregistered shares to three other individuals so they could sell them to the public right after the company's stock had risen dramatically due to announcement of acquisition of a cryptocurrency platform.[22]

II.  Issuer and Auditor Cases

A.  Accounting Fraud and Other Misleading Disclosures

In March, the SEC settled charges of accounting fraud against a California-based energy storage and power delivery product manufacturer and three of its former officers.[23]  The SEC alleged that the company prematurely recognized revenue to better meet analyst expectations, that a former sales executive inflated revenues by executing secret deals with customers and concealing them from finance and accounting personnel, and that the former CEO and former controller failed to adequately respond to red flags that should have alerted them to the misconduct.  Without admitting or denying the allegations, the company agreed to pay penalties of $2.8 million; the former CEO and controller agreed to pay a combined total of approximately $100,000 in disgorgement, interest and penalties; and the former sales executive agreed to be barred from serving as an officer or director of a public company for five years and pay a $50,000 penalty. In April, the SEC settled charges of accounting fraud against a Japanese electronics company.[24]  The SEC alleged that the company's U.S. subsidiary prematurely recognized more than $82 million in revenue by backdating an agreement with an airline and providing misleading information to an auditor.  The matter involved FCPA allegations as well. Also in April, the SEC instituted settled proceedings against a California internet services and content provider.[25]  The SEC alleged that the company failed to timely disclose a major data breach in which hackers stole personal data relating to hundreds of millions of user accounts.  In addition, the SEC alleged that the company did not share its knowledge of the breach with its auditors or outside counsel, and failed to maintain adequate controls and procedures to assess its cyber-disclosure obligations.  Without admitting the allegations, the company agreed to pay a $35 million penalty to settle the charges. In May, the SEC filed a complaint against three former executives of a Houston-based health services company.[26]  The complaint alleged that the executives falsified financial information—including financial statements for three fictitious subsidiaries acquired by the company—to induce a private firm to acquire a majority of the company's equity.  In a parallel action, DOJ brought criminal charges against the defendants. In June, the SEC filed a complaint against a California-based telecommunications equipment manufacturer and three of its executives.[27]  According to the SEC's complaint, the executives inflated company revenues by prematurely recognizing revenue on sales and entering into undisclosed side agreements that relieved customers of payment obligations.  The SEC also alleged that the defendants inflated the prices of products to hit revenue targets with the agreement that the company would later repay the difference as marketing development fees.  Without admitting or denying the charges, the defendants agreed to pay penalties totaling $75,000.  In addition, two of the individual defendants consented to five-year officer and director bars; the other individual defendant consented to a bar from appearing or practicing before the SEC as an accountant for five years.

B.  Auditor Cases

In February, in a case the SEC said underscores its determination to pursue violations "regardless of the location of the violators," a foreign auditor and his U.S.-based accounting firm, settled charges alleging they providing substantial assistance in a fraudulent shell company scheme by issuing misleading audit reports for numerous companies.[28]  The SEC suspended the auditor and his firm from appearing or practicing before the Commission. In March, the SEC announced settled charges against several foreign firms of the large international accounting networks based on allegations that the firms improperly relied on component auditors that were not registered with the PCAOB, even though the component auditors performed substantial work that should have triggered registration.[29] The SEC alleged violations of PCAOB standards that require sufficient analysis and inquiry when relying on another auditor.  Without admitting or denying the allegations, the four foreign firms agreed to pay roughly $400,000 combined in disgorgement and penalties. Additionally, an auditing firm, two of its partners and a registered financial advisory firm settled charges in May relating to violations of the Custody Rule.[30]  According to the SEC, the auditors failed to meet the independence requirements of the Custody Rule by both preparing and auditing financial statements of several funds and because they had a direct business relationship with the financial advisory firm through a fee-referral relationship.  The SEC also charged the respondents for failing to comply with the requirement of regular PCAOB inspections and cited multiple professional conduct violations, including for failing to design and implement appropriate oversight mechanisms, insufficient quality control and violation of professional due care, among others.  Without admitting or denying the allegations, the defendants were barred from appearing before the Commission and agreed to pay roughly $52,000 combined in disgorgement and penalties. The SEC is also ensuring that firms are not associating with barred auditors. In April, an accounting firm and its sole officer and founder settled charges with the SEC for allegedly violating the Sarbanes Oxley Act of 2012, which prohibits auditors barred by the PCAOB from association with a registered public accounting firm from associating with corporate issuers in an accountancy or financial management capacity.[31]  Without admitting or denying the findings, the company and its founding officer agreed to cease and desist from the association and agreed to pay a $22,500 civil penalty.

C.  Private Company Cases

While the number of cases against public companies remains low, the SEC has continued to step up its enforcement efforts against private companies. In March, the SEC instituted settled proceedings against a California-based financial technology company.[32]  The SEC alleged that the respondent offered unregistered stock options to its employees without providing the employees with timely financial statements and risk disclosures.  Without admitting the allegations, the company agreed to pay a $160,000 penalty to settle the charges. Also in March, the SEC filed a complaint against a California-based health care technology company, its former CEO, and a former president at the company.[33]  The complaint alleged that the defendants made numerous false statements in investor presentations, product demonstrations and media articles about their flagship product—including misrepresentations regarding expected revenue and the U.S. Department of Defense's adoption of the product—which deceived investors into believing the product was revolutionary.  Without admitting the allegations, the company and former CEO agreed to settle the charges.  Under the settlement terms, the former CEO agreed to pay a $0.5 million penalty, be barred from serving as an officer or director of a public company for ten years, return 18.9 million shares of the company, and relinquish her voting control by converting her Class B Common shares to Class A Common shares.  The SEC will continue to litigate its claims against the former president in federal court. And in April, the SEC filed a fraud complaint against four parties:  a biotechnology startup formerly based in Massachusetts, its CEO, an employee, and the CEO's close friend.[34]  According to the SEC, the CEO and the employee made false claims to investors about the company's finances and the company's progress in seeking FDA approval for one of its products.  The complaint also alleged that the defendants engaged in a fraudulent scheme to acquire and merge the company with a publicly traded company, manipulated the shares of the new entity, and diverted a portion of the sale proceeds.  The SEC is litigating the case in federal court and seeks to freeze the company's and CEO's assets, as well as prohibit the defendants from soliciting money from investors.  In addition, the SEC seeks a permanent injunction, the return of the ill-gotten gains with penalties, and industry and penny stock bars.  The DOJ brought parallel criminal charges against the individual defendants.

III.  Investment Advisers and Funds

A.  Fees and Expenses

In June, a private equity firm settled allegations that it had charged accelerated monitoring fees on portfolio company exits without adequate disclosure.[35]  According to the SEC, the undisclosed receipt of accelerated fees from portfolio companies resulted in negligent violations of various provisions of the Advisers Act.  To settle the matter, the Respondents agreed to pay $4.8 million in disgorgement and prejudgment interest and $1.5 million in penalties. Shortly thereafter, the SEC filed a settled action against a New York-based venture capital fund adviser for allegedly failing to offset consulting fees against management fees in accordance with organizational documents for the funds it advised.[36]  The SEC alleged that the adviser received $1.2 million in consulting fees from portfolio companies in which the funds had invested, and that those fees were not properly offset against advisory or management fees paid by investors, resulting in an overpayment of over $750,000.  The adviser reimbursed its clients, plus interest, and agreed to pay a $200,000 penalty.  Significantly, the SEC's press release cites to the adviser's remediation and cooperation, indicating that this was taken into account in determining the appropriate resolution.

