iAlthough there has been significant discussion in securities law circles concerning what the Securities and Exchange Commission (SEC) will look like under President Joe Biden’s SEC chair nominee Gary Gensler, most commentators agree that Gensler’s SEC will have an increased focus on enforcement. Early enforcement actions and legislative changes in 2021 point to the key areas and tactics for the SEC’s Division of Enforcement, including, but not limited to, an enhanced focus on environmental, social, and governance (ESG) and climate change issues; an increased reliance on disgorgement awards, particularly in insider trading and digital currency cases; and continued actions against companies that engage in unregistered offerings of digital asset securities, fail to adequately disclose executive compensation in the form of perquisites (“perks”), violate Regulation Fair Disclosure (Regulation FD), or provide misleading disclosures related to the COVID-19 pandemic’s effects on business or operations. In ramping up enforcement activities in 2021, the SEC is also likely to continue its reliance on its whistleblower program and improvements to and expansion of its data analytics program. We provide a brief summary of each of these areas below.
SEC Announces Enforcement Task Force Focused on ESG and Climate Change
Since inauguration day, the SEC has repeatedly signaled that ESG and climate change will be areas of significant focus for the new administration, from Acting Chair Allison Herren Lee’s announcement on February 1, 2021, of a senior policy advisor dedicated to these issues to her announcement on February 24, 2021, directing the SEC’s Division of Corporation Finance to scrutinize disclosures for adherence to the SEC’s 2010 guidance on climate change-related disclosures, and culminating in her public statement on March 15, 2021, in which she called for public comments on climate change disclosures. In addition, on March 3, 2021, the SEC’s Division of Examinations also announced an enhanced focus on climate- and ESG-related risks as examination priorities in 2021. Consequently, the SEC’s announcement on March 4, 2021, of a new Climate and ESG Task Force in the Division of Enforcement comes as no surprise.
The new task force will be led by Acting Deputy Director of Enforcement Kelly Gibson. Gibson will oversee a 22-member team drawn from that division. According to the SEC’s press release, the task force’s initial focus will be to “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules” and “analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”
The creation of the task force signals that the SEC will regulate climate- and ESG-related disclosures not only through guidance and rulemaking but also through enforcement. For 2021, we expect the SEC to increase its focus on proactively identifying misconduct, including through continuing use of data analytics to mine and assess information to identify potential violations. As the SEC’s data analytics program becomes more advanced, companies should expect that the SEC will expand its use of data analytics from traditional areas of enforcement — such as detecting unusual trading patterns in order to identify instances of suspected insider trading — to take into account other areas of misconduct, such as disclosure issues related to ESG or climate change.
Anticipated SEC enforcement actions will likely include Section 10(b) and Rule 10b-5 actions under the Securities Exchange Act of 1934, as amended (Exchange Act) as well as books and records violations under Section 13 of the Exchange Act. Consequently, companies should take a close look with counsel at ESG- and climate-related disclosures in anticipation of the expected enforcement action in this area.
Congress Codifies SEC’s Disgorgement Power
The National Defense Authorization Act for Fiscal Year 2021 (NDAA) became law on January 1, 2021. Tucked into the defense spending bill was a significant revision that codifies and arguably expands the SEC’s disgorgement power under the Exchange Act. Among other changes, the Exchange Act amendments (i) expressly authorize the SEC to seek disgorgement in civil enforcement proceedings in federal court, (ii) increase the statute of limitations for fraud enforcement actions from five to 10 years, and (iii) extend the time period for actions brought against defendants located outside the United States. The full text of the enrolled version of the NDAA can be found here.
Background
Historically, the SEC has used its disgorgement power to recover illegal gains obtained as a result of securities violations. The Exchange Act only explicitly authorizes the SEC to obtain disgorgement as a civil remedy in administrative proceedings and does not explicitly authorize the SEC to seek disgorgement in federal court actions; however, under long-standing legal precedent, courts have awarded the SEC this remedy pursuant to their power to grant “equitable relief” under the Exchange Act.
