The SEC this year has demonstrated its willingness to incentivize whistleblowers and companies to share information about misconduct and assist with the SEC’s investigations. To that end, the SEC issued its first Deferred Prosecution Agreement (DPA) with an individual on November 12, 2013. A DPA is an agreement whereby the SEC refrains from prosecuting cooperators for their own violations if they comply with certain undertakings.
This first DPA is with Scott Herckis, a former Fund Administrator for Connecticut-based hedge fund Happelwhite Fund LP. In September 2012 Herckis resigned and contacted government officials regarding the misappropriation by the fund’s founder and manager, Berton Hochfeld, of $1.5 million in hedge fund proceeds. Herckis further reported that Hochfeld had overstated the fund’s performance to investors. Herckis’s cooperation with the SEC, including producing voluminous documents and helping the SEC staff understand how Hochfeld was able to perpetrate the fraud, led the SEC to file an emergency action and freeze $6 million of Hochfeld’s and the fund’s assets. Those frozen assets will be distributed to the fund’s investors. Read More
Following a defense verdict in the insider trading case brought against him by the SEC, Dallas Mavericks owner Mark Cuban has not been sitting on the bench—but rather using his blog to stay on the offensive. Since the October 16, 2013 verdict, Cuban continues to post about the case on his blog—including, just a few days ago, blogging about when his own blog became the focus of the trial. According to his October 26 post, an SEC attorney asked him during trial if everything he posted on his blog was true information, to which he replied that it was meant more “to communicate a point” and stimulate discussion. Following up, the SEC attorney asked: “If you post on your blog that you think the Lakers are going to stink in 2013 . . . you’re not telling this jury that that’s an opinion you don’t honestly hold, right?” Cuban posted that the courtroom “cracked up” when he replied “This year?”, before going on to answer: “Well, no. In 2004, I wouldn’t say it. They had Shaq, they had Kobe, they actually went to the finals . . . To answer your question, if I said in 2004 that they stink, I didn’t believe it.” In an earlier blog entry, Cuban also poked fun at the former Head of Enforcement—posting about internal emails, disclosed earlier in the case, in which SEC attorneys commented on photos of Cuban. Read More
In a recent speech to the Securities Enforcement Forum, SEC Chair Mary Jo White fleshed out the Commission’s plan to pursue all violations of federal securities laws, “not just the biggest frauds.” She also addressed the looming question of whether this approach makes the best use of the agency’s limited resources.
Chair White compared the SEC’s strategy of pursuing all forms of wrongdoing, no matter how big or small, to the “broken window” theory of policing, which was largely credited for reducing crime in New York City under Mayor Rudy Giuliani. According to the “broken window” theory, a broken window which remains unfixed is a “signal that no one cares, and so breaking more windows costs nothing.” On the other hand, a broken window which is fixed indicates that “disorder will not be tolerated.” Chair White postulated that the same theory applies to the US securities markets: minor violations that go ignored may lead to larger violations, and may foster a culture where securities laws are treated as “toothless guidelines.” Characterizing the SEC as the investors’ “cop,” she declared that the SEC needs to be a “strong cop on the beat,” understanding that even the smallest securities violations have victims. Read More
A new route to soliciting direct securities investments has opened. For the first time in 80 years, start-ups and small businesses can broadly advertise and broadly solicit to raise money for private offerings. Changes to SEC Rule 506, which took effect September 23, 2013, allow companies to avoid complex and costly public offerings and instead search for investors via the Internet, newspaper, social media, direct mail, and other media. The change is the result of the JOBS Act, which required the SEC to permit general solicitation for certain private placements that are exempt from the registration requirements of Section 5 of the 1933 Act.
To travel this route, investors must be “accredited,” defined in the new rule as having a net worth of over $1,000,000 or at least $200,000 in annual income. While the accreditation has long been required for private placements, issuers were permitted to sell to non-accredited investors who qualified as sophisticated purchasers. Businesses who raise funds under the new rule must now take additional “reasonable steps” to ensure all investors are accredited. Rule 506(c) provides a non-exclusive list of means to satisfy this “reasonable steps” requirement. Issuers may use investor’s tax forms, bank statements, credit reports, and certifications from accountants, brokers, and investment advisors to ensure accreditation – assuming that investors are willing to deliver copies of such documents to issuers. There may be other means not specified that would also be acceptable also. Issuers will want to keep careful records about how they accredit investors, because they will bear the burden to establish their exemption from the registration provisions of the Securities Act. If an issuer cannot do so, it may be subject to liability for general solicitation in connection with an unregistered offering in violation of the federal securities laws. Read More
After first announcing a change on June 18 of this year to demand more admissions in SEC actions, an SEC leader recently made further comments echoing that same sentiment, as well as referencing the SEC’s intended use of stiffer monetary penalties. On October 1, at a Practising Law Institute conference, SEC Enforcement Division Co-Director Andrew Ceresney discussed the new SEC regime’s motto of strict enforcement and provided concrete, practical advice for defense lawyers on how to effectively interact with the SEC’s enforcement personnel.