B.  Conflicts of Interest

In March, the SEC instituted settled proceedings against two investment adviser subsidiaries for undisclosed conflicts of interest with regard to the practice of recalling securities on loan.[37]  The SEC alleged that the advisers were affiliated with insurance companies, but also served as investment advisers to insurance-dedicated mutual funds.  The advisers would lend securities held by the mutual funds, and then recall those securities prior to their dividend record dates.  This meant that the insurance company affiliates, as record shareholders of such shares, would receive a tax benefit on the basis of the dividends received.  However, according to the SEC, this recall system resulted in the mutual funds (and their investors) losing income, while the insurance company affiliates reaped a tax benefit.  Without admitting or denying the allegations, the advisers agreed to pay approximately $3.6 million to settle the charges. In April, the SEC instituted proceedings against a New York-based investment adviser in connection with the receipt of revenue sharing compensation from a service provider without disclosing conflicts of interest to its private equity clients.[38]  According to the SEC, the investment adviser entered into an agreement with a company that provided services to portfolio companies.  Pursuant to that agreement, when portfolio companies made purchases, the service provider would receive revenue, and, in turn, the investment adviser would receive a portion of that revenue.  Without admitting or denying the allegations of Advisers Act violations, the investment adviser agreed to pay nearly $800,000 in disgorgement, prejudgment interest, and civil penalties. In early June, the SEC instituted settled proceedings against a New York-based investment adviser in connection with alleged failures to disclose conflicts of interest to clients and prospective clients relating to compensation paid to the firm's individual advisers and an overseas affiliate.[39]  According to the SEC, this undisclosed compensation, which came from overseas third-party product and service providers recommended by the adviser, incentivized the adviser to recommend certain products and services and a pension transfer.  The SEC also found that the adviser made misleading statements regarding investment options and tax treatment of investments.  In settling the action without admitting or denying the allegations, the investment adviser agreed to pay an $8 million civil penalty and to engage an independent compliance consultant.  In a parallel action, the Commission filed a complaint in federal court in Manhattan against the adviser's former CEO and a former manager. On the same day, the SEC filed another settled administrative proceeding relating to undisclosed conflicts of interest with a Delaware-based investment adviser.[40]  The settlement order alleges that the adviser negotiated side letters with outside asset managers resulting in arrangements under which the asset managers would make payments to the adviser based on the amount of client assets placed or maintained in funds advised by those asset managers.  This was not disclosed to clients, and contravened the adviser's agreements with two specific advisory clients.  The SEC also alleged that the adviser failed to implement policies and procedures to prevent conflicts of interest and failed to maintain accurate records relating to the payments from the outside asset managers.  Without admitting or denying the Commission's findings, the adviser agreed to pay a $500,000 penalty.

C.  Fraud and Other Misconduct

In January, the SEC filed settled charges against a California-based investment adviser and its CEO and President for failing to adequately disclose the risks associated with investing in their advisory business.[41]  According to the SEC, the firm decided to borrow cash from investors—including its own retail investor clients whose portfolio accounts were managed by the CEO—in the form of promissory notes, in order to fund its business expenses, which exceeded the amount of money received from advisory fees.  In their efforts to market the promissory notes, the CEO and President failed to disclose the true financial state of the firm or the significant risk of default.  In settling the action, the investment adviser agreed to various undertakings, including an in-depth review and enhancement of compliance policies and procedures, and the provision of detailed information regarding noteholders to the staff.  In addition, the firm paid a $50,000 penalty and each principal paid a $25,000 penalty. Also in January, the SEC filed charges in the District of Massachusetts against two Boston-based investment advisers, alleging they engaged in various schemes to defraud their clients, including stealing client funds, failing to disclose conflicts of interest, and secretly using client funds to secure financing for their own investments.[42]  The SEC also alleged that one of the individuals violated his fiduciary duties to clients by obtaining a loan from a client on unfavorable terms to that client and charging advisory fees over 50% higher than the promised rate.  According to the complaint, the pair in one instance misappropriated nearly $450,000 from an elderly client, using the funds to make investments in their own names and to pay personal expenses for one of the individual advisers.  The U.S. Attorney's Office for the District of Massachusetts also filed criminal charges against the same advisers in a parallel action.  While the SEC action remains pending, the individuals have both pleaded guilty to criminal charges.[43] The SEC also initiated a number of enforcement actions for alleged cherry-picking by investment advisers.  In February, the SEC instituted a litigated action against a California-based investment adviser, its president and sole owner, and its former Chief Compliance Officer for allocating profitable trades to the investment adviser's account at the expense of its clients.[44]  The SEC's complaint also alleges that the adviser and president misrepresented trading and allocation practices in Forms ADV filed with the Commission.  The former CCO agreed to settle the charges against him—without admitting or denying allegations that he ignored red flags relating to the firm's allocation practices—and pay a fine of $15,000; the litigation against the investment adviser and president remains ongoing.  And in March the SEC instituted settled proceedings against a Texas-based investment adviser and its sole principal for disproportionately allocating unprofitable trades to client accounts and profitable trades to their own accounts.[45]  The investment adviser agreed to pay a total of over $700,000 in disgorgement, prejudgment interest, and civil penalties, and the principal agreed to a permanent bar from the securities industry. In April, the SEC filed a settled administrative proceedings against an Illinois-based investment adviser and its president in connection with allegedly misleading advertisements about investment performance.[46]  According to the SEC, the adviser did not disclose that performance results included in advertisements—in the form of written communications and weekly radio broadcasts and video webcasts by its president—were often based on back-tested historical results generated by the adviser's models, rather than actual results.  The adviser also allegedly failed to adopt written policies and procedures designed to prevent violations of the Advisers Act.  In reaching the agreed-upon resolution, the SEC took into account remediation efforts undertaken by the adviser during the course of the SEC's investigation, including hiring a new CCO and engaging an outside compliance consultant who conducted an in-depth review of the compliance program and made recommendations which were then implemented by the adviser.  The investment adviser agreed to pay a $125,000 penalty, and the adviser's president agreed to pay a $75,000 penalty. In May, the SEC charged a California-based individual investment adviser with lying to clients about investment performance and strategy, inflating asset values and unrealized profits in order to overpay himself in management fees and bonuses, and failing to have the private funds audited.[47]  The adviser settled the charges without admitting or denying the allegations, agreeing pay penalties and disgorgement in amounts to be determined by the court. Later that month, the SEC filed settled charges against a Delaware-based investment adviser and its managing member for allegedly making misrepresentations and omissions about the assets and performance of a hedge fund they managed.[48]  According to the SEC, the adviser misrepresented the performance and value of assets in the hedge fund after losing nearly all of its investments after the fund's trading strategy led to substantial losses.  In addition to making false representations to the fund's two investors, the adviser withdrew excessive advisory fees based on the inflated asset values.  Without admitting or denying the charges, the adviser and managing member agreed to a cease-and-desist order under which the individual also agreed to a broker-dealer and investment company bar, as well as a $160,000 penalty. In another pair of cases filed in May, the SEC charged a hedge fund and a private fund manager in separate cases involving inflated valuations.  In one case, the SEC alleged that the fund manager's Chief Financial Officer failed to supervise portfolio managers who engaged in asset mismarking.[49]  The asset mismarking scheme resulted in the hedge fund reaping approximately $3.15 million in excess fees.  The SEC had previously charged the portfolio managers in connection with their misconduct in 2016.  The CFO agreed to pay a $100,000 penalty and to be suspended from the securities industry for twelve months, while the firm agreed to pay over $9 million in disgorgement and penalties.  In the other case, the SEC filed a litigated action in the U.S. District Court for the Southern District of New York against a New York-based investment adviser, the company's CEO and chief investment officer, a former partner and portfolio manager at the company, and a former trader, in connection with allegations that the defendants inflated the value of private funds they advised.[50]  According to the complaint, the defendants fraudulently inflated the value of the company's holdings in mortgage-backed securities in order to attract and retain investors, as well as to hide poor fund performance.  This litigation is ongoing. Finally, in late June the SEC announced a settlement with an investment adviser that allegedly failed to protect against advisory representatives misappropriating or misusing client funds.[51]  Without sufficient safeguards in place, one advisory representative was able to misappropriate or misuse $7 million from advisory clients' accounts.  Without admitting or denying the SEC's findings, the adviser agreed to pay a $3.6 million penalty, in addition to a cease-and-desist order and a censure.  The representative who allegedly misused the $7 million from client accounts faces criminal charges by the U.S. Attorney's Office for the Southern District of New York.

