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Financial Services Law Insights and Observations


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  • 5th Circuit rules against SEC’s use of ALJs


    On May 18, the U.S. Court of Appeals for the Fifth Circuit held that the SEC’s in-house adjudication of a petitioners’ case violated their Seventh Amendment right to a jury trial and relied on unconstitutionally delegated legislative power. The appellate court further determined that SEC administrative law judges (ALJs) are unconstitutionally shielded from removal. In a 2-1 decision, the 5th Circuit vacated the SEC’s judgment against a hedge fund manager and his investment company arising from a case, which accused petitioners of fraud under the Securities Act, the Securities Exchange Act, and the Advisers Act in connection with two hedge funds that held roughly $24 million in assets. According to the SEC, the petitioners had, among other things, inflated the funds’ assets to increase the fees they collected from investors. Petitioners sued in federal court, arguing that the SEC’s proceedings “infringed on various constitutional rights,” but the federal courts refused to issue an injunction claiming they lacked jurisdiction and that petitioners had to continue with the agency’s proceedings. While petitioners’ sought review by the SEC, the U.S. Supreme Court issued a decision in Lucia v. SEC, which held that SEC ALJs are “inferior officers” subject to the Appointments Clause of the Constitution (covered by InfoBytes here). Following the decision, the SEC assigned petitioners’ proceeding to an ALJ who was properly appointed, “but petitioners chose to waive their right to a new hearing and continued under their original petition to the Commission.” The SEC eventually affirmed findings of liability against the petitioners, and ordered the petitioners to cease and desist from committing further violations and to pay a $300,000 civil penalty. The investment company was also ordered to pay nearly $685,000 in ill-gotten gains, while the hedge fund manager was barred from various securities industry activities.

    In vacating the SEC’s judgment, the appellate court determined that the SEC had deprived petitioners of their right to a jury trial by bringing its action in an “administrative forum” instead of filing suit in federal court. While the SEC challenged “that the legal interests at issue in this case vindicate distinctly public rights” and therefore are “appropriately allowed” to be brought in agency proceedings without a jury, the appellate court countered that the SEC’s enforcement action was “akin to traditional actions at law to which the jury-trial right attaches.” Moreover, the 5th Circuit noted that while “the SEC agrees that Congress has given it exclusive authority and absolute discretion to decide whether to bring securities fraud enforcement actions within the agency instead of in an Article III court[,] Congress has said nothing at all indicating how the SEC should make that call in any given case.” As such, the 5th Circuit opined that this “total absence of guidance is impermissible under the Constitution.”

    Additionally, the 5th Circuit raised concerns about the statutory removal restrictions for SEC ALJs who can only be removed for “good cause” by SEC commissioners (who are removable only for good cause by the president). “Simply put, if the President wanted an SEC ALJ to be removed, at least two layers of for-cause protection stand in the President’s way,” the appellate court concluded. “Thus, SEC ALJs are sufficiently insulated from removal that the President cannot take care that the laws are faithfully executed. The statutory removal restrictions are unconstitutional.”

    The dissenting judge disagreed with all three of the majority’s constitutional conclusions, contending that the majority, among other things, misread the Supreme Court’s decisions as to what are and are not “public rights,” and that “Congress’s decision to give prosecutorial authority to the SEC to choose between an Article III court and an administrative proceeding for its enforcement actions does not violate the nondelegation doctrine.” The judge further stated that while the Supreme Court determined in Lucia that ALJs are “inferior officers” within the meaning of the Appointments Clause in Article II, it “expressly declined to decide whether multiple layers of statutory removal restrictions on SEC ALJs violate Article II.” Consequently, the judge concluded that he found “no constitutional violations or any other errors with the administrative proceedings below.”

    Courts Appellate Fifth Circuit SEC ALJ Constitution Securities Act Securities Exchange Act Advisers Act Enforcement

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  • SEC awards whistleblowers $3.5 million


    On May 6, the SEC announced awards totaling nearly $3.5 million to four whistleblowers whose information and assistance led to successful SEC enforcement actions. According to the redacted order, three joint whistleblowers provided SEC staff with information that led to the opening of a new investigation, which resulted in a successful enforcement action. These joint whistleblowers’ information also caused another agency to open an investigation and led to a separate successful action. Another whistleblower provided insights based on an independent analysis of information that focused the staff’s attention on allegations that were not previously known to staff that advanced the investigation. The SEC has awarded approximately $1.3 billion to 273 individuals since issuing its first award in 2012.

