Client Alert

The Potential Declawing of the SEC: The Financial CHOICE Act

Gavel and Hundred-Dollar Bill

The Financial CHOICE Act (or “CHOICE Act 2.0”), which would significantly narrow the SEC’s ability to bring enforcement actions and make it more challenging for it to prevail in such actions, is inching its way towards becoming law. On May 4, 2017, the Financial Services Committee passed the Act and it is now slated to be introduced to the House in the coming weeks. As part of the push by the current administration to deregulate, this bill aims to repeal key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, including those directed towards the SEC.  Although the Act has a long way to go before it is enacted, many of its provisions would have far-reaching consequences and would change the way the SEC operates as we know it.

Should the CHOICE Act 2.0 become law, the following are some of the more important effects it would have on the SEC’s enforcement abilities:

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2016 Could Be Peak SEC

2016 was a high-water mark for SEC enforcement activity; however, with the uncertainties associated with the new administration’s enforcement regime, we could be seeing a downturn going forward. According to a recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research, the SEC’s 2016 fiscal year (spanning October 1, 2015 – September 30, 2016) saw the highest number of enforcement actions brought against public companies and their subsidiaries since 2009, the year the Pollack Center and Cornerstone Research first began tracking information on such actions.  The 92 actions brought against public companies and their subsidiaries last year is more than double the level of enforcement activity from just three years ago and represents the latest in a continuing upward trend of enforcement actions.  Also consistent with recent trends, the vast majority of these actions have been brought as administrative enforcement proceedings before SEC ALJs, rather than civil actions in federal court.

The SEC continues to focus most heavily on issuers’ reporting and disclosure obligations, which comprised more than a quarter of the enforcement actions initiated last year. The SEC has consistently emphasized issuer disclosures as an area of enforcement priority and its pattern of activity has, to date, backed that up.  Last year also brought enhanced focus on investment advisors and investment companies, with the SEC initiating more actions against those defendants in 2016 than in the previous three years combined.  Allegations of foreign corrupt practices and actions against companies making initial or secondary securities offerings also resulted in an increased rate of enforcement activity over prior periods.

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Understanding the New DOJ Compliance Guidance: Part 2 – Autonomy, Resources, and Staffing

This is the second in a series of posts where we will explore critical elements of a successful compliance program. In February, the Department of Justice’s Fraud Section offered a new perspective on what the government expects in an anti-corruption compliance program, in the form of a series of questions that companies should be prepared to answer about their program.  The guidance offers companies a roadmap for building or assessing their compliance program.  In this series, we will explore recent and past guidance on key compliance topics, as well as key takeaways for companies of all sizes.

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It would be a mistake for companies to dismiss the Fraud Section’s recent guidance, which one high-level DOJ official suggested may be used more broadly by DOJ’s Criminal Division, as business as usual. It is not just more of the same.  The guidance does more than merely flesh-out existing direction; it operationalizes compliance.  Consider two examples from the guidance’s “Autonomy and Resources” section:

  • Empowerment – Have there been specific instances where compliance raised concerns or objections in the area in which the wrongdoing occurred?  How has the company responded to such compliance concerns?  Have there been specific transactions or deals that were stopped, modified, or more closely examined as a result of compliance concerns?
  • Compliance Role – Was compliance involved in training and decisions relevant to the misconduct?  Did the compliance or relevant control functions (e.g., Legal, Finance, or Audit) ever raise a concern in the area where the misconduct occurred?

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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

Second Circuit Halts Constitutional Challenge to SEC Administrative Proceedings

On June 1, the Second Circuit in Tilton et al. v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016), echoed recent Seventh and D.C. Circuit decisions (respectively, Bebo v. SEC, No. 15-1511 (7th Cir. Aug. 24, 2015), cert. denied, 136 S. Ct. 1500 (Mar. 28, 2016), and Jarkesy v. SEC, No. 14-5196 (D.C. Cir. Sept. 29, 2015)) in finding that constitutional or other challenges to SEC proceedings cannot go forward in court until the administrative proceeding ends; review can only be sought as an appeal from a final decision by the Commission.  The Second Circuit’s decision in Tilton creates unanimity among the circuit courts that have addressed the issue to date, although, as we previously reported, the Eleventh Circuit is likely to rule on the issue sometime this year in Hill v. SEC, No. 15-12831. Unless the Eleventh Circuit bucks this trend and creates a circuit split, it now looks unlikely that the Supreme Court will weigh in on this issue (particularly because the Supreme Court previously denied a petition to review the Seventh Circuit’s decision in Bebo).