D.  Investment Company Share Price Selection

The first half of 2018 saw the launch of the SEC's Share Class Selection Disclosure Initiative (SCSD Initiative), as well as several cases involving share class selections.  Under the SCSD Initiative, announced in February, the SEC's Division of Enforcement agreed not to recommend financial penalties against mutual fund managers which self-report violations of the federal securities laws relating to mutual fund share class selection and promptly return money to victimized investors.[52]  Where investment advisers fail to disclose conflicts of interest and do not self-report, the Division of Enforcement will recommend stronger sanctions in future actions. In late February, a Minnesota-based broker-dealer and investment adviser settled charges in connection with the recommendation and sale of higher-fee mutual fund shares when less expensive share classes were available.[53]  In turn, those recommendations resulted in greater revenue for the company and decreased customers' returns.  The company, without admitting or denying the allegations, consented to a penalty of $230,000. In April, three investment advisers agreed to settle charges in connection with their failure to disclose conflicts of interest and violations of their fiduciary duties by recommending higher-fee mutual fund share classes despite the availability of less expensive share classes.[54]  Collectively, the companies agreed to pay nearly $15 million in disgorgement, prejudgment interest, and penalties.  The SEC used the announcement of the cases to reiterate its ongoing SCSDC Initiative.

E.  Other Compliance Issues

In January, the SEC announced settled charges against an Arizona-based investment adviser and its sole principal in connection with a number of Advisers Act violations, including misrepresentations in filed Forms ADV, misrepresentations and failure to produce documents to the Commission examination staff, and other compliance-related deficiencies.[55]  According to the SEC, the adviser's Forms ADV for years misrepresented its principal's interest in private funds in which its advisory clients invested.  While the clients were aware of the principal's involvement with the funds, the adviser falsely stated in filings that the principal had no outside financial industry activities and no interests in client transactions.  Additionally, the SEC alleged that the adviser misstated its assets under management, failed to adopt written policies and procedures relating to advisory fees, and failed to conduct annual reviews of its policies and procedures.  Without admitting or denying the SEC's allegations, the investment adviser agreed to pay a $100,000 penalty, and the principal agreed to a $50,000 penalty and to a prohibition from acting in a compliance capacity. In April, the SEC filed settled charges against a Connecticut-based investment adviser and its sole owner for improper registration with the Commission and violations of the Commission's custody and recordkeeping rules.[56]  According to the settled order, the adviser misrepresented the amount of its assets under management in order to satisfy the minimum requirements for SEC registration.  The adviser also allegedly—while having custody over client assets—failed to provide quarterly statements to clients or to arrange for annual surprise verifications of assets by an independent accountant, as required by the Custody Rule, and also failed to make and keep certain books and records required by SEC rules.  Without admitting or denying the allegations, the adviser and its owner agreed to the entry of a cease-and-desist order, and the owner agreed to pay a $20,000 civil penalty and to a 12-month securities industry suspension. A few weeks later, a fund administrator settled cease-and-desist proceedings in connection with the company's alleged noncompliance in maintaining an affiliated cash fund.[57]  According to the SEC, from mid-2008 to the end of 2012, the firm's pricing methodology for its affiliated unregistered money market fund was flawed.  The SEC alleged that the deficiencies in the pricing methodology caused the affiliated cash fund to violate Investment Company Act.  To settle the charges, the trust agreed to pay a civil monetary penalty of $225,000. And in June, the SEC announced settlements with 13 private fund advisers in connection with their failures to file Form PF.[58]  Advisers who manage $150 million or more of assets are obligated to file annual reports on Form PF that indicate the amount of assets under management and other metrics about the private funds that they advise.  In turn, the SEC uses the data contained in Form PF in connection with quarterly reports, to monitor industry trends, and to evaluate systemic risks posed by private funds.  Each of the 13 advisers failed to timely file Form PF over a number of years.  Without admitting or denying the allegations, each of the 13 advisers agreed to pay a $75,000 civil penalty.

IV.  Brokers and Financial Institutions

A.  Supervisory Controls and Internal Systems Deficiencies

The SEC brought several cases during the first half of 2018 relating to failures of supervisory controls and internal systems.  In March, the SEC filed a litigated administrative proceeding against a Los Angeles-based financial services firm for failing to supervise one of its employees who was involved in a long-running pump-and-dump scheme and who allegedly received undisclosed benefits for investing her customers in microcap stocks that were the subject of the scheme.[59]  The employee agreed to settle fraud charges stemming from the scheme.  The SEC alleged that the firm ignored multiple signs of the employee's fraud, including a customer email outlining her involvement in the scheme and multiple FINRA arbitrations and inquiries regarding her penny stock trading activity.  The firm even conducted two investigations, deemed "flawed and insufficient" by the SEC, but failed to take action against the employee.  The SEC previously charged the orchestrator of the pump-and-dump scheme, as well as 15 other individuals and several entities. Also in March, the SEC announced settled charges against a New York-based broker-dealer for its failure to perform required gatekeeping functions in selling almost three million unregistered shares of stock on behalf of a China-based issuer and its affiliates.[60]  The SEC alleged that the firm ignored red flags indicating that the sales could be part of an unlawful unregistered distribution. At the end of June, the SEC charged a New York-based broker-dealer and two of its managers for failing to supervise three brokers, all three of whom were previously charged with fraud in September 2017.[61]  According to the SEC, the firm lacked reasonable supervisory policies and procedures, as well as systems to implement them, and if those systems had been in place, the firm likely would have prevented and detected the brokers' wrongdoing.  In separate orders, the SEC found that two supervisors ignored red flags indicating excessive trading and failed to supervise brokers with a view toward preventing and detecting their securities-laws violations.