    Securities SEC Enforcement Whistleblower

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  • 4th Circuit will not revive investors’ data breach case

    Privacy, Cyber Risk & Data Security

    On April 21, the U.S. Court of Appeals for the Fourth Circuit affirmed a district court’s dismissal of a securities suit against a hotel corporation (defendant) alleging that they misled the plaintiffs regarding data vulnerabilities connected to a major breach of customers’ personal information. According to the opinion, two years after merging with another hospitality corporation, the defendant “learned that malware had impacted approximately 500 million guest records in the [hospitality corporation’s] guest reservation database.” An investor filed a putative class action against the defendant and nine of its officers and directors, alleging that its failure to disclose severe vulnerabilities in the hospitality corporation’s IT systems rendered 73 different public statements false or misleading in violation of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and SEC Rule 10b-5. The district court granted the defendant’s motion to dismiss with prejudice and concluded that the plaintiffs “‘failed to adequately allege a false or misleading statement or omission, a strong inference of scienter, and loss causation,’ which doomed the claim under Section 10(b) and Rule 10b-5 as well as the secondary liability claim [under Section 20(a) of the Exchange Act].” The investor appealed, dropping its challenge to 55 of the statements but maintaining its challenge to the other 18.

    On appeal, the 4th Circuit agreed with the district court that the defendant’s statements about the importance of cybersecurity were not misleading with respect to the quality of its cybersecurity efforts. The appellate court found that “[t]he ‘basic problem’ with the complaint on this point is that ‘the facts it alleges do not contradict [the defendant’s] public disclosures,’” and that reiterating the “basic truth” that data integrity is important does not mislead investors or create a false impression. The appellate court also noted that the complaint “concedes that [the defendant] devoted resources and took steps to strengthen the security of hospitality corporation’s systems,” and that the company included “such sweeping caveats that no reasonable investor could have been misled by them.” The appellate court concluded that the defendant “certainly could have provided more information to the public about its experience with or vulnerability to cyberattacks, but the federal securities laws did not require it to do so.”

    Privacy/Cyber Risk & Data Security Courts Data Breach Appellate Fourth Circuit SEC Securities Exchange Act

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  • SEC awards $6 million to whistleblowers


    On April 25, the SEC announced awards totaling nearly $6 million to two groups of whistleblowers whose information and assistance led to a successful SEC enforcement action. According to the redacted order, the first group of whistleblowers provided the SEC with key documents that led the staff to seek additional documents from the respondent, and the second group provided firsthand accounts of the misconduct at issue. Both groups, which consisted of five individuals, provided ongoing assistance throughout the investigation.

    The SEC has awarded approximately $1.2 billion to 268 individuals since issuing its first award in 2012.

    Securities SEC Whistleblower Enforcement

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  • International medical waste provider agrees to $84 million FCPA settlement

    Financial Crimes

    On April 20, the DOJ entered into a deferred prosecution agreement (DPA) with an Illinois-based international medical waste management company, in which the company agreed to pay a fine of approximately $52.5 million related to a conspiracy to violate the FCPA’s anti-bribery provision and books and records provisions. Together with a related resolution with the SEC, and with various foreign authorities, the total resolution will reach over $84 million.

    According to the DOJ, between 2011 and 2016, the company participated in a scheme to bribe officials at government agencies and instrumentalities in Brazil, Mexico, and Argentina to obtain and retain business and to secure improper advantages in connection with providing waste management services. An executive at the company’s Latin America division directed employees in the company’s offices in Brazil, Mexico, and Argentina to pay bribes, typically in cash, that were calculated as a percentage of the underlying contract payments owed to the company from government customers.

    As part of the DPA, the company agreed to cooperate with the DOJ’s ongoing or future investigations, to improve its compliance program, and to retain an independent compliance monitor for two years, followed by self-reporting for the remainder of the term.

    The DOJ noted that in addition to cooperation and remediation the resolution reflects a number of factors including, the company’s (i) “failure to voluntarily and timely disclose the conduct that triggered the investigation”; and (ii) “the nature, seriousness, and pervasiveness of the offense.”

    The SEC simultaneously announced a resolution of a related matter, in which the company consented to a cease-and-desist order finding violations of the FCPA’s anti-bribery, books and records, and internal accounting controls provisions.  According to the SEC, the scheme also included sham third-party vendors who used false invoices to conceal cash payments to government clients. In addition, the company failed to have sufficient internal accounting controls in place to prevent or detect the misconduct and failed to implement its FCPA policies or procedures prior to 2016. Under the terms of the order, the company agreed to pay $28.2 million in disgorgement and prejudgment interest, of which up to $4.2 million will be offset by disgorgement paid to foreign authorities.

