Observations From the Enforcement Directors at SEC’s Annual Conference
Enforcement Co-Directors Stephanie Avakian and Steven Peikin recently addressed notable enforcement decisions, actions and trends affecting public companies and regulated entities.
On April 8 and 9, 2019, the US Securities and Exchange Commission held its annual SEC Speaks conference in Washington, DC. Division of Enforcement Co-Directors Stephanie Avakian and Steven Peikin, and their colleagues outlined notable enforcement decisions, actions and trends. The speakers addressed the recent Lorenzo Supreme Court decision, the Division’s focus on retail investors, the Wells process and cooperation credit.
The Enforcement Division highlighted the recent Supreme Court decision, Lorenzo v. SEC. In Lorenzo, the Supreme Court held that that the dissemination of false or misleading statements with the intent to defraud can fall within the scope of SEC Rules 10b–5(a) and (c), even if the disseminator cannot be held liable under Rule 10b–5(b). Previously, in Janus Capital Group v. First Derivative Traders, the Court limited fraud liability to individuals or entities with ultimate authority for the statement. In Lorenzo, a director of investment banking at a brokerage firm knowingly sent false statements to prospective investors. The director claimed he could not be held liable because his supervisor directed and controlled the statements. The Court found that, even though the director did not “make” the statement, he nevertheless could be held liable under the other two prongs of Rule 10b-5. Reading Rule 10b-5 broadly, the Court reasoned that an individual who knowingly disseminates a false statement “employ[s]” a “device,” “scheme” or “artifice to defraud” under Subsection (a) and “engage[s] in a[n] act, practice, or course of business” that “operate[s] . . . as a fraud or deceit” under Subsection (c).
The Enforcement Division believes that the decision clarifies the scope of Section 10(b) of the Securities and Exchange Act of 1934 and Section 17(a)(1) and (a)(3) of the Securities Act of 1933. From the SEC’s perspective, the decision vindicates its view of the separate provisions of Rule 10b-5 as mutually supportive, rather than mutually exclusive.
The Enforcement Division anticipates defense arguments that Lorenzo is limited only to dissemination and attempts to narrow the definition of dissemination. The Enforcement Division cautioned that these arguments would be met with skepticism by the staff.
Takeaway: Expect the Enforcement Division to interpret Lorenzo broadly. In particular, in the eyes of the SEC, the decision expands the liability of individual officers and directors.
The SEC emphasized its focus on protecting retail investors. As part of this focus, the staff expressed the intent to continue investigating fraud that targets the most vulnerable investors, including senior citizens and members of certain ethnic communities. The staff also continues to address conflicts of interest involving investment advisers, such as conflicts related to undisclosed commissions or expense avoidance practices. The SEC will focus on revenue streams for investment advisers.
Takeaway: Investment advisers should consider conducting an inventory of revenue sources and analyzing each source for potential undisclosed conflicts of interest.
The Wells Process
The Enforcement Division shared what it considers the best and worst practices when making a Wells submission. Among other suggestions, the panel explained that practitioners should (1) prioritize and focus on the most important issues rather than disputing every alleged violation and (2) be realistic about goals of the submission. For example, without conceding the ability to argue more broadly in litigation, defense counsel might challenge an element such as scienter rather than argue that the SEC should not bring charges at all. Expert reports can be helpful during the Wells process, so long as they are of the caliber that would be admissible in court. The staff welcomes white papers and factual presentations because the background information can be useful and advance investigations.
In terms of worst practices, the panel noted that defense counsel should not use a white paper or factual presentation to tout professional background or success as a means to intimidate the SEC; successful presentations focus on how defense counsel will win at trial, rather than saying that defense counsel will win at trial.
Takeaway: Wells submissions should be tailored and address the most vulnerable portions of the staff’s case. Expert reports are welcome when the reports present focused factual analysis and would be admissible in court.
Co-Directors Peikin and Avakian went into significant detail regarding the importance of cooperation. They observed that “high quality” cooperation can advance investigations in a meaningful way and lead to reduced charges and penalties, or can result in the SEC not bringing a case. In raising this topic, Director Avakian identified the four Seaboard factors for cooperation credit: self-policing, self-reporting, cooperation and remediation.
In discussing how to best message to the public the benefits of cooperation, given the lack of uniformity in cooperation credit, the Enforcement Division strives to state in its orders the types of actions that the SEC deems important. The Enforcement Division referenced the February 2019 action against Gladius Network LLC for conducting an unregistered initial coin offering. Ultimately, in what the Division of Enforcement highlighted as a successful invocation of cooperation credit principles, Gladius self-reported and agreed to return funds to investors and to register its tokens as securities. The SEC imposed no penalty for the unregistered coin offering. The order contains language that the Enforcement Division believes provides details regarding when to credit a company with substantial cooperation.
Cooperation can take many forms, but “forthrightness” was emphasized. Examples included steps that meaningfully advance an investigation, such as reformatting search terms or alerting the staff of new custodians for a document review or proactively identifying witnesses. The Division of Enforcement explained that such actions help a party build credibility and obtain cooperation credit. The Division of Enforcement highlighted that developing a good relationship with the staff at the outset of the investigation through proactive and helpful dialogue is critical. A privilege waiver, or waiver of other legal rights, is not necessary to receive cooperation credit, nor are “cooperation points” deducted for not waiving privilege.
Takeaway: The SEC continues to emphasize the benefits of cooperation. Proactive efforts and a positive working relationship are essential to earning credit.
This year’s SEC Speaks provided guidance by the SEC’s leadership and staff regarding its enforcement trends and goals. It remains to be seen how these trends and goals play out in the remaining months of 2019.