The US Court of Appeals for the Eleventh Circuit recently issued an important decision that addresses two types of allegations that plaintiffs routinely rely on to plead loss causation in federal securities fraud cases. In Meyer v. Greene, 2013 US App. LEXIS 4187 (11th Cir. Feb. 25, 2013), the Eleventh Circuit appears to have become the first federal court of appeals to rule definitively that the mere announcement of an investigation by the US Securities and Exchange Commission (“SEC”) followed by a decline in a company’s stock price is insufficient to plead loss causation. The Court also ruled, consistent with decisions from other federal circuits, that a negative third-party analyst presentation is not a corrective disclosure for purposes of pleading loss causation if the presentation is based on publicly available information.
Posts Tagged ‘SEC investigations’
Recent press stories have revived speculation that corporate insiders may be abusing rule 10b5-1 trading plans to reap unfair profits from inside knowledge of their companies.  The SEC is reported to have expanded its probe beyond trades highlighted by the press to cover a larger range of executive trading activity.  Other regulators have launched their own investigations, and investor groups have joined the conversation. 
In light of this widespread and intensifying scrutiny, companies and executives should consider techniques that make it easier to demonstrate compliance with the requirements of rule 10b5-1, such as:
- having the first trade under a 10b5-1 plan take place after some reasonable “seasoning period” has passed from the time of adoption of the plan,
- having each executive use only one 10b5-1 plan at a time, and
- minimizing terminations and amendments of 10b5-1 plans.
The current controversy centers on trading by executives under 10b5-1 plans that, in hindsight, appears “well-timed.” Much like in the stock option pricing controversy from a few years ago, the press and some analysts have employed a retrospective statistical analysis of 10b5-1 plan trades to argue that insiders using the plans seem to be doing surprisingly well.
In our paper, SEC Investigations and Securities Class Actions: An Empirical Comparison, we compare investigations by the SEC with securities fraud class action filings involving public companies. Critics of securities class actions commonly contrast those suits with enforcement actions brought by the SEC. According to those critics, the SEC is superior to plaintiffs’ lawyers both in targeting defendants and securing sanctions against them. With respect to targeting, critics of securities class actions claim that the settlement dynamics of class actions encourage plaintiffs’ lawyers to bring a high proportion of non-meritorious suits. If companies must pay substantial costs when they are unjustifiably targeted, the deterrent value of class actions is diluted. With regard to sanctions, class action settlements are almost always paid by the company and its directors’ & officers (D&O) insurance; the corporate officers responsible for the fraud rarely contribute. By contrast, SEC enforcement actions commonly lead to payments from the responsible officers; the SEC also has the authority to bar individuals from serving as directors and officers of public companies, a career death sentence for the individual subjected to a bar. Critics of class actions argue that the combination of more precise targeting of suits and more individual sanctions yields a stronger deterrent punch for SEC enforcement relative to class actions.
In recent months, two district courts have addressed the issue whether employees who claim they were retaliated against for internally reporting violations of the Foreign Corrupt Practices Act can bring a private civil lawsuit against their former employers under the Dodd-Frank anti-retaliation provision. Although both courts decided that the anti-retaliation provision of the Dodd-Frank Act did not apply in these particular cases, the courts disagreed over whether Dodd-Frank whistleblower protections could apply to FCPA whistleblowers who report internally but not to the SEC.
The Whistleblower Provisions
The “anti-retaliation” provision of the Dodd-Frank Act, 15 U.S.C. §78u-6(h)(1)(A) prohibits employers from retaliating against a “whistleblower” for:
- i. providing information to the Securities and Exchange Commission (“SEC” or “Commission”);
- ii. initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such information; or
- iii. making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.) (“SOX”), [certain other securities laws], and any other law, rule, or regulation subject to the jurisdiction of the Commission.