In June 2020, the US Supreme Court[1] found that disgorgement qualifies as equitable relief under the Exchange Act and that any amount disgorged must be limited to the wrongdoer’s net profits, which it defined as revenue less legitimate business expenses. The decision, however, continued a trend limiting the SEC’s authority to pursue disgorgement actions in federal court. In dicta, the Supreme Court criticized disgorgement awards against multiple wrongdoers based on a joint and several liability theory and implied that the amount disgorged must be awarded only to victims, not the US Treasury, as the SEC has done in past cases. Moreover, in 2017, the Supreme Court[2] held that disgorgement is a “penalty” under the Exchange Act, subject to the same five-year statute of limitations as other civil penalties.
The Supreme Court’s 2020 decision cast doubt on the SEC’s reliance on disgorgement awards, and subsequent enforcement actions indicated that the SEC would forgo such actions to instead seek significantly larger penalties as a remedy in some cases. Nevertheless, the SEC continued seeking disgorgement in some insider trading actions in late 2020,[3] and fiscal year 2020 ultimately proved to be a record-breaking year for SEC disgorgement awards, as reported in the Division of Enforcement’s Annual Report. Parties to SEC enforcement actions were ordered to pay a total of nearly $3.59 billion in disgorgement, and a significant portion of that was attribution to a single action involving $1.2 billion.[4] Disgorgement awards were up by $3.41 million from fiscal year 2019, and as in 2019, the top 5% of cases that involved the largest financial remedies accounted for the vast majority (81%) of all financial remedies that the SEC obtained (compared with 70% in 2019).
Explicit Authorization to Seek Disgorgement
The NDAA expressly authorizes the SEC to seek disgorgement of any illegal gains resulting from a securities violation in federal court, codifying case law that permitted the SEC’s long-standing practice of seeking such awards. These Exchange Act amendments also address other issues previously identified by the Supreme Court. Although the NDAA maintains the past requirement limiting disgorgement to the defendants’ net profits, Congress removed a prior restriction that required disgorgement to be for the benefit of investors, which addresses past criticisms relating to the SEC’s distribution of disgorgement awards to the US Treasury. The NDAA also appears to prohibit joint and several liability.
Statute of Limitations
Most significantly, the NDAA extends the deadlines by which the SEC must bring certain actions. First, the amendments provide that the SEC may seek disgorgement for claims involving fraud, such as Section 10(b) violations, subject to a 10-year statute of limitations. Likewise, the NDAA provides that the SEC may seek a claim for any equitable remedy, including injunctions or cease and desist orders, within 10 years after the date on which the violation occurred. Second, the amendments specifically reaffirm the five-year statute of limitations for the SEC to seek disgorgement for non-fraud claims, and because the time limit runs from the “latest date of the violation that gives rise to the action or proceeding,” this potentially increases the ordinary five-year period for such SEC actions. Third, the NDAA includes an unlimited tolling provision relating to actions brought against defendants located outside the United States. Consequently, any time that a defendant spends outside the United States is not counted toward the accrual of the statute of limitations period, and as such, the period could be tolled indefinitely until the defendant returns to the United States. These changes will allow the SEC to aggressively pursue enforcement actions, unencumbered by former jurisprudential time limitations.
These amendments to the Exchange Act apply to any action or proceeding pending on, or commenced after, the date of the NDAA’s enactment.
Recent Enforcement Actions and Future Implications
The full impact of the NDAA’s amendments to the Exchange Act remain to be seen, as they raise additional issues that will likely need to play out in subsequent litigation. For example, because the NDAA provides statutory authorization for the SEC to seek disgorgement that is not tied to its authority to seek equitable relief based on prior case law, it is unclear whether the Supreme Court’s previous limitations on equitable relief will apply. In addition, the SEC’s statutory authorization could be interpreted as more limited because the NDAA states that the SEC can require disgorgement “of any unjust enrichment by the person who received such unjust enrichment.” By contrast, the Supreme Court has permitted the SEC to seek disgorgement against affiliates of the wrongdoer in certain circumstances.
