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Disclosure Controls and Procedures – Not Just a Quarterly Certification

On June 15, 2021, the SEC announced that it had settled charges against First American Financial Corporation for failures in First American’s disclosure controls and procedures.  Rule 13a-15(a) under the Exchange Act requires issuers to maintain disclosure controls and procedures designed to ensure that information required to be disclosed by an issuer in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. 

According to the SEC’s order, in May 2019, company management learned from a journalist that the company was experiencing a cybersecurity vulnerability that had resulted in the inadvertent public availability of customers’ personal data.  First American responded by issuing a statement to the press explaining that the company had learned of a design defect that had resulted in “possible unauthorized access to customer data” and had taken “immediate action to address the situation and shut down external access” to the data.  A few days later, First American issued a press release that was also furnished on Form 8-K.  In the release, the company reported that there was “[n]o preliminary indication of large-scale unauthorized access to customer information.”

Contrary to these disclosures, the SEC found that the vulnerability had exposed sensitive personal data, including social security numbers, in over 800 million images of customer documents for a period dating back to as early as 2003.  The SEC also found that the senior executives of the company who were

Anti-Money Laundering Continues to be Among the Highest Regulatory Priorities, As Evidenced by Recent Enforcement Cases and Releases

For the past decade, anti-money laundering (“AML”) has been at the forefront of securities regulators’ priorities. Indeed, AML enforcement cases have resulted in some of the highest fines imposed by securities regulators, and even the most cursory review of SEC and FINRA annual examination priorities letters reveals AML-related concerns in virtually each of them in the past 10 years. Based on recent enforcement actions and regulatory pronouncements, this focus will continue to be top of mind for regulators and, given the relationship between AML and other headline topics, such as cybersecurity and fraud, broker-dealers should anticipate that future examinations and other regulatory inquiries will heavily focus on AML-related issues. Securities regulators continue to emphasize that any reasonable AML program must be risk-based, and firms should consider periodically conducting a 360º assessment of their AML risks (beyond the annual independent AML testing pursuant to FINRA Rule 3310(c)). At bottom, broker-dealers should be aware of, and be nimble in responding to, cybersecurity and other types of fraud-related developments, and be prepared to modify their AML program in light of their own risk assessments and material developments in the regulatory landscape.

Click here to read the Alert in full.

SEC announces re-examination of proxy advisor rules and interpretations

Newly installed Chairman Gary Gensler announced on June 1, 2021 that he is directing the SEC staff to consider whether to revisit its recent actions with respect to proxy voting advice businesses, including:

  • The SEC’s 2020 proxy rule amendments
    • As discussed in our July 24, 2020 blog, the amendments codified the SEC’s interpretation that the definition of solicitation encompassed proxy voting advice and established requirements for exemptions from the information and filing requirements.
  • The SEC’s 2019 interpretation and guidance regarding solicitation
    • As discussed in our October 2019 newsletter, the SEC stated its view that proxy voting advice generally constitutes a “solicitation” subject to the federal proxy rules and explained what proxy advisers should consider disclosing in order to avoid a potential violation of Rule 14a-9 where the failure to disclose such information would render the advice materially false or misleading.

As a result of the Chairman’s announcement, the SEC staff announced later on June 1 that it has decided that it will not recommend enforcement action based on the 2019 interpretation and guidance or the 2020 amendments during this period of staff review.

In addition, the SEC staff announced that if the 2020 amendments ultimately remain in place, it will not recommend enforcement action based on their conditions for a reasonable period after any resumption by ISS of its litigation challenging the 2020 amendments and 2019 interpretation and guidance.

Following these announcements, Commissioners Pierce and Roisman

SEC Chair Directs Staff to Consider New Rules to Manage Risks Highlighted by Game-Like Trading Apps

SEC Chair Gary Gensler testified yesterday before the House Committee on Financial Services about the SEC’s efforts to assess and address the market volatility that occurred in GameStop and other “meme stocks” resulting in significant price volatility and trading volume spikes earlier this year. 