Given the SEC’s ongoing commitment to deter current and future violations, Mr. Ceresney stated that the SEC will continue to increase penalties in an aggressive bid to deter misconduct. He stated that “[t]here is room for bolder actions” and monetary penalties are a deterrent that everyone understands. Mr. Ceresney also advised defense lawyers on how to handle meetings with SEC enforcement personnel. He stated that defense lawyers should focus on a case’s broad policy or legal arguments, including the circumstances surrounding the case, the client’s settlement position, and any flaws in the legal theory and policy implications of the case. Most importantly, stated Mr. Ceresney, defense lawyers must answer the SEC’s questions, must be trustworthy, and must not attempt to intimidate the SEC. Read More
On September 26, SEC Chair Mary Jo White gave an important speech to the Council of Institutional Investors in Chicago. The speech, entitled “Deploying the Full Enforcement Arsenal,” provides the first detailed roadmap to the Commission’s enforcement priorities in the White administration. While some of the SEC’s enforcement program going forward will involve a continuation and reinforcement of efforts begun during the administration of former Chair Mary Schapiro and former Enforcement Director Robert Khuzami, much of it will entail new initiatives. The bottom line is that — not surprisingly — Chair White, a former U.S. Attorney, is committed to a vigorous, prosecutorial-minded enforcement program.
Here are the key takeaways from the speech:
Individuals First. Perhaps most importantly, Chair White stated that the “core principle of any strong enforcement program is to pursue responsible individuals wherever possible.” Accordingly, she has “made it clear that the staff should look hard to see whether a case against individuals can be brought. I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in.” She also indicated that the Commission is likely to seek more industry and officer-and-director bars against individuals. Chair White described this focus on individuals first as a “subtle” shift in approach, but it is one that, if followed in practice, will have significant consequences, particularly when paired with some of the other initiatives described below. Read More
“Life settlements” are financial transactions in which the original owner of a life insurance policy sells it to a third party for an up front, lump sum payment. The amount paid for the policy is less than the death benefit on the policy, yet greater than the amount the policyholder would otherwise receive from an insurance company if the policyholder were to surrender the policy for its cash value. For the life settlement investor that buys the policy, the anticipated return is the difference between the death benefit and the purchase price plus the amount paid in premiums to keep the policy in force until the death benefit is payable.
Some commentators have deemed life settlements as essentially a “bet” on the life of the insured. The longer the insured lives, the lower the rate of return on the investment. Critics of life settlements are quick to point out that investors have a financial interest in the early demise of the insured person. The life settlement industry has been subject to extensive litigation for several years.
An important and as yet unsettled question is whether life settlements are “securities” as defined under federal and state securities law. This basic question has important ramifications for how life settlement contracts will be treated by courts and regulators. Read More
On September 18, 2013, the SEC voted to propose a new rule that would require public companies to disclose the ratio of compensation of its CEO to the median compensation of its employees.
The new rule, required under the Dodd-Frank Act, gives companies flexibility to determine the median annual total compensation of its employees in any way that best suits their particular circumstances when calculating the ratio. SEC Chair, Mary Jo White stated that the SEC is very interested in receiving comments to the proposed approach and the flexibility it provides.
