Join us tomorrow for the webcast – “SEC Enforcement: Priorites & Trends” – to hear Hunton Andrews Kurth’s Scott Kimpel, Locke Lord’s Allison O’Neil, and Quinn Emanuel’s Kurt Wolfe provide insights into the lessons learned from recent enforcement activities and insights into what the new year might hold – including how the election may impact the SEC’s enforcement program.
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On Tuesday, the Supreme Court heard oral arguments in Facebook, Inc. v. Amalgamated Bank. The outcome of this case – as well as another biggie teed up for oral argument next week – could affect the way we draft risk factors and cautionary disclaimers.
Here, as Meredith previewed a few months ago, the company is facing allegations that the “cyber & data privacy” risk factor in its 2016 Form 10-K was misleading because it didn’t disclose that Cambridge Analytica had already improperly collected and harvested user data. “Hypothetical risk factors” are a type of disclosure that the SEC has been kvetching about since… at least 2019, when it settled an enforcement action with Facebook/Meta on this same issue, and as recently as last month when it settled an enforcement action with a SolarWinds victim under a similar theory of “half-truth” liability.
The more recent action was accompanied by a joint dissent from Commissioners Peirce and Uyeda that pointed out that updating risk factors for risks that have materialized is not always straightforward. Based on the tone of the oral argument in the Facebook case, it sounds like at least a few of the Justices share similar views. This WaPo article recaps:
In a lively argument, with hypotheticals involving the potential dangers posed by meteor strikes and space trash, at least three conservative justices seemed sympathetic to Facebook’s arguments that it had not misled investors and that its disclosures were forward looking. The court’s three liberal justices, in contrast, expressed support for the view of investors behind the lawsuit, who are backed in the case by the Biden administration.
Chief Justice John G. Roberts Jr. seemed concerned about the implications for public companies of adopting the position of the investors, calling it “a real expansion of the disclosure obligation.” Justices Neil M. Gorsuch and Brett M. Kavanaugh said the Securities and Exchange Commission could be more explicit if it wanted to require companies to report relevant past events.
I was a little surprised by one exchange from the oral argument. I am no Constitutional law expert, but after the Court’s very recent decision in Loper Bright that agencies should stay in their lane, I didn’t expect a Justice to suggest that the SEC should handle this issue through rulemaking. From WaPo:
“Why can’t the SEC just write a reg?” Kavanaugh asked. “Why does the judiciary have to walk the plank on this and answer the question when the SEC could do it?”
Maybe this was a trick question, in which case I’d like to submit a guess that this rule already exists, at least to some extent, by way of Item 101 and Item 303. Clearly, there are a lot of open questions here. The biggest one being, who would have predicted we’d still be talking about Cambridge Analytica during Election Week 2024? Lucky us.
On Monday, FASB announced that it had published an Accounting Standards Update that will require publicly traded companies to provide more detail about expenses that are reflected on their income statement. Specifically, ASU 2024-03, Disaggregation of Income Expenses (DISE), will require companies to:
1. Disclose the amounts of (a) purchases of inventory; (b) employee compensation; (c) depreciation; (d) intangible asset amortization; and (e) depreciation, depletion, and amortization recognized as part of oil- and gas-producing activities (or other amounts of depletion expense) included in each relevant expense caption.
2. Include certain amounts that are already required to be disclosed under current generally accepted accounting principles (GAAP) in the same disclosure as the other disaggregation requirements.
3. Disclose a qualitative description of the amounts remaining in relevant expense captions that are not separately disaggregated quantitatively.
4. Disclose the total amount of selling expenses and, in annual reporting periods, an entity’s definition of selling expenses.
Investors have been calling for this update for several years. I’ve blogged about the “employee compensation” aspect a few times on CompensationStandards.com. This PwC memo explains what the new ASU will require and provides helpful FAQs. Here’s an excerpt that clarifies where the new disclosures will appear:
The new standard does not change the presentation of expense information or expense captions reported on the face of the income statement. Rather, the new standard requires disclosures in the footnotes that provide disaggregated information about an entity’s expense captions that are presented on the face of the income statement within continuing operations.
The new ASU is effective for annual reporting periods beginning after December 15, 2026 and interim reporting periods beginning after December 15, 2027.
In the latest “Understanding Activism with John & J.T.” podcast, John and Orrick’s J.T. Ho were joined by Elizabeth Gonzalez-Sussman, head of Skadden’s shareholder engagement and activism practice. Prior to joining Skadden, Elizabeth was a partner at Olshan Frome, where she advised hedge funds and large investors on the strategy and execution involved in all types of shareholder activism-related activities.
