White-Collar to Blue-Collar in One Day

Last week, the U.S. Supreme Court issued two notable decisions on the same day.

One was a civil white-collar case, the other a criminal drug-trafficking case, and in both cases, the Court reversed the lower-court ruling on appeal.

In the civil case, the Court imposed a five-year statute of limitations on SEC cases that seek to disgorge profits. That’s the same period that applies in cases to enforce a fine, penalty, or forfeiture. Although disgorgement of profits is traditionally a form of restitution that’s measured by a defendant’s wrongful gain, the Court ruled that it’s a penalty in SEC cases for a couple reasons. First, the agency uses it to deter and punish defendants as much as to compensate victims. Sometimes, the money goes to Uncle Sam, and sometimes, the only victim is the public at large. Second, the agency often disgorges more than defendants have gained, leaving them worse off than before they broke the law. That may be the point, but that makes it a penalty.

In a footnote, the Court even seemed to call into question whether courts could order disgorgement at all. That’s something they’ve been doing since the 1970s, so it’s a big deal. For more in-depth analysis of this decision, see here.

In the criminal case, the Court reined in the government’s forfeiture power. Forfeiture allows the government to seize money or property that’s derived from a crime. But the law limits this to what someone actually and personally receives or obtains. That means you can’t be responsible for amounts obtained by someone else. So the hypothetical college student who gets $500 per month to drop off a few packages isn’t on the hook for the whole multimillion-dollar drug enterprise.

Here, two brothers worked in a hardware store together. One of them owned the store, and the other was a salaried employee. The two were charged with selling large amounts of a product they knew or had reason to know was being used to make meth. In three years, the store grossed about $400,000 from selling the stuff and netted $270,000.

The government wanted the $270,000 in profits. The owner agreed to forfeit $200,000 of it when he pleaded guilty, but the employee went to trial. He was acquitted of three counts, convicted of eleven, and sentenced to sixty months in prison. Then the government went after him for the remaining $70,000.

Although the government agreed that the employee had no ownership interest in the store and didn’t personally benefit from the illicit sales, it argued that, in a conspiracy, everyone is responsible for the full proceeds of the conspiracy. And it won that argument on appeal.

But the Supreme Court rejected that and reversed.

 

SEC Lights Up Another Cannabis Company

In what may be a sign of maturity for the industry, the Securities and Exchange Commission has sued another marijuana-related business for violating federal securities laws.

Last month, the SEC charged a California-based company and two former executives with a classic pump-and-dump scheme. First, the Commission says, the defendants touted phony revenue to drive up the price of the company’s stock. Then they unloaded their own shares for millions of dollars. According to the complaint, much of the revenue came from a series of sham transactions with a shell company that the executives controlled. So the SEC charged them with fraud as well as offering and selling unregistered securities.

The company and one of the executives have settled the case without admitting or denying liability. The executive agreed to pay more than $12 million, among other penalties.

Meanwhile, the company has turned over a new leaf, so to speak, overhauling its management, business model, and board of directors.

The SEC will continue to scrutinize the market, however, which highlights something cannabis companies should already know: get your ducks in a row, and run your business the right way.

Puff and pass if you want, but don’t pump and dump.

SEC Reports Enforcement Results for 2016

As we wind down the calendar year, the Securities and Exchange Commission has already reported its enforcement results for the fiscal year that ended September 30.

In case you missed it, here’s the press release. Naturally, there’s some self-patting on the back, but if the past predicts the future, the agency is looking to file cases. Its numbers have climbed steadily over the last dozen years, and it continues to ramp up its use of big-data analytics and the whistleblower program, which it launched in 2011.

Here are some highlights from 2016.

  • The agency filed a total of 868 cases, which was a new single-year high.
  • It filed a record number of cases involving investment companies or advisers and a record number under the Foreign Corrupt Practices Act.
  • It obtained over $4 billion in judgments and orders, which matched the haul from each of the last two years.
  • It awarded more money to whistleblowers ($57 million) than in all prior years combined.