B.  AML Cases

During the first half of 2018, the SEC brought a number of cases in the anti-money laundering ("AML") arena.  In March, the SEC brought settled charges against a New York-based brokerage firm for failure to file Suspicious Activity Reports (or "SARs") reporting numerous suspicious transactions.[62]  The brokerage firm admitted to the charges, and agreed to retain a compliance expert and pay a $750,000 penalty.  The SEC also brought charges against the brokerage firm's CEO for causing the violation, and its AML compliance officer for aiding and abetting the violation.  Without admitting or denying the charges, the CEO and AML compliance officer respectively agreed to pay penalties of $40,000 and $25,000. In May, the SEC instituted settled charges against two broker-dealers and an AML officer for failing to file SARs relating to the suspicious sales of billions of shares in penny stock.[63]  Without admitting or denying the SEC's findings, the broker-dealers agreed to penalties; the AML officer agreed to a penalty and an industry and penny stock bar for a minimum of three years.

C.  Regulatory Violations

In January, the SEC instituted a settled administrative proceeding against an international financial institution for repeated violations of Rule 204 of Regulation SHO, which requires timely delivery of shares to cover short sales.[64]  The SEC's order alleged that the firm improperly claimed credit on purchases and double counted purchases, resulting in numerous, prolonged fail to deliver positions for short sales.  Without admitting or denying the allegations, the firm agreed to pay a penalty of $1.25 million and entered into an undertaking to fully cooperate with the SEC in all proceedings relating to or arising from the matters in the order. In March, the SEC announced settled charges against a Los-Angeles broker dealer for violating the Customer Protection Rule, which requires that broker-dealers safeguard the cash and securities of customers, by illegally placing more than $25 million of customers' securities at risk to fund its own operations.[65]  Specifically, the broker-dealer on multiple occasions moved customers' securities to its own margin account without obtaining the customers' consent.  The SEC's Press Release noted that it had recently brought several cases charging violations of the Customer Protection Rule.  Without admitting or denying the allegations, the broker dealer agreed to pay a penalty of $80,000. Also in March, the SEC filed a settled action against a New York-based broker dealer and its CEO and founder for violating the net capital rule, which requires a broker-dealer to maintain sufficient liquid assets to meet all obligations to customers and counterparties and have adequate additional resources to wind down its business in an orderly manner if the firm fails financially.[66]  The SEC found that for ten months, the firm repeatedly failed to maintain sufficient net capital, failed to accrue certain liabilities on its books and records, and misclassified certain assets when performing its net capital calculations.  According to the SEC, the firm's CEO was involved in discussions about the firm's unaccrued legal liabilities and was aware of the misclassified assets, but he nevertheless prepared the firm's erroneous net capital calculations.  As part of the settlement, he agreed to not serve as a financial and operations principal (FINOP) for three years and to pass the required licensing examination prior to resuming duties as a FINOP; the firm agreed to pay a $25,000 penalty. And in a novel enforcement action also arising in March, the SEC filed a settled action against the New York Stock Exchange and two affiliated exchanges in connection with multiple episodes, including several disruptive market events, such as erroneously implementing a market-wide regulatory halt, negligently misrepresenting stock prices as "automated" despite extensive system issues ahead of a total shutdown of two of the exchanges, and applying price collars during unusual market volatility on August 24, 2015, without a rule in effect to permit them.[67]  The SEC also, for the first time, alleged a violation of Regulation SCI, which was adopted by the Commission to strengthen the technology infrastructure and integrity of the U.S. securities markets.  The SEC charged two NYSE exchanges with violating Regulation SCI's business continuity and disaster recovery requirement.  Without admitting or denying the allegations, the exchanges agreed to pay a $14 million penalty to settle the charges.

D.  Other Broker-Dealer Enforcement Actions

In June, the SEC settled with a Missouri-based broker-dealer, alleging that the firm generated large fees by improperly soliciting retail customers to actively trade financial products called market-linked investments, or MLIs, which are intended to be held to maturity.[68]  The SEC alleged that the trading strategy, whereby the MLIs were sold before maturity and the proceeds were invested in new MLIs, generated commissions for the firm, which reduced the customers' investment returns.  The order also found that certain representatives of the firm did not reasonably investigate or understand the significant costs of the MLI exchanges.  The SEC also alleged that the firm's supervisors routinely approved the MLI transactions despite internal policies prohibiting short-term trading or "flipping" of the products. Later in June, the SEC announced that it had settled with a New York-based broker-dealer for the firm's violations of its record-keeping provisions by failing to remediate an improper commission-sharing scheme in which a former supervisor received off-book payments from traders he managed.[69]  The SEC also filed a litigated complaint in federal court against the former supervisor and former senior trader for their roles in the scheme.  As alleged by the SEC, the former supervisor and another trader used personal checks to pay a portion of their commissions to the firm's former global co-head of equities and to another trader.  The practice violated the firm's policies and procedures and resulted in conflicts of interest that were hidden from the firm's compliance department, customers, and regulators.

E.  Mortgage Backed Securities Cases

The SEC appeared to be clearing out its docket of enforcement actions dating back to the mortgage crisis. In February, the SEC announced a settlement against a large financial institution and the former head of its commercial mortgage-backed securities ("CMBS") trading desk, alleging that traders and salespeople at the firm made false and misleading statements while negotiating secondary market CMBS sales.[70]  According to the SEC's order, customers of the financial institution overpaid for CMBS because they were misled about the prices at which the firm had originally purchased them, resulting in increased profits for the firm to the detriment of its customers.  The order also alleged that the firm did not have in place adequate compliance and surveillance procedures which were reasonably designed to prevent and detect the misconduct, and also found supervisory failures by the former head trader for failing to take appropriate corrective action.  The firm and trader, without admitting or denying the allegations, agreed to respective penalties of $750,000 and $165,000.  The firm also agreed to repay $3.7 million to customers, which included $1.48 million ordered as disgorgement, and the trader agreed to serve a one-year suspension from the securities industry. Similarly, in mid-June, a large New York-based wealth management firm paid $15 million to settle SEC charges that its traders and salespersons misled customers into overpaying for residential mortgage backed securities (RMBS) by deceiving them about the price that the firm paid to acquire the securities.[71]  The SEC also alleged that the firm's RMBS traders and salespersons illegally profited from excessive, undisclosed commissions, which in some instances were more than twice the amount that customers should have paid.  According to the SEC, the firm failed to have compliance and surveillance procedures in place that were reasonably designed to prevent and detect the misconduct.

