Posts by: Editorial Board

Extra, Extra! – Extraterritoriality And Criminal Actions As To Alleged Securities Fraud

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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 →

The Blue Sky Is The Limit for Securities Liability in Washington

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Many state securities laws, known as blue sky laws, are patterned after Section 12(a)(2) of the Securities Act of 1933.  The interpretation of these state blue sky laws, however, may diverge significantly from the interpretation of analogous federal securities statutes.  The recent Washington Court of Appeals opinion in FutureSelect Portfolio Management, Inc. et al. v. Tremont Group Holdings, Inc. et al., No. 68130-3-1 (Wn. Ct. App. Aug. 12, 2013), highlights one such divergence in which the scope of potential primary liability for secondary actors under the Washington State Securities Act extends beyond the scope of the federal law on which it was based.

In FutureSelect, a group of Washington state investors (“FutureSelect”) lost millions of dollars after purchasing interests in the Rye Funds, a “feeder fund” that invested in Bernie Madoff’s Ponzi scheme.  The investors sued Tremont Group Holdings, Inc., the general partner in the Rye Funds and its affiliates, as well as the audit firm Ernst & Young LLP.  The plaintiffs’ claims against EY were based primarily on the allegation that EY misrepresented that it had conducted its audit of the Rye Funds’ financial statements in conformity with generally accepted auditing standards when issuing its unqualified audit opinion on these financial statements.  The trial court dismissed the plaintiffs’ claims against EY for failure to state a claim, but the Washington State Court of Appeals reversed that decision on appeal. READ MORE →

Time is Money: Second Circuit Vacates SEC’s $38 Million Fine Against Hedge Fund Pentagon Capital Management

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On August 8, 2013, the Second Circuit vacated the SEC’s $38 million fine against hedge fund Pentagon Capital Management PLC, holding that the Supreme Court’s decision in Gabelli v. SEC required the case to be remanded for recalculation of the civil penalty. This case is one of several SEC enforcement actions affected by the Gabelli ruling since the Court issued its decision less than six months ago. The Second Circuit’s decision highlights the limiting effect Gabelli will have on civil remedies available to the SEC for securities law violations that occurred more than five years before the agency initiated its enforcement action.

In Gabelli, the Court held that the five-year statute of limitations for filing civil enforcement actions seeking penalties for fraud begins to run from the date of the alleged violation, not when the SEC discovers, or reasonably should have discovered, the violation. Citing Gabelli, the Second Circuit in SEC v. Pentagram Capital Management PLC found that any profits Pentagon earned more than five years before the SEC filed its suit could not be included in the penalty. The parties agreed that remand on the issue was required.

The SEC alleged that Pentagon and its owner, Lewis Chester, committed securities fraud under Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 by engaging in late trading of mutual funds. Late trading involves placing and executing orders as if they occurred at or before the time the mutual fund price was determined. Such trading allows the purchaser to profit from information released after the mutual fund price is fixed each day, but before it can be adjusted the following day. The SEC alleged that Pentagon engaged in late trading through its broker dealer, Trautman Wasserman & Co., from February 2001 through September 2003. READ MORE →

Where There’s Thunder, There’s Lightning: SEC’s Investigation of IBM’s Cloud Computing Accounting May Be a Harbinger of a New Enforcement Focus

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Pen and Calculator

Cloud computing may be the next shoe to drop. On the heels of Mary Jo White’s recent appointment as Chairman of the SEC and predictions that it may refocus enforcement on accounting fraud came word last week that the Commission is investigating IBM’s cloud-computing accounting. In an SEC filing, IBM defended its revenue accounting for cloud-based services, stating “[w]e are confident that the information we have provided has been consistently accurate.”

This may just be the tip of the iceberg for an industry estimated by some analysts to generate global revenues of $131 billion this year, 60% of which originate in the United States.

Cloud computing has no single definition but one basic expression would be the practice of storing and accessing information on servers accessed through the Internet. There are many cloud-computing business models, including Infrastructure as a Service (“IaaS”), in which customers access computing power, such as servers, through physical equipment owned by the provider; Platform as a Service (“PaaS”), in which customers use a provider’s computing environment—including operating systems, programming languages, and databases—to create applications remotely; and Software as a Service (“SaaS”), services that allows users to operate software remotely. Google Documents and the e-Discovery platform Relativity are just two cloud-based services that readers may be familiar with. READ MORE →

The Honeymoon is Over: Post-DOMA, Same-Sex Couples Now Spouses For Purposes of the Securities and Exchange Act Rules

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The Supreme Court in U.S. v. Windsor held that the federal Defense of Marriage Act’s (DOMA) section defining marriage as between a man and woman is unconstitutional because it violates the Fifth Amendment’s equal protection clause. Under Section 3 of DOMA a person could only be considered a spouse under federal law if they were married to a person of the opposite sex.

The term “spouse” appears several times in the Securities and Exchange Act Rules. Exchange Act Rule 10b5-2 provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the misappropriation theory of insider trading. The misappropriation theory expands the traditional view of insider trading to cases where a person misappropriates confidential information in breach of a duty owed to the source of the information.

Subsection (b)(3) of Rule 10b5-2 enumerates circumstances where this duty is presumed to exist and includes circumstances when “a person receives or obtains material nonpublic information from his or her spouse[.]” Because Rule 10b5-2’s enumerated list is non-exclusive it’s possible a duty of trust and confidence could be found between domestic partners regardless of the Windsor ruling. However, the expanded definition of spouse post-Windsor shifts the burden, creating a rebuttable presumption that such a duty exists between same-sex couples in states where they are legally married for the purposes of the misappropriation theory of insider trading.

There are other instances where the term spouse may be significant under the securities laws, including beneficial reporting requirements for Section 16 insiders and Audit Committee independence rules.

 

Broker-Dealers: The New Frontier for SEC Enforcement

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People at a Table

In a split vote last week, the SEC adopted new rules designed to increase protections for customers who invest money and securities with broker-dealers. Recent rulemaking and statements made by the SEC have highlighted the fact that broker-dealer regulation is becoming a growing area of SEC interest. In connection with last Wednesday’s vote, SEC Chair Mary Jo White stated that “[i]nvestors need to feel confident that their money is safe when it’s being held by their broker-dealers… [and] these rules will strengthen the audit requirements for broker-dealers and enhance [the SEC’s] oversight of the way they maintain custody over their customer’s needs.”

The new rules amend the broker-dealer reporting and notification rules codified in Section 17 and Rules 17a-5 and 17a-11 of the Exchange Act. Currently, a broker-dealer is required to file an annual report with the SEC and the SRO designated to examine that broker-dealer. The report must contain audited financial statements conducted by an independent public accountant registered with the PCAOB. Under the new requirements, a broker must file a quarterly report telling the SEC whether and how it maintains control over its client’s funds. The new rules also require that the broker-dealer let the SEC review the work-papers of the accountant, if requested. READ MORE →

Here’s Looking At You, Money Market Funds

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While money market funds did not exist when Humphrey Bogart spoke his famous line in Casablanca, since the 2008 financial crisis, reforming money market funds have been the subject of high drama and intense scrutiny on Capitol Hill. Advocates for reform finally got their long awaited breakthrough last Wednesday, June 5, 2013, when the Securities and Exchange Commission voted unanimously to propose legislation that would reform money market funds. The SEC’s goal with the reform is to make money market funds less susceptible to “runs” that could harm investors.

The SEC’s goal of reform has been in the works for a long time, was championed by former Chair of the SEC, Mary Schapiro, and has been continued by current Chair Mary Jo White. A money market fund is a type of fixed-income mutual fund that invests in debt securities with short maturities and minimal credit risk. They first developed in the early 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts. Money market funds have grown considerably since then and currently hold more than $2.9 trillion in assets.

Money market funds seek stability and security with the goal of never losing money and keeping their net asset value (“NAV”) at $1.00. However, many felt reform was necessary after a money market fund “broke the buck” at the height of the financial crisis in September 2008 and re-priced its shares below its $1.00 stable share price to $0.97. Investors panicked and within a few days, investors had pulled approximately $300 billion from similar money market funds. Intervention from the United States Treasury Department prevented further runs on the funds. READ MORE →

SEC Considering More Stringent Requirements For Cybersecurity Disclosures in the Wake of Stock Manipulating Hacking Case

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Following up on clues earlier this year that the SEC may increase its scrutiny of cybersecurity disclosures, SEC Chairman Mary Jo White has asked the Commission to evaluate current guidance for cybersecurity disclosures and to consider whether more stringent requirements are necessary.  White asked the Commission to assemble a report on general practice and compliance with existing guidelines, and to make recommendations for future guidance.  White did not yet commit to changes to the current guidelines, issued in October 2011, pending issuance of the report.

Senator Jay Rockefeller, who disclosed the Chairman’s directive, has recently encouraged the SEC to provide further guidance on cybersecurity disclosures.  He has already sponsored legislation in this arena, including the Cybersecurity Act of 2012, which would have pushed the private sector to share internal information within the industry and with government agencies.  The proposed legislation in 2012 would have also encouraged the enactment of protective measures for computer networks.  Senator Rockefeller has expressed concern about the lack of information regarding cybersecurity risks, and appears poised to push for additional disclosures.  READ MORE →

A Look Ahead at SEC Enforcement Actions – with Orrick’s Jim Meyers

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Orrick partner Jim Meyers provides his perspective to JD Supra in the May 14, 2013 article, “A Look Ahead at SEC Enforcement Actions – with Orrick’s Jim Meyers.” Jim comments on trends in Securities and Exchange Commission enforcement, the new arrivals of SEC chairwoman, Mary Jo White and Enforcement Unit co-head, Andrew Ceresney, the recent “Non-Prosecution Agreement” with Ralph Lauren, and more.

To read the full JD Supra article, please click here.

Where There’s Smoke, There’s FIRREA

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Few can ignite a legal firestorm like U.S. District Judge Jed Rakoff of the Southern District of New York. Last week, in a mortgage fraud suit against Bank of America and Countrywide, Judge Rakoff refused to dismiss a novel claim for civil penalties under the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). The ruling will surely encourage civil prosecutors to make wider use of FIRREA, which provides a generous ten-year statute of limitations and low burden of proof, in pursuing financial fraud cases.

FIRREA was enacted in response to the Savings and Loan debacle of the 1980s, as well as the fraud scandals that emerged during that era. The statute includes a clause imposing a civil penalty for mail and wire fraud and other violations “affecting a federally insured financial institution.” Until recently the civil penalty provision has been ignored by prosecutors, leaving courts without occasion to decide what exactly the statute means by “affecting” a financial institution. READ MORE →