The SEC Wants You to Self-Report

At a conference in November, the SEC’s Director of Enforcement, Andrew Ceresney, announced that, from now on, you must self-report violations of the Foreign Corrupt Practices Act if you want the Enforcement Division to recommend a non-prosecution or deferred-prosecution agreement. Even then, Mr. Ceresney warned, you may not get an NPA or DPA, but the Division won’t even consider it if you fail to self-report. To self-report, in other words, is now a necessary, threshold condition to negotiating an NPA or DPA.

On the heels of that announcement, last month, one company that had self-reported its FCPA violations was able to resolve civil and criminal charges on relatively favorable terms.

First, the company settled the civil SEC investigation that commenced after it reported that two of its subsidiaries were making improper payments to foreign officials to win business. The improper payments included non-business-related travel, gifts, and entertainment that totaled $1.5 million over five years. To settle the case, the company agreed to cease and desist from further violations and to surrender $14 million in profits.

Next, the company settled the parallel, criminal investigation by entering into an NPA with the Justice Department. The three-year NPA requires the company to pay $15 million in fines, improve its compliance program, and report on its progress to the government.

Finally, one of the company’s employees earned a three-year DPA of his own based on his substantial cooperation during the SEC investigation. It was the Commission’s first DPA with an individual in an FCPA case.

To be clear, self-reporting has long been a factor in the Commission’s framework for evaluating cooperation by people or businesses. Generally, the SEC will credit your cooperation based on how much you helped, how important the case was, how culpable you were personally, and how much of a threat you continue to pose.

But going forward, self-reporting appears to carry significantly more weight with the agency, at least in FCPA cases.

 

The SEC Dodd-Frank Whistleblower Program

Speaking of whistleblowers, the Securities and Exchange Commission just published its annual report to Congress on its own program that it launched in 2011.

And overall, it seems to be on the upswing.

The SEC’s program authorizes monetary awards for volunteering original information that results in a successful enforcement action, including sanctions that exceed $1 million. It doesn’t matter whether you help open a successful investigation or close an existing one more efficiently or favorably.

If you fit the bill, you get ten to thirty percent of whatever the agency collects, and the percentage will vary with the facts and circumstances of the case. Factors that can raise your percentage include the value of your information, the overall assistance you provide, the public interests at stake, and whether you tried to report the matter internally (and suffered retaliation for it) before going to the government. Factors that can lower your percentage include your own unclean hands, if any, whether you delayed unreasonably in reporting the matter, and whether you interfered with your company’s internal compliance program (if any).

According to the report, since 2011, the Commission has paid over $54 million to 22 whistleblowers, and in the last fiscal year alone, it paid over $37 million to eight of them. One received over $30 million and another received over $3 million.

Who are they? According to the agency, about half are current or former employees of the companies they blow the whistle on. Others include ticked-off investors, industry peers, or personal contacts of the person or company in question. They hail from all fifty states as well as other countries, but most come from California, New York, New Jersey, Florida, and Texas. Many submit their information anonymously through counsel.

What do they report on? It runs the gamut, but often, they report on misstated corporate disclosures and financials; fraud in connection with securities offerings; price manipulation; insider trading; unregistered offerings; or violations of the Foreign Corrupt Practices Act.

The SEC’s Home-Court Advantage

As noted in a series of reports over the last year or so, the Securities and Exchange Commission has steadily been sending more of its cases, including contested cases, to be heard before its own, administrative judges rather than litigating them in federal court. The trend follows passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which amplified the agency’s ability to exact civil penalties in administrative hearings without having to sue in federal court.

According to the Wall Street Journal, the Commission won 90% of contested cases before its own judges from October 2010 through March 2015, compared to 69% of such cases in federal court. The agency did even better from September 2011 through September 2014, winning 22 of 23 cases before its judges, compared to 67% of such cases in federal court.

According to another, competing analysis, the agency won just 70% of the time before its own judges, but only if winning were defined as the agency’s running the table and getting everything it wanted. Otherwise, it did a lot better than that, and as far as actually losing, that happened in just six out of 359 cases, or less than 2% of the time.

Finally, on administrative appeals from these decisions, the Commission agreed with its own judges in 90% of cases from January 2010 through March 2015.

In response to all this, some defendants have filed constitutional challenges in federal court, some of which have gained traction. Other critics include business lobbies, federal judges, and even former agency officials, including one former SEC judge who says she retired under pressure from peers who questioned “her loyalty to the SEC” based on her decisions.

