Securities Fraud

Hold the Phone: SEC Takes One Last Stand Before the Tenth Circuit regarding the Constitutionality of the SEC’s Administrative Law Judges

Last week, the United States Securities and Exchange Commission filed a petition for rehearing en banc with the Tenth Circuit Court of Appeals, imploring the court to reconsider a divided panel’s ruling on the unconstitutionality of its administrative law judges in Bandimere v. SEC.  In that ruling (detailed here), the Tenth Circuit overturned the Commission’s sanctions against Mr. Bandimere because the SEC administrative law judge (“ALJ”) presiding over Mr. Bandimere’s case was an inferior officer who should have been constitutionally appointed (rather than hired) to the position, in violation of the Appointments Clause of the United States Constitution.

Primarily relying on its prior submissions and Judge Monroe G. McKay’s dissent in the panel’s original ruling, the SEC argues that the original decision reflects a fundamental misunderstanding of the role of ALJs and Supreme Court precedent, and risks throwing essential features of the agency into disarray. In particular, the SEC questioned the majority’s opinion that Freytag v. Commissioner, 501 U.S. 868 (1991), was dispositive in equating special trial judges of tax court to the ALJs to find that the ALJs are inferior officers who must be constitutionally appointed.  The SEC distinguishes the roles of its ALJs from those of the special tax court trial judges by noting differences in their power and function.  First, the special trial judges are vested with authority, including the power to enforce compliance with their orders, that is different in degree and kind from the powers given to ALJs.  For example, both the special trial judges and ALJs have the power to issue subpoenas, but unlike the special trial judges, ALJs have no authority to enforce subpoenas.  ALJs can only request the Commission to seek enforcement of the subpoenas in district court.  In addition, unlike the special trial judges, ALJs cannot use contempt power—a hallmark of a court—to enforce any order it may issue.  Second, the function between the special trial judges and ALJs differ because the Tax Court in Freytag was required to defer to the special trial judge’s factual finding unless “clearly erroneous, whereas the SEC decides all questions of fact and law de novo.

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The Call for a Statutory Insider Trading Law

Judge Jed S. Rakoff (S.D.N.Y.) recently made headlines after urging lawyers to draft and advocate for a more straightforward insider trading statute to replace judicially-created insider trading law. During his keynote speech at the New York City Bar’s annual Securities Litigation & Enforcement Institute, Judge Rakoff explained that the law has become overly-complicated since courts were forced to define insider trading by shoehorning the concept into the fraud provisions of the Securities Exchange Act of 1934. As a result, increasingly suspect theories have been developed to address potential insider trading in an expanding variety of scenarios.

In promoting a statutory solution for insider trading law, Judge Rakoff pointed to the Europe Union (“EU”) as an example. He explained that the EU defined insider trading by statute in simple and broad terms, and avoided relying on the framework of fraud.  Considering Judge Rakoff’s influence and expertise in securities law, inquiry into the EU’s approach to insider trading is warranted.

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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

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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Not So Fast: The Tenth Circuit Creates a Split by Denying the Constitutionality of the SEC’s Administrative Law Judges

court decision

Just before the clock struck 2017, the United States Court of Appeals for the Tenth Circuit weighed in on the constitutionality of the United States Securities and Exchange Commission’s (“SEC” or “Commission”) administrative law judges. In Bandimere v. SEC, the Tenth Circuit overturned Commission sanctions against Mr. Bandimere because the SEC administrative law judge (“ALJ”) presiding over Mr. Bandimere’s case was an inferior officer who should have been constitutionally appointed to the position in violation of the Appointments Clause of the United States Constitution.

