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Posts by: William Foley

Changing the Game, Again: Supreme Court Could Limit SEC’s Authority to Seek Disgorgement

This week, the Supreme Court heard argument regarding whether the SEC’s actions to disgorge ill-gotten gains are subject to a five-year statute of limitations for “any civil fine, penalty, or forfeiture.”

The appeal stems from an SEC action alleging that between 1995 and 2006, Charles Kokesh, a New Mexico-based investment adviser, misappropriated a staggering $35 million from two investment advisory companies that he owned and controlled, squandering the money of tens of thousands of small investors. While Kokesh moved into a gated mansion and bought himself a personal polo court (complete with a stable of 50 horses), he allegedly concealed his massive ill-gotten earnings by distributing false proxy statements to investors and filing dozens of false reports with the Securities and Exchange Commission.

In 2009, the SEC brought a civil enforcement action against Kokesh in the District of New Mexico alleging violations of the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940. The jury found violations of all three acts, and the district court ordered Kokesh to disgorge the $35 million he misappropriated (plus interest) and pay a $2.4 million civil monetary penalty for the “egregious” frauds he committed within the prior five years.  While the district court ordered disgorgement of all of Kokesh’s ill-gotten gains since 1995, the civil monetary penalty it imposed was constrained by the five-year statute of limitations found in 28 U.S.C. § 2462, which applies to claims throughout the U.S. Code for “any civil fine, penalty, or forfeiture.”

Kokesh agreed to pay the civil monetary penalty, but challenged the disgorgement order on appeal before the U.S. Court of Appeals for the Tenth Circuit. Although none of the statutes he was found to have violated have statutes of limitations of their own, Kokesh argued that the SEC’s claim for disgorgement was subject to the five-year limitations period codified in Section 2462.  The Tenth Circuit disagreed, and upheld the disgorgement order on the basis that disgorgement is not a “penalty” or “forfeiture,” as those terms are used in Section 2462.  Unlike a penalty, it found that “the disgorgement remedy does not inflict punishment,” but “leaves the wrongdoer in the position he would have occupied had there been no misconduct.”  The Tenth Circuit also held that disgorgement is different from a “forfeiture,” which it held is used in Section 2462 to narrowly refer to an in rem procedure to seize property regardless of whether the property-owner committed any wrongdoing or whether “the value of the property” had any “relation to any loss to others or gain to the owner.”

The U.S. Supreme Court granted certiorari to decide whether SEC civil enforcement actions seeking disgorgement of ill-gotten gains are subject to Section 2462’s five-year statute of limitations. In his petition for certiorari, Kokesh asked the Supreme Court to rein in the SEC’s increasing use of disgorgement following the Supreme Court’s 2013 decision, Gabelli v. SEC, 133 S. Ct. 1216. Gabelli shortened the limitations period available under Section 2462 by setting the accrual date on the date of the alleged violation, rather than the date of discovery.  (For a discussion on Gabelli and the circuit split it resolved, see here and here).

In a brief filed March 27, 2017, the SEC urged the Supreme Court to affirm the Tenth Circuit’s finding that wrongdoers should not get the benefit of Section 2462’s general five-year limitations period because disgorgement is neither a penalty nor a forfeiture.  Kokesh responded that the Tenth Circuit and the SEC’s view of “penalty” and “forfeiture” are artificially narrow, and disgorgement is a penalty and a forfeiture under Section 2462.  Kokesh’s view has support from the Eleventh Circuit, which decided in SEC v. Graham, 823 F.3d 1357 (11th Cir. 2016) that Section 2462 applies when the SEC seeks disgorgement.

The case has attracted considerable attention from industry-insiders. Amici curiae include Mark Cuban, who submitted a brief arguing that Congress never gave the SEC the authority to order “draconian remedies labeled ‘disgorgement’ that are unbounded by statutes of limitations.”  The Chamber of Commerce and American Petroleum Institute filed a joint amici brief,  in which they asked the Supreme Court to consider the effect its opinion will have on the authority of other government agencies, including the Environmental Protection Agency and Consumer Financial Protection Bureau, to order disgorgement for “long-past conduct that may have been acceptable at the time.”