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Taking Action That Affects The Shareholder Vote? Expect the “Gimlet Eye”

On May 19, 2016, the Delaware Chancery Court preliminarily enjoined the directors of Cogentix Medical from reducing the size of the company’s board because, under the facts presented, there was a reasonable probability that the board reduction plan was implemented to defeat insurgent candidates in a contested director election.  Pell v. Kill, C.A. No. 12251-VCL (Del. Ch. May 19, 2016).  The decision is a reminder that board actions that affect the shareholder vote—particularly decisions that make it more difficult for stockholders to elect directors not supported by management—will be subject to enhanced judicial scrutiny by Delaware courts on the lookout with a “gimlet eye” for conduct having a preclusive or coercive effect on the stockholder vote.

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Supreme Court Issues Two Decisions That Limit Access to Federal Courts

On May 16, 2016, the United States Supreme Court handed down two decisions that may, in practice, limit the ability to access federal district courts.  In Spokeo, Inc. v. Robins, No. 13-1339, 578 U.S. ___ (2016), the Supreme Court rejected the Ninth Circuit’s conclusion that statutory violations are per se sufficient to confer Article III standing, and, in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, No. 14-1132, 578 U.S. ___ (2016), the Court concluded that jurisdiction under Section 27 of the Securities and Exchange Act (Exchange Act) is limited to suits brought under the Exchange Act and state law claims that turn on the plaintiff’s ability to prove the violation of a federal duty.

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Delaware Supreme Court Reaffirms KKR, But Sounds Cautionary Note to Gatekeepers

On May 6, 2016, the Delaware Supreme Court affirmed the Delaware Chancery Court’s ruling that Zale Corporation’s sale to Signet Jewelers withstood scrutiny under the business judgment rule because the transaction was approved by a fully-informed, uncoerced vote of the disinterested stockholders, and that an aiding and abetting breach of fiduciary duty claim against Zale’s financial advisor failed as a matter of law where the plaintiff failed to establish that the Zale board had acted with gross negligence.  In so holding, the Court reaffirmed its holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), that in cases in which Revlon would otherwise apply, approval of the transaction by a fully-informed, uncoerced majority of disinterested stockholders invokes the deferential business judgment rule standard of review.  While the Court also affirmed the Chancery Court’s dismissal of the aiding and abetting claim against Zale’s financial advisor, it called the Chancery Court’s reasoning for the dismissal into doubt and sounded a cautionary note to gatekeepers that they are not insulated from liability merely because they are alleged to have aided and abetted a non-exculpated breach of fiduciary duty by their director clients.

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Eighth Circuit Breathes Life Into Halliburton’s Price Impact Defense

The first Circuit Court of Appeals decision applying the Supreme Court’s landmark 2014 decision in Halliburton Co. v. Erica P. John Fund Inc., 134 S. Ct. 2398 (2014) (“Halliburton II”), favored the defendants, finding as a matter of law that Best Buy Co. and its executives successfully rebutted the presumption of reliance set forth in Basic v. Levinson, 485 U.S. 224 (1988) at the class certification stage through evidence of a lack of price impact from their alleged misstatements.  See IBEW Local 98 Pension Fund et al. v. Best Buy Co., Inc. et al., Case No. 14-3178 (8th Cir. Apr. 12, 2016).  By reversing the district court and holding that a class could not be certified, the Eighth Circuit showed that Halliburton II provides defendants with a meaningful opportunity to challenge the fraud on the market presumption.  The plaintiffs’ bar, however, will be eager to highlight Best Buy’s unique pattern in trying to limit the impact of the decision beyond this case.  Whether other federal courts follow the Eighth Circuit’s lead and deny class certification motions based on Halliburton II in greater numbers, and outside the Best Buy fact pattern, remains to be seen.

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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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