The SEC originally brought an administrative action against Mr. Bandimere in 2012, alleging he violated various securities laws. An SEC ALJ presided over the fast paced, “trial-like” hearing, and the ALJ ultimately found Mr. Bandimere liable, barred him from the securities industry, imposed civil penalties and ordered disgorgement.  The SEC reviewed that decision and reached the same result.  Mr. Bandimere, therefore, appealed the SEC’s decision to the Tenth Circuit. READ MORE

Stockholders Petition the Supreme Court to Liberalize Eleventh Circuit Rules for Pleading Securities Fraud

Building

A recent petition for certiorari filed in the United States Supreme Court asks the Court to clarify what an aggrieved investor must plead to state a claim for securities fraud under the Securities and Exchange Act of 1934 (the “Exchange Act”).  The petition focuses on the “loss causation” element, which requires plaintiffs to prove a direct causal link between the alleged fraud and the loss in value for which they seek to recover.  In a typical fraud in-the-market case, plaintiffs allege loss causation by showing that they bought the defendant’s securities at prices artificially inflated by fraud, and then had those securities lose value after a “corrective disclosure” revealed the fraud to the public.  If the Supreme Court decides to grant certiorari, it will have the opportunity to lift certain barriers to pleading loss causation in some jurisdictions.

Petitioners, three New England funds (“Funds”) that own stock in Health Management Associates, Inc. (“HMA”), seek to reverse the Eleventh Circuit’s decision that they failed to establish loss causation as a matter of law. The Funds alleged that HMA’s stock price fell precipitously following two disclosures to the market: (1) an announcement that the government had begun an investigation into HMA for fraud, and (2) an analyst report publicizing a whistleblower case filed by a former employee against HMA three months earlier.  A panel for the Eleventh Circuit upheld the lower court’s decision that neither event could form the basis of a securities fraud claim.  First, the panel held that the announcement of a government investigation could not raise an inference of loss causation at the pleading stage because there had been no finding of “actual wrongdoing.”  Second, the panel held that the analyst report was not a “corrective disclosure” because it reported on a publicly-filed case that, although it hadn’t been reported on until then, was already disclosed to the market. READ MORE

Keep Looking Forward: Federal Court Holds Company’s Bad Legal Predictions Protected by PSLRA’s Safe Harbor

Gavel and Hundred-Dollar Bill

In a comprehensive tour of the Private Securities Litigation Reform Act’s (“PSLRA”) safe-harbor provisions, on November 22, 2016, a federal court in Massachusetts dismissed a shareholder class-action lawsuit against Neovasc, Inc.  In holding that Neovasc’s ultimately faulty predictions concerning the outcome of a trade secrets lawsuit fell within the PSLRA’s safe harbor, the court rejected the plaintiff’s attempts to import a scienter requirement into the safe-harbor inquiry, among other things, and dismissed the complaint without leave to amend.

This putative class-action came on the heels of a $70 million jury verdict against Neovasc in May 2016. In that case, a jury found that Neovasc misappropriated certain trade secrets from CardiAQ Valve Technologies after CardiAQ had severed its manufacturing relationship with Neovasc, and Neovasc had patented a competing product.  Neovasc’s stock price fell approximately 75 percent when the jury verdict was announced.  Shortly after the verdict and stock decline, shareholders filed the class action, alleging securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  The plaintiff alleged, among other things, that prior to the verdict, Neovasc CEO Alexei Marko mischaracterized the lawsuit as “baseless,” and that Neovasc had misstated that the suit was “without merit” in the company’s SEC filings.

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Ninth Circuit Smells a Rat and Reinstates Claim That Pharmaceutical Company Failed to Disclose Cancers in Animal Testing

The Ninth Circuit recently revived a securities class action against Arena Pharmaceuticals, issuing a decision with important guidance to pharmaceutical companies speaking publicly about future prospects for FDA approval of their advanced drug candidates. The court’s opinion reemphasizes the dangers of volunteering incomplete information, holding that a company that touts the results of trials or tests as supportive of a pending application for FDA approval must also disclose negative test results or concerns expressed by the FDA about those studies—even if the company reasonably believes the concerns are unfounded and are the product of a good faith disagreement.

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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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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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