02.28.2012

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Updates

The annual “SEC Speaks” conference, where the U.S. Securities and Exchange Commission ("SEC" or "the Commission") and its senior staff review the major developments from the prior year and preview their plans for the upcoming year, convened in Washington, D.C. from February 24-25, 2012.  While the clarion call that emerged from last year's conference was a plea for additional resources to manage the unprecedented new mandate created by the Dodd-Frank Wall Street Reform and Consumer Protection Act, this last year has prompted a renewed rallying cry by the SEC as it emerges from the all-consuming Dodd-Frank rulemaking efforts with a record 735 enforcement actions and an eye toward ratcheting up its proactive risk-based initiatives. 

Chairman Schapiro Touts SEC’s “Entrepreneurial” Structural Changes

Chairman Mary L. Schapiro pronounced the SEC “fundamentally better equipped to perform” after last year’s “modest” funding turnaround and highlighted the strides the SEC has made in improved technology, training efforts, research capabilities and operational management.  Schapiro also noted broadened hiring efforts to bring non-lawyer industry experts on staff, including traders and academics, as well as the doubling of the staff’s training budget and enhancement of research capabilities—such as the new agency-wide electronic discovery program. 

Characterizing the SEC’s new strategic approach as more entrepreneurial in nature, Schapiro touted the staff’s increased ability to recognize threats and move rapidly to address them.  For example, the new national examination program from the Office of Compliance has resulted in 42% of exams identifying “significant findings” with an increase in exam referrals to the Division of Enforcement rising from 10% to 15% in the last year alone. 

Streamlined Enforcement Processes: From Formal Orders to Wells Submissions

David Bergers, the SEC’s regional director in Boston, highlighted Enforcement’s enhanced ability to pursue reports of wrongful conduct stemming from the delegation of formal order authority to senior officers in the Division that allows the SEC to escalate an investigation more quickly and to compel testimony and document production.  Bergers also noted that under the streamlined Wells notice process, the SEC will allow only a single post-Wells meeting so that prolonged settlement negotiations do not delay recommending an action to the Commission.  This is consistent with Dodd-Frank, which requires an action to be filed—or a notice of intent to not file—within 180 days of the Wells notice, with any extension requiring the Commission’s approval. 

Whistleblower Office Launches– Tips Rolling In

Sean McKessy, chief of the SEC’s Office of the Whistleblower, reported that the new Whistleblower Program from Dodd-Frank has resulted in hundreds of high-quality tips, as well as prodded numerous untold companies to enhance their own internal compliance programs.  McKessy emphasized that the office has engaged in significant internal outreach to educate staff across the divisions to ensure they understand the type of information that should be captured from whistleblowers as well as how to process award payments.  According to McKessy, the current priority is to improve and maintain communication with whistleblowers and their counsel, noting that the office has successfully returned more than 2,000 calls within 24 business hours of receiving a tip on the hotline.  McKessy noted, however, the problematic tension between meeting Dodd-Frank’s requirement that the SEC maintain communication with whistleblowers and the agency’s policy prohibiting staff from commenting on the status of pending investigations.

In response to widespread criticism that the Dodd-Frank whistleblower program is likely to undermine internal corporate reporting, McKessy defended the program’s approach as "balanced" because it includes “built-in incentives” that enable whistleblowers to report internally first and still remain eligible for the bounty.  McKessy also noted that he has anecdotally observed that a “significant majority“ of the tips received were—according to the whistleblowers themselves—reported first internally within their respective companies. 

Enforcement Themes

Khuzami Promises “More Cases to Come” Out of 2008 Financial Crisis

Robert Khuzami, director of the SEC’s Division of Enforcement, emphasized the ongoing efforts to bring cases arising from the financial crisis, in addition to the nearly 100 actions brought to date against individuals and/or entities—more than half of which include CFOs, CEOs or other senior officers.  Jason Anthony, special counsel in the Structured and New Products Unit, also addressed the SEC’s “very large focus” on financial crisis cases, noting continued investigation surrounding the sale of loans and coordination with industry experts to assess the accuracy of disclosures made to investors (e.g., credit quality of underlying loans; conformance to originator guidelines; accurate property valuations; and undisclosed delinquencies or defects). 

