Tweet, Tweet: The SEC Gets Social

The SEC recently issued an investor alert to warn investors about potential fraudulent investment schemes involving popular social media sites such as Facebook, YouTube and Twitter, turning its eye towards investor fraud perpetuated via social media. The alert, issued by the SEC’s Office of Investor Education and Advocacy, provides five tips to help consumers recognize and avoid investment fraud, easily made anonymous online, using social media websites and services: (1) be wary of unsolicited offers to invest; (2) look for “red flags,” e.g., offers that sound too good to be true or that “guarantee” returns; (3) look for “affinity frauds,” which are “investment scams that prey upon members of identifiable groups, such as religious or ethnic communities, the elderly or professional groups;” (4) be thoughtful about privacy and security settings; and (5) ask questions and investigate investment opportunities thoroughly. The alert also describes common investment scams that have used social media and the internet to gain traction, including “Pump-and-dump” schemes, fraudulent “research opinions” or “investment newsletters,” high-yield investment programs, and offerings that just fail to comply with applicable registration provisions of the federal securities laws.

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When the Whistle Blows, What Follows?

Real estate investment trust American Realty Capital Properties (“ARCP”) recently announced the preliminary findings of an Audit Committee investigation into accounting irregularities and the resulting resignation of its Chief Financial Officer and Chief Accounting Officer. The events surrounding ARCP are a case study of how, within a matter of weeks, an internal report of concerns to the Audit Committee can lead to both internal and external scrutiny: an internal investigation and review of financial reporting controls and procedures, on the one hand; media coverage, securities fraud litigation, and an inquiry by the Securities Exchange Commission, on the other.

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There’s No Place Like Home: The Constitutionality of the SEC’s In-House Courts

Until recently, it was extremely rare for the SEC to bring enforcement actions against unregulated entities or persons in its administrative court rather than in federal court. However, as a result of the Dodd-Frank Act (and perhaps the SEC’s lackluster record in federal court trials over the past few years), the SEC is committed to bringing, and has in fact brought, more administrative proceedings against individuals that previously would be filed in federal court. Many have questioned the constitutionality of these administrative proceedings. As U.S. District Judge Jed Rakoff remarked in August 2014: “[o]ne might wonder: From where does the constitutional warrant for such unchecked and unbalanced administrative power derive?” Several recent SEC targets agree with Judge Rakoff, and have filed federal court suits challenging the constitutionality of the SEC’s administrative proceedings. (Notably, in a 2011 order regarding the SEC’s first attempt to use its expanded Dodd-Frank powers to bring more administrative cases, Judge Rakoff denied a motion to dismiss a constitutional challenge to the SEC’s decision to bring an administrative proceeding in an insider trading case against an unregulated person, following which the SEC terminated that proceeding and litigated in federal court.)

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The MCDC Initiative: Round One Is Underway

The clock will strike on the first self-report deadline under the SEC’s Municipalities Continuing Disclosure Cooperation Initiative (the “MCDC Initiative”) at 12:00 a.m. EST on September 10, 2014.  Under the MCDC Initiative, underwriters and issuers of municipal securities may choose to self-report any potential, materially inaccurate statements relating to prior compliance with continuing disclosure obligations in exchange for a recommendation of “favorable settlement terms.”  Under the terms of the original SEC announcement, the deadline for both underwriters and issuers was September 10.  But the SEC announced a set of modifications to the MCDC Initiative on July 31, 2014, including a shift to a piecemeal approach whereby the deadline for underwriters went unchanged but the deadline for issuers was moved to December 1, 2014.  This decision was admonished in an August 28, 2014 letter from U.S. Representatives Steve Stivers and Krysten Sinema to SEC Chair Mary Jo White, in which they “urge[d] the SEC to extend the self-reporting deadline for dealers to match the deadline for issuers” because there “simply is no justification for separate reporting deadlines.” Read More

No “Loos” Causation From Mere Announcement Of Internal Investigation

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

Judge Rakoff’s “Sour Grapes”: SEC v. Citigroup Settlement Approved

On August 5, 2014, U.S. District Judge Jed Rakoff reluctantly approved a$285 million settlement in the SEC’s enforcement action against Citigroup.  In SEC v. Citigroup, the SEC alleged that after Citigroup realized in early 2007 that the market for mortgage-backed securities was beginning to weaken, it created a billion-dollar fund to sell some of these assets to investors without disclosing either that Citigroup had exercised significant influence in selecting the assets to include in the fund and had itself retained a $500 million short position in the assets it had helped select.