At the very least, the amendments bolster the SEC’s ability to seek disgorgement in future enforcement actions in federal court by providing it with expanded authority and, in particular, extended time to pursue such actions. The Division of Enforcement has taken its enhanced disgorgement powers in stride, and in early 2021, the SEC has sought disgorgement as a remedy in several cases.[5] Moreover, lessons from 2020 indicate that the SEC will pursue disgorgement as a remedy even when relatively small amounts of illicit gains from insider trading are at issue. For example, the SEC sought disgorgement of as little as $13,153 and $23,140 in 2020. If the SEC continues to seek disgorgement awards throughout the year, 2021 could prove to be another banner year for such awards. Now that the SEC’s disgorgement power has been codified and enhanced, the first and second quarters of 2021 would be a good time for companies to reach out to counsel for assistance in reviewing their insider trading policies.
Digital Currency and Executive Perks Remain an Enforcement Focus
As in 2020, digital currency and executive perks enforcement actions look to be continued areas of SEC focus for 2021.
Recent Digital Currency Enforcement Actions
Not only is the SEC expected to use its enhanced disgorgement power to discourage insider trading, but it also has shown a predilection for seeking disgorgement awards in recent digital currency enforcement actions, which were a focus of SEC enforcement in 2020 and continue to be in the first quarter of 2021.
For example, in June 2020, Telegram Group Inc. and its wholly owned subsidiary TON Issuer Inc. settled an SEC enforcement action regarding its alleged unregistered offering of securities (digital tokens called “Grams”), by agreeing to return to investors over $1.2 billion in ill-gotten gains from the sale of the Grams and paying an $18.5 million penalty for violating federal securities laws.[6] Similarly, in October 2020, the SEC settled an enforcement action brought against Kik Interactive Inc. for the alleged unregistered offering and sale of digital asset securities (digital “Kin” tokens),[7] and on December 22, 2020, the SEC filed a complaint seeking injunctive relief, disgorgement, and civil penalties against Ripple Labs, Inc. and two of its executives for allegedly selling unregistered digital asset securities, known as “XRP,” for $1.38 billion. In its answer, Ripple asserted that XRP is a virtual currency not subject to securities regulation, which is the position that securities regulators in the United Kingdom, Japan, and Singapore have taken. Most recently, on February 1, 2021, the SEC filed suit against three individuals for the allegedly fraudulent and unregistered digital asset securities offerings of “B2G” tokens. The SEC is seeking injunctive relief, disgorgement, and civil monetary penalties; permanently prohibiting defendants from participating — directly or indirectly — in the issuance, purchase, offer, or sale of any digital asset security; and permanently barring two of the defendants from acting as an officer or director of a public company. If these enforcement trends continue, companies involved in the digital asset securities space should be careful to avoid any actions that could be construed as an unregistered offering of securities.
Recent Executive Perks Enforcement Action
On February 24, 2021, the SEC settled charges against Gulfport Energy Corporation and its former CEO for failing to properly disclose as compensation certain perks provided to the CEO, which signals a continuation of the SEC’s focus on executive perks enforcement actions. According to the settlement orders, the undisclosed compensation included approximately $650,000 in the form of perks, including the cost of the CEO’s personal use of chartered aircraft and a company credit card for personal expenses that were not timely repaid. As in 2020, companies should review proxy statement compensation disclosures to ensure that executive perks are adequately disclosed in compliance with the relevant SEC regulations.
SEC Brings First Regulation FD Enforcement Action in Two Years
Regulation FD enforcement actions are uncommon for the Division of Enforcement. Before March 5, 2021, the last such action was the SEC’s lawsuit against TherapeuticsMD in 2019, and prior to that, the SEC did not bring a Regulation FD enforcement action for almost six years. In the latest Regulation FD suit, filed against AT&T, Inc. and three of its Investor Relations executives, the SEC claims that AT&T repeatedly violated Regulation FD and that the executives aided and abetted AT&T’s violations by selectively disclosing material nonpublic information to research analysts. The SEC alleges that in 2016, AT&T learned that a decline in its first-quarter smartphone sales would cause the company’s revenue to fall short of analysts’ estimates for that quarter. Consequently, three Investor Relations executives made private phone calls to analysts at approximately 20 different firms, in which they purportedly disclosed AT&T’s internal smartphone sales data and the impact of that data on the company’s internal revenue metrics. Further, the SEC asserts that the company’s internal documents indicated that such information was of the type generally considered “material” to AT&T’s investors and that selective disclosure under Regulation FD was therefore prohibited. In a public statement on March 5, 2021, AT&T claimed that the company publicly disclosed the smartphone trend on “multiple occasions” prior to the analyst calls. In addition, AT&T stated that the declining phone sales had “no material impact” on its earnings, indicating that AT&T intends to take the position that any selective disclosure was not in violation of Regulation FD. The SEC is seeking permanent injunctive relief and civil monetary penalties against each defendant.
Regardless of the outcome in this particular case, its very existence may signal an increased focus on Regulation FD enforcement actions in 2021 and continuing under the Biden administration. Companies should ensure that appropriate care is taken in handling material nonpublic information and that adequate internal policies and procedures are in place to prevent selective disclosures in violation of Regulation FD.
Potential for Additional COVID-19-Related Disclosure Enforcement Actions in 2021
We anticipate that there may be additional COVID-19-related enforcement actions in 2021. In late 2020, the SEC settled its first enforcement action against a public company for allegedly misleading COVID-19-related disclosures. In its SEC filings earlier in 2020, The Cheesecake Factory Incorporated stated that its restaurants were “operating sustainably” during the COVID-19 pandemic; however, according to the SEC’s order, the company’s internal documents at that time indicated that the company was losing approximately $6 million in cash per week and internal projections indicated that it only had 16 weeks of cash remaining. While this internal information was not disclosed in The Cheesecake Factory’s public filings, the company allegedly shared the information with potential private equity investors or lenders in connection with efforts to secure additional liquidity. Similarly, although the company’s public disclosure described actions that The Cheesecake Factory undertook to preserve financial flexibility during the COVID-19 pandemic, the company failed to disclose that it had informed its landlords that it would not pay rent in April due to the impacts of the COVID-19 pandemic. As annual reporting and earnings results season continues, the SEC is expected to continue to scrutinize companies’ COVID-19-related disclosures. Consequently, SEC enforcement in this area remains likely in 2021.
Future Implications for SEC Enforcement in 2021
The first few months of 2021 have provided a preview of what SEC enforcement may look like as the year unfolds. As the SEC ramps up enforcement efforts under a new administration, companies should expect an increased focus on ESG and climate change disclosures; more enforcement actions that seek disgorgement awards, particularly in the insider trading and digital currency spaces; continued enforcement interest in digital currencies and executive perks disclosures; a potential increase in Regulation FD enforcement; and additional COVID-19-related disclosure enforcement actions. In preparing for a more active Division of Enforcement, companies should remain vigilant with disclosures and related compliance practices in order to avoid attracting unwanted enforcement attention.
[1] See Liu v. SEC, 140 S. Ct. 1936 (2020).
[2] See Kokesh v. SEC, 137 S. Ct. 1635 (2017).
[3] See, e.g., SEC v. Bohra, No. 2:20-cv-01434 (W.D. Wa. Oct. 16, 2020).
[4] See SEC v. Telegram Group Inc., 448 F. Supp. 3d 352 (S.D.N.Y. June 26, 2020).
[5] See, e.g., SEC v. Airborne Wireless Network et al., No. 1:21-cv-01772 (S.D.N.Y. Mar. 2, 2021); SEC v. GPB Capital Holdings, LLC et al., No. 1:21-cv-00583 (E.D.N.Y. Feb. 4, 2021); SEC v. Kristijan Krstic et al., No. 21-cv-0529 (E.D.N.Y. Feb. 1, 2021); SEC v. Vuuzle Media Corp. et al., No. 2:21-cv-01226 (D.N.J. Jan. 27, 2021); SEC v. Eric C. Malley and MG Capital Management LP, No. 1:21-cv-00237 (S.D.N.Y. Jan. 12, 2021).
[6] See SEC v. Telegram Group Inc., 448 F. Supp. 3d 352 (S.D.N.Y. June 26, 2020).
[7] See SEC v. Kik Interactive Inc., No. 19-cv-05244 (S.D.N.Y. Oct. 21, 2020).