Judge Paul Crotty of the U.S. District Court for the Southern District of New York recently held that Goldman Sachs & Co. did not have a duty to publicly disclose the receipt of a Wells Notice from the Securities and Exchange Commission (“SEC”). Prior to this decision, no court had ever been asked to consider disclosure obligations with respect to Wells Notices. Going forward, this decision may inform companies’ consideration of whether and when to publicly disclose receipt of a Wells Notice.
The case, Richman v. Goldman Sachs Group, Inc., centered on allegations by class action plaintiffs against Goldman relating to the firm’s role in a synthetic collateralized debt obligation (“CDO”) called ABACUS 2007 AC-1 (“Abacus”). In January 2009, Goldman’s SEC filings disclosed ongoing governmental investigations related to the Abacus transaction. Between July 2009 and January 2010, the SEC issued Wells Notices to Goldman and two Goldman employees involved in the Abacus transaction, notifying them that Enforcement Division staff “intend[ed] to recommend an enforcement action.” The SEC filed a complaint against Goldman and one of its employees in April 2010, which Goldman settled for $550 million in July 2010. Plaintiffs alleged that Goldman’s failure to disclose its receipt of the Wells Notices was an actionable omission under Section 10(b) and Rule 10b-5 of the Exchange Act, and that Goldman had an affirmative legal obligation to disclose its receipt of the Wells Notices under applicable regulations.
On March 19, 2012, the Securities and Exchange Commission (“SEC”) announced that it had credited the substantial cooperation of a former senior executive of an investment adviser in an investigation  by declining to take enforcement action against him. The SEC’s announcement can be found here. This is the first time the SEC has publicly recognized the cooperation of an individual since the announcement two years ago of its policy statement intended to incentivize individuals to cooperate in investigations, found here.  This announcement provides some much needed insight into the potential benefits of cooperating in an SEC investigation. However, the unique facts of the case mean that it will have limited application to other cases.
I. SEC’s Cooperative Initiative
As we have discussed in a prior alert, SEC’s Initiative to Foster Cooperation–Perspective and Analysis (Jan. 14, 2010), , the SEC announced a new policy under which individuals could cooperate in an enforcement investigation to avoid a civil enforcement action or receive a lesser sanction. Although the evaluation of cooperation requires a case-by-case analysis of the specific circumstances presented, the Cooperation Policy Statement explained that the SEC’s general approach would be to determine whether, how much, and in what manner to credit cooperation by individuals by evaluating four considerations: (1) the assistance provided by the cooperating individual in the SEC’s investigation or related enforcement actions; (2) the importance of the underlying matter in which the individual cooperated; (3) the societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct; and (4) the appropriateness of cooperation credit based upon the profile of the cooperating individual.
In our recent report, SEC Settlements Trends: 1H 2011 Update, my co-authors (Jan Larsen and James Overdahl) and I document that the SEC settled with 344 defendants in the first half of its 2011 fiscal year (“1H11”), putting the agency on pace to settle with 688 defendants for the full year, in line with the 681 settlements in FY10. This stability in overall settlements, however, contrasts with a substantial shift in their composition. The number of company settlements rose by 43% to 114, an annual pace of 228, compared with 160 for the entire 2010 fiscal year. As a result, company settlements made up 33% of 1H11 settlements. Individual settlements declined 12% to 230, an annual pace of 460, compared with 521 in FY10.
However, individual accountability remained an important theme in 1H11. Indeed, four of the 10 largest settlements in 1H11 were with individuals, including the $310 million default judgment entered against Milowe Allen Brost and Gary Allen Sorenson, which also rates as the ninth-largest SEC settlement since the passage of the Sarbanes-Oxley Act (“SOX”). Other individual defendants settling with the SEC in 1H11 included Jacob “Kobi” Alexander, former CEO of Comverse Technology, and Joseph P. Nacchio, former CEO of Qwest Communications.