Matthew Martens, chief litigation counsel, defended the SEC’s litigation record and settlement practices, noting in particular the recent judicial criticism of “neither admit nor deny” language in its settled cases.  According to Martens, the SEC has shown that it does not walk away from a fight, as evidenced by the financial crisis cases where it is litigating against 12 (or 44%) of the 27 charged entities and 50 (or 74%) of the 68 charged individuals.

Per Martens, it is the SEC’s policy to accept settlements with recoveries that the SEC could reasonably expect to receive at trial, and he argued that it would be a mistake to reject settlements simply because they lack admissions.  Martens further posited that the use of detailed public complaints ensures that the public is adequately put on notice regarding any wrongful conduct that has occurred. 

Neither Director Khuzami nor Martens directly expounded on Khuzami’s January announcement that the SEC will no longer allow defendants to neither admit nor deny civil fraud or insider trading cases when, at the same time, they admit to or have been convicted of criminal violations—a policy change that follows recent sharp criticism in federal court and on Capitol Hill concerning the SEC’s practice of allowing companies to repeatedly settle fraud cases without admitting or denying the charges.

Ongoing Focus on “Expert Networks” in Insider Trading Cases 

Sanjay Wadhwa, associate regional director in the New York Regional Office and deputy chief of the Market Abuse Unit, announced that there are “a lot more” expert network cases in the pipeline, with ongoing and promising investigations coming out of the Galleon case and recent charges against Broadband alleging illicit gains totaling $110 million. 

Wadhwa addressed the “enormous amount of talk” surrounding the use of wiretaps and whether they have become a routine tool for insider trading cases, noting that it is the Department of Justice—and not the SEC—that uses wiretaps.  He noted that the SEC has brought a large number of standalone cases using only “traditional” investigation techniques.  Illustrating this point, Wadhwa highlighted the agency’s recent success in connecting insider trading defendants through the use of disposable pre-paid phones and pay phones in Times Square, MetroCard data to trace subway use, and credit card records to track restaurant meetings.  

FCPA Enforcement Becoming More Institutionalized

Kara Brockmeyer, chief of the SEC’s specialized FCPA Unit, announced the December launch of the “FCPA Spotlight” page on the agency’s website (http://www.sec.gov/spotlight/fcpa.shtml) that includes links to every FCPA action ever brought by the agency and also provides FCPA case statistics going back five years.  The SEC’s new page also includes an Investor Bulletin specific to the FCPA as well as links to the statute.

Brockmeyer noted that the SEC brought 20 FCPA actions last year alone (19 companies, one individual), collecting $200 million in sanctions (with another $288 million collected by DOJ).  She reaffirmed the SEC’s interest in pursuing FCPA cases against both companies and individuals and advised not to “read into the statistics” as there is sometimes a delay or lag before the SEC is ready to bring charges against individuals—although it brings the charges simultaneously when able.

Brockmeyer addressed the recent medical device sweep cases, highlighting the recently settled action with Smith & Nephew, and promised that “more will be coming,” in addition to cases targeting the pharmaceutical industry.  She also touched on various international developments in anti-corruption enforcement, including recent anti-bribery laws passed in Russia and China, and noted that Switzerland brought its first foreign corruption case.  Brockmeyer indicated that the SEC is seeing more and better cooperation in connection with foreign corruption cases between regulators and across borders.

Aiding & Abetting Liability Expanded Under Dodd-Frank, but Control Person Liability in Flux

Merri Jo Gillette, regional director in Chicago, commented on the expansion of aiding and abetting liability under Dodd-Frank, noting that the SEC now has more flexibility to assert aiding and abetting claims under the Securities Act and the Investment Advisor’s Act as well as to seek civil monetary penalties under the latter.  Prior to Dodd-Frank, the SEC was required to show that an aider and abettor knowingly provided substantial assistance, but now the SEC can prove the charge under a knowing or reckless state of mind.  Gillette remarked that the SEC will continue to look at the application of aiding and abetting liability to third-party servicers, such as accountants and lawyers.

In terms of changes to civil penalties under Dodd-Frank, Gillette explained that the most significant development is the SEC’s ability to seek penalties in administrative proceedings as well as expanded authority to penalize secondary actors, as the SEC can now explicitly seek penalties both for direct violations as well as against persons who were “causes” of direct violations.

Although Dodd-Frank resolved a previously existing circuit split to establish the SEC’s unequivocal authority to bring injunctive actions against control persons, Gillette noted that there remained differences across circuits regarding the elements of control person liability as well as the availability of an affirmative defense.  According to Gillette, some circuits require culpable participation by a control person, while others apply a less rigorous standard that requires control persons to actually participate in the operation of the business and/or to have power to control the transactions or actions giving rise to the primary violations.  In private actions, some courts have held that “appropriate systems” could give rise to an affirmative defense if a control person is able to demonstrate that he or she acted in good faith and did not directly or indirectly induce the conduct—although it remains to be seen whether this defense will be more widely recognized across the federal districts. 

Failure to Supervise Charges for Legal/Compliance Officers

Commissioner Daniel Gallagher focused his comments on “failure to supervise” liability for a broker-dealer’s legal and compliance personnel under the Securities Exchange Act and the Investment Advisors Act.  Although legal and compliance officers are not automatically considered “supervisors,” they can fall under this category when the facts and circumstances of a particular case reveal they held the requisite degree of responsibility, ability or authority to affect the conduct of another employee such that they have become a part of the management team’s collective response to a problem and hence subject to “failure to supervise” liability.  Gallagher observed that the SEC has not provided a clear or definitive answer regarding when the actions of a broker-dealer’s legal and compliance personnel transform them into “supervisors,” but expressed hope that the SEC would provide clear guidance in the future.  He acknowledged that “robust engagement on the part of legal and compliance personnel raises the specter that such personnel could be deemed to be ‘supervisors’ subject to liability for violations of law by the employees they are held to be supervising,” which then leads to “the perverse effect of increasing the risk of supervisory liability in direct proportion to the intensity of their engagement in legal and compliance activities.”  To take advantage of an in-house employee’s expertise without subjecting him or her to potential liability for failure to supervise, firms should consider using legal and compliance personnel on internal boards and committees as non-voting providers of advice, rather than members with voting privileges.

Five Areas of Focus in Municipal Securities and Public Pensions

Elaine Greenberg, chief of the Municipal Securities and Public Pensions Unit, outlined five categories of investigatory focus, including:

  1. Offering and Disclosure Fraud:  pursuing municipal issuers for material misrepresentations in bond offering documents and broker dealers for defrauding municipalities;

  2. Pay to Play/Public Corruption:  focus on public pension fund corruption;

  3. Public Pension Accounting and Disclosure:  looking at states with significant future pension liabilities and whether material misstatements were made to bond holders;

  4. Valuation and Pricing Fraud:  scrutinizing general lack of transparency in over-the-counter trading; and

  5. Tax or Arbitrage Fraud.

Accounting Enforcement

The SEC continued to emphasize the importance of auditor independence.  Because the SEC’s auditor independence standards are broader than those of the AICPA (American Institute of CPAs), the Accounting Enforcement panel cautioned that companies considering an initial public offering should carefully review the scope of their auditor’s services for compliance with the SEC’s more stringent requirements.  Fraud enforcement in the context of financial reporting also continues to be a high priority for the SEC.  The SEC warned that additional areas of focus will be cross-border transactions, disclosures, revenue recognition, loan losses, valuation, impairment, expense recognition and related party transactions.  In response to concerns regarding the quality of audited financial statements for issuers with significant foreign operations, the SEC announced the launch of a risk-based inquiry to identify issuers with a high potential for misreporting foreign operations under GAAP principles.

Looking Ahead

After overcoming budget limitations despite increased responsibilities under Dodd-Frank, the realigned SEC now appears to be re-energized and ready to expand upon its enforcement efforts in 2012.  The SEC’s more expansive view of its mission dovetails with the president’s proposed budget for 2013, reflecting an 18.5% increase over the SEC's 2012 appropriation, which would allow the agency to add 676 professionals next year, a 15% increase in its staffing level.  This budget increase would also support new technology initiatives, including surveillance and risk analysis tools, better electronic discovery tools, and continued build-out of the agency’s system to track tips, complaints and referrals—all of which were highlighted at SEC Speaks this year.  The SEC appears poised for an active and aggressive 2012 and may well meet or exceed last year’s record number of enforcement actions through increased intra- and interagency cooperation and the use of new tools and capabilities afforded by Dodd-Frank.

© 2012 Perkins Coie LLP


 

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