Last month, Lynn blogged that the SEC was nearing the $1 billion mark for lifetime awards under its whistleblower program. This Arnold & Porter memo says that FY 2021 will also set a record of its own: with more than 3 months left, the Commission has awarded $370 million, compared to the $175 million record from last year. The memo was published prior to the SEC’s latest announcements this week of a $5.3 million award and a $1 million award.
The memo delves in to how the whistleblower program works – and says that recent orders may show a willingness to grant more awards. There has also been a huge increase in the number of tips lately, which may lead to more investigations. The memo says that companies can prepare for the possibility of whistleblower activity by considering:
– Risk Assessments. Consider conducting risk assessments related to internal reporting structures to make sure that all reports—not just those going to an internal hotline—are captured, triaged, and investigated if appropriate. Use internal whistleblower information to get ahead of a potential problem with the regulators or law enforcement. Companies that are able to conduct thorough internal investigations showing a clear, robust response to an internal tip will be better able to effectively self-correct and have a defensible position if regulators or law enforcement get involved.
– Annual Training. Consider if annual training is appropriately robust and targeted to middle management to ensure that tips received outside of the employee hotline or formal reporting mechanisms are identified, logged, and triaged. This is particularly important given that 81% of SEC whistleblower awardees reported their concerns internally, including in many instances to their direct supervisor, before or at the same time as reporting to the Commission. If all tips are not identified and centrally reviewed, it is a lost opportunity for a company to self-correct an issue.
– Internal Reporting Mechanisms in a Post-Covid World. As more companies are pivoting back to an in-person workforce, consider a refresh on internal reporting mechanisms as well as related training. Record-breaking numbers of tips were reported to the SEC during the pandemic. This may have been because of a breakdown in internal reporting mechanisms for a remote workforce. Consider a fresh internal reporting campaign to refocus a returning workforce, whether it be full-time in the office, continuing remote, or some hybrid. The statistics show that the current mechanisms for internal reporting may not be effective anymore.
– Anti-Retaliation Policies and Training. Ensure that whistleblower anti-retaliation polices and training are up-to-date. Now is the time for companies to review anti-retaliation policies to ensure they are clear and concise. Annual training should be conducted to ensure that everyone understands what retaliation is and knows the steps that can and cannot be taken once someone reports internally or to the government. Zero tolerance policies that are advertised to the workforce can help employees get comfortable reporting internally rather than straight to the governmental authorities.
– Domestic and International Policies. Review and update both domestic and international policies. In light of the purported award in the PAC case, companies should be aware that whistleblower tips may arise from and with respect to any part of their business, including activity overseas. In FY 2020, 11% of whistleblower submissions to the Commission were submitted from non-US countries. Since the inception of the program, the SEC has received tips from whistleblowers in 130 countries. Properly and consistently implemented robust internal reporting mechanisms and whistleblower policies provides an additional safeguard for compliance with US and international laws and regulations.
– Liz Dunshee
The merger between the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) has now closed – and the combined organization will now be known as the Value Reporting Foundation. The deal is an effort to simplify the ESG reporting landscape by aligning disclosure tools from two of the major players. From the press release:
The Value Reporting Foundation is a global nonprofit organization that offers a comprehensive suite of resources designed to help businesses and investors develop a shared understanding of enterprise value — how it is created, preserved or eroded over time. The resources — including Integrated Thinking Principles, the Integrated Reporting Framework and SASB Standards — can be used alone or in combination, depending on business needs. These tools, already adopted in over 70 countries, comprise the 21st century market infrastructure needed to develop, manage and communicate strategy that creates long-term value and drives improved performance.
As I blogged last fall when this merger was announced, the VRF also intends to support other organizations such as the IFRS Foundation. There seems to be an acknowledgement that there are too many players in the “reporting framework” space right now. That makes it difficult for companies to determine what’s important to disclose and difficult for investors to compare disclosures.
The Value Reporting Foundation may have more global reach & influence than the IIRC or SASB had on their own – with SASB gaining a lot of acceptance in the US but not oversees, and the inverse being true for IIRC. Michael Bloomberg, who is the chair of the TCFD and who has been a SASB supporter since its early days, is also a Chair Emeritus of the new organization. It remains to be seen whether or how any of these standards will get adopted by national regulators.
All of the existing resources from the IIRC and SASB remain available on their websites for now – but you can also visit the new VRF website for more tools.
– Liz Dunshee
We’re regularly posting new podcasts for members! In this 25-minute episode, Dave Lynn and McKesson’s Jim Brashear take a deep dive in to the SEC’s new requirements for electronic signatures for SEC filings. Topics include:
– Background of Signature Requirements
– The SEC’s Regulation S-T Rule Changes
– How to Authenticate an Individual’s Identity
– Addressing Non-Repudiation
– Initial Electronic Signature Authentication Document
– Retention of Electronic Signatures
– Liz Dunshee
Insider trading is always a juicy topic in the financial media. Once the spotlight is focused on trades that appear well-timed, Rule 10b5-1 technicalities are of limited use to companies and execs who want to reclaim the narrative – which is especially true when the “safe harbor” trades occur only days after adopting a trading plan. This Bloomberg article shows that those types of details are now getting picked up and scrutinized. Here’s an excerpt:
Short-term plans for stock trades are surprisingly prevalent, hinting at a significant gap in the agency’s surveillance, according to research from Stanford University and the Wharton Business School. The academics there reviewed 20,000 plans filed on paper by corporate leaders. About 38% of the plans call for trades within the same quarter, before earnings results were announced. About 82% have cooling-off periods of fewer than six months. The transactions consistently avoid large losses and foreshadow future price declines, according to the study.
I first blogged back in February about the Stanford research that Bloomberg is citing – the study was getting quite a bit of buzz and was cited by a handful of US Senators who were urging the SEC to take action. Fast-forward to now, and reforms to Rule 10b5-1 are looking more likely in light of SEC Chair Gary Gensler’s remarks earlier this month and the appearance of the rule on the Reg Flex Agenda.
One of the biggest changes that’s being evaluated is whether to propose adding a “cooling off” requirement to the safe harbor. Another potential change would be proposing disclosure about a plan’s adoption date on the Form 4 that’s filed to report the transactions under the plan. Right now, that info is only required on Form 144s, which see very little daylight since they’re typically submitted in paper format to the SEC. That was another big point of contention in the Stanford study.
Although it’s currently not baked into the rule, many companies already require insiders to observe a “cooling off” period when they adopt Rule 10b5-1 trading plans. The pause between the time the plan is adopted and the execution of the first trade functions as a “belt & suspenders” to ensure the insider doesn’t possess any material non-public info at the time the plan is adopted, which is one of the requirements to get safe harbor treatment. As we note in our “Rule 10b5-1 Trading Plans Handbook,” practice varies in terms of the length of this period – typical time frames are anywhere from two weeks, to 30, 60 or 90 days. Chair Gensler floated the idea that there should be a much longer pause than is common right now – as long as 4-6 months.
We’ve been posting memos about these potential reforms in our “Rule 10b5-1″ Practice Area – and we have an all-star webcast lined up on the topic next month, on Tuesday, July 20th at 2pm ET.
– Liz Dunshee
A member recently posted this question in our Q&A Forum (#10,761):
What do companies do to enforce their insider trading policies when employees accidentally trade during a blackout period?
I’ve had this come up a few times. The first thing that needs to be done is to review the facts and circumstances surrounding the violation in order to assess its seriousness and to determine whether there’s a potential control issue. Then, there needs to be some kind of sanction, even if the violation was accidental and did not result in any violation of the law. In the case of minor violations, there’s usually been some sort of formal reprimand and additional training in the policy’s requirements.
The really key thing is that you need to enforce the policy in order to get any credit for it from the SEC and other regulators. There are discussions of issues associated with enforcement of insider trading policies throughout our Insider Trading Policies Handbook.
– Liz Dunshee
Earlier this week, the Supreme Court issued its long-awaited decision in Goldman Sachs Group v. Arkansas Teacher Retirement Systems, a securities fraud class action against Goldman Sachs. The litigation arose out of statements Goldman made before the 2008 financial crisis about its commitment to compliance and its ability to identify & prevent conflicts of interest.