In the paper, SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter? forthcoming in the Journal of Accounting and Economics as published by Elsevier, I investigate SEC enforcement leniency by exploring whether the SEC rewards firm cooperation and forthright disclosures following a restatement. I develop models that explain SEC sanctions and SEC monetary penalties, and then assess the incremental impact of cooperation and forthright disclosures. I consider a firm to have cooperated with the SEC if it voluntarily initiates an independent investigation into its misconduct. Forensic accountants, legal counsel, or independent committees of directors usually perform the investigations and the firm subsequently passes the information on to the SEC.
I follow the SEC’s 2001 Seaboard Report in defining forthright disclosures as those that are timely, complete, and effective. Timeliness captures the speed with which managers release information to market participants, and it is defined as the number of days between the end of the violation period and the first public announcement of the misconduct. I define complete and effective disclosures in two ways, with both capturing the visibility of misconduct-related disclosures to investors and the SEC. The first identifies where information about the misconduct is placed within a press release. I consider information disclosed in the headline of a press release (rather than the text or footnotes) to be the most effective form of disclosure, as it increases the likelihood that investors and SEC staff will notice and react to the information (Files et al. 2009; Gordon et al. 2009). The second identifies the type of SEC filing used to report the misconduct, with disclosure in a Form 8-K or an amended periodic filing considered the most effective.
Investors and lawmakers have been clamoring for a more aggressive and nimble SEC, and it looks like they’re about to get it. But at what cost?
In August, the Commission and its enforcement director announced a series of bold new measures designed to expedite investigations, create specialized units to focus on priority cases, and flatten out management of the enforcement division.
Among those measures was a new SEC rule – adopted for a one-year trial period – which for the first time delegates to the agency’s enforcement director the legal authority to issue “formal orders of investigation” without first getting approval from the politically-appointed commissioners. The director himself announced that he will sub-delegate this new responsibility to other senior officials who report directly to him.
In SEC investigations, “formal orders” are significant mostly because they empower staff investigators to issue judicially enforceable subpoenas that require people and companies to turn over documents and give sworn testimony. Without such an order, the staff must rely entirely on voluntary cooperation to obtain information.
Delegation of authority to issue these orders will undoubtedly serve its intended purpose of enabling SEC enforcement staff to act more swiftly and authoritatively in the early stages of their investigations. But the move represents a dramatic departure from historical SEC practice and raises broader questions about delegation and accountability at independent federal agencies.
Like many independent federal agencies from the New Deal era, the SEC exercises a number of quasi-legislative and quasi-executive functions, yet for the most part operates autonomously from either Congressional or Presidential control. Its five commissioners (including its chairman) are appointed by the President for staggered five-year terms and must be confirmed by the Senate, but neither Congress nor the President can remove commissioners from office at will. By law, no more than three commissioners can be from the same political party at any given time.
Although this structure has been upheld by the courts, independent agencies exercise law enforcement powers on inherently shakier constitutional footing than the Cabinet departments and executive agencies operating under full Presidential control, such as the U.S. Department of Justice. Moreover, a critical safeguard in this structure is the presumption that commissioners of an independent agency – the only personnel tethered to the political process by a presidential appointment and Senate confirmation – will be accountable for significant action taken by the agency and its staff.
When it comes to the SEC, issuing formal investigation orders is a sufficiently important responsibility that it should not be delegated by the agency’s commissioners.
This is a period of significant change in the SEC’s enforcement program. A variety of new measures have already been implemented and numerous additional proposals are currently under consideration. The implications are likely to be significant for any company or financial institution that may be responding to SEC investigations in the months ahead. New policy decisions and their methods of implementation are likely to affect such matters as the SEC’s deployment of its resources, the pace and focus of investigations and opportunities for timely resolution of enforcement inquiries.
Chairman Mary Schapiro and Director of Enforcement Robert Khuzami have focused on speeding up the process of conducting investigations and bringing cases. One of Chairman Schapiro’s first acts was to terminate the agency’s “pilot program” regarding financial penalties, which had been widely viewed as slowing the enforcement process. We view this as a favorable development, given the practical concerns that our firm initially raised about this program. See “Implications of the New SEC Penalty Policy” (May 15, 2007); “SEC Penalties Revisited” (June 8, 2007). Another early step was to streamline the procedure by which the staff obtains formal orders of investigation, which permit the staff then to issue investigative subpoenas as needed to obtain documents and testimony.