    Financial Crimes SEC DOJ FCPA Bribery Enforcement Of Interest to Non-US Persons Brazil Argentina Mexico

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  • SEC seeks to include market participants as dealers or government securities dealers


    On March 28, the SEC announced two proposed rules, which would require market participants, such as proprietary (or principal) trading firms, who assume certain dealer functions, in particular those who as act as liquidity providers in the markets, to register with the SEC, to become members of a self-regulatory organization (SRO), and comply with federal securities laws and regulatory obligations. According to the SEC, the rules would establish that a market participant engaging in the activities described in the rules is a “dealer” or “government securities dealer” and, absent an exception or exemption, is required to: (i) register with the Commission under Section 15(a) or Section 15C, as applicable; (ii) become a member of an SRO; and (iii) comply with federal securities laws and regulatory obligations, including as applicable, SEC, SRO, and Treasury rules and requirements. A footnote in the proposal indicates that its new rules would apply to any digital asset that is regarded as a security or a government security within existing laws. The SEC also released a Fact Sheet regarding the proposals, which provides information on why the proposal matters and how it applies. Comments are due 60 days after publication of the proposing release on the SEC’s website or 30 days after publication in the Federal Register, whichever period is longer. SEC Chair Gary Gensler released a statement stating he believes that the proposed rules “reflect[] Congress’s statutory intent that firms engaging in important liquidity-providing roles in the securities markets, including in the U.S. Treasury market, be registered with the Commission.”

    Securities Agency Rule-Making & Guidance Digital Assets SEC Federal Register

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  • SEC awards $1.25 million to whistleblower


    On March 25, the SEC announced that it awarded a whistleblower $1.25 million for providing specific and credible information that prompted SEC staff to begin an investigation that resulted in a successful SEC covered action. According to the redacted order, the whistleblower voluntarily provided original information and participated extensively in assisting SEC staff through identifying witnesses, explaining critical documents, and helping focus the investigation on key issues, which saved SEC time and resources.

    The SEC has awarded approximately $1.2 billion to 256 individuals since issuing its first award in 2012.

    Securities SEC Whistleblower Enforcement

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  • SEC proposes climate risk disclosures


    On March 21, the SEC announced a proposed rule to require registrants to disclose certain climate-related information in their registration statements and periodic reports. According to the proposed rule, a registrant must disclose, among other things, information regarding its direct and certain indirect emissions of greenhouse gas (GHG). The GHG emissions disclosure proposals “would provide investors with decision-useful information to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks.”

    The proposed rule also establishes that accelerated filers and large accelerated filers would be required to include an attestation report from an independent attestation service provider covering certain emissions disclosures, with a phase-in over time, to promote the reliability of GHG emissions disclosures for investors. The proposed rule further noted additional disclosure requirements for registrants that have made a so-called net-zero commitment or adopted a plan to reduce their GHG footprint or exposures.

    The same day, the SEC released a Fact Sheet on the proposed rule, which summarized the content of the proposed disclosure and presentation and attestation requirements, among other things. According to a statement released by SEC Chair Gary Gensler, the proposed rule will “provide investors with consistent, comparable, and decision-useful information for making their investment decisions and would provide consistent and clear reporting obligations for issuers.” However, a statement released by SEC Commissioner Hester M. Peirce took a different view, stating that the proposed amendments would “turn[] the disclosure regime on its head” and noting that some elements are “missing,” such as “[a] credible rationale for such a prescriptive framework when our existing disclosure requirements already capture material risks relating to climate change;[a] materiality limitation; [and] [a] compelling explanation of how the proposal will generate comparable, consistent, and reliable disclosures.” Treasury Secretary Janet L. Yellen also released a statement commending the proposal and the SEC, calling the effort “an important step to protect investors and strengthen the overall resilience of the financial system.”

    Comments on the proposal are due 30 days after publication in the Federal Register, or 60 days after the date of issuance and publication on, whichever period is longer.

    Securities Agency Rule-Making & Guidance SEC Climate-Related Financial Risks Department of Treasury Federal Register Risk Management Disclosures

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  • SEC issues $3 million in whistleblower awards


    On March 18, the SEC announced whistleblower awards totaling over $3 million to three individuals for providing information and assistance in three separate covered actions. According to the first redacted order, the SEC awarded approximately $1.5 million to a whistleblower for providing information which led to the successful prosecution of an enforcement action. Additionally, the whistleblower assisted the staff throughout the investigation. According to the second redacted order, the SEC awarded over $1 million to an individual who provided information that prompted Commission staff to open an investigation that led to the successful prosecution of an enforcement action. The whistleblower continued to provide assistance by participating in interviews and giving additional documents. In the third redacted order, the SEC awarded over $400,000 to a whistleblower whose comprehensive tip led to an investigation and who provided substantial ongoing cooperation. The whistleblower also raised concerns internally, causing the conduct to cease.

    The SEC has awarded approximately $1.2 billion to 254 whistleblowers since issuing its first award in 2012.

    Securities Whistleblower Enforcement SEC

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  • SEC awards $14 million to whistleblower


    On March 11, the SEC announced that it awarded a whistleblower nearly $14 million for exposing ongoing fraud by publishing on online report. According to the redacted order, the whistleblower voluntarily provided original information and prompted the opening of an investigation, which resulted in a successful enforcement action against the company and its CEO and the return of millions of dollars to harmed investors.

    The SEC has awarded approximately $1.2 billion to 249 individuals since issuing its first award in 2012.

    Securities SEC Enforcement Whistleblower Investigations

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