Last week, a divided panel of the U.S. Court of Appeals for the Fifth Circuit struck down the U.S. Department of Labor’s (“DOL”) “Fiduciary Rule,” a controversial measure that redefined exemptions to Employee Retirement Income Security Act of 1974 (“ERISA”) provisions concerning fiduciaries. The DOL’s rule, promulgated in April 2016, consisted of a package of seven interrelated rules, and it sparked controversy by redefining how brokers and other financial professionals serve consumers. First, the Fiduciary Rule reinterpreted the ERISA term “investment advice fiduciary,” heightening the fiduciary duty for these financial professionals to a “best interest” standard for their clients with ERISA plans and individual retirement accounts (“IRAs”). This “best interest” standard marked a significant departure from the prior standard for brokers, which required them to recommend investments that were merely “suitable” for their clients. Second, the Fiduciary Rule created a “Best Interest Contract Exemption,” which allowed financial professionals to avoid prohibited transactions penalties as long as they contractually affirmed their fiduciary status. READ MORE
Posts by: Robert Stern
The Commissioners and senior officials of the Securities and Exchange Commission (“SEC” or “Commission”) addressed the public on February 23-24 at the annual “SEC Speaks” conference in Washington, D.C. Throughout the conference, many speakers referred to the new energy that SEC Chairman Jay Clayton had brought to the Commission since his confirmation in May 2017. The speakers also seemed relieved that the SEC was finally operating with a full set of commissioners since the recent additions of Robert J. Jackson, Jr. and Hester M. Peirce. Clayton’s address introduced the main refrain of the conference: that the SEC under his leadership is focused on the long-term interests of Main Street investors. Other oft-repeated themes included the challenges presented by cybersecurity and the fast-paced developments in cryptocurrency and blockchain. To address these shifts in focus, the Enforcement division plans to add more resources to the retail, cybersecurity and cryptocurrency spaces.
Following are the key litigation and enforcement takeaways.
Main Street Investors
Commissioner Kara Stein picked up on Clayton’s Main Street investors focus when she asked whether increasingly complex and esoteric investments, such as product strategies and structures that utilize derivatives, were appropriate for retail investors. She explained that it was not a question whether the financial industry could develop and sell these products, but whether it should. She said it was not clear that financial professionals fully understood the products they were selling, and that even if brokers and advisers made disclosures regarding the potential outcomes and risks to investors, complete disclosures might not even be possible due to the products’ complexity. Both SEC and FINRA Enforcement have brought actions related to the sales practices of inverse and leveraged ETFs, as well as the purchase and sale of complex products. Stein opined that gatekeepers needed to remember the real people behind every account number when they were advising clients on how to handle these types of products.
Steven Peikin, Co-Director of the Division of Enforcement, described the SEC’s Share Class Selection Disclosure Initiative as one way in which Enforcement was trying to help Main Street investors. The Initiative was created to address the problem of investment advisers putting their clients into higher fee share classes when no fee or lower fee classes were available. The SEC is incentivizing advisers to self-report this issue by promising not to impose any penalties, and only requiring them to disgorge their profits to investors. Peikin encouraged investment advisers to take advantage of this opportunity, indicating that if the Commission learned that an adviser had engaged in this conduct and did not self-report, it would be subject to significant penalties. The Chief of the SEC’s Broker-Dealer Task Force shared that AML programs and SAR-filing obligations are also a priority for the Enforcement division and OCIE exams. READ MORE
Startups need funding, and most startups want to raise money with as little legal red tape as possible. But when a startup takes investment money, it is issuing securities, and federal securities laws generally require a company – or “issuer” – to register the offering and sale of any securities with the Securities Exchange Commission (“SEC”). The bad news is that most early-stage companies don’t have the legal resources to comply with the SEC’s registration and reporting requirements. The good news is that Congress and the SEC recognize this and so have created certain exemptions from the registration requirement.
The most commonly used exemptions derive from Sections 4(a)(2) and 3(b)(1) of the Securities Act of 1933. Section 4(a)(2) exempts issuer transactions “not involving any public offering,” while Section 3(b)(1) authorizes the SEC to create additional exemptions. The SEC adopted Regulation D (“Reg D”) in 1982 to clarify and expand the exemptions available under these two sections. The SEC further expanded Reg D in 2013 following passage of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”).