V.  Insider Trading

A.  Classical Insider Trading And Misappropriation Cases

In January, a former corporate insider and a former professional in the brokerage industry agreed to settle allegations that they traded on the stock of a construction company prior to the public announcement of the company's acquisition.[72]  The insider purportedly tipped his friend, who was then a registered broker-dealer, about the impending transaction in return for assistance in obtaining a new job with his friend's employer following the merger.  According to the SEC, the broker-dealer traded on that information for a profit exceeding $48,000.  Without admitting or denying the SEC's findings, both individuals consented to pay monetary penalties, and the trader agreed to disgorge his ill-gotten gains. The following month, the SEC sued a pharmaceutical company employee who allegedly traded in the stock of an acquisition target despite an explicit warning not to do so.[73]  According to the SEC, the defendant bought stock in the other company a mere 14 minutes after receiving an e-mail regarding the acquisition.  Without admitting or denying the SEC's allegations, the employee agreed to disgorgement of $2,287 and a $6,681 penalty. In February, the SEC charged the former CEO and a former officer of a medical products company with trading on information regarding a merger involving one of their company's largest customers.[74]  Without admitting or denying the allegations, the two executives agreed to disgorge a total of about $180,000 in trading proceeds and to pay matching penalties. In March, the SEC charged a former communications specialist at a supply chain services company with garnering more than $38,000 in illicit profits after purchasing shares in his company prior to the public announcement of its acquisition.[75]  Without admitting or denying the allegations, the defendant subsequently agreed to $38,242 in disgorgement and the payment of a penalty to be determined following a subsequent motion by the SEC.[76] That same month, the SEC filed suit against the former chief information officer of a company who sold shares of his employer prior to public revelations that that company had suffered a data breach.[77]  In addition, the U.S. Attorney's Office for the Northern District of Georgia brought  parallel criminal charges.  Both cases are still pending.  Subsequently, at the end of June, the SEC charged another employee at that same company with trading on nonpublic information that he obtained while creating a website for customers affected by the data breach.[78]  The defendant agreed to a settlement requiring him to return ill-gotten gains of more than $75,000 plus interest, and a criminal case filed by the U.S. Attorney's Office for the Northern District of Georgia remains ongoing. In April, the SEC charged a New York man with tipping his brother and father about the impending acquisition of a medical-supply company based on information that he learned from his friend, the CEO of the company being acquired.[79]  The SEC alleged that the father and brother garnered profits of about $145,000 based on their unlawful trading, and—without admitting or denying the SEC's allegations—the tipper agreed to pay a $290,000 penalty.  The SEC's investigation remains ongoing. Also in April, the SEC and the U.S. Attorney's Office for the District of Massachusetts filed parallel civil and criminal charges against a man accused of trading on a company's stock based on information gleaned from an unidentified insider.[80]  The man purportedly purchased shares using his retirement savings in advance of eight quarterly earnings announcements over a two-year period, reaping over $900,000 in illicit profits.  The SEC's complaint also names the man's wife as a relief defendant, and the matter remains ongoing. Finally, in May, the SEC charged two men with reaping small profits by trading on non-public information in advance of a merger of two snack food companies based on information gained from a close personal friend at one of the merging companies.[81]  Both defendants agreed to settle the lawsuit by disgorging ill-gotten gains and paying penalties.

B.  Misappropriation by Investment Professionals and Other Advisors

At the end of May, the SEC charged a vice president at an investment bank with repeatedly using confidential knowledge to trade in advance of deals on which his employer advised.[82]  The defendant allegedly used client information to trade in the securities of 12 different companies via a brokerage account held in the name of a friend living in South Korea, evading his employer's rules that he pre-clear any trades and use an approved brokerage firm.  The trader purportedly garnered approximately $140,000 in illicit profits, and the U.S. Attorney's Office for the Southern District of New York filed a parallel criminal case.  Both matters are still being litigated. In June, the SEC sued a Canadian accountant for trading on information misappropriated from his client, a member of an oil and gas company's board of directors.[83]  Based on this relationship, the defendant gained knowledge of an impending merger involving the company.  Without admitting or denying the SEC's allegations, he agreed to be barred from acting as an officer or director of a public company, and to pay disgorgement and civil penalties of $220,500 each.  The defendant also consented to an SEC order suspending him from appearing or practicing before the Commission as an accountant. Finally, that same month, the SEC charged a credit ratings agency employee and the two friends he tipped about a client's nonpublic intention to acquire another company.[84]  According to the SEC, the tipper learned the confidential information when the client reached out to the agency to assess the impact of the merger on the company's credit rating.  Based on the information they received, the friends allegedly netted profits of $192,000 and $107,000, respectively.  In addition, the U.S. Attorney's Office for the Southern District of New York filed a parallel criminal case against all three individuals..

C.  Other Trading Cases And Developments

In February, the Third Circuit Court of Appeals issued a decision in United States v. Metro reversing the district court's sentencing calculation following the appellant's conviction on insider trading charges.[85]  The appellant, Steven Metro, was a managing clerk at a New York City law firm, and over the course of five years, he disclosed material nonpublic information to a close friend, Frank Tamayo, concerning 13 different corporate transactions.  Tamayo then transmitted that information to a third-party broker, who placed trades on behalf of Tamayo, himself, and other clients, yielding illicit profits of approximately $5.5 million.  Metro pleaded guilty to one count of conspiracy and one count of securities fraud, and the district court attributed the entire $5.5 million sum to Metro in calculating the length of his sentence.  Metro objected, arguing that he was unaware of the broker's existence until after he stopped tipping Tamayo. On appeal, the Third Circuit vacated Metro's sentence after determining that the district court made insufficient factual findings to substantiate imputation of all illicit profits to Metro, holding: "When the scope of a defendant's involvement in a conspiracy is contested, a district court cannot rely solely on a defendant's guilty plea to the conspiracy charge, without additional fact-finding, to support attributing co-conspirators' gains to a defendant."  The court emphasized that "when attributing to an insider-trading defendant gains realized by other individuals . . . a sentencing court should first identify the scope of conduct for which the defendant can fairly be held accountable . . . ."  Such an inquiry "may lead the court to attribute to a defendant gains realized by downstream trading emanating from the defendant's tips, but, depending on the facts established at sentencing, it may not," and the court therefore found that the government erred in propounding a "strict liability" standard. Finally, the first half of this year also saw limited activity by the SEC to freeze assets used to effectuate alleged insider trades.  In January, the SEC obtained an emergency court order freezing the assets of unknown defendants in Swiss bank accounts.[86]  According to the SEC, those unknown defendants were in possession of material nonpublic information regarding the impending acquisition of a biopharmaceutical company, and some of the positions taken in those accounts represented almost 100 percent of the market for those particular options.  The illicit trades allegedly yielded about $5 million in profits..

VI.  Municipal Securities and Public Pensions Cases

In the first half of 2018, the SEC's Public Finance Abuse Unit continued the slower pace of enforcement that began in 2017, pursuing two separate cases against municipal advisors. In January, the SEC charged an Atlanta, Georgia-based municipal advisor and its principal with defrauding the city of Rolling Fork, Mississippi.[87]  The SEC alleged that the municipal advisor had fraudulently overcharged Rolling Fork for municipal advisory services in connection with an October 2015 municipal bond offering and had failed to disclose certain related-party payments.  The related-party payments consisted of an undisclosed $2500 payment made to the advisor by an employee of a municipal underwriter shortly before the advisor recommended that the city hire the underwriter's firm.  The parties subsequently agreed to settle the case.[88]  Without admitting or denying the allegations against them, the advisor and principal consented to the entry of judgments permanently enjoining them from violating Sections 15B(a)(5) and 15B(c)(1) of the Securities Exchange Act of 1934 and MSRB Rule G-17.  The judgment also requires the defendants to pay a total of about $111,000 in disgorgement, interest, and penalties. In addition, the SEC settled its case against the municipal underwriter.  Without admitting the SEC's findings, the underwriter agreed to a six-month suspension and to pay a $20,000 penalty.

And in May, the SEC brought settled administrative proceedings against another municipal advisor and its owner.[89]  The SEC alleged that, by misrepresenting their municipal advisory experience and failing to disclose conflicts of interest, the advisor and owner had defrauded a South Texas school district and breached their fiduciary duties to that district.  Without admitting to the allegations, the advisor and owner agreed to pay a combined total of approximately $562,000 in disgorgement, interest, and penalties..