SEC Commissioner Michael S. Piwowar, in a strongly worded statement, expressed his dissatisfaction with the proposed rule. Quoting from Charles Dickens’ A Tale of Two Cities – “it was the best of times, it was the worst of times” – Piwowar declared that the pay ratio disclosure proposal “represents what is worst about our current rulemaking agenda.” Piwowar’s concerns were twofold. First, that the pay ratio disclosure could harm investors. Piwowar expressed his concern that investors using pay ratios to compare companies risked being distracted from material investment information and mislead by the conclusions offered by the ratios. Additionally, he noted that investors may also be harmed if pressure to maintain a low pay ratio curtails expansion of business operations into regions with lower labor costs. Second, he was troubled by his observation that the pay ratio rule could have a negative effect on compensation, efficiency, and capital formation because the competitive impacts of the disclosure would disproportionally fall on U.S. companies with large workforces and global operations and could influence how companies structure their business, leading to inefficiencies, higher cost of capital and fewer jobs. Read More
The Ninth Circuit recently reversed a ruling by the U.S. District Court of Nevada granting summary judgment in favor of the SEC in a case alleging violations of Section 5 of the Securities Act of 1933 in connection with the sale of unregistered securities. The SEC’s complaint alleged that 1st Global Stock Transfer LLC (“Global”), a transfer agent, and Global’s owner, Helen Bagley (collectively “Defendants”), assisted in the sale of unregistered securities for CMKM Diamonds, Inc. (“CMKM”), a purported diamond and gold mining company. The SEC’s complaint further alleged that CMKM had no legitimate business operations but instead the Company concocted false press releases and distributed fake maps and videos of mineral operations to its investors. While CMKM was one of several defendants in the action, the SEC only moved for summary judgment against Global, Bagley, and CMKM’s attorney. The District Court granted the SEC’s motion for summary judgment against the three defendants, but only Global and Bagley appealed that ruling.
In perpetrating the scheme, CMKM’s attorney was alleged to have provided hundreds of false opinion letters supporting the issuance of unregistered stock without restrictive legends to indicate that the stock was unregistered. Relying on these opinion letters, Global and Bagley issued additional CMKM stock without restrictive legends, believing that the issuance was legal. After a year and a half of this practice, Bagley became suspicious and asked a second law firm to confirm the opinion letters. The second law firm, however, relied on the first attorney’s opinion letters and also issued an opinion letter stating that the issuance of additional CMKM stock was valid. Based on the additional opinion letter, Global and Bagley continued to issue CMKM shares without restrictive legends. Read More
On September 6, 2013, the SEC charged the former head of investor relations at First Solar Inc., an Arizona-based solar company, with violating Regulation FD, which is designed to prevent issuers from selectively disclosing material nonpublic information to certain market participants before disclosing the information to the general public. In this matter, the SEC determined that Lawrence D. Polizzotto violated Regulation FD when he indicated in “one-on-one” phone conversations with about 20 sell-side analysts and institutional investors that the company was unlikely to receive a much anticipated loan guarantee from the U.S. Department of Energy. When First Solar disclosed the same information the following morning in a press release, the company’s stock dropped 6 percent. In addition to a cease-and-desist order, Polizzotto agreed to pay $50,000 to settle the SEC’s charges. The SEC determined not to bring an enforcement action against First Solar, due in part to the company’s “extraordinary cooperation” with the investigation.
The Polizzotto action is noteworthy for several reasons. First, is the contrast between that action and the only Regulation FD case to go to litigation. In June 2004, the SEC filed a civil action against Siebel Systems, Inc. for violating Regulation FD and an earlier SEC cease-and-desist order, and against two of the company’s senior executives for allegedly aiding and abetting Siebel’s violations. The alleged violations were very similar to those alleged against Polizzotto: in both cases, the SEC alleged that the company, through its executives, violated Regulation FD by selectively disclosing material nonpublic information to analysts and favored investors in one-on-one meetings before disclosing it publicly. There were, however, several differences in the facts of the two matters. In the Siebel matter, the U.S. District Court for the Southern District of New York held that the nonpublic statements made at the one-on-one meetings were not material because they did not add to, contradict, or significantly alter the information that the company had previously made available to the general public. Although not literally the same as the public statements, the court found that the private statements generally conveyed the same material information. On the other hand, the SEC deemed that Polizzotto’s statements provided new information about the status of the loan guarantees for one of company’s major projects, even though a letter from a Congressional committee to the Energy Department about the loan guarantee program and the status of conditional commitments, including three involving First Solar, had already caused concern within the solar industry about whether the Energy Department would be able to move forward with its conditional commitments. The final blow to Polizzotto may have been First Solar’s recognition of the significance of private statements to analysts and particular investors about the loss of the loan guarantee. For example, a company lawyer had specifically advised that, in discussing this development, the company would “be restricted by Regulation FD in any [sic] answering questions asked by analysts, investors, etc. until such time that we do issue a press release or post to our website….” Thus, despite the fact that the court in the Siebel Systems action did not consider an 8 percent stock price movement following public disclosure to be material, the SEC here considered the 6 percent stock price movement to be material. Read More