In rebuttal, the Commission has explained the spread in part by noting that many administrative cases are routine cases in which the outcome is not in doubt. These include defaults in which the defendant doesn’t bother to show up as well as cases limited to imposing administrative penalties after the defendant has already lost in court.

The criticism, however, may have struck a nerve.

Last month, the Commission proposed amendments to its procedures to align them more with the rules in federal court. These amendments, which the agency is soliciting public comment on through December 4, propose to do the following things among others:

  1. afford defendants up to eight months to prepare for a hearing in complex cases instead of the current four months;
  2. afford defendants the right to subpoena documents as well as depose up to three witnesses in complex, single-defendant cases or up to five witnesses in complex, multi-defendant cases;
  3. require the exchange of expert reports and disclosures before the hearing;
  4. introduce limits on the use of hearsay evidence; and
  5. set deadlines of eight to ten months for the agency to rule on appeals, which have dragged on in some cases.

Some argue these amendments don’t go far enough. They don’t give the defense enough time or discovery to work with; they don’t eliminate hearsay evidence altogether; and they don’t stop the Commission from hearing appeals on cases decided by its own judges.

Still, the criticism has struck a nerve. On Monday, the Wall Street Journal reported that the Commission has begun to curb its use of administrative judges in contested cases, and lately, it’s begun to lose more cases before those judges.

Even so, the words of one SEC official ring true: “Whatever forum we’re talking about, we win … the vast majority of the time.”

SEC Announces Its 2013 Enforcement Results in the Financial Markets

Here is a link to the Securities & Exchange Commission’s press release reporting its enforcement numbers for fiscal year 2013, which ran from October through September. Over that period last year, the agency filed 686 public lawsuits in the name of our capital markets, and it obtained a record $3.4 billion in monetary sanctions, like disgorgement of profits, including $3 billion from 169 people and entities associated with the financial crisis. Some of those results may have been the product of the agency’s tally in 2011, when it filed 735 enforcement actions, the most in its history. The people charged reportedly include 70 CEOs, CFOs, and other senior business executives.

Other highlights? The agency brought several novel actions against securities exchanges, including one that resulted in a largest-ever penalty of $10 million against NASDAQ for the bungled Facebook IPO. It rewrote its longstanding settlement policy to require admissions of wrongdoing in certain cases, and it settled the first cases in conformity with that. It continued to prosecute insider trading at full tilt, and it paid out more than $14 million to whistleblowers under its new program.

Coming attractions? At a higher level, two stand out. First, there is a pipeline of activity to come. The Enforcement Division opened 908 new investigations last year, and it obtained 574 formal orders of investigation on previously-opened files. The SEC issues formal orders when it finds it likely that a securities-law violation has occurred, and the formal order grants staff the ability to issue subpoenas and administer oaths. Second, the Commission is harnessing the power of Big Data. It’s reportedly upgraded its data-analytics capabilities significantly, which means it can review and analyze higher volumes of electronic documents as well as conduct better forensic analysis overall, detecting patterns of fraud or other malfeasance in the data.

Beware: The Rising Tide of Anti-Bribery Enforcement Does Not Abate

They say that the Foreign Corrupt Practices Act is among the statutes most feared by companies with foreign operations, and to be sure, if you do business overseas or across the border, you’d better contend with it.

The FCPA, which was enacted in 1977, is America’s—and perhaps the world’s—foremost anti-bribery law aimed at combating corporate corruption abroad. It punishes you for bribing foreign public officials to win business, and it requires your company to maintain adequate books, records, and accounting controls to foster compliance.

The statute provides for criminal prosecution by the Department of Justice as well as civil prosecution by the DOJ or the Securities and Exchange Commission, and in either case, the statute has teeth. The criminal fines and civil monetary penalties can spiral into the millions of dollars per violation, and for individuals, none of it can be indemnified by the corporation. People can go to prison. And businesses can be barred from obtaining government contracts or lose valuable export privileges.

At a conference two weeks ago, leading representatives from the DOJ and the SEC summarized their enforcement efforts in 2013, and they previewed 2014. The highlights?