Judge Rakoff initially declined to approve the proposed consent judgment because he said it lacked “sufficient evidence to enable it to assess whether the agreement was fair, adequate, reasonable, and in the public’s interest.”  He was forced to reconsider that position when the Second Circuit ruled, on appeal, that the “primary focus of the [district court’s] inquiry . . . should be on ensuring the consent decree is procedurally proper, . . . taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.” Read More

SEC Can’t Pass On Pot Stock Puffery

Corporations facing federal securities suits can sometimes avoid liability by claiming that their forward-looking statements were so vague or indefinite that they could not have affected the company’s stock price and are therefore not material.  Such statements are not actionable because courts consider them “puffing,” famously described by Judge Learned Hand nearly 100 years ago as “talk which no sensible man takes seriously.”  Though we cannot know today what Judge Hand would think of the civil complaint recently filed by the SEC against several marijuana-company stock promoters, it’s safe to say that this isn’t the kind of ‘puffing’ he had in mind.

The defendants in the SEC civil action are all stock promoters, most of whom operate websites where they promote stocks, including microcap or so-called “penny” stocks.  The SEC alleges that the defendants promoted shares in microcap companies related to the marijuana industry. For example, one of the companies, Hemp Inc., claims to be involved with medical marijuana.  According to the SEC, three of the defendants bought and sold more than 40 million shares in Hemp Inc. in order to give the appearance that there was an active market in the company’s stock.  In reality, the transactions allegedly consisted of wash trades and matched orders.  A wash trade occurs when a security is traded between accounts, but with no actual change in beneficial ownership, while a matched order entails coordinating buy and sell orders to create the appearance of trading activity.  As the defendants were allegedly generating trading activity, they were also allegedly promoting the stock on the Internet, touting “a REAL Possible Gain of OVER 2900%” in Hemp Inc. stock.  Wow, that is high.

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On a Roll: The SEC Continues to Deliver on its Promise to Seek Admissions of Wrongdoing

The SEC announced last week that it has obtained yet another admission of wrongdoing in connection with an agreement to settle an SEC enforcement action.  This time, Peter A. Jenson, the former COO of Harbinger Capital Partners LLC, admitted that he aided and abetted Harbinger’s CEO, Philip Falcone, in obtaining a fraudulent loan from Harbinger.  Jenson agreed to a $200,000 penalty along with a two-year suspension from practicing as an accountant on behalf of any SEC-regulated entity.  The settlement awaits court approval.

The Jenson settlement is the latest in a series of settlements in which the SEC has obtained admissions of wrongdoing since announcing changes to its “no admit/no deny” settlement policy in June 2013. Other examples include the March 2014 Lions Gate settlement, the February 2014 Scottrade settlement, and the August 2013 Falcone/Harbinger settlement that settled charges related to those Jenson settled last week.    Read More

SEC Gives Itself the Home Court Advantage in an Accounting Fraud / Internal Controls Action Against a Corporate CEO

An otherwise mundane SEC announcement on July 30, 2014 of an enforcement action charging a public company CEO and CFO with accounting fraud and internal controls violations is significant because the SEC is proceeding against the non-settling individual (the CEO) in an administrative proceeding rather than in federal court.  While not unprecedented, it has been, to date, exceedingly rare for the Commission to proceed against an unregulated entity or person administratively rather than in federal court.  This decision reflects the Commission’s and Enforcement Division’s recently, but frequently, stated intent to bring more administrative proceedings that previously would have been brought in federal court, now that the Commission has expanded remedies under Dodd-Frank Act.  The decision also raises significant due process issues.

The action itself charges Marc Sherman and Edward Cummings, CEO and former CFO, respectively, of QSGI Inc., a Florida-based computer equipment company, with violation of the antifraud and other provisions of the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act of 2002.  According to the Commission’s press release, Sherman and Cummings claimed they had disclosed all significant deficiencies in internal controls over financial reporting to the company’s independent auditors, but in fact did not disclose or direct anyone else to disclose ongoing inventory and accounts receivable issues or improper acceleration of recognition and the resulting falsification of QSGI’s books and records.  The Commission also alleges that the executives signed SEC filings and Sarbanes-Oxley certifications that were rendered false and misleading due to the above issues.  Cummings entered into an administrative settlement with the SEC, agreeing to a cease and desist order, a $23,000 civil penalty, a 5-year officer and director bar, and a 5-year bar on appearing or practicing before the Commission as an accountant.  Sherman did not settle, and will instead litigate against the Division of Enforcement in an administrative proceeding. Read More

SEC Charges Hedge Fund Adviser with Whistleblower Retaliation under Dodd-Frank

On June 16, 2014, the SEC issued its first-ever charge of whistleblower retaliation under section 922 of the Dodd-Frank Act, charging a hedge fund advisor and its owner with “engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC.” Read More