On September 10, 2015, a divided panel of the Second Circuit issued an opinion in Berman v. [email protected] LLC, No. 14-4626 (2nd Cir. Sept. 10, 2015), creating a split with the Fifth Circuit on an issue that has also divided lower federal courts: whether the anti-retaliation provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act apply to tipsters who claim retaliation after reporting internally, or only to those retaliated against after reporting information to the SEC. The Second Circuit, granting Chevron deference to SEC interpretive guidance, held that Dodd-Frank protections apply to internal whistleblowers. This stands in contrast to the Fifth Circuit’s holding in Asadi v. G.E. Energy (USA), LLC, 720 F.3d 620 (5th Cir. 2013), where that court found that on their face, the Dodd-Frank anti-retaliation provisions unambiguously limited protection to whistleblowers reporting to the SEC, and that, therefore, the SEC’s contrary guidance was not entitled to deference. Given this Circuit split, Supreme Court review is possible.
On August 4, 2015 the Securities and Exchange Commission issued interpretive guidance elaborating its view that the anti-retaliation provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act apply equally to tipsters who claim retaliation after reporting internally, as well as those who are retaliated against after reporting information to the SEC. The guidance reflects that there is a split among federal courts over whether Dodd-Frank’s whistleblower retaliation provisions apply to internal as well as external reporting, and recognizes that the only circuit court to decide the issue to date, the Fifth Circuit, has taken a contrary position to that of the Commission in Rule 21F, the regulation the SEC adopted to implement the whistleblower legislation, holding that internal reports are not protected by Dodd-Frank. Whether internal reports qualify for Dodd-Frank coverage has important implications because, among other things, Dodd Frank provides enhanced recoveries (including two times back pay) and longer time frames (six years) for bringing a retaliation claim than would be available under the anti-retaliation provisions in the Sarbanes-Oxley Act of 2002.
In recent months, issues related to internal control systems and reporting have taken on an increased profile and significance. For example, as previously noted by the authors here and here, the SEC has sought to prioritize compliance with internal controls by initiating a growing number of investigations into companies based on allegations of inadequate internal controls.
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
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
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
On October 10, 2012, a federal district judge in Missouri granted in part and denied in part class action plaintiffs’ motion to compel certain documents that KPMG had supplied to the Public Company Accounting Oversight Board (“PCAOB”) in a 2006 investigation.
Judge Ortrie D. Smith held that KPMG was not required to produce the bulk of its withheld documents relating to a 2006 PCAOB inspection because those documents were privileged under SOX. Specifically, SOX provides that documents and information prepared or received by or specifically for the PCAOB are confidential and privileged and not subject to disclosure. Not all documents fell under the privilege, the court held: documents from the underlying transaction and work that was the subject of the investigation were not prepared for the PCAOB and so could not claim the privilege protection.
The court rejected plaintiffs’ arguments that the SOX privilege only covers documents “in the hands” of the PCAOB and not third parties, like KPMG, because the privilege covered materials both prepared for, and received by, the PCAOB. Finally, KPMG had not waived the privilege when it shared some of the information with Sprint employees or defendants in the litigation.
On May 15, 2012, the Ninth Circuit Court of Appeals affirmed the decision of the district court finding in favor of the Securities Exchange Commission (“SEC”) on allegations that Carl Jasper, the former Chief Financial Officer of Maxim Integrated Products, Inc., violated various provisions of the securities laws in connection with the company’s stock options backdating scheme. SEC v. Jasper, Case No. 10-17064 (9th Cir. May 15, 2012). The court found that for ten consecutive quarters, Maxim granted backdated options with an exercise price equal to the lowest price of Maxim stock for each quarter. READ MORE
Earlier this month, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act, which had strong bipartisan and business support, is aimed at stimulating economic growth by allowing U.S. and foreign startup and emerging companies to more easily raise capital and transition to public companies.
The JOBS Act works by reducing a number of regulatory burdens that were imposed by the 2002 Sarbanes-Oxley Act. It directs the Securities and Exchange Commission to revise Rule 506 under the 1933 Securities Act to allow general advertising and solicitation for private placements, with no limit on the number of securities that are bought and sold, so long as they are sold only to accredited investors. It also amends Rule 144A(d)(1) of the Securities Act, which allows private resales of securities to qualified institutional buyers (“QIBs”), to permit such securities to be generally advertised to persons other than QIBs—as long as they are only later sold to QIBs. These changes have the effect of allowing firms to market themselves to a greatly expanded base of potential investors. READ MORE