Topics covered during this 33-minute podcast include:
– The reasons why companies have fared better in proxy fights in recent years
– The current environment for activist settlements and tips for companies considering a settlement
– Activism in multi-class companies
– The decline in “bed bug” letters and when it still makes sense to send them
– Elizabeth’s lessons for corporate clients from her experience in advising activists
– Implications of recent Delaware case law and statutory changes for settlement terms
– Dealing with multiple activists
– Evolution of activist strategies and lawyers’ roles over the next few years
This podcast series is intended to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. John & J.T. continue to record new podcasts, and I think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
Programming note: In observance of Veterans Day, we will not be publishing blogs on Monday. Thank you to all who have served or have family members who have served.
Earlier this week, the SEC’s Office of Inspector General released its annual report on the agency’s top management and performance challenges. This year’s report is 20 pages – compared to last year’s 34-page review. This reflects the OIG’s cycle of preparing a detailed examination in one year and following up with a shorter summary the following year.
In the OIG’s view, the current (anti-)regulatory environment is one of the biggest risks the SEC currently faces. The report lists several rules that were recently vacated or stayed, and observes:
The current regulatory environment may lead to increased forum shopping by petitioners and extended periods of uncertainty about the permissible scope of agency action.
With heightened judicial scrutiny, agencies, including the SEC, must continue to develop a thorough administrative record, including meaningful opportunity for public participation and reasoned responses to public submissions. The SEC already invests considerable resources toward these ends, but should be prepared for additional litigation, as industry and public interest groups may take opportunities to challenge regulations.
The OIG also notes:
The SEC should anticipate increased litigation by parties challenging current and future rulemakings and ensure that new regulations will withstand judicial scrutiny.
Over the past year or two, the SEC has been signaling that it understands these risks, by taking extra time to consider comments and building out the cost-benefit analysis in its adopting releases. But the OIG is doing more: it’s auditing the rulemaking process and internal controls, focusing on:
– The opportunity for interested persons to participate in rulemaking;
– Assessing and documenting the impact of proposed rules on competition, efficiency and capital formation; and
– Ensuring that staff with appropriate skills and experience are involved in formulating and reviewing proposed rules.
It expects to complete a report on this in 2025. That said, in light of this week’s election results, there’s a chance that in the near future, the SEC won’t care so much about adopting and defending new rules (at least, the ones that arguably make being a public company more difficult). John will be blogging in the coming week about what other developments might be in store at the SEC next year…
This year’s report from the SEC’s Office of Inspector General also acknowledges the Supreme Court’s decision this year in SEC v. Jarkesy – which prevents the SEC from using administrative proceedings in contested securities fraud actions for civil penalties. The report says this has created uncertainty on the enforcement front:
The decision may have broader implications for the SEC’s enforcement program, as open questions remain, such as the constitutionality of seeking civil penalties in other types of administrative proceedings It is difficult to predict whether the availability of a federal jury trial will make defendants more likely or less likely to resolve claims in advance of litigation The uncertainty surrounding the SEC’s ability to adjudicate other enforcement actions administratively, as well as the additional resources required to bring actions in federal court, pose challenges for the SEC.
Related to this, but not mentioned in the report, is the fact that the SEC has been dismissing misconduct proceedings against accountants that were pending before administrative law judges. I blogged about that a couple months ago – here’s a LinkedIn post about the impact that the proceedings had on one accountant’s career.
According to this year’s annual report from the SEC’s Office of Inspector General, budget constraints are affecting the SEC’s ability to fulfill its mission and mitigate the risks it is facing. Here’s an excerpt:
The current budget environment constrains the SEC’s ability to address each of the challenges described in this report. Flat funding for Fiscal Year (FY) 2024 required an Agency-wide freeze on hiring, as well as the elimination of certain performance bonuses and other employee benefits. Increasing personnel costs limit the resources available to update and improve legacy information systems, including information security. The changing regulatory environment will likely increase operational demands on the Agency and its staff. Lack of resources may hinder the Agency’s ability to meet these challenges, mitigate its risks, and pursue its vital mission.
On the plus side, the report says there’s been lower attrition this year. But in addition to the hiring freeze, funding limitations are making it difficult to keep pace with competitive compensation arrangements for staff. Depending on how appropriation laws shake out, the SEC may have to suspend some benefits. That could affect the agency’s ability to recruit and retain staff.
Remember when the SEC’s X account was hacked earlier this year? A political circus ensued, and it eventually came out that the SEC hadn’t enabled two-factor authentication, which left its account vulnerable to a SIM swap scheme.
We hadn’t heard much more about the incident since January, but the wheels of justice have been turning. Last month, the DOJ announced the arrest of a 25-year-old Alabama man, who allegedly conspired with others. Here’s how the government says the crime happened:
As described in the indictment, Council, who used online monikers including “Ronin,” “Easymunny,” and “AGiantSchnauzer,” received personal identifying information (PII) and an identification card template containing a victim’s name and photo from co-conspirators. Council then used his identification card printer to create a fake ID with the information. Council proceeded to obtain a SIM card linked to the victim’s phