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New SEC Enforcement Priorities Likely Under Biden Administration

November 18, 2020

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BCLP Washington Partner Ashley Ebersole was quoted Nov. 13 by Compliance Week regarding possible new enforcement priorities at the Securities and Exchange Commission under a Biden administration. Much will hinge on selection of a new SEC chairman, as current Chairman Jay Clayton has announced his intent to step down at year end before his term officially is scheduled to end in June 2021. “Selection of the new SEC chair, whether from inside the agency or outside, will signal much in terms of the likely approach,” said Ebersole, a former SEC attorney. He also noted that compliance officers “should be prepared for a continued SEC enforcement focus on pursuing fraud involving Main Street investors, but also a likely redoubling of efforts to sanction conduct by financial institutions.”

SEC Modernizes Auditor Independence Rules to Focus on Actual Threats to Objectivity

The Securities and Exchange Commission (the “SEC”) recently adopted final amendments to the auditor independence requirements set forth in Rule 2-01 of Regulation S-X.  The SEC stated that the final amendments were based on recurring fact patterns that the SEC staff has observed over the years in which certain relationships and services triggered technical independence rule violations without necessarily impairing an auditor’s objectivity and impartiality.  These relationships either triggered non-substantive rule breaches or required potentially time-consuming audit committee review of non-substantive matters, thereby diverting time, attention, and other resources of audit clients, auditors, and audit committees from other investor protection efforts.

In the adopting release, the SEC stated that the amendments “…maintain the bedrock principle that auditors must be independent in fact and in appearance while…more effectively focusing the independence analysis on those relationships or services that are more likely to threaten an auditor’s objectivity and impartiality.”  The SEC anticipates that Rule 2-01, as amended, will make the auditor independence rules easier to apply and appropriately limit the situations in which auditors are not deemed to be independent.

The amendments include, among others:

  • In connection with determining whether auditor independence exists in the context of initial public offerings, an amendment shortening the applicable look-back period to cover the immediately preceding fiscal year (rather than the period covered by the registration statement, which can be up to three years);
  • In connection with identifying relationships that may preclude a finding of auditor independence, an amendment providing that a sister entity

DOJ Releases Framework for Cryptocurrency Enforcement

On October 8, 2020, the U.S. Department of Justice (“DOJ”) released the publication “Cryptocurrency: An Enforcement Framework,” (“Framework”) which described emerging threats and enforcement challenges associated with cryptocurrency. DOJ’s Cyber-Digital Task Force produced the Framework to highlight important relationships DOJ has built with other domestic and international regulatory and enforcement partners, and its strategic response to address emerging issues concerning cryptocurrency and the “blockchain” or “distributed ledger” technology underlying it.  The Framework’s stated goal is to ensure that cryptocurrencies and associated technologies are safe and do not imperil public safety or national security. While DOJ explicitly recognizes cryptocurrency’s potential in the Framework, it also outlines both threats and illicit opportunities that cryptocurrency provides for nefarious actors.

For a full discussion of the Framework, please refer to this BCLP client alert co-authored by Ashley Ebersole, Ben Saul, Mark Sere and Jason Semmes.

SEC Charges Andeavor LLC With Stock Buyback Controls Violations

On October 15, 2020, the Securities and Exchange Commission (“SEC”) announced settled charges against U.S. refiner Andeavor LLC (“Andeavor”) for inadequate controls related to a stock buyback plan it executed while it was in talks to be acquired by Marathon Petroleum Corp. in 2018. Without admitting the SEC’s findings, Andeavor agreed to pay a $20 million penalty to settle the charges.

According to the SEC, in March of 2017 Andeavor’s then-Chairman and CEO began confidential discussion with Marathon’s Chairman and CEO about a potential business combination. After months of analysis regarding the potential synergies that a combined company would produce, the CEOs agreed to suspend their discussions. Then in February 2018, just two days before a meeting to resume talks about a potential deal, Andeavor’s CEO directed its then-CFO to initiate a share buyback to repurchase $250 million of shares. The SEC found that Andeavor’s internal accounting controls failed to ensure the buyback adhered to the company’s securities trading policy, a policy that prohibited repurchases while the company was in possession of material non-public information.

Andeavor used an abbreviated and informal process to evaluate whether the requirements for the buyback were satisfied. That process did not require conferring with persons reasonably likely to have material non-public information about corporate developments prior to approval of the share repurchase. As a result, no one involved in Andeavor’s process discussed with Andeavor’s CEO the prospects that Andeavor and Marathon would agree to a deal. Because they did not do so, the company

SEC Puts SAFT Issuers On Notice (Again)

For the second time this year (see our previous reported here), a judge in the U.S. District Court for the Southern District of New York determined that an initial coin offering (“ICO”) involving the Simple Agreement for Future Tokens (“SAFT”) framework constituted an unlawful unregistered securities offering, establishing a daunting precedent for both potential and past SAFT issuers.  The most recent such ruling came on September 30, 2020, in response to dueling Motions for Summary Judgment in the SEC v. Kik Interactive Inc. case, as profiled further here.

Red flags for directors: SEC may take magnifying glass to disclosures involving significant judgments in COVID-19 era

In a fast-paced webinar, the Heartland NACD chapter recently explored the board’s role in SEC inquiries and discussed red flags for directors, as well as SEC trends and developments. Panelists included Terri Vaughan, a seasoned board leader; Lory Stone, an SEC enforcement attorney; and Terry Pritchard, an experienced securities litigator at Bryan Cave Leighton Paisner LLP.

