Internal investigations are an ever-present challenge for companies. They can involve virtually any topic and arise in myriad ways. Embezzlement, accounting improprieties, bribery, and financial statement adjustments can all lead to a closely scrutinized investigation, with likely triggers of whistleblower reports, news articles, litigation demands, or regulatory inquiries. The common denominator is that they present high pressure and/or high stakes. Consequently, it is imperative that matters not be made worse through a flawed internal investigation. In today’s post, we cover some of the essential topics to keep in mind when managing an internal investigation to ensure that the investigation itself does not cause or exacerbate harm to the company.
George E. Greer
George Greer, a partner in Orrick’s Seattle office, is a member of the Securities Litigation, Investigations and Enforcement Group. Mr. Greer’s practice focuses on complex commercial litigation with an emphasis on securities, corporate governance and professional liability for accounting firms, class actions and energy issues. Chambers USA currently reports that “Greer has particular expertise in matters relating to allegations of false accounting and financial reporting.” A prior edition of Chambers USA reported that “The market describes him as a ‘bright, strategic’ lawyer who ‘understands how to deal with people effectively’ and ‘gets great results.’”
Mr. Greer’s current matters include the following.
- Representation of Microsoft in a derivative action pending in federal court.
- Representation of a Big Four accounting firm in an SEC investigation.
- Representation of a Big Four accounting firm in a wage-and-hour class action challenging the exempt status of unlicensed accountants.
- Representation of the Audit Committee of the Board of Directors of Fortune 500 company in internal investigation concerning FCPA issues.
Mr. Greer has represented issuers, officers, directors, accountants and underwriters in class action securities litigation and in SEC investigations and enforcement proceedings. Mr. Greer’s practice also includes representation of companies, Special Litigation Committees and individuals in corporate governance disputes. He has conducted a number of internal investigations on behalf of boards of directors of both public and private companies. His experience in the energy arena includes the representation of the Bonneville Power Administration in an arbitration involving more than a billion dollars in claimed damages.
As we have previously reported, practitioners and judges alike have recently been questioning the SEC’s increased use of administrative proceedings. Defense lawyers complain that administrative proceedings, which have historically been a rarely used enforcement tool, are stacked against respondents. Recently, Judge Rakoff of the U.S. District Court for the Southern District of New York publicly discussed the “dangers” that “lurk in the SEC’s apparent new policy.” Director of Enforcement Andrew Ceresney delivered a speech late last month responding to public criticism, in particular countering many points raised by Judge Rakoff.
Securities fraud actions are often filed on the heels of an announcement of an internal or SEC investigation. A recent Ninth Circuit decision, Loos v. Immersion Corp., may make it easier for company executives to sleep at night following such an announcement. The Ninth Circuit has joined a growing number of circuits holding that the announcement of an internal investigation, standing alone, is insufficient to show loss causation at the pleading stage. Read More
On April 14, 2014, a divided panel of the U.S. Court of Appeals for the District of Columbia held in National Assoc. of Mfg., et al. v. SEC that the required disclosures pursuant to the SEC’s Conflict Minerals Rule violated the First Amendment’s prohibition against compelled speech, throwing that rule into uncertainty and possibly opening the door to constitutional challenges to similar disclosure rules.
The Conflict Minerals Rule requires companies and foreign private issuers in the U.S. to disclose their use of “conflict minerals” both to the SEC and on their websites. The Rule, which was adopted pursuant to Section 1502 of the Dodd-Frank Act as a response to the Congo War, defines “conflict minerals” as gold, tantalum, tin, and tungsten from the Democratic Republic of Congo (“DRC”) or an adjoining country, which directly or indirectly financed or benefited armed groups in those countries. The deadline for satisfying the Rule, which became effective in November 2012, is May 31, 2014. The National Association of Manufacturers, along with Business Roundtable and the U.S. Chamber of Commerce, challenged the Rule in the district court and then appealed to the Circuit Court. Read More
On March 10, 2014, the Securities and Exchange Commission (“SEC”) announced that issuers and underwriters of municipal securities may voluntarily report materially inaccurate statements made in offering documents regarding prior continuing disclosure compliance through a program called the Municipalities Continuing Disclosure Cooperation Initiative (the “MCDC Initiative”).
Orrick and BLX Group have issued a client alert with key information.
On August 8, 2013, the Second Circuit vacated the SEC’s $38 million fine against hedge fund Pentagon Capital Management PLC, holding that the Supreme Court’s decision in Gabelli v. SEC required the case to be remanded for recalculation of the civil penalty. This case is one of several SEC enforcement actions affected by the Gabelli ruling since the Court issued its decision less than six months ago. The Second Circuit’s decision highlights the limiting effect Gabelli will have on civil remedies available to the SEC for securities law violations that occurred more than five years before the agency initiated its enforcement action.
In Gabelli, the Court held that the five-year statute of limitations for filing civil enforcement actions seeking penalties for fraud begins to run from the date of the alleged violation, not when the SEC discovers, or reasonably should have discovered, the violation. Citing Gabelli, the Second Circuit in SEC v. Pentagram Capital Management PLC found that any profits Pentagon earned more than five years before the SEC filed its suit could not be included in the penalty. The parties agreed that remand on the issue was required.
