Late yesterday, Bloomberg broke news that the SEC is investigating whether Coinbase allows trading in digital assets that should be registered as “securities.” The charges haven’t been publicly confirmed by the Commission or the company.
This would be an even more direct enforcement attack on the crypto space than last week’s insider trading action. If the SEC pursues the claim & wins this interpretive issue, it would trigger a cascade of rules and may require Coinbase to register as an exchange. Here’s an excerpt:
The US Securities and Exchange Commission’s scrutiny of Coinbase has increased since the platform expanded the number of tokens in which it offers trading, said two of the people, who asked not to be named because the inquiry hasn’t been disclosed publicly. The probe by the SEC’s enforcement unit predates the agency’s investigation into an alleged insider trading scheme that led the regulator last week to sue a former Coinbase manager and two other people.
In a 32-page petition submitted last week (the same day as this blog that the company’s CLO posted in response to the SEC’s insider trading complaint), Coinbase called on the SEC to propose and adopt rules to govern the regulation of digital assets, and accused the Commission of an enforcement-first approach to regulatory challenges. Coinbase – which has enlisted quite a lot of brainpower to analyze these issues – takes the position that the tokens that it lists on its platform aren’t “securities.” Its petition includes 50 multi-part questions for the Commission to consider and seek public input on.
In our “Insider Trading Policies” Handbook, we’ve long noted that the SEC has touted its use of data analytics to identify suspicious trading patterns. A year ago, I blogged that those tools seem to be getting even more advanced. That’s a useful point to know & share if you’re on the compliance side, trying to instill fear & obedience. If you’re a bad guy, it’s not such happy news.
Yesterday, the SEC announced that it’s added a few more notches to its “data analytics” belt. Here’s more detail:
The Securities and Exchange Commission today filed insider trading charges against nine individuals in connection with three separate alleged schemes that together yielded more than $6.8 million in ill-gotten gains. Those charged include a former chief information security officer (CISO), an investment banker, and a former FBI trainee, all of whom allegedly shared confidential information with their friends, who then traded on that confidential information. Each of the three actions announced today originated from the SEC Enforcement Division’s Market Abuse Unit’s (MAU) Analysis and Detection Center, which uses data analysis tools to detect suspicious trading patterns.
The SEC also announced insider trading charges yesterday against a retired US Congressional Representative and former prosecutor who allegedly traded on MNPI he received as a consultant after leaving Congress. Insider trading: don’t do it! See our “Insider Trading Policies” Practice Area for lots of resources that can help you convince your colleagues, friends & clients to stay on the right side of the law.
In 2019, SCOTUS set the stage for expansive “scheme liability” under Exchange Act Rule 10b-5(a) & (c) in Lorenzo v. SEC. Unlike primary liability under Rule 10b-5(b), scheme liability under subsections (a) & (c) can attach to someone who didn’t “make” the misrepresentation or omission. When the 10th Circuit applied Lorenzo later that year, it put an exec on the hook for “disseminating” false & misleading statements.
In what’s good news for those involved with preparing disclosures and supporting documentation, the 2nd Circuit – which has been called the “Mother Court” of securities law in another SCOTUS decision, according to this Paul Weiss memo – recently held that an actionable claim under subsections (a) and (c) must be based on more than alleged misrepresentations & omissions alone. There must be “something extra.”
“individuals who helped draft, research, print, or wordsmith [a] statement at some point in time, but who lacked ultimate control, cannot be primarily liable.” Read alongside the Supreme Court’s Janus decision, the Rio Tinto Court explained, Lorenzo “signaled that it was not giving the SEC license to characterize every misstatement or omission as a scheme.” The Second Circuit reasoned that Janus would be undermined if scheme liability were expanded to encompass mere participation.
The Rio Tinto Court further cautioned that expanding scheme liability to reach actors other than the “makers” of misstatements would lower the bar for private plaintiffs, who face a heightened pleading standard for Rule 10b-5(b) cases under the Private Securities Litigation Reform Act that does not apply to scheme liability cases.
Similarly, limiting statements cases to subsection (b) would maintain the distinction between cases the SEC could pursue from those private plaintiffs could bring — i.e., the SEC, but not private plaintiffs, may pursue aiders and abettors of Section 10(b) violations. Embracing the “SEC’s reading of Lorenzo,” the Second Circuit explained, would be contrary to Supreme Court precedent and would undermine “Congress’ determination that this class of defendants should be pursued by the SEC and not private litigants.”