[1] Lucia v. SEC, 585 U.S. __ (2018).  For more on Lucia, see Gibson Dunn Client Alert, SEC Rules That SEC ALJs Were Unconstitutionally Appointed (June 21, 2018), available at www.gibsondunn.com/supreme-court-rules-that-sec-aljs-were-unconstitutionally-appointed. [2] See Gibson Dunn Client Alert, U.S. Supreme Court Limits SEC Power to Seek Disgorgement Based on Stale Conduct (June 5, 2017), available at www.gibsondunn.com/united-states-supreme-court-limits-sec-power-to-seek-disgorgement-based-on-stale-conduct. [3] SEC v Kokesh, No. 15-2087 (10th Cir. Mar. 5, 2018); see also Jonathan Stempel, SEC Can Recoup Ill-gotten Gains from New Mexico Businessman: U.S. Appeals Court, Reuters (Mar. 5, 2018), available at www.reuters.com/article/us-sec-kokesh/sec-can-recoup-ill-gotten-gains-from-new-mexico-businessman-u-s-appeals-court-idUSKBN1GH2YK. [4] Adam Dobrik, Unhelpful to Threaten SEC with Trial, Says Enforcement Director, Global Investigations Review (May 10, 2018), available at globalinvestigationsreview.com/article/jac/1169315/unhelpful-to-threaten-sec-with-trial-says-enforcement-director. [5] See SEC v. Cohen, No. 1:17-CV-00430 (E.D.N.Y. July 12, 2018) (holding claims for injunctive relief time-barred). [6] Dunstan Prial, High Court Agrees To Review Banker's Copy-Paste Fraud, Law360 (Jun. 18, 2018), available at https://www.law360.com/securities/articles/1054568. [7] SEC Press Release, SEC Awards Whistleblower More Than $2.1 Million (Apr. 12, 2018), available at www.sec.gov/news/press-release/2018-64. [8] SEC Press Release, SEC Announces Its Largest-Ever Whistleblower Awards (Mar. 19, 2018), available at https://www.sec.gov/news/press-release/2018-44. [9] Ed Beeson, SEC Whistleblowers Net $83M In Largest Ever Bounties, Law360 (Mar. 19, 2018), available at www.law360.com/articles/1023646/sec-whistleblowers-net-83m-in-largest-ever-bounties. [10] In re Claims for Award in connection with [redacted], Admin. Proc. File No. 2018-6 (Mar. 19, 2018), available at https://www.sec.gov/rules/other/2018/34-82897.pdf. [11] SEC Press Release, SEC Awards More Than $2.2 Million to Whistleblower Who First Reported Information to Another Federal Agency Before SEC (Apr. 5, 2018), available at www.sec.gov/news/press-release/2018-58. [12] SEC Press Release, SEC Awards Whistleblower More Than $2.1 Million (Apr. 12, 2018), available at www.sec.gov/news/press-release/2018-64. [13] Digital Realty Trust, Inc. v. Somers, 583 U.S. __ (2018); see Dunstan Prial, Supreme Court Narrows Definition Of Whistleblower, Law360 (Feb. 21, 2018), available at www.law360.com/securities/articles/1003954. [14] Jennifer Williams Alvarez, SEC Proposes Changes to Whistle-Blower Program, Agenda: A Financial Times Services (Jun. 28, 2018), available at [insert]. [15] SEC Public Statement, Statement on Cybersecurity Interpretive Guidance (Feb. 21, 2018), available at www.sec.gov/news/public-statement/statement-clayton-2018-02-21. [16] SEC Public Statement, Statement on Potentially Unlawful Online Platforms for Trading Digital Assets (March 7, 2018), available at https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading. [17] SEC Press Release, SEC Charges Former Bitcoin-Denominated Exchange and Operator with Fraud (Feb. 21, 2018), available at https://www.sec.gov/news/press-release/2018-23. [18] SEC Press Release, SEC Halts Alleged Initial Coin Offering Scam (Jan. 30, 2018), available at www.sec.gov/news/press-release/2018-8. [19] SEC Press Release, SEC Halts Fraudulent Scheme Involving Unregistered ICO (April 2, 2018), available at www.sec.gov/news/press-release/2018-53. [20] SEC Press Release, SEC Charges Additional Defendant in Fraudulent ICO Scheme (April 20, 2018), available at www.sec.gov/news/press-release/2018-70. [21] SEC Press Release, SEC Obtains Emergency Order Halting Fraudulent Coin Offering Scheme (May 29, 2018), available at www.sec.gov/news/press-release/2018-94. [22] SEC Press Release, SEC Obtains Emergency Freeze of $27 Million in Stock Sales of Purported Cryptocurrency Company Longfin (April 6, 2018), available at www.sec.gov/news/press-release/2018-61. [23] SEC Press Release, SEC Charges Energy Storage Company, Former Executive in Fraudulent Scheme to Inflate Financial Results (Mar. 27, 2018), available at www.sec.gov/news/press-release/2018-48. [24] SEC Press Release, Panasonic Charged with FCPA and Accounting Fraud Violations (Apr. 30, 2018), available at www.sec.gov/news/press-release/2018-73. [25] SEC Press Release, Altaba, Formerly Known as Yahoo!, Charged With Failing to Disclose Massive Cybersecurity Breach; Agrees To Pay $35 Million (Apr. 24, 2018), available at www.sec.gov/news/press-release/2018-71. [26] SEC Press Release, SEC Charges Three Former Healthcare Executives With Fraud (May 16, 2018), available at www.sec.gov/news/press-release/2018-90. [27] SEC Litig. Rel. No. 24181, SEC Charges California Company and Three Executives with Accounting Fraud (July 2, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24181.htm. [28] SEC Press Release, SEC Obtains Bars and Suspensions Against Individuals and Accounting Firm in Shell Factory Scheme (Feb. 16, 2018), available at www.sec.gov/news/press-release/2018-21. [29] SEC Press Release, Foreign Affiliates of KPMG, Deloitte, BDO Charged in Improper Audits (Mar. 13, 2018), available at www.sec.gov/news/press-release/2018-39. [30] In the Matter of Winter, Kloman, Moter & Repp, S.C., Curtis W. Disrud, CPA, and Paul R. Sehmer, CPA, Admin. Proc. File No. 3-18466 (May 04, 2018), available at www.sec.gov/litigation/admin/2018/34-83168.pdf. [31] AP File No. 3-18442, SEC Charges New Jersey-Based Company and Founder for Impermissible Association with Barred Auditor (Apr. 19, 2018), available at www.sec.gov/enforce/34-83067-s. [32] SEC Admin. Proc. File No. 3-18398, Fintech Company Charged For Stock Option Offering Deficiencies, Failed To Provide Required Financial Information To Employee Shareholders (Mar. 12, 2018), available at www.sec.gov/litigation/admin/2017/34-82233-s.pdf. [33] SEC Press Release, Theranos, CEO Holmes, and Former President Balwani Charged With Massive Fraud (Mar. 14, 2018), available at www.sec.gov/news/press-release/2018-41. [34] SEC Litig. Rel. No. 24121, SEC Charges Biotech Start-up, CEO With Fraud (Apr. 24, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24121.htm. [35] In the Matter of THL Managers V, LLC, and THL Managers, VI, LLC, Admin. Proc. File No. 3-18565 (June 29, 2018), available at www.sec.gov/litigation/admin/2018/ia-4952.pdf. [36] SEC Admin. Proc. File No. 3-18564, SEC Charges New York-Based Venture Capital Fund Adviser for Failing to Offset Consulting Fees (June 29, 2018), available at www.sec.gov/enforce/ia-4951-s. [37] SEC Press Release, (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-35. [38] SEC Admin. Proc. File No. 3-18449, SEC Charges a New York-Based Investment Adviser for Breach of Fiduciary Duty (Apr. 24, 2018), available at www.sec.gov/enforce/ia-4896-s. [39] SEC Press Release, SEC Charges Investment Adviser and Two Former Managers for Misleading Retail Clients (June 4, 2018), available at www.sec.gov/news/press-release/2018-101. [40] In re Lyxor Asset Management, Inc., Admin Proc. File No. 3-18526 (June 4, 2018), available at www.sec.gov/litigation/admin/2018/ia-4932.pdf. [41] SEC Admin. Proc. File No. 3-18349, Investment Adviser and Its Principals Settle SEC Charges that They Failed to Disclose Risks of Investing in Their Advisory Business (Jan. 23, 2018), available at  www.sec.gov/enforce/33-10454-s. [42] SEC Litig. Rel. No. 24037, SEC Charges Two Boston-Based Investment Advisers with Fraud (Jan. 31, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24037.htm. [43] Nate Raymond, Ex-Morgan Stanley adviser sentenced to U.S. prison for fraud, Reuters (June 28, 2018), available at www.reuters.com/article/morgan-stanley-fraud/ex-morgan-stanley-adviser-sentenced-to-u-s-prison-for-fraud-idUSL1N1TU28Q. [44] SEC Litig. Rel. No. 24054, SEC Charges Orange County Investment Adviser and Senior Officers in Fraudulent "Cherry-Picking" Scheme (Feb. 21, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24054.htm. [45] SEC Press Release, Investment Adviser Settles Charges for Cheating Clients in Fraudulent Cherry-Picking Scheme (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-36. [46] In re Arlington Capital Management, Inc. and Joseph L. LoPresti, Admin. Proc. File No. 3-18437 (Apr. 16, 2018), available at www.sec.gov/litigation/admin/2018/ia-4885.pdf. [47] SEC Litig. Rel. No. 24142, SEC Charges California Investment Adviser in Multi-Million Dollar Fraud (May 15, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24142.htm. [48] In re Aberon Capital Management, LLC and Joseph Krigsfeld, Admin. Proc. File No. 3-18503 (May 24, 2018), available at www.sec.gov/litigation/admin/2018/ia-4914.pdf. [49] SEC Press Release, Hedge