Gensler said the SEC is working to determine, in the face of changes in technology and finance, how to continue to achieve core public policy goals while ensuring that the markets work for everyday investors.  Gensler cited seven factors that were at play during the volatile trading periods:

  • Gamification and User Experience:  Mobile apps expanded access to capital markets, making it easy for investors to sign up, start trading, get wealth management advice, and learn about investing. The apps use a host of familiar online features, such as gamification (points, rewards, leaderboards, bonuses, and competitions), behavioral prompts and differential marketing, to increase customer engagement.
    • Gensler said the staff is preparing a request for public input to consider these issues and determine how to ensure investors using apps with these types of features are appropriately protected and how SEC rules, including Regulation Best Interest, apply in these situations. Gensler noted that many SEC regulations were written well before today’s technologies and communication practices existed and need to be re-evaluated to protect the futures, retirements and education of the investing public.
  • Payment for Order Flow:  Gensler noted that in the last few years, most retail broker-dealers stopped charging fees for trades

Russia Now Focal Point of Additional Sanctions and Export Controls, With an Added Bonus for Public Companies (Oh my!)

In response to a variety of activities allegedly undertaken by Russia, the U.S. Government has imposed a series of additional sanctions and export control measures since early March.  Collectively, the March and April sanctions take a variety of forms, including the suspension of entry into the United States and the denial of visas to certain non-U.S. citizens, denial of government credit and financial assistance, cessation of all foreign military financing, export controls changes, expanded sanctions authority, and additional designations of blocked persons.  These sanctions may affect anyone doing business with or in Russia.  Public companies should be particularly mindful of the potential for more reporting pursuant to Section 13(r)(1)(D) of the Securities and Exchange Act of 1934 (“34 Act”) as a side effect of certain of the additional sanctions.

Additional Sanctions Introduced and More Designations Under Existing Authorities

Following the determination that the Government of the Russian Federation violated the Chemical Weapons Convention based on the Navalny attack, the U.S. Government designated multiple new parties under existing sanctions authorities.  Pursuant to Section 231 of the Countering America’s Adversaries Through Sanctions Act (“CAATSA”), the U.S. State Department added six parties to its list of persons that are part of or act for, or on behalf of, the Russian intelligence or defense sectors.  The newly added parties are:

  • 27th Scientific Center;
  • 48 Central Scientific Research Institute Sergiev Posad;
  • 48 Central Scientific Research Institute Kirov;
  • 48 Central Scientific Research Institute Yekaterinburg;
  • State Scientific Research Institute of Organic Chemistry and Technology; and
  • 33rd Scientific Research

SEC Division of Enforcement No Longer Recommending Settlement Offers Contingent on Waivers

In a Statement released on February 11, 2021, Acting SEC Chair Allison Herren Lee announced that, in a return to the longstanding practice of the SEC Division of Enforcement (the “Division”), the Division will no longer recommend a settlement offer conditioned on the grant to the company of a waiver from automatic disqualifications triggered by certain securities law violations and sanctions.  Such automatic disqualifications can, for example, prevent a company from being considered a Well-Known Seasoned Issuer (WKSI), engaging in certain private securities offerings under Rule 506 of Regulation D, and serving in certain capacities for an investment company.

In taking this action, Acting Chair Lee noted that while in many instances a waiver may be appropriate, the waiver determination should, as a policy matter, be made separately from considerations relating to the settlement of an enforcement case.  She further noted that waivers should not be used as a bargaining chip in settlement negotiations, and that reinforcing this critical separation ensures that both processes are fair and that consideration of requested waivers is “forward-looking and focused on protecting investors, the market, and market participants from those who fail to comply with the law.”  Going forward, waiver requests will be reviewed by the SEC’s Divisions of Corporation Finance and Investment Management under standards separate from the law enforcement mandate.

Lessons from GameStop: Small Investors “100% Don’t Care” About Risk

Like KC Chiefs quarterback Patrick Mahomes eating green beans in a recent commercial, even though he “100% [doesn’t] like them,” it appeared the Reddit r/WallStreetBets group that banded together to buy GameStop shares “100% don’t care” about market risk and potential investment losses.  

Inspired by social media cheerleaders, thousands of small investors acted with irrational exuberance, driving the share price from less than $20 on January 15, 2021 to $483 on January 28, 2021 before it closed that day below $200, and plummeted more than 40% to $53 on February 4.  

Average investors watched in disbelief as trading markets were turned upside down by investors who appeared to ignore financial and other disclosures, disregarding the risks of possible complete loss of their investments.

Understandably, the executives of GameStop and some players on the social media investor radar screen have so far declined to comment.  The social media blitz was completely outside control of the issuer’s management and they likely don’t have sufficient information to attempt to explain it.  To wit, one of GameStop’s reactions to the inexplicable volatility was to restrict trading in its shares.