While this is encouraging news in the short term, the “something extra” that can trigger scheme liability remains undefined. The MoFo memo emphasizes that more cases are in the hopper. Corruption of the audit process or concealment of info from auditors could be examples of actions that would trigger liability under these provisions. Stay tuned to our “Securities Litigation” Practice Area for instructions on how these complex cases could affect your processes for preparing SEC filings and your guidance to clients.
When it comes to being sued for alleged misstatements or omissions, forward-looking statements can be fertile ground for plaintiffs and the SEC. This Woodruff Sawyer blog recounts a Tesla case from last year that took issue with production estimates.
As anyone who’s spent their early associate years combing through “cautionary statements” knows, there’s an art to making sure the forward-looking statements are reasonable and that cautionary language accompanies the statements and is specific enough to protect the company under the Private Securities Litigation Reform Act. Now is a good time to audit your process and ensure you’re keeping up with best practices. The blog walks through these pointers:
1. Review your forward-looking statements disclaimers often.
A company is best served to regularly review the cautionary statements included in its forward-looking statements disclaimers. This will help ensure that the cautionary statements reflect the risks and circumstances impacting the company at any given time. While a quarterly review of the forward-looking statements disclaimers is a good practice, reviewing in conjunction with ongoing public disclosures is a best practice. That is, companies should be mindful to consider updating forward-looking statements disclaimers to account for new risks related to its business, market, or other conditions (e.g., the COVID-19 pandemic, global conflict).
2. Pressure-test forward-looking statements.
This one may be obvious, but it’s still important to stress that there must be a reasonable basis underlying each of the forward-looking statements your company expects to make and to confirm in advance of repeating those statements. For example, if your management team is slated to provide an update on the company’s strategy and financial outlook at a company-sponsored investor day, there should be a robust internal review and confirmation of each forward-looking statement included in the slide presentation, as well as any related scripts and talking points.
3. Ensure the forward-looking statements are appropriately qualified by cautionary statements.
Forward-looking statements should be accompanied by cautionary statements tailored to your company’s circumstances. These cautionary statements should help investors understand how your forward-looking statements may differ materially from the company’s expectations. For example, if your company is a clinical-stage pharmaceutical company and you expect to make forward-looking statements regarding the timing of clinical trial results as part of an investor presentation, the disclaimer should include cautionary statements that speak to clinical trials. Certain risks that may be appropriate for your disclaimer to reference may include anticipated challenges or delays in conducting your clinical trials; difficulty obtaining scarce raw materials and supplies; resource constraints, including human capital and manufacturing capacity; and regulatory challenges.
4. The forward-looking statements disclaimer should be reviewed/managed by a cross-functional team.
Most companies delegate management of the forward-looking statements disclaimer to its legal function. As a best practice, companies should ensure that other functions (e.g., Finance, Investor Relations, Accounting) are also involved in the review and commenting process. A robust process will help to establish that the cautionary statements included in your forward-looking statements disclosure can stand up to claims that the disclaimer was not reflective of the current risks and/or circumstances that could impact your business.
5. State at the outset of events where forward-looking statements will be made that such statements will be made and where to find the associated cautionary statements.
As noted earlier, in the case that your company will be making oral forward-looking statements, ensure that a company representative orally states that the company will be making forward-looking statement and reference that cautionary language is contained in a “readily available” written document. This oral statement should be consistent across different settings. There may be a tendency to truncate the oral statement that is used during earnings calls when it comes to more informal events like a company town hall or fireside chat. That should be avoided.
6. Include forward-looking statements disclaimers in certain internal presentations and communications.
As discussed earlier, certain internal presentations may call for the inclusion of forward-looking statements disclaimers. Certain internal communications, like company-wide emails, may fall into the same category. Best practice would be to establish guidelines regarding which internal presentations and communications call for these disclaimers. These guidelines can then be shared with the functional teams that organize internal presentations and communications with the instruction that they involve Legal early in the planning process.
7. Don’t forget about your website and social media presence.
Many companies include forward-looking statements disclaimers on their websites. These disclaimers are typically linked to via a section in the footer or included in the website’s terms of use. Social media is another area where companies make forward-looking statements. If you are one of these companies, it is a good idea to identify who manages your company’s website and social media presence. Best practice would be to educate those teams as to the importance of forward-looking statements disclaimers and establish a process whereby those teams can easily collaborate with Legal to ensure compliance with securities laws.