When Kokesh came up for argument on Tuesday, April 18, it was one of the first cases argued before nine justices in over a year.  During oral argument, several of the justices appeared to reject the contentions of both parties regarding whether disgorgement is categorically a penalty or forfeiture.  Justice Kagan agreed with Justice Ginsburg that the better view may be to consider disgorgement a penalty (subject to a five-year statute of limitations) if the government keeps the proceeds, and a compensatory remedy (not subject to a statute of limitations) if the proceeds are distributed to the victims.  A majority or near-majority of the Bench also expressed discomfort at the fact that no statutory authority expressly authorizes courts to order disgorgement in SEC civil enforcement actions, and that the SEC has not promulgated any formal guidance explaining the circumstances under which it seeks disgorgement or its procedures for distributing the proceeds to victims.  Unable to identify any clear authority defining disgorgement as a penalty, forfeiture, or neither, the Court appeared receptive to Kokesh’s argument that SEC civil enforcement actions seeking disgorgement should be constrained by Section 2462.

A decision is expected by late June.

SEC Reportedly Centralizing Authority to Issue Formal Investigation Orders

According to a report in the Wall Street Journal, the acting Chairman of the Securities and Exchange Commission has centralized authority to issue formal orders of investigation – a critical authority that triggers the ability of SEC staff attorneys to issue subpoenas.  The move, which was not publicized by the SEC, would curb existing powers of the Commission’s enforcement staff.

Since 2009, the power to issue formal orders of investigation had been “sub-delegated” to about 20 senior attorneys within the SEC’s Enforcement Division. However, according to the Journal report, acting SEC Chairman Michael Piwowar ordered the authority to be centralized exclusively with the Director of Enforcement. READ MORE

Gordon v. Verizon: New York Parts Company with Delaware

People at a Table

On February 2, 2017, the New York Appellate Division, First Department, issued a decision in Gordon v. Verizon Communications, Inc., No. 653084/13, 2017 WL 442871 (1st Dep’t 2017), approving the settlement of litigation over an acquisition by Verizon Communications (“Verizon”) and articulating a new test to evaluate the fairness of such settlements. The Gordon decision signals that New York will remain a friendly venue to disclosure-based M&A settlements and may see increased shareholder M&A lawsuits as a result

As we have repeatedly written about (here, here and here), Delaware Chancery Courts have spent the past year attempting to curtail, or eliminate altogether, M&A litigation settlements where the sole remedy is enhanced proxy disclosures. Chancellor Bouchard’s landmark decision in In re Trulia Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), rejected these “disclosure-only” settlements, finding that the “enhanced” disclosures produced by such settlements were not “material or even helpful” to stockholders.  The Chancery Court bemoaned the proliferation of disclosure-only settlements in Delaware, and indicated that these types of settlements would be met by “continued disfavor” unless the supplemental disclosures are “plainly material,” i.e., they must “significantly alter the ‘total mix’ of information made available.”

In Trulia’s wake, the number of M&A suits filed in Delaware plummeted—declining by almost 75% in the first half of 2016—as plaintiffs’ counsel opted to file in federal court or states other than Delaware in the hope of finding more hospitable fora for “disclosure-only” resolutions.  READ MORE

Salman v. U.S.: Supreme Court Resolves Insider Trading Split

On December 6, 2016, the United States Supreme Court affirmed an insider trading conviction in a case where the “insider” obtained no direct pecuniary benefit from the disclosure.  Justice Samuel Alito, writing for a unanimous court, held that a recipient of insider information may still be criminally liable where the insider initially gave the information to a trading relative or friend and thereby received a “personal benefit.”  The court heard oral arguments in October.

Salman v. United States concerned the prosecution of Bassam Salman, a recipient of insider tips from Michael Kara, his brother in law, who in turn received insider information from his brother, Maher Kara.  Salman knew that Michael, who also traded on the information, was getting tips from Maher, a Citigroup banker working on various health care deals.  Maher, the “tipper,” never received any financial or other concrete benefit in the exchange, but testified that he suspected Michael was trading on the information he provided and there was evidence the brothers had a close relationship. READ MORE

(Proxy) Voting Made Easy?

The SEC recently proposed amendments to the proxy voting rules to require parties in a contested election to use universal proxy cards that would include the names of all board of director nominees. This proposed change would eliminate the two “competing slates” cards and allow shareholders to vote for their preferred combination of board candidates, as they could if they voted in person.

