Financial Institutions

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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What to Watch for From the New SEC Chairman

Last Thursday, Jay Clayton was officially sworn in as the new Chairman of the Securities and Exchange Commission.  As the new Chairman takes office, here are a few things we’re keeping an eye on:

Will Chairman Clayton take a position on the recently introduced bipartisan bill that would increase civil monetary penalties in SEC enforcement actions?  The “Stronger Enforcement of Civil Penalties Act of 2017” would significantly increase civil monetary penalties in enforcement actions to as much as $1 million per violation for individuals and $10 million per violation for entities, or three times the money gained in the violation or lost by the victims.  The current maximum civil monetary penalties are $181,071 and $905,353 per violation for individuals and entities, respectively.

Will the new Chairman preserve the directive reportedly issued by former Acting Chairman Michael Piwowar to re-centralize authority to issue formal orders of investigation?  In 2009, the SEC adopted a rule that delegated authority to issue formal orders initiating investigations to the Director of Enforcement, who then “sub-delegated” it to regional and associate directors and unit chiefs within the Enforcement Division.  In February, Piwowar reportedly revoked the “sub-delegated” authority, ordering it re-centralized exclusively with the Director of Enforcement.

Will enforcement actions against public companies increase or decrease after hitting their highest level since 2009 last year?  A recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research found that the 92 actions the SEC brought against public companies and their subsidiaries in 2016 is more than double the level of enforcement activity from just three years prior. READ MORE

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.” READ MORE

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

A Fraud By Any Other Name: Seventh Circuit Holds That SLUSA Extends to Class Actions That Could Be Pursued Under Federal Securities Fraud Laws

A divided panel of the Seventh Circuit recently held that the Securities Litigation Uniform Standards Act (“SLUSA”) requires any covered class action that “could have been pursued under federal securities law” to be brought in federal court.  The plaintiff maintained an investment account at LaSalle Bank, which was later acquired by Bank of America.  Each night, LaSalle invested (“swept”) the account’s balance into a mutual fund approved by the plaintiff.  Without the plaintiff’s knowledge, LaSalle also allegedly pocketed the fees that some of the mutual funds paid each time a balance was transferred.  When the plaintiff found out, he brought a class action in state court, arguing that LaSalle had breached its contractual and fiduciary duties to its customers by secretly paying itself fees generated by their accounts.

LaSalle and Bank of America successfully argued before the district court that SLUSA required removal of the case to federal court. SLUSA authorizes defendants to demand removal of any class action with at least fifty members that alleges “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”  Congress drafted SLUSA to force securities class actions out of state courts and into federal courts, where plaintiffs must clear higher pleading hurdles.

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New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus

On January 12, 2017 the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for the year, including areas of focus for Retail Investors, Senior Investors and Retirement Investments, Market-wide risks, FINRA oversight, and cybersecurity.  These priorities reflect an extension of previous years’ commitments, in particular with regard to focus on the retirement industry and cybersecurity.  The “Regulation Systems Compliance and Integrity” (Regulation SCI) adopted by the SEC in November 2014 will also be a continued focus.

Once again, protection of retail investors is of primary concern for the OCIE. Among the detailed areas of focus are examining risks related to electronic investment advice, “wrap fee” programs where investors are charged a single fee for bundled advisory and brokerage services, and “Never-before examined” Investment advisers, an initiative that was started in 2014 to engage with newly-registered advisers that had never-before been examined.  Examination of Exchange-Traded funds (ETFs) and continuation of the ReTIRE initiative are two carryovers from 2016 priorities .  The OCIE previously identified ETFs, which are sometimes seen as alternatives to mutual funds, for examination related to compliance with the Securities Exchange Act of 1934 and the Investment Company Act of 1940. ReTIRE, launched in June 2015, places particular focus on those SEC-registered investment advisers and broker dealers who offer retirement-oriented investment services to retail investors, including examining whether there is a reasonable basis for the recommendations made.  This year, the SEC will expand ReTIRE to include “assessing controls surrounding cross-transactions, particularly with respect to fixed income securities.”

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Gatekeepers No More: Delaware Supreme Court Clarifies Scope of Potential Financial Advisor Liability In M&A Sales Transactions

On November 30, 2015, the Delaware Supreme Court issued a 107-page opinion affirming the Court of Chancery’s post-trial decisions in In re Rural/Metro Corp. Stockholders Litigation (previously discussed here).  In the lower court, Vice Chancellor Laster found a seller’s financial advisor (the “Financial Advisor”) liable in the amount of $76 million for aiding and abetting the Rural/Metro Corporation board’s breaches of fiduciary duty in connection with the company’s sale to private equity firm Warburg Pincus LLC.  See RBC Capital Mkts., LLC v. Jervis, No. 140, 2015, slip op. (Del. Nov. 30, 2015).  The Court’s decision reaffirms the importance of financial advisor independence and the courts’ exacting scrutiny of M&A advisors’ conflicts of interest.  Significantly, however, the Court disagreed with Vice Chancellor Laster’s characterization of financial advisors as “gatekeepers” whose role is virtually on par with the board’s to appropriately determine the company’s value and chart an effective sales process.  Instead, the Court found that the relationship between an advisor and the company or board primarily is contractual in nature and the contract, not a theoretical gatekeeping function, defines the scope of the advisor’s duties in the absence of undisclosed conflicts on the part of the advisor.  In that regard, the Court stated:  “Our holding is a narrow one that should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to” an aiding and abetting claim.  In that (albeit limited) sense, the decision offers something of a silver lining to financial advisors in M&A transactions.   Equally important, the decision underscores the limited value of employing a second financial advisor unless that advisor is paid on a non-contingent basis, does not seek to provide staple financing, and performs its own independent financial analysis.

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FBI Warns Against Fraudulent E-mail Scheme

Companies should take notice of a new fraud scheme that has been making the rounds, targeting businesses that regularly make wire transfers.  Known as the “Business E-mail Compromise,” or BEC, this scam targets employees responsible for wiring money, instructing them under false pretenses to wire large sums to fraudulent accounts.  The Federal Bureau of Investigation estimates that the scam has claimed over 2,000 victims and resulted in losses totaling nearly $215 million since October 2013.  In one version of the BEC fraud, the e-mail accounts of high-level business executives (CEO, CFO, CTO, etc.) are compromised by the creation of spoof e-mail addresses.  The imposters then use the compromised executive’s e-mail account to send a request for a wire transfer to a second employee within the company who is responsible for processing such requests.  This version of the scheme has been referred to as “CEO Fraud” or the “Business Executive Scam.”  In another variation of the scam, businesses which have a long-standing relationship with a particular supplier or vendor (i.e. a landlord) receive a spoofed e-mail purportedly from that vendor directing the business to wire funds for invoice payment to an alternate, fraudulent account.  This version of the scheme has been referred to as “The Bogus Invoice Scheme” or “The Supplier Swindle.”

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Are Bank Branches in New York the Gateway to Seizure of Foreign Assets: The New York Court of Appeals Reconsiders the Separate Entity Rule

On September 16, 2014, the New York Court of Appeals heard oral argument on a certified question from the Second Circuit in Motorola Credit Corp. v. Standard Chartered Bank, an important case concerning the application of New York’s “separate entity rule” to foreign banks that maintain a branch in New York.

When someone obtains a judgment in New York, he may enforce that judgment by serving a restraining notice on a bank that holds the judgment debtor’s assets. Once the bank receives that notice, it may not distribute the funds to any person other than the sheriff. The judgment creditor may also sue for a court order requiring the bank to turn over the judgment debtors’ assets. READ MORE