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
The leaders of the Securities and Exchange Commission addressed the public on February 21-22 at the annual SEC Speaks conference in Washington, D.C. The presentations covered an array of topics, but common themes included the Commission’s ongoing effort to carry out the rulemaking agenda set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act, its role as an enforcement body post-financial crisis, its increasing utilization of technology, and its renewed focus on the conduct of gatekeepers. In a surprise appearance, Dallas Mavericks owner and former insider trading defendant Mark Cuban attended the first day of the conference. During his time at the conference, Mr. Cuban shared his thoughts on a number of the presentations via his Twitter account.
From a litigation and enforcement perspective, key takeaways from the conference include the following: Read More
Momentum for the SEC’s Dodd Frank whistleblower program is growing, and 2014 can be expected to bring continued expansion of the program and the number and types of whistleblower actions initiated by the SEC. The SEC’s annual report to Congress reported that 3,238 whistleblower tips were received in 2013, up almost 10% from 2012, and awards to whistleblowers who provide information to the SEC are increasing as more substantive tips are received.
An investigation by the SEC into a whistleblower tip can take several years to culminate in an enforcement action, so the last year likely saw just the beginning of a wave of enforcement actions. Despite the fact that over 6,000 tips have been received through 2013, the SEC has issued only six separate awards to tipsters. Those awards have ranged from $125,000 to a record $14 million, representing 10 to 30 percent of the overall funds recovered by the SEC in these whistleblower cases. Read More
Comments made by Kara N. Brockmeyer, the Securities Exchange Commission’s chief of the Foreign Corruption Practices Act (FCPA) unit, and Charles E. Duross, deputy chief of the Department of Justice’s FCPA unit, at the recent International Conference on the FCPA suggest that both agencies are increasing their scrutiny of possible FCPA violations for the next year. Both units have increased their resources for tackling investigations of possible FCPA violations. Additionally, both agencies have increased awareness among other U.S. and international government agencies so that those agencies could also be on the lookout for possible FCPA violations. Having strengthened their relationships with overseas regulators, both agencies are optimistic that they are in the position to bring significant FCPA cases in the following year.
According to Andrew Ceresney, co-director of the SEC’s enforcement division, the SEC also expects that FCPA violations will be “increasingly fertile ground” for the Dodd-Frank whistle-blower program. The SEC received 149 FCPA violation tips from whistle-blowers in just the last year and the SEC expects more enforcement cases to arise from whistle-blowers. Read More
Two victories for employers last week in Dodd-Frank and SOX whistleblower cases may provide a basis for at least a sliver of optimism among employers and whistleblower defense lawyers hammered by a recent series of employee-favorable decisions under the two main federal statutes covering whistleblowing activity.
Banko v. Apple
In Banko v. Apple Inc., Case No. 3:13-cv-02977-RS, a Northern District of California judge dismissed a Dodd-Frank retaliation claim where the employee only made a complaint internally to management and never complained to the Securities and Exchange Commission (SEC). The court followed the reasoning of the Fifth Circuit in Asadi v. G.E. Energy (USA), L.L.C. (see Orrick’s prior blog post on Asadi) and rejected a broader interpretation of the Act adopted by four district courts and the SEC that Dodd-Frank covers internal reporting protected by the Sarbanes-Oxley Act (SOX) as well as reports to the SEC. Read More
Executive compensation decisions are core functions of a board of directors and, absent unusual circumstances, are protected by the business judgment rule. As Delaware courts have repeatedly recognized, the size and structure of executive compensation are inherently matters of business judgment, and so, appropriately, directors have broad discretion in their executive compensation decisions. In light of the broad deference given to directors’ executive compensation decisions, courts rarely second-guess those decisions. That is particularly so when the board or committee setting executive compensation retains and relies on the advice of an independent compensation consultant.