Regardless of how this saga ultimately ends for GameStop, it has raised important questions like whether a company should keep its trading window closed even after earnings are announced and the company has disclosed all material nonpublic information.  Normally, there “ought not” be any liability concerns for an issuer in such a situation, but that could be risky when judged in hindsight.  Large

Defense Bill Significantly Bolsters SEC’s Disgorgement Authority

Introduction

The National Defense Authorization Act (“NDAA”) became law on January 1, 2021 after Congress overrode a presidential veto of the legislation. While the NDAA appropriates funds for defense-related activities and the then-President objected to the legislation based primarily on collateral issues like liability for online content, the Act also will have a significant impact on securities law enforcement.  The legislation included language that significantly bolsters the power of the Securities and Exchange Commission (“SEC”) to obtain disgorgement of ill-gotten gains from securities law violators who are unjustly enriched. This is a reversal of fortune for the SEC, which has lost a string of recent notable court cases that curtailed its disgorgement authority.

Summary

The NDAA’s SEC-friendly provisions both solidify the agency’s authority to obtain disgorgement through its enforcement actions and provide a materially longer statute of limitations in which the SEC can file these actions. First, Section 6501 of the NDAA amends Section 21(d) of the Securities Exchange Act of 1934 (“Exchange Act”) to expressly authorize the SEC to obtain disgorgement as a remedy for violations of the securities laws. Prior to this amendment, the Exchange Act authorized the SEC to seek “any equitable relief that may be necessary or appropriate,”1 and courts routinely awarded the agency disgorgement as an equitable remedy. But this longstanding practice was hampered by two recent Supreme Court opinions, Kokesh v. SEC and Liu v. SEC.

In Kokesh, the Supreme Court unanimously ruled that disgorgement constituted a “penalty” rather than “equitable relief” and was therefore subject to the five-year statute

SEC Rule 144 Proposals Target “Toxic” Convertible Securities and Paper Filings

Last week the SEC proposed to amend Rule 144 in order to:

  • Eliminate tacking for shares underlying market-adjustable securities of unlisted companies
  • Update and simplify certain filing requirements, including mandating electronic filing of Form 144s

Elimination of tacking for shares underlying market-adjustable securities of unlisted companies

The proposals would amend Rule 144(d)(3)(ii) to eliminate “tacking” for securities acquired upon the conversion or exchange of the market-adjustable securities of an unlisted company – that is, a company without any securities listed, or approved for listing, on a national securities exchange. As a result, the holding period for the underlying securities — either six months for securities issued by a reporting company or one year for securities issued by a non-reporting company — would not begin until the conversion or exchange of the market-adjustable securities.

In the SEC’s view, the change is needed because applying Rule 144 “tacking” provisions to market-adjustable securities undermines one of the key premises of Rule 144, which is that holding securities at risk for an appropriate period of time prior to resale can demonstrate that the seller did not purchase the securities with a view to distribution and as a result is not an underwriter for the purpose of Securities Act Section 4(a)(1).

In transactions involving market-adjustable securities, the discounted conversion or exchange features in these securities typically provide holders with protection against investment losses that would occur due to declines in the market value of the underlying securities prior to conversion or exchange. Often,

SEC affirms NYSE rule changes allowing primary capital raises by issuers in direct listings

Yesterday, by another 3-2 vote, the SEC approved changes to NYSE listing rules relating to primary direct listings after conducting a “de novo” review following objections raised by certain investors and commentators.

In August, using delegated authority, the SEC’s Division of Trading and Markets had approved changes to NYSE listing rules to allow companies to raise capital in connection with a direct listing on the NYSE without a firm commitment offering.  Shortly afterwards, the SEC notified the NYSE that the rule changes had been stayed following receipt of notice from the Council of Institutional Investors (CII) that the CII was submitting a petition for a full Commission review of the delegated approval by the Division.

The Commission conducted a de novo review, considering the CII petition and comments submitted.  The majority decided to affirm the rule change – described in our earlier post – as consistent with applicable law.  The CII’s principal concerns, which were shared by Commissioners Lee and Crenshaw, related to:

  • The lack of an underwriter and corresponding due diligence, resulting in reduced investor protection
  • The reduced ability for shareholders to recover damages for false or misleading disclosures, due to the judicial doctrine of “traceability,” under which courts have held that plaintiffs lack standing to pursue claims if they cannot trace their purchased shares back to the offering covered by the registration statement

In response to these concerns, the SEC majority concluded:

  • Primary direct listings will be registered under the Securities Act and subject
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