Visit our “Forward-Looking Statements” Practice Area for more practical guidance on crafting cautionary statements – including examples and court opinions that show how disclosures can be challenged.
With the soon-to-be-effective universal proxy rules being a hot topic for anyone who advises boards or activists or who has a hand in proxy season, I wanted to highlight this recent “Deal Lawyers Download” podcast that John taped with Goodwin’s Sean Donahue about the rules. This is a follow-up to the popular DealLawyers.com webcast – “Universal Proxy: Preparing for the New Regime” – that we held earlier this year.
Topics addressed in this 19-minute podcast include:
– How will universal proxy change the dynamic of proxy contests?
– What strategic and tactical opportunities does universal proxy create for activists?
– What are some vulnerabilities that public companies may not have focused on?
– What should public companies do between now and September 1 to put themselves in the best position to deal with the universal proxy rules?
A lot of folks expect universal proxy to redefine the rules of the game – and on such a high-profile topic, you don’t want to be caught flat-footed. In addition to the webcast and podcast I already mentioned, visit the DealLawyers.com “Proxy Fights” Practice Area for more guidance. Also, stay tuned for additional members-only content on DealLawyers.com that will help you prepare to hit the ground running.
If you aren’t already a member of DealLawyers.com, sign up now and take advantage of our “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund! You can sign up online, by calling 800-737-1271, or by emailing sales@ccrcorp.com.
John’s also having a blast with these “Deal Lawyers Download” podcasts – here are all the episodes he’s taped so far. If you have something you’d like to talk about, don’t hesitate to email him at john@thecorporatecounsel.net. He’s wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game. We view these sites as a resource that the community participates in, and hearing from members is one of the best parts of any day!
Dave recently blogged about some of the potential implications of the SCOTUS’s decision in West Virginia v. EPA for the SEC’s proposed climate disclosure rules. This Freshfields blog also addresses that issue, and suggests that the decision make create some significant challenges to the SEC moving forward:
The Court’s ruling may complicate the finalization, enactment and enforcement of the SEC’s proposed rule, which is contemplated to be adopted later this year. If the SEC’s proposed rule is adopted in its current or similar form, critics may challenge it under the major questions doctrine by citing the Supreme Court’s reasoning in West Virginia v. EPA, and, in doing so, arguing that the SEC is relying on ambiguous statutory text to claim a significant expansion of power in a subject matter in which it lacks expertise.
Some have argued that the SEC’s statutory authority is “relatively clear,” and draw a distinction between the EPA’s direct regulation of emissions from coal plants and the SEC’s efforts to enhance disclosure. A former SEC attorney speculated that, if a claim is brought, the SEC could argue that the applicable court rely on the “Chevron doctrine” rather than the major questions doctrine. The Chevron doctrine requires courts to accept an agency’s interpretation of an ambiguous law if it is “rational” and “reasonable.” Notably, there is no discussion of the Chevron doctrine in the Court’s opinion in West Virginia v. EPA; however, the dissent noted that courts can “circumvent a Chevron deference analysis altogether” by interpreting a statute as negating an agency’s claimed authority.
It isn’t just the SEC’s proposed climate change disclosure rules that may face a challenge based on West Virginia v. EPA. As this Dechert memo points out, the major questions doctrine may also come into play when “the SEC or other financial regulators seeking to regulate markets involving cryptocurrencies and other blockchain products,” or when agencies like the FTC seek to alter traditional understandings of antitrust and competition law.
Some very heavy hitters have argued that the SEC’s authority to promulgate these rules is pretty clear. Having read some arguments to the contrary, I’m less sanguine about the SEC’s chances in federal court if it adopts rules along the lines it has proposed. Regardless of the legal merits of their arguments, I think the proponents may have failed to “read the room”. The arguments advanced for the SEC’s authority to require climate disclosure appear to be premised on the view that this authority is virtually limitless, and that’s just not where the federal courts are right now when it comes to agency power.