Until this year, Reg D included three rules – Rules 504, 505, and 506 – that provided specific exemptions from registration. Rules 504 and 505 exempted certain offerings up to $1 million and $5 million, respectively. Rule 506 spelled out two “safe harbors” – 506(b) and 506(c). If an offering met the conditions of either of Rule 506’s “safe harbors,” it would be deemed a transaction “not involving any public offering” and would be exempt under Section 4(a)(2). READ MORE
This week, the Supreme Court heard argument regarding whether the SEC’s actions to disgorge ill-gotten gains are subject to a five-year statute of limitations for “any civil fine, penalty, or forfeiture.”
The appeal stems from an SEC action alleging that between 1995 and 2006, Charles Kokesh, a New Mexico-based investment adviser, misappropriated a staggering $35 million from two investment advisory companies that he owned and controlled, squandering the money of tens of thousands of small investors. While Kokesh moved into a gated mansion and bought himself a personal polo court (complete with a stable of 50 horses), he allegedly concealed his massive ill-gotten earnings by distributing false proxy statements to investors and filing dozens of false reports with the Securities and Exchange Commission.
In 2009, the SEC brought a civil enforcement action against Kokesh in the District of New Mexico alleging violations of the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940. The jury found violations of all three acts, and the district court ordered Kokesh to disgorge the $35 million he misappropriated (plus interest) and pay a $2.4 million civil monetary penalty for the “egregious” frauds he committed within the prior five years. While the district court ordered disgorgement of all of Kokesh’s ill-gotten gains since 1995, the civil monetary penalty it imposed was constrained by the five-year statute of limitations found in 28 U.S.C. § 2462, which applies to claims throughout the U.S. Code for “any civil fine, penalty, or forfeiture.” READ MORE
On February 2, 2017, the New York Appellate Division, First Department, issued a decision in Gordon v. Verizon Communications, Inc., No. 653084/13, 2017 WL 442871 (1st Dep’t 2017), approving the settlement of litigation over an acquisition by Verizon Communications (“Verizon”) and articulating a new test to evaluate the fairness of such settlements. The Gordon decision signals that New York will remain a friendly venue to disclosure-based M&A settlements and may see increased shareholder M&A lawsuits as a result
As we have repeatedly written about (here, here and here), Delaware Chancery Courts have spent the past year attempting to curtail, or eliminate altogether, M&A litigation settlements where the sole remedy is enhanced proxy disclosures. Chancellor Bouchard’s landmark decision in In re Trulia Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), rejected these “disclosure-only” settlements, finding that the “enhanced” disclosures produced by such settlements were not “material or even helpful” to stockholders. The Chancery Court bemoaned the proliferation of disclosure-only settlements in Delaware, and indicated that these types of settlements would be met by “continued disfavor” unless the supplemental disclosures are “plainly material,” i.e., they must “significantly alter the ‘total mix’ of information made available.”
In Trulia’s wake, the number of M&A suits filed in Delaware plummeted—declining by almost 75% in the first half of 2016—as plaintiffs’ counsel opted to file in federal court or states other than Delaware in the hope of finding more hospitable fora for “disclosure-only” resolutions. READ MORE
On August 17, 2016, jurors in a New York federal court convicted Sean Stewart on criminal charges of conspiracy, securities fraud, and tender offer fraud after more than five days of deliberation. Stewart, a former investment banker for JPMorgan and Perella Weinberg Partners, was charged with leaking confidential information about health care mergers to his father, Robert Stewart, on at least five occasions over the course of four years. The case provides a victory to Preet Bharara, the United States Attorney for the Southern District of New York, after a series of setbacks in the form of unfavorable decisions in the aftermath of the Second Circuit’s decision in U.S. v. Newman, the repercussions of which have been covered extensively on this blog (see here, here). As the first conviction post-Newman, U.S. v. Stewart provides some insight into the kinds of facts that might support an insider trading charge in the Second Circuit going forward and is thus worthy of analysis.
On May 16, 2016, the United States Supreme Court handed down two decisions that may, in practice, limit the ability to access federal district courts. In Spokeo, Inc. v. Robins, No. 13-1339, 578 U.S. ___ (2016), the Supreme Court rejected the Ninth Circuit’s conclusion that statutory violations are per se sufficient to confer Article III standing, and, in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, No. 14-1132, 578 U.S. ___ (2016), the Court concluded that jurisdiction under Section 27 of the Securities and Exchange Act (Exchange Act) is limited to suits brought under the Exchange Act and state law claims that turn on the plaintiff’s ability to prove the violation of a federal duty.