Nevertheless, despite the high hurdle to challenging compensation packages, shareholder plaintiffs continue to aggressively challenge executive compensation decisions, in particular at companies that have performed poorly and received negative or low say-on-pay advisory votes. Read More
In its seminal decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), regarding antifraud provisions of the U.S. securities laws, the Supreme Court held that “Section 10(b) [of the Securities Exchange Act of 1934] reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Id. at 2888. Although Morrison—which involved a private action by foreign plaintiffs—appeared to set down a bright-line rule, it spurred a number of questions, including whether its holding would apply beyond the private civil context, to SEC civil enforcement actions and criminal prosecutions as well. A large number of courts have already applied Morrison to SEC actions. In a recent significant development, the Court of Appeals for the Second Circuit concluded that Morrison also applies to criminal cases brought pursuant to Section 10(b) and Rule 10b–5. United States v. Vilar, Case No. 10-521, at *3 (2d Cir. Aug. 30, 2013). But the Dodd-Frank Act’s “extraterritorial jurisdiction” amendment to the Exchange Act for actions brought by the SEC and the DOJ—the immediate congressional response to Morrison—will presumably be invoked by the government for actions based on post-amendment conduct. Read More
A Texas federal judge denied defendants ArthoCare CEO Michael A. Baker and CFO Michael T. Gluk’s motion to dismiss the SEC’s claim against them under Sarbanes-Oxley (“SOX”) Section 304’s clawback provision. Section 304 requires CEOs and CFOs to reimburse their company for any bonus or similar compensations, or any profits realized from the sale of company stock, for the 12-month period following a financial report, if the company is required to prepare an accounting restatement due to material noncompliance committed as a result of misconduct.
Baker and Gluk, who were not alleged to have participated in the misconduct that led to ArthoCare’s restatement, challenged Section 304 as unconstitutional, arguing that the SEC could not require them to repay bonus compensation and profits from stock sales for merely holding CEO and CFO positions during the time of the alleged misconduct. In particular, they argued that Section 304 is vague and is unconstitutional because it does not require a reasonable relationship between the triggering conduct and the penalty as is required by the Due Process Clause.
Judge Sam Sparks of the Western District of Texas rejected the Officer-Defendants’ constitutional arguments. Judge Sparks first held that Section 304 was not vague because it clearly referred to misconduct on behalf of the issuer of the allegedly false financial statement. Judge Sparks noted that Defendants “should have been monitoring the various internal controls to guard against such misconduct; they signed the SEC filings in question, and represented they in fact were actively guarding against noncompliance. As such, they shouldered the risk of Section 304 reimbursement when noncompliance nevertheless occurred.” Read More
The U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) can breathe a little easier after President Barak Obama’s re-election on Tuesday, November 6, 2012, according to legal scholars and attorneys.
Presidential Candidate Mitt Romney voiced his criticisms of the Dodd-Frank Act during the October 3, 2012, presidential debate, promising to repeal and replace Dodd-Frank. While the political climate in the United States Congress made repeal of Dodd-Frank unlikely, Romney’s administration may have eliminated or weakened provisions of the Act, appointed SEC and CFTC heads who were less interested in aggressive enforcement, and reduced both agencies’ funding.
Legal scholars and attorneys predict that President Obama’s re-election will allow the SEC and the CFTC to continue their aggressive enforcement campaigns of 2011. President Obama’s re-election is particularly important for the CFTC, which Dodd-Frank awarded new oversight powers. The Romney administration may have eliminated key provisions of the Act, returning the CFTC to the limited role it exercised under President George W. Bush. Under President Obama, the CFTC is likely to continue its expanded watchdog role and receive the funding necessary to do so. Read More
In what may be one of the first Dodd-Frank retaliation claims to make it past a motion to dismiss, a federal court on September 25, 2012 issued a ruling attempting to harmonize the definition of “whistleblower” under the landmark statute with its protections against employer retaliation for engaging in whistleblower activities. Acting in accord with the SEC’s final rule on the statute as well as opinions from the few federal courts to have weighed in on the subject, the court sided with the alleged whistleblower.
For some eighteen years, Richard Kramer had served as the vice president of human resources and administration at Trans-Lux Corporation. In that role, he had a number of responsibilities related to Trans-Lux’s ERISA-governed pension plan. Concerned with what he saw as conflicts of interest and deficiencies in the pension plan committee’s composition and reporting, Kramer went to Trans-Lux’s leadership and later the board’s audit committee to sound the alarm. Kramer eventually sent a letter to the SEC the old-fashioned way—by regular mail—a choice that would later have significance in the case.
Within hours of Kramer reaching out to Trans-Lux’s audit committee with his concerns, Trans-Lux’s CEO and another Trans-Lux employee reprimanded Kramer, and went downhill from there: Kramer’s staff was reassigned, an investigation into him was launched by Trans-Lux’s in-house counsel, his responsibilities were diminished, and he was eventually terminated. Kramer later sued Trans-Lux, claiming among other things that the Company had retaliated against him in violation of Dodd-Frank. Trans-Lux moved to dismiss. Read More
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