  • This year was the fifth biggest on record in terms of overall penalties, and counting.
  • DOJ is investigating more than 150 FCPA cases and expects to bring “very significant” cases in 2014.
  • The trend is toward more international cooperation and cross-border enforcement as other countries ramp up their own anti-bribery and corruption regimes.

Don’t Mess With Texas, (Mark) Cubans, or the SEC When It Comes to Insider Trading

As you may have heard, Texan billionaire Mark Cuban was acquitted a couple weeks ago in an insider-trading trial that accused him of selling his stake in a Canadian search-engine company after learning from its CEO that it was planning a stock sale that would dilute his stake. Cuban’s conversation with the CEO took place in 2004, just months after he had purchased his stake, and their conversation was by phone, so there was no recording of it. By selling his shares before the transaction was announced, Cuban avoided $750,000 in losses.

The Securities & Exchange Commission sued Cuban, alleging that his phone conversation included an agreement to keep the information confidential, which meant he was not allowed to trade on it. The SEC sued him for violations of §17(a) of the Securities Act of 1933, §10(b) of the Securities Exchange Act of 1934, and the SEC’s Rule 10b-5. These are some of the government’s most important tools for prosecuting insider trading and other forms of securities fraud. On October 16, after five years of litigation and an eight-day trial, the jury returned a defense verdict on all claims.

But there is some confusion about what insider trading means, or meant, in the Cuban case. The government wasn’t alleging so-called “classical” insider trading, which happens when a corporate insider—say, the CEO himself—trades on juicy information that the public doesn’t know about. There, liability is based on the notion that insiders bear a fiduciary duty to the company’s shareholders, including prospective shareholders looking to buy stock. As a result, the insiders must either not trade on the material, nonpublic information or disclose the information before they do.

In Cuban’s case, the government’s lawsuit was based on a “misappropriation” theory of insider trading, which reaches company outsiders (like shareholders) who come into possession of inside information under circumstances in which they owe a duty of confidentiality to its source. That’s why a company’s lawyers, for example, can’t trade on material, nonpublic information they gain by virtue of their representation. But who else owes such a duty? Well, in 2000, the SEC promulgated Rule 10b5-2, which identifies three, non-exclusive situations that create a duty of trust or confidence that, if breached, can support a misappropriation theory of insider trading:

  1. A person agrees to maintain the information in confidence;
  2. The person communicating the information has a history, pattern, or practice of sharing confidences with the recipient, such that the recipient knows or reasonably should know that there is an expectation of confidentiality; or
  3. The recipient obtains the information from a spouse, parent, child, or sibling, unless the recipient can prove that he or she neither knew nor reasonably should have known that there was an expectation of confidentiality because there was no agreement, understanding, history, pattern, or practice to that effect. (How’s that for a mouthful.)

Cuban’s case involved the first scenario. His defense was that there was no confidentiality agreement between him and the CEO, and absent that, he had no obligation to avoid trading on the information. He also presented evidence that the information was not confidential anyway because it had already been made public through an SEC filing that the company had made before their phone conversation.

Ultimately, the jury found that the government failed even to prove that Cuban received material, nonpublic information in the first place. It probably didn’t help that the government’s star witness—the company’s CEO at the time—testified by videotape rather than in court at trial. It turns out that the SEC couldn’t subpoena him because he lives in Canada, and apparently, he wasn’t willing or able to make the trip down south. His videotaped testimony, moreover, was from a deposition he gave in 2011, seven years after his conversation with Cuban.

The Cuban verdict, however, probably won’t affect the SEC’s priorities going forward. The agency has brought more insider-trading cases in the last three years than in any three-year period in its history, and for the most part, it’s been successful at trial, winning approximately 85% of the time.

SEC Pays Out Its Largest Whistleblower Award So Far, By Far

Do you remember that Dodd-Frank financial-reform law we passed a couple years ago? Well, among many other things, it authorized the Securities & Exchange Commission to pay out whistleblower awards of 10-30% of the money it recovers in an enforcement action, if the whistleblower supplies high-quality, original information that results in monetary sanctions over $1 million. Previously, the Commission had paid out awards of about $50,000. This time around: $14 million. And the agency is just getting started, so we can expect the program to be a major part of its enforcement efforts going forward.

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