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:
• SEC Chair Mary Jo White began her address by discussing the “unprecedented rulemaking agenda” currently facing the SEC by virtue of the mandates set forth in both the Dodd-Frank and Jumpstart Our Business Startups (“JOBS”) Acts. She repeatedly stressed the SEC’s lack of sufficient funding but ensured the audience that the state of the SEC is “strong, busy, and proactive.” On enforcement, Chair White touted last year’s return of $3.4 billion in disgorgement and civil penalties to investors, which she said represented the highest amount in the history of the Commission. She briefly discussed last year’s modification of the long-standing “no admit/no deny settlement protocol” and her expectation that, in 2014, more settlements will include admissions of wrongdoing “as the new protocol continues to evolve and be applied.” Chair White also discussed the Financial Reporting and Audit Task Force, which was formed last year “to look at trends or patterns of conduct that are risk indicators for financial fraud, including in areas like revenue recognition, asset valuations, and management estimates.” She described the task force’s focus on “identifying potential material misstatements in financial statements and disclosures” and predicted that it will produce several significant investigations in the year ahead.
• Andrew Ceresney, the Director of the Division of Enforcement, said that the Division of Enforcement is “reordering” its priorities to focus on the post-financial crisis market. He also discussed the Division’s results from 2013, including the fact that the SEC has now filed five matters that have settled where an admission was included as one component of the settlement. Ceresney forecasted that in the “coming weeks” the SEC will announce “many actions” that show “aggressive use” of its authority.
• Enforcement Division Chief Counsel Joseph Brenner discussed the Division’s use of “all tools” to carry out its mission. He gave examples that included the SEC’s first-ever action under Section 10A of the Exchange Act related to audit partner rotation and audit committee reporting requirements and a case brought under Section 20(d) of the Exchange Act for alleged insider trading in options. Brenner also discussed Section 20(b) of the Exchange Act, a rarely used provision that prohibits any person from performing an unlawful act “through or by means of any other person.” According to Brenner, the Commission has not used this provision in decades but has been thinking about it “a lot” lately as a potential theory of liability. He said that this Section could be used more frequently as a vehicle for secondary liability claims, particularly because it does not “require proof of an underlying violation by somebody else.” Brenner added that this provision could thus “fill a gap” caused by the Supreme Court’s decision in Janus Capital Inc. v. First Derivative Traders and be used to target actors who, acting with scienter, cause another to “make” a false statement. Cuban articulated his take on Brenner’s comments in this tweet.
• Charlotte Buford, Assistant Chief Counsel in the Division of Enforcement, described the SEC’s increasing use of administrative proceedings. She mentioned that while in the past there may have been a presumption that particular types of cases “belonged” in either federal court or, alternatively, in an administrative proceeding, she stressed that no such presumption is currently in place and that the proper forum for any particular case is evaluated on a case-by-case basis. Factors that the Division considers in making this evaluation include which forum will be most efficient, whether a jury or a SEC ALJ would be the best-suited fact finder for a particular case, and litigation considerations including whether the Division wants or needs to take discovery. In response to a question from moderator and former Commissioner Roel Campos as to whether the SEC’s increasing use of administrative proceedings presents any due process concerns, Joseph Brenner responded that, notwithstanding Judge Jed Rakoff’s opinion in SEC v. Gupta, “the law supports” the administrative proceeding process and that this process “is a level playing field” that presents “no due process problems.” It was at this moment that Cuban tweeted this.
• Chief Litigation Counsel in the Division of Enforcement Matthew Solomon mentioned that the SEC has been “aggressive” in bringing insider trading cases “and will continue to be.” He stated that the SEC will focus on gatekeepers such as attorneys and accountants (noting the Division’s recent “Operation Broken Gate” enforcement initiative against certain auditors), particularly in the insider trading space. He added that, despite its recent string of losses in insider trading trials, the agency will continue to bring insider trading cases premised upon circumstantial evidence that “asks the jury to draw inferences.” He also mentioned the recent decision in SEC v. Contorinis in which the Second Circuit held that the SEC could obtain disgorgement of profits that a defendant did not personally make, but that “he has bestowed on others” (in Contorinis, the focus was on profits made by a fund that the defendant co-managed). Solomon described this case as a “real example of value added” by the SEC in a case that involved a parallel criminal proceeding and agreed that, in some cases, this decision could give the SEC “additional leverage” in future settlement talks.
• Regional Director and Chair of the Financial Reporting and Audit Task Force David Woodcock said that he is “not fully sure why” accounting fraud cases have become a smaller percentage of the SEC’s litigation docket, and that the Financial Reporting and Audit Task Force is “looking to change” how the SEC finds, investigates, and prosecutes accounting-focused cases. Woodcock reported that the task force is looking to technology, outside experts, whistleblowers, academia, and others to help reshape how the SEC looks at accounting cases. He mentioned two areas that are of particular interest to the task force: internal controls and companies’ failure to disclose material weaknesses therein even prior to the filing of any restatement and outside auditors who fail to “fulfill their gatekeeping role.”
• Michael Osnato, Chief of the Complex Financial Instruments Unit in the Division of Enforcement, described his unit’s strategy of finding “the most complicated products in the most complicated part of the market” and to “go there and find cases.” He stated that the first area of priority for his unit is the over-the-counter market, where there are “really complicated products” and “not a lot of price transparency.” More generally, Osnato discussed the unit’s focus on how products are being used, rather than on the products themselves. For example, he explained, the unit is examining synthetic transactions that may be used to hide or shift risk, particularly offshore.