The new rules would apply to all non-exempt votes for contested elections other than those involving registered investment companies and business development companies, would require management and dissidents to provide each other with advance notice of the names of their nominees, and would set formatting requirements for the universal proxy cars. As with any newly proposed SEC rule, there will be a comment period of 60 days to solicit public opinion.

Interestingly, the Commission’s vote to adopt the newly proposed rules was a split decision, with Commissioner Piwowar issuing a strongly worded dissent. According to Commissioner Piwowar, the proposed universal proxy rules “would increase the likelihood of proxy fights at public companies,” and would allow special interest groups to “use their increased influence to advance their own special interests at the expense of shareholders.” He also noted that under the new rules, dissidents are only required to solicit holders of shares representing a majority of those entitled to vote, meaning that many retail investors will not receive either the dissident’s proxy statement or disclosures about the dissident’s nominees.

Too Good to Be True: Fraudulent Self-Promotion Lands “Prodigy” in Hot Water with SEC

In June 2014, the Office of Investor Education and Advocacy at the Securities and Exchange Commission issued an alert cautioning that investment newsletters are often “used to carry out schemes designed to deceive investors.” In particular, the SEC advised investors to be “highly suspicious” of newsletter “promises” of “high investment returns” and to contact the SEC to report potential securities fraud in newsletters and other promotional materials.

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CDX Holdings, Inc. v. Fox: Chancery Court’s Decision Is Affirmed, But Dissent Blasts Use of “Hindsight Bias” Analysis

Building

On June 6, 2016, the Supreme Court of Delaware affirmed a decision of the Chancery Court finding that corporate directors and officers involved in a sales transaction breached a contract with option holders to fairly value their options (see here for a thorough explanation of the Chancery Court decision, and in particular, the Court’s criticism of the retained financial advisers that provided a valuation analysis).  The Supreme Court decision also included a disproportionately lengthy dissent condemning both the Chancery Court’s findings and its reliance on “social science studies” to reach them.

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Recent SEC Enforcement Actions and Public Commentary Demonstrate the Commission’s Continued Focus on Internal Control Failures

We have previously written about how, over the past few years, the SEC and other regulatory agencies have devoted substantial resources to investigations regarding allegations that public companies have inadequate internal controls and/or a system for reporting those controls.  See herehere and here.  That effort shows no signs of waning.  As recently as March 23, 2016, the SEC announced a settlement with a multi-national company due in part to the internal controls failures at two foreign subsidiaries.  On March 10, 2016, the SEC announced a settlement of claims against Magnum Hunter Resources Corporation in connection with alleged internal control failures.  And, on February 17, 2016, the SEC announced a settlement of claims against a biopesticide company, Marrone Bio Innovations, based on the company having reported misstated financial results caused in part by internal control failures.[1]

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Supreme Court Affirms Class Certification and Judgment Predicated upon “Representative Evidence”

On March 22, 2016, the Supreme Court issued a decision permitting class plaintiffs to rely on “representative” or “sample” evidence to satisfy the prerequisites to class certification and certain elements of their claims.  See Tyson Foods, Inc. v. Bouaphakeo, No. 14-1146, 2016 WL 1092414 (Mar. 22, 2016).  This is one of the relatively few recent class action decisions by the Court that could be construed as something other than a victory for class defendants.  As Justice Thomas stated in dissent, the decision arguably is inconsistent with the Court’s pro-defendant decisions in Wal-Mart and Comcast.  We have previously discussed the Supreme Court’s recent class action jurisprudence, including the Wal-Mart and Comcast decisions.

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Former Hedge Fund Manager’s Civil Rights Suit Against New York U.S. Attorney Permitted to Proceed into Discovery

Shortly into his tenure as United States Attorney for the Southern District of New York, Preet Bharara announced a crackdown on insider trading, indicating that it would be his office’s “top criminal priority” and that investigations would utilize novel and “covert methods” to achieve convictions, including using wiretaps and informants.  According to Bharara, “every legitimate tool should be at our disposal.”  Over the next several years, federal prosecutors in Manhattan initiated nearly 100 insider trading cases against some of Wall Street’s leading names, and secured more than 80 convictions, many through guilty pleas.  For his work, Time magazine featured Bharara on its February 13, 2012 cover under the headline: “This Man is Busting Wall Street.”

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