It has been reported that approximately two-thirds of companies in the U.S. are affected by fraud, losing an estimated 1.2% of revenue each year to such activity.  Indirect costs associated with fraud, such as reputational damage and costs associated with investigation and remediation of the fraudulent acts, may also be substantial. When and where implemented, an internal whistleblower hotline is a critical component of a company’s anti-fraud program, as tips are consistently the most common method of detecting fraud.  Consequently, it is essential that companies consider implementing, if they have not already done so, effective whistleblower hotlines.  To the extent hotlines are currently in place, companies need to evaluate them to ensure that the hotlines are operating as intended and are effective in preventing and identifying unethical or potentially unlawful activity, including corporate fraud, securities violations and employment discrimination or harassment. This evaluation should be a key element of every company’s assessment of its compliance and ethics program.
Archive for the ‘Securities Litigation & Enforcement’ Category
Two recent Dodd-Frank whistleblower awards suggest that the program is becoming the kind of “game changer” for law enforcement that many had predicted. The program, which took effect in August 2011, mandates the payment of bounties to persons who voluntarily provide information leading to a successful securities enforcement action in which more than $1 million is recovered. Informants are entitled to receive between 10 and 30 percent of the amounts recovered, with the precise amount to be determined by the SEC.
Last month, the SEC announced that it brought enforcement actions primarily relating to Section 16(a) under the Securities Exchange Act against 34 defendants. The defendants were 13 individuals who were or had been officers or directors of public companies, five individual investors, ten investment funds/advisers and six public companies.
This post briefly discusses several noteworthy points regarding this development and also discusses practical steps that companies could consider taking in response.
As an echo of the last financial crisis, the two themes that have arguably dominated the corporate governance debate globally are investor activism and corporate governance enforcement. Recent years have seen by all accounts the highest rates of institutional investor activism on a range of issues such as executive remuneration, non-financial disclosure and board composition, and at the same time, increased oversight and enforcement. Stewardship-oriented initiatives and rigorous enforcement activity by securities but also banking sector regulators have seen a level of heightened interest in Europe and North America, and to a lesser extent in emerging markets.
The increasing use of Non- and Deferred Prosecution Agreements (N/DPAs) has enabled federal prosecutors to incrementally expand their traditional role, exemplifying a shift in prosecutorial culture from an ex-post focus on punishment to an ex-ante emphasis on compliance. N/DPAs are contractual arrangements between the government and corporate entities that allow the government to impose sanctions against the respective entity and set up institutional changes in exchange for the government’s agreement to forego further investigation and corporate criminal indictment. N/DPAs enable corporations to resolve allegations of corporate criminal conduct, strengthen corporate compliance mechanisms to prevent corporate wrongdoing in the future, and mitigate the risks that collateral consequences of a conviction can bring for companies, their shareholders, employees, and the economy.
On September 10, 2014, the Securities and Exchange Commission announced an unprecedented enforcement sweep against 34 companies and individuals for alleged failures to timely file with the SEC various Section 16(a) filings (Forms 3, 4 and 5) and Schedules 13D and 13G (the “September 10 actions”).  The September 10 actions named 13 corporate officers or directors, five individuals and 10 investment firms with beneficial ownership of publicly traded companies, and six public companies; all but one settled the claims without admitting or denying the allegations. The SEC emphasized that the filing requirements may be violated even inadvertently, without any showing of scienter. Notably, among the executives targeted by the SEC were some who had provided their employers with trading information and relied on the company to make the requisite SEC filings on their behalf.
On September 4, 2014, the Delaware Court of Chancery issued two lengthy post-trial opinions,  both authored by Vice Chancellor John W. Noble, finding that recapitalization or restructuring transactions did not satisfy the entire fairness standard of review. Although plaintiffs in each instance had received a fair price, the court found that the defendants had employed unfair processes and breached their fiduciary duties.
Significantly, one of the cases involved a recognizable set of facts: various plaintiff stockholders challenged a recapitalization that was approved at the same time the company conducted an “insider” round of financing as the company was running out of cash. The recapitalization and financing were approved by a five-member board of directors, three of whom were designated by venture capital funds that either participated in the financing or were said to have received a special benefit, with no participation by the company’s other stockholders. While the company received an informal and insider-led valuation of $4 million at the time of the recapitalization, the court found that the company’s equity at that time actually had a value of zero. However, as a result of the recapitalization, the company was able to acquire new lines of businesses. Four years after the recapitalization, the company was sold for $175 million. Following the sale, six years of litigation unfolded.
In its recent decision in Halliburton Co., et al. v Erica P. John Fund, Inc., the U.S. Supreme Court upheld the legal standard for reliance in Rule 10b-5 securities fraud class actions that it had established some 25 years ago in Basic, Inc. v. Levinson. This standard, known as the fraud-on-the market doctrine, created a rebuttable presumption that plaintiffs relied on the integrity of the market price if they can establish that the market for that security was efficient. Defendants can rebut this presumption in several ways, including showing that the market for the security was not efficient or that the security’s price was not affected by the misrepresentations at issue. In delivering its ruling, the Halliburton Court noted that market efficiency is not a binary, yes-or-no proposition but is instead a matter of degree, pointing out that “a public, material misrepresentation might not affect a stock’s price even in a generally efficient market.” (Halliburton, 573 U.S. ___ at 10.)
In its landmark 2010 decision in Morrison v. National Australia Bank, the Supreme Court articulated what seemed to be a bright-line test for determining the extent to which the U.S. securities laws apply to transactions with international elements. In so doing, the Court harshly rejected the fact-intensive “conduct/effects” tests propounded several decades ago by the Second Circuit and followed by many other courts throughout the country.
Last week, the Second Circuit got its revenge. In a long-awaited decision in ParkCentral Global Hub Limited v. Porsche Automobile Holdings SE, the court declined “to proffer a test that will reliably determine when a particular invocation of [the Securities Exchange Act's anti-fraud provision] will be deemed appropriately domestic or impermissibly extraterritorial.” Instead, the Second Circuit held that courts must carefully consider the facts and circumstances of each case to avoid the very result that the Supreme Court had hoped to prevent in Morrison: promiscuous application of the U.S. securities laws to transactions that have little, if any, relationship to the United States.
Four years ago this month, with the country still reeling from financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act–the most sweeping financial reform effort since the Great Depression. The goal of Dodd-Frank was as ambitious as its scope; as President Barack Obama remarked, the legislation would “restore markets in which we reward hard work and responsibility and innovation, not recklessness and greed.”