Kevin LaCroix keeps close tabs on securities class action filings, and recently blogged on the “D&O Diary” about how the first half of 2022 is shaping up in comparison with prior years. This excerpt summarizes his findings:
The number of securities class action lawsuit filings in the first half of 2022 remained at the lower levels that prevailed last year and below the more elevated levels that prevailed during the period 2017-2020. Though the number of securities class action lawsuit filings in the year’s first six months is below the recent higher levels, the number of suits filed is still consistent with long-term averages. The difference in the number of filings so far this year and the elevated numbers during the recent period were both largely due to merger objection lawsuit filings patterns.
According to my tally, there were 103 federal court securities class action lawsuits filed in the first half of 2022. That first half number annualizes to a projected year-end total of 206, which would be slightly below the 211 federal court securities class action lawsuits filed in 2021 and well below the 319 federal court securities suits filed in 2020.
Kevin goes on to explain that while there’s still a booming business in federal court merger objection filings, most of these cases are not being filed as class actions, but as individual lawsuits. That’s why they don’t show up in the stats.
Rule 3-13 of Regulation S-X gives the SEC authority to waive certain financial statement requirements that public companies would otherwise have to comply with. Historically, many of the requests for Rule 3-13 waivers were submitted by companies engaging in acquisitions and related to the SEC’s rules regarding acquired company financial statements. The SEC amended those rules in 2020 to lessen the burden on acquiring entities. According to this Thomson Reuters report, that has resulted in a decline in waiver requests:
“We have seen a decline in our waiver letter process over the last two years. And I would say that this is directly related to the rulemaking that the division did, specifically CorpFin OCA related to 3-05, 3-14 and pro formas, and article 11. I mean, it really addressed our common waivers we’ve received,” CorpFin Chief Accountant Lindsay McCord said at the 40th annual SEC Financial Reporting Institute Conference hosted by the University of Southern California (USC) on June 2, 2022.
The article also discusses the Staff’s recent tweaks to the Rule 3-13 waiver process intended to make it more efficient.
According to a recent Fortune article, it looks like the idea of separating the roles of CEO and Board Chair is gaining more traction among public companies. Here’s an excerpt:
A growing share of companies are tapping independent directors to hold the chairman seat, according to a new survey from The Conference Board using data from ESGAUGE, and shared exclusively with Fortune. The percentage of S&P 500 companies that combine the board chair and CEO roles dropped from 49% in 2018 to 44% in 2022, while the percentage of companies with an independent board chair increased from 30% to 37% in that same time frame, according to the report.
Conventional wisdom says the more directors who are not affiliated with the company, the better because it decreases potential conflicts of interest and better positions boards to maintain objectivity when making executive decisions. These days, companies are even more inclined to separate CEO and board chair duties because of directors’ increased workloads.
The percentage of companies splitting the two roles seems to be heavily weighted toward small caps. The article says that 55% of companies with $50 billion or more in annual revenue have the same person serving as CEO and Chair, but only 25% of companies with annual revenue under $100 million combine the two positions. (h/t The Activist Investor)
Audit committees focus a lot of attention on the potential for financial fraud, but this Deloitte memo says that they need to devote greater attention to an emerging area of fraud risk – ESG fraud. Here’s an excerpt:
In preparation for expected new reporting requirements, many companies are in the process of developing more robust ESG-related disclosure controls and procedures as well as internal control over financial reporting (ICFR). Some companies are developing ESG-related metrics for financial reporting and for incorporation into incentive compensation.
Ahead of these possible rule changes, fraud risk in this area should be top of mind for audit committees and a focal point in fraud risk assessments overseen by the audit committee. Many companies are currently providing information to investors that is not governed by the same types of controls present in financial reporting processes.
As an example, companies may voluntarily provide information on carbon emissions that has not been gathered, tested, and reported under the kind of internal controls that typically are present with financial reporting. This may suggest a heightened opportunity for people within the organization to manipulate ESG-related information.
The memo notes that the increasing desire to link the achievement of ESG metrics to compensation is another factor that may elevate fraud risk. It points out that under the classic “fraud triangle” theory, the presence of three factors – financial pressure, opportunity, and rationalization – can create an elevated risk of fraud, and that ESG-related financial incentives can represent a source of financial pressure.
Lawrence has blogged about this issue – and related guidance – on PracticalESG.com. If you aren’t already a member of that site, sign up to take access curated, practical guidance on these risks. Our “100-Day Promise” makes this a “no-risk” situation: during the first 100 days as an activated member, you may cancel for any reason and receive a full refund.