Fund Firm Charged for Asset Mismarking and Insider Trading (May 8, 2018), available at www.sec.gov/news/press-release/2018-81. [50] SEC Press Release, SEC Charges Hedge Fund Adviser With Deceiving Investors by Inflating Fund Performance (May 9, 2018), available at www.sec.gov/news/press-release/2018-83. [51] SEC Press Release, SEC Charges Morgan Stanley in Connection With Failure to Detect or Prevent Misappropriation of Client Funds (June 29, 2018), available at www.sec.gov/news/press-release/2018-124. [52] SEC Press Release, SEC Launches Share Class Selection Disclosure Initiative to Encourage Self-Reporting and the Prompt Return of Funds to Investors (Feb. 12, 2018), available at www.sec.gov/news/press-release/2018-15. [53] SEC Press Release, SEC Charges Ameriprise With Overcharging Retirement Account Customers for Mutual Fund Shares (Feb. 28, 2018), available at www.sec.gov/news/press-release/2018-26. [54] SEC Press Release, SEC Orders Three Investment Advisers to Pay $12 Million to Harmed Clients (Apr. 6, 2018), available at www.sec.gov/news/press-release/2018-62. [55] SEC Admin. Proc. File No. 3-18328, Formerly Registered Investment Adviser Settles SEC Charges Related to Filing False Forms ADV and Other Investment Advisers Act Violations (Jan. 3, 2018), available at www.sec.gov/litigation/admin/2018/ia-4836-s.pdf. [56] SEC Admin. Proc. File No. 3-18423, SEC Charges Investment Adviser for Improperly Registering with the Commission and Violating Several Rules (Apr. 5, 2018), available at www.sec.gov/enforce/ia-4875-s. [57] In re SEI Investments Global Funds Services, Admin. Proc. File No. 3-18457 (Apr. 26, 2018), available at www.sec.gov/litigation/admin/2018/ic-33087.pdf. [58] SEC Press Release, SEC Charges 13 Private Fund Advisers for Repeated Filing Failures (June 1, 2018), available at www.sec.gov/news/press-release/2018-100. [59] SEC Press Release, SEC Charges Recidivist Broker-Dealer in Employee's Long-Running Pump-and-Dump Fraud (Mar. 27, 2018), available at www.sec.gov/news/press-release/2018-49. [60] SEC Press Release, Merrill Lynch Charged With Gatekeeping Failures in the Unregistered Sales of Securities (Mar. 8, 2018), available at www.sec.gov/news/press-release/2018-32. [61] SEC Press Release, SEC Charges New York-Based Firm and Supervisors for Failing to Supervise Brokers Who Defrauded Customers (June 29, 2018), available at www.sec.gov/news/press-release/2018-123. [62] SEC Press Release, Broker-Dealer Admits It Failed to File SARs (Mar. 28, 2018), available at www.sec.gov/news/press-release/2018-50. [63] SEC Charges Brokerage Firms and AML Officer with Anti-Money Laundering Violations (May 16, 2018), available at www.sec.gov/news/press-release/2018-87. [64] Administrative Proceeding File No. 3-18341, Industrial and Commercial Bank of China Financial Services LLC Agrees to Settle SEC Charges Relating to Numerous Regulation SHO Violations That Resulted in Prolonged Fails to Deliver (Jan. 18, 2018), available at www.sec.gov/litigation/admin/2018/34-82533-s.pdf. [65] SEC Press Release, Broker Charged with Repeatedly Putting Customer Assets at Risk (Mar. 19, 2018), available at www.sec.gov/news/press-release/2018-45. [66] Admin. Proc. File No. 3-18409, SEC Charges Broker-Dealer, CEO With Net Capital Rule Violations (Mar. 27, 2018), available at www.sec.gov/enforce/34-82951-s. [67] SEC Press Release, NYSE to Pay $14 Million Penalty for Multiple Violations (Mar. 6, 2018), available at www.sec.gov/news/press-release/2018-31. [68] SEC Press Release, Wells Fargo Advisors Settles SEC Chargers for Improper Sales of Complex Financial Products (June 25, 2018), available at www.sec.gov/news/press-release/2018-112. [69] Lit. Rel. No. 24179, SEC Charges Cantor Fitzgerald and Brokers in Commission-Splitting Scheme (June 29, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24179.htm. [70] SEC Press Release, Deutsche Bank to Repay Misled Customers (Feb. 12, 2018), available at www.sec.gov/news/press-release/2018-13. [71] SEC Press Release, SEC Charges Merrill Lynch for Failure to Supervise RMBS Traders (June 12, 2018), available at www.sec.gov/news/press-release/2018-105. [72] Admin. Proc. File No. 3-18335, Former Corporate Insider and Brokerage Industry Employee Settle Insider Trading Charges with SEC (Jan. 11, 2018), available at www.sec.gov/litigation/admin/2018/34-82485-s.pdf. [73] Lit. Rel. No. 24056,  SEC: Insider Bought Minutes After Warnings Not to Trade (Feb. 28., 2018), available at www.sec.gov/litigation/litreleases/2018/lr24056.htm. [74] Lit Rel. No. 24044, SEC Charges Former Medical Products Executives with Insider Trading (Feb. 12, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24044.htm. [75] Lit Rel. No. 24065, SEC Charges Corporate Communications Specialist with Insider Trading Ahead of Acquisition Announcement (Mar. 8, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24065.htm. [76] Lit Rel. No. 24163, Court Enters Consent Judgment against Robert M. Morano (June 11, 2018), available at https://www.sec.gov/litigation/litreleases/2018/lr24163.htm. [77] Press Release, Former Equifax Executive Charged With Insider Trading (Mar. 14, 2018), available at www.sec.gov/news/press-release/2018-40. [78] Press Release, Former Equifax Manager Charged With Insider Trading (June 28, 2018), available at www.sec.gov/news/press-release/2018-115. [79] Lit Rel. No. 24104, SEC Charges New York Man with Insider Trading (Apr. 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24104.htm. [80] Lit Rel. No. 24097, SEC Charges Massachusetts Man in Multi-Year Trading Scheme (Apr. 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24097.htm. [81] Lit Rel. No. 24134, SEC Charges Two Pennsylvania Residents with Insider Trading (May 4, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24134.htm. [82] Press Release, SEC Charges Investment Banker in Insider Trading Scheme (May 31, 2018), available at www.sec.gov/news/press-release/2018-97. [83] Lit Rel. No. 24165, SEC Charges Canadian Accountant with Insider Trading (June 12, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24164.htm. [84] Lit Rel. No. 24178, SEC Charges Credit Ratings Analyst and Two Friends with Insider Trading (June 29, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24178.htm. [85] 882 F.3d 431 (3d Cir. 2018); see also Tom Gorman, "SEC Disgorgement: A Path For Reform?," SEC Actions Blog (Feb. 20, 2018), available at http://www.lexissecuritiesmosaic.com/net/Blogwatch/Blogwatch.aspx?ID=32139&identityprofileid=PJ576X25804. [86] Lit Rel. No. 24035, SEC Freezes Assets Behind Alleged Insider Trading (Jan. 26, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24035.htm. [87] SEC Press Release, SEC Charges Municipal Adviser and its Principal with Defrauding Mississippi City (January 5, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24025.htm. [88] SEC Press Release, SEC Obtains Judgments Against Municipal Adviser and Its Principal for Defrauding Mississippi City (July 2, 2018), available at www.sec.gov/litigation/litreleases/2018/lr24182.htm. [89] SEC Press Release, SEC Levies Fraud Charges Against Texas-Based Municipal Advisor, Owner for Lying to School District (May 9, 2018), available at www.sec.gov/news/press-release/2018-82.
The following Gibson Dunn lawyers assisted in the preparation of this client update:  Marc Fagel, Mary Kay Dunning, Amruta Godbole, Amy Mayer, Jaclyn Neely, Joshua Rosario, Alon Sachar, Tina Samanta, Lindsey Young and Alex Zbrozek. Gibson Dunn is one of the nation's leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators. Our Securities Enforcement Group offers broad and deep experience.  Our partners include the former Directors of the SEC's New York and San Francisco Regional Offices, the former head of FINRA's Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California, and former Assistant United States Attorneys from federal prosecutors' offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force. Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Group, and our White Collar Defense Group. Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work or any of the following: New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Barry R. Goldsmith - Co-Chair (+1 212-351-2440, bgoldsmith@gibsondunn.com) Laura Kathryn O'Boyle (+1 212-351-2304, ) Mark K. Schonfeld - Co-Chair (+1 212-351-2433, mschonfeld@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Washington, D.C. Stephanie L. Brooker  (+1 202-887-3502, sbrooker@gibsondunn.com) David P. Burns (+1 202-887-3786, dburns@gibsondunn.com) Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Richard W. Grime - Co-Chair (+1 202-955-8219, rgrime@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tadavis@gibsondunn.com) Marc J. Fagel - Co-Chair (+1 415-393-8332, mfagel@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com)