Congress appears poised to authorize the SEC to hire more staff and to increase its budget, and on May 7, 2009 the Obama Administration proposed a 6.8% funding increase for the agency in fiscal 2010. The key issue to watch is how the agency uses the new money, and who it hires to fill the new slots. Everyone’s interests will be best served if the SEC is able to recruit to its ranks new staff who will bring the agency the benefit of experience. In Congressional testimony on May 7, 2009, Mr. Khuzami stated that one of his goals is to increase the staffing of Enforcement’s trial unit. See here. This would be a positive development. Bringing more trial lawyers on board will enable the SEC to try more cases – but involving those seasoned trial lawyers in the pre-authorization case review process will also enhance the enforcement staff’s ability to identify the cases that should not be brought because they will be losers in court.
The GAO has also emphasized the theme of streamlining the SEC’s internal processes to allow investigations to be completed and cases filed more swiftly, in its report on the SEC’s enforcement program issued on May 7, 2009. See here. Streamlining is a laudable goal. At the same time, not all investigations should be pursued to completion, and not all investigations should lead to enforcement actions. The goal of bringing meritorious cases more rapidly should not compromise the staff’s ability to weed out the investigations that should be closed without action.
As the SEC’s new leadership contemplates reform, there are some additional ideas that should be considered. While these suggestions would in some ways be advantageous for companies involved in investigations, they would at the same time enhance the SEC’s own efficiency and effectiveness:
• Early meetings with defense counsel – The willingness of enforcement staff to meet with defense counsel and engage in a dialogue early in an investigation varies greatly among SEC offices. An open-door policy and a willingness to listen is not only fair to the parties involved, but in the SEC’s own interest. These early discussions can bring factual information to the attention of the staff that will enable them to narrow or even close investigations at an early stage, so that their limited resources can be deployed on more promising matters. Prudent defense counsel will not abuse the opportunity to meet with the staff, and will use this approach only in inquiries that genuinely warrant being closed down early.
• Better coordination among investigating authorities – It is commonplace for SEC investigations to be accompanied by parallel investigations of the same facts by one or more other regulatory or prosecutorial authorities. In some cases, parallel proceedings are appropriate. In many cases, however, little if any public interest is served by multiple simultaneous investigations of the same facts. The main result is an exponential increase in the cost of the investigation for the parties involved, as well as misallocation of regulatory resources. While this is a problem that the SEC does not have the unilateral ability to solve, senior officials should use their persuasive powers to discourage unnecessarily duplicative investigations.
• Open the investigative files – The SEC’s enforcement manual, which was publicly released last year, recognizes that the staff has discretion to provide access to its evidentiary files to defense counsel at the conclusion of an investigation, as part of the Wells process, in which the staff engages in dialogue with counsel concerning possible enforcement action. In practice, the staff’s willingness to exercise this discretion varies greatly, and full open access is rare. In most cases at this stage, there is no compelling need to maintain secrecy about the testimony of witnesses or the contents of documentary evidence. Decision-making by the senior staff and by the Commission itself will be better-informed at the Wells stage if defense counsel are able to see the evidentiary record. This cuts both ways. Open access will help expose cases that have weak evidentiary support and should be closed or narrowed. At the same time, defense counsel will be better able to recognize cases where the staff’s evidence is strong and where a settlement should be pursued.
Additional proposals are bound to come under discussion as the agency’s new leadership continues to think creatively about improving the effectiveness of the enforcement program. This process should continue to include careful analysis of the likely practical effects of each new idea. For companies involved in investigations, it is essential to be mindful of the ongoing changes at the SEC, and the opportunities and challenges for effective advocacy that they present. Getting meritorious cases resolved sooner, while also weeding out marginal investigations faster, should be in everyone’s interests.