The SEC alleged that Pentagon and its owner, Lewis Chester, committed securities fraud under Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 by engaging in late trading of mutual funds. Late trading involves placing and executing orders as if they occurred at or before the time the mutual fund price was determined. Such trading allows the purchaser to profit from information released after the mutual fund price is fixed each day, but before it can be adjusted the following day. The SEC alleged that Pentagon engaged in late trading through its broker dealer, Trautman Wasserman & Co., from February 2001 through September 2003. Read More
On April 8, 2013, Judge Shira A. Scheindlin of the Southern District of New York granted auditor Deloitte Touche Tohmatsu CPA’s (“DTTC”) motion to dismiss a shareholder class action, finding that plaintiffs failed to sufficiently allege scienter or any misstatements by DTTC pursuant Section 10(b) and Rule 10b-5 of the Securities Exchange Act. Plaintiffs alleged that DTTC issued unqualified audit opinions on behalf of its client Longtop from 2009 to 2011. During that period, Longtop reported very strong financial results, which were later revealed to be fraudulently inflated.
In May 2011, DTTC released a public letter of resignation as Longtop’s auditor, disclosing that its second round of bank confirmations were cut short by Longtop’s deliberate interference, that Longtop’s CEO admitted the company’s books were fraudulent, and that DTTC had resigned due to that admission and Longtop’s deliberate interference with its audit. As a result, the NYSE stopped trading on Longtop’s securities and delisted the company.
In dismissing shareholder claims against DTTC, the court applied the stringent test for plaintiffs to meet when alleging scienter against an auditor. Because “an outside auditor will typically not have an apparent motive to commit fraud, and its duty to monitor an audited company for fraud is less demanding than the company’s duty not to commit fraud,” an auditor’s mere failure to identify problems with a company’s internal controls and accounting practices will not constitute recklessness. Read More
The U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) can breathe a little easier after President Barak Obama’s re-election on Tuesday, November 6, 2012, according to legal scholars and attorneys.
Presidential Candidate Mitt Romney voiced his criticisms of the Dodd-Frank Act during the October 3, 2012, presidential debate, promising to repeal and replace Dodd-Frank. While the political climate in the United States Congress made repeal of Dodd-Frank unlikely, Romney’s administration may have eliminated or weakened provisions of the Act, appointed SEC and CFTC heads who were less interested in aggressive enforcement, and reduced both agencies’ funding.
Legal scholars and attorneys predict that President Obama’s re-election will allow the SEC and the CFTC to continue their aggressive enforcement campaigns of 2011. President Obama’s re-election is particularly important for the CFTC, which Dodd-Frank awarded new oversight powers. The Romney administration may have eliminated key provisions of the Act, returning the CFTC to the limited role it exercised under President George W. Bush. Under President Obama, the CFTC is likely to continue its expanded watchdog role and receive the funding necessary to do so. Read More
On September 10, 2012, the CFTC issued rules mandating new record-keeping and registration requirements for swap dealers and major swap participants in the $700 trillion derivative global market. The rules were published in the Federal Register on September 11, 2012 and will take effect on November 13, 2012. The issuance finalizes rules adopted in a 5 to 0 CFTC vote on August 27, 2012. The rules were issued under Section 731 of the Dodd Frank Act, which amended the Commodity Exchange Act to require the adoption of standards relating to the confirmation, processing, netting, documentation, and valuation of swaps. Through these regulations, CFTC aims to effectively regulate swap dealers and major swap participants, and impose rigorous clearing and trade execution requirements on a previously unchecked derivatives market.
A swap is a derivative product in which counterparties exchange the cash flows of their financial instrument for the cash flows of the other party’s instrument. Swaps can include currency swaps, interest rates swaps, and, more recently, credit default swaps.
The final rules require swap dealers and major swap participants to timely and accurately confirm swap transactions by the end of the first business day following the date of execution. The rules also mandate portfolio reconciliation on a daily, weekly, and quarterly basis, and portfolio compression as a risk management tool. Furthermore, swap dealers and participants must now establish and enforce policies and procedures that are reasonably designed to ensure that each dealer and participant and its counterparties agree to all of the terms in the swap trading relationship documentation. The rules also require dealers and participants to agree with their counterparties regarding the methods, procedures, rules, and inputs for swap valuations. Read More
On July 11, 2012, the Securities and Exchange Commission (SEC) approved a new rule, which will require the national securities exchanges and self-regulatory organizations like the Financial Industry Regulatory Authority (FINRA) to establish a market-wide consolidated audit trail. The new consolidated audit trail will improve regulators’ ability to monitor and analyze trading activity. With the approval of Rule 613, the exchanges and FINRA must jointly submit to the SEC a comprehensive plan of how they plan to develop, implement, and maintain the consolidated audit trail. Rule 613 also requires that the consolidated audit trail collect and identify every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options in all U.S. markets. Read More