© 2018 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 1, 2017 |
Key Developments in Latin American Anti-Corruption Enforcement

Washington, D.C. partner F. Joseph Warin; Los Angeles partner Michael Farhang and associates Michael Galas, Abiel Garcia, and John Sandoval; São Paulo partner Lisa Alfaro; Denver associate Tafari Lumumba; and Orange County associate Sydney Sherman are the authors of “Key 2017 Developments in Latin American Anti-Corruption Enforcement,” [PDF] published in Trade Security Journal on May 2017.

June 21, 2018 |
Supreme Court Rules That SEC ALJs Were Unconstitutionally Appointed

Click for PDF Lucia v. SEC, No. 17-130  Decided June 21, 2018 Today, the Supreme Court held that administrative law judges of the Securities and Exchange Commission are inferior “Officers of the United States” within the meaning of the Constitution’s Appointments Clause.  Thus, the ALJs were unconstitutionally appointed by SEC staff. Background: The SEC has relied on ALJs to resolve hundreds of enforcement actions.  Raymond Lucia challenged the lawfulness of sanctions that the SEC had imposed on him, arguing that the ALJ hearing his case was not constitutionally appointed.  He asserted that SEC ALJs are “Officers of the United States” under the Constitution’s Appointments Clause, which requires such officers to be appointed by the President, “Courts of Law,” or “Heads of Departments.” SEC ALJs, however, were appointed by agency staff.  A panel of the D.C. Circuit held that the ALJs are mere “employees”—governmental officials with lesser responsibilities than “Officers” and thus not subject to the Appointments Clause.  An evenly divided en banc court affirmed. Issue: Whether SEC ALJs are “Officers of the United States” subject to the Appointments Clause. Court's Holding: Yes.  Because SEC ALJs exercise “significant authority pursuant to the laws of the United States,” they are inferior “Officers” under the Appointments Clause.  As such, the ALJs may not be appointed by agency staff and must instead be appointed by the President, the SEC itself, or a court of law.

“[T]he Commission’s ALJs issue decisions containing factual findings, legal conclusions, and appropriate remedies. . . . And when the SEC declines review (and issues an order saying so), the ALJ’s decision itself ‘becomes final’ and is ‘deemed the action of the Commission.’”

Justice Kagan, writing for the Court Gibson Dunn represented the winning party:  Raymond Lucia What It Means:
  • The ruling largely rests on the Court’s conclusion that SEC ALJs are “near-carbon copies” of special trial judges of the Tax Court that the Court had previously found were inferior “Officers” because they exercise “significant authority.”  See Freytag v. Commissioner, 501 U.S. 868 (1991).
  • The ruling provides new guidance on the relief available for litigants who make a timely Appointments Clause challenge:  The Court ordered the SEC to provide Mr. Lucia a new hearing before a different ALJ who has been constitutionally appointed, reasoning that the ALJ who originally presided over Mr. Lucia’s case could not be expected to consider the case “as though he had not adjudicated it before.”
  • Before the Court issued its decision, the SEC released an order purporting to “ratify” the past ALJ appointments, but the Court did not address the validity of that order.
  Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice
Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com
 

Related Practice: Securities Enforcement

Marc J. Fagel +1 415.393.8332 mfagel@gibsondunn.com Barry R. Goldsmith +1 212.351.2440 bgoldsmith@gibsondunn.com Richard W. Grime +1 202.955.8219 rgrime@gibsondunn.com
Mark K. Schonfeld +1 212.351.2433 mschonfeld@gibsondunn.com
  © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.