• Kara Brockmeyer, head of the FCPA Unit in the Division of Enforcement, stated that the unit is off to a fast start in 2014. Brockmeyer talked about the non-prosecution agreement that the SEC entered into with Ralph Lauren in April 2013 and the factors that caused Ralph Lauren to qualify for such agreement. Those factors included the fact that the company had self-reported the violation in a timely fashion, that it discovered the violation through its own internal FCPA training process, that it cooperated with the SEC during its investigation by providing translations of documents and by bringing witnesses to the United States for interviews with the SEC, and that the problem was isolated to conduct in only one foreign country. She also discussed her expectation that more FCPA cases, including some litigated cases, may be brought as administrative proceedings. Lastly, Brockmeyer also discussed the SEC’s cross-border working group and its focus on cases related to China. In particular, she mentioned recent cases against Chinese audit firms and noted that there are “a few more in the pipeline.”
• John Avery, Deputy Solicitor, discussed the application of the Supreme Court’s 2011 decision in Janus in federal courts across the country and highlighted those cases that have held that Janus’ holding as to what it means to “make” a statement does not apply to subsections (a) and (c) of Rule 10b-5 and Section 17(a) of the Securities Act. He did note, however, the Second Circuit’s May 2013 decision in Fezzani v. Bear Stearns & Co., in which the court held that “only the person who communicates the misrepresentation is liable in private actions under Section 10(b).” The SEC has filed an amicus brief in the Second Circuit in support of a pending petition for rehearing, in which the SEC argues that the Fezzani decision conflated “manipulative conduct with misrepresentations” and improperly applied Janus to all sections of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
• Associate General Counsel Laura Jarsulic discussed the SEC’s increasing use of the summary affirmance procedure described in Rule 411(e) of the SEC’s Rules of Practice applicable to administrative proceedings. Under this procedure, which she reported has been used three times since 2011, the Commission adopts the initial decision of its ALJ as its own, though the Commission does conduct its own review of the case record. Under this procedure, if the matter is appealed to federal court then the ALJ’s decision would be the operative decision reviewed by the court. Jarsulic expressed her expectation that the SEC may be looking to use this procedure more in the future.
• Commissioner Luis Aguilar stressed his “increasing concern” with the potential for cyber attacks to harm investors and warned that both the public and private sectors should consider cyber security a high-priority issue. While the Commission’s efforts on the subject have thus far focused on disclosures related to cyber security risk, Commissioner Aguilar called for a deeper understanding of the issue so that the SEC will be able to prepare for and respond to “inevitable” cyber attacks. Commissioner Aguilar’s speech also discussed transfer agents, whom he called “critical gatekeepers” who fulfill an important function that will become “even more critical” after the passage of the JOBS Act. He called for the SEC to take a “hard look” at its framework for the regulation of transfer agents and warned that “the tsunami is coming and we need to be ahead of it rather than behind it.”
• Commissioner Daniel Gallagher defended the SEC against the “misinformation and spin” that dragged the SEC’s reputation “through the mud” after the financial crisis. He called the Dodd Frank Act a “monstrosity” that was untethered to the causes of the financial crisis and described it as a “political response to a very real crisis.” Commissioner Gallagher emphasized that, apart from its obligations stemming from Dodd Frank, the SEC “still has a day job” and “must regain its seat at the table of financial service regulators.”
• Chief Accountant in the Office of the Chief Accountant Paul Beswick focused the majority of his presentation on the role of audit committees in public companies. He stressed the role of audit committees in conducting an independent review of financial reporting and isolating a company’s independent auditors from management. Beswick noted that audit committees are in a unique position to resolve disputes between a company’s management and its auditor and that audit committees have the ability to carry out this responsibility by hiring independent counsel and other advisors. He also discussed auditor independence and repeatedly stressed that ensuring auditor independence is a responsibility that is shared between a company and its auditor. He elaborated that monitoring auditor independence is an ongoing responsibility that should involve the audit committee. In particular, Beswick said that he finds it “disappointing” when a company brings an independence concern to the SEC without having first consulted its audit committee on the subject. Finally, he mentioned that “lots” of the audit committee reports he has seen are “boilerplate” and that he would “love to see” more audit committees disclose “greater clarity on how the audit committee discharges its duty in overseeing the auditor.”
• Jeff Minton, Chief Counsel in the Office of the Chief Accountant, also emphasized auditor independence and audit committee communication. He discussed the topic in the context of initial public offerings and highlighted that companies in pursuit of an IPO must have had an independent auditor for at least two years prior to the offering. Minton added that, under the rules of the Public Company Accounting Oversight Board, communications between a company’s auditor and its audit committee regarding all relationships that may reasonably bear on independence must occur before the auditor accepts an IPO engagement. He described “some foot faults” that he has seen where a company did not complete this assessment until it was “well down the road of going public” and said that there is “simply little appetite for that” at the Commission. Minton also discussed suspensions of accountants under Section 102(e) of the SEC’s Rules of Practice, which have “dramatically increased” since the passage of Sarbanes-Oxley and are routinely brought against both auditors and in-house accountants.