During a discussion of red flags that should draw directors’ attention, Ms. Stone noted that the SEC may take a magnifying glass to disclosures involving significant judgements and estimates, particularly in the current economic conditions.  She quoted her former colleague Steven Peikin, previous Co-Director of the Division of Enforcement, who stated in a speech at a recent securities enforcement forum:

Recognizing that the economic impacts of any downturn may vary across different industries and sectors, the [SEC’s Coronavirus] Steering Committee has developed a systematic process to review public filings from issuers in highly-impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry. We are also looking for disclosures, impairments, or valuations that may attempt to disguise previously undisclosed problems or weaknesses as coronavirus-related.

Other red flags discussed during the webinar included:

  • Tips/hotline reports, which should be closely examined by the board;
  • “Domineering” CEOs who may have unchecked power;
  • Auditor resignations, which should prompt the board to understand the reason for the resignation;
  • Management shake-ups, with abrupt terminations or resignations;
  • Government investigations;
  • Financial restatements;
  • Practice changes in judgment areas (debt restructuring, revenue recognition practices);

Second Circuit Case Shows How Confidentiality Pact May Support Insider Trading Charges

A recent decision by the U.S. Court of Appeals for the Second Circuit shows how an investor’s entering into a confidentiality agreement with an issuer of securities may support insider trading charges against the investor.

The decision, United States v. Kosinski, No. 18-3065 (2d Cir., Sept. 22, 2020), did not create new law in the Second Circuit.  But the court did reaffirm its earlier holding that by agreeing to keep confidential  information provided by an issuer, a trader had taken on a fiduciary-like duty to the issuer sufficient to support insider trading charges under section 10(b) of the Securities Exchange Act of 1934.  And it rejected the argument that to create the requisite duty, the agreement needed to have a no-trading provision as well as a confidentiality provision.

What creates a sufficient duty has been a hotly disputed issue in insider trading law in recent years.  It elicited heightened attention during the SEC’s case against billionaire Dallas Mavericks owner Mark Cuban, where the SEC’s charges were based in part on an alleged promise by Cuban to maintain confidentiality as to information provided by issuer Mamma.com.

But Cuban’s case did not resolve that issue as a legal matter.  Rather, the U.S. Court of Appeals for the Fifth Circuit, without addressing all of the legal questions posed,  held that the SEC had alleged enough to support a finding that Cuban had agreed both to maintain confidentiality and not to trade, so that the case could go to a jury.  It did,

SEC Announces Charges Against Fulton Financial Corporation and Interface, Inc., in Bellwether of Increased Earnings Management Enforcement Activity

On September 28, the SEC announced charges against two public companies, Interface, Inc. (“Interface”) and Fulton Financial Corporation (“Fulton”), for violations related to the reporting of improperly calculated earnings per share (“EPS”) that enabled the companies to meet or exceed consensus analyst estimates.  In the case of Interface, charges were also levied against the company’s former Chief Financial Officer (“CFO”) and Chief Accounting Officer (“CAO”) for directing subordinates to book unsupported, manual accounting entries that did not comply with generally accepted accounting principles (“GAAP”). These enforcement actions are a result of the implementation of an “EPS Initiative” by the Division of Enforcement that seeks to leverage risk-based data analytics to identify potential instances of accounting and disclosure violations, including those resulting from earnings management practices.

The SEC focused on accounting entries recorded on Interface’s books during the period from the second quarter of 2015 through the second quarter of 2016. The SEC alleged that Interface reported financial results that did not accurately reflect the company’s actual performance, and, instead, inflated income and EPS figures to show consistent earnings growth.  The alleged misstatements were found to be materially misleading because the earnings reported in two quarters enabled the company to meet consensus analyst EPS estimates when, had the unsupported accounting entries not been made, the company would have delivered results below analyst estimates. The SEC alleged that a lack of adequate internal controls over financial reporting created an environment in which the CFO and CAO (then-Corporate Controller) were able to direct

SEC Amends Whistleblower Award Program Rules to Add Clarity, Efficiency and Transparency

On September 23, 2020, the SEC voted 3-2 to adopt long-awaited amendments to rules governing its Whistleblower Program. The amendments’ stated purpose is to provide greater clarity to whistleblowers, and increase the whistleblower program’s efficiency and transparency.  In addition, according to SEC Chairman Jay Clayton, the “rule amendments will help us get more money into the hands of whistleblowers, and at a faster pace.” Click here to read the Alert in full.

Kodak Releases Special Committee Report – Details Failures in Corporate Governance Practices

We previously blogged about the myriad issues arising in connection with the botched announcement by Kodak of a potential $765 million loan from the federal government as part of its coronavirus response measures, as well as insider stock transactions preceding and immediately following the announcement.  Kodak’s board formed a special committee to conduct an internal investigation.  Akin Gump, retained by the special committee to conduct the investigation, last week delivered its report of over 70 pages of factual findings and legal analysis, concluding that there were no violations of law or company policy, but identifying corporate governance issues requiring attention and remediation.  The company has posted the report on its website.

As we previously blogged, on July 27 the internal public relations team at Kodak released an alert to local media that Kodak would be making a big announcement the following day concerning a major initiative between Kodak and the federal government.  Stories immediately started circulating on social media and the websites of local network affiliates. Kodak then contacted the recipients of the advisory to tell them it was meant only as background and was not intended for publication.  The formal announcement followed before the market open on July 28 when Kodak and the U.S. International Development Finance Corp (DFC) jointly announced a ”letter of interest” contemplating a $765 million loan to Kodak to launch a new pharmaceutical business. Although the press release made clear that this was only a letter of interest and the loan was subject

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