A few years later – in the midst of the financial crisis – it came to light that Goldman didn’t fully comply with all laws, didn’t prevent all conflicts of interest, etc. (the bank paid $550 million in 2010 to settle SEC charges related to a subprime mortgage CDO, among other things). Goldman’s stock price dropped, and the lawsuit commenced.
The plaintiffs presented a 10b-5 “fraud on the market” theory that Goldman’s statements about its honesty & integrity had artificially inflated the stock price. Under this theory, anyone who bought shares was defrauded, because they suffered a loss after the truth came to light.
SCOTUS kind of disagreed – but it’s muddy. It’s not the home run that companies and D&O insurers were hoping for, because the Court held that the company has the burden of proof to present evidence that “severs the link” between the statements it made and the price drop. However, companies can offer all sorts of evidence as part of that effort, and lower courts can consider that “generic” statements are less likely to impact price.
In this Twitter thread, Tulane Law prof Ann Lipton predicts the courts may end up coming pretty close to examining the merits of plaintiffs’ “price drop” arguments at the class certification stage. It could get messy in trying to distinguish this type of analysis from the Halliburton I holding of a decade ago, which said that plaintiffs don’t have to prove “loss causation” in order to get class certification.
This Gibson Dunn memo summarizes the issues & the holding in more detail. Here’s an excerpt:
– Today’s decision is the first time the Supreme Court has discussed the “inflation-maintenance” theory of securities fraud, although the Court expressly noted that it was taking no view on the “validity” or “contours” of that theory. Under the inflation-maintenance theory, a misrepresentation causes a stock price to remain inflated by preventing inflation from dissipating from the price. The theory, which has become increasingly common in securities class actions, often depends on an inference that a negative disclosure about the company corrected an earlier misrepresentation, and that a drop in the stock price associated with the disclosure is equal to the amount of inflation maintained by the earlier misrepresentation.
– The Court’s decision suggests important limitations on the theory. The Court explained that the inference that the back-end price drop equals front-end inflation “starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure,” and this occurs “when the earlier misrepresentation is generic . . . and the later corrective disclosure is specific.”
– The decision thus holds that defendants in securities class action suits may rebut the Basic presumption by arguing that the allegedly fraudulent statements are too generic to have impacted the price of the security, even if those arguments overlap with the ultimate merits of the case.
– The Court also clarified that its prior decisions in Basic and Erica P. John Fund, Inc. v. Halliburton Co., 563 U. S. 804, 813 (2011), established that securities-fraud defendants bear the ultimate burden of persuading the court that the Basic presumption does not apply. The Court’s decision thus underscores the importance of defendants offering factual and expert evidence at the class certification stage to rebut the Basic presumption.
We’ll see what happens here, but it sounds like this holding is unlikely to cut the plaintiffs’ bar off at the pass. With the “inflation maintenance” theory still kicking, aspirational statements may continue to land companies in court under the “everything is securities fraud” paradigm. Once you get there, you can claim the statements were “generic” and submit a lot of evidence to show why the class shouldn’t proceed.
For more commentary, see:
– This Dorsey blog
– This Stinson blog
– Matt Levine’s column
– Liz Dunshee
There are two great questions of our time:
1. Is everything securities fraud?
2. Is ESG the answer to everything?
A recent study from Duke Law prof Emily Strauss attempts to answer both of these queries. She first finds that event-based securities litigation – and the big settlements that often result from it – is being driven by institutional investors who piggyback on regulatory investigations into big companies. This Cooley blog summarizes the study and highlights some surprising stats:
In a conclusion that may seem counter-intuitive, the author found that regular securities cases, where shareholders are the primary victims, are almost 20 percentage points more likely to be dismissed (55%) than event-driven securities cases (36%). What’s more, the average shareholder settlement in event-driven securities litigation (where the misconduct most directly harms victims other than shareholders) is $24.3 million compared to $7.2 million for regular securities litigation where the primary victims are shareholders.
The author noted that these correlations “persist even when controlling for firm size, class period duration, court expertise, and indicia of merits of the lawsuit, such as institutional investors as lead plaintiffs, earnings restatements within the class period, and whether the complaint cited an SEC investigation.” In addition, defendant companies in event-driven securities cases are larger on average ($29.6 billion in total assets), compared to regular securities class actions on average ($8 billion in total assets).
And, almost 70% of event-driven securities cases were brought by pension funds and other institutional investors, compared with only 42% of regular securities litigation. That’s notable because “institutional investor lead plaintiffs are associated with lower dismissal probability and dramatically higher settlement values. They also generally appear to sue much larger firms.”
Professor Strauss suggests that mandatory ESG disclosures may dampen opportunities for this type of litigation. The logic is that companies would be more likely to disclose (and address) the underlying issues that lead to the types of incidents likely to set off the chain reaction of investigations, stock drops, and lawsuits – and shareholders would be better able to monitor them along the way. Others believe that additional ESG disclosure will just provide fodder for different types of opportunists, at least during the “transition phase.”
– Liz Dunshee
I continue to team up with Courtney Kamlet of Vontier to interview women (and their supporters) in the corporate governance field about their career paths – and what they see on the horizon. We recently celebrated our two-year anniversary of this series. Check out our latest episodes!
– Ginny Fogg, recently retired General Counsel of Norfolk Southern
– Michelle Leder, Founder of the financial news site footnoted*
– Karen Francis, Senior Advisor at TPG Capital, and Board Chair at Vontier Corporation
– Jackie Cook, Director of Sustainable Stewardship Research at Morningstar
– Lily Brown, Partner at WilmerHale
– Liz Dunshee
You know we love “fake SEC filings” around here – and this CNBC article recaps quite the scheme. Allegedly, a group of scammers scooped up shares from dormant shells that were still trading sporadically on the OTC. After using fake resignation letters and statements to reinstate the companies’ state corporate registrations and get the companies’ EDGAR codes, they filed 8-Ks to say that they were the new execs/directors, issued press releases about completely fabricated deals, and dumped the stock at an inflated price. Yesterday, the SEC announced that it had filed a complaint against the apparent ringleader.
Although I’m somewhat impressed and flattered that these folks would take the time to understand the mechanics of EDGAR and Secretary of State filings, I’m left thinking that these steps turned the pump & dump into an extra well-documented crime. They used their real names in the filings!
I’m also a little disappointed. If the alleged scammers were trying to appear legitimate, they should’ve gone all the way and made the other required filings, like the press releases and periodic reports. Maybe these filings were made and have since been removed – but if not, I’d like to know whether it was the time & effort that held them back from doing that, or if they simply decided that more securities fraud was a bridge too far.
While I’m nit-picking, here’s another suggestion for improvement: at least some of the companies also had suspended their Exchange Act filing obligations many years in advance of the Item 5.02 filing. It’s suspicious to drop a new Form 8-K out of nowhere. What legitimacy was gained from all this work?
I’m definitely not giving crime advice here, and I’m too risk averse to understand the appeal of any of this – especially for a mere $100k in trading profits! But what I’ve learned today is that it’s probably better to just stick to message boards and social media for your pump & dump.
– Liz Dunshee
A recent Gartner survey of 166 public & private companies found that 62% expect audit fees to increase this year. The survey also found that companies that automate at least a quarter of their internal controls paid 27% lower audit fees on average, and that companies have some success in keeping fees down through negotiation.
Dan Goelzer’s latest newsletter provides a nice summary of all the findings. Here are a few takeaways:
– Companies in the banking and insurance sectors had the highest percentage of fee increases – 69 percent of those respondents reported increases. The technology/telecom sector had the lowest percentage of fee increases – 41 percent of respondents in that sector reported increases in 2020.
– Of the companies in all industries that reported fee increases, 22 percent reported increases of 6 percent or more, compared to 2019.
– Companies that sought to negotiate fees with their auditor were frequently rewarded. Gartner reports that, of the respondents that undertook negotiation, 45 percent said their fees decreased by more than 6 percent, while half were able to decrease their fees by 3 to 6 percent.
– Companies with fewer controls were the greatest beneficiaries of automation. Respondents with less than 50 controls, and more than 25 percent of those controls automated, reported 52 percent lower audit fees, compared to companies with less than 25 percent of automated controls.
Dan says that other surveys also indicate that fees could jump this year – so audit committees may want to look at internal control automation & fee negotiation as cost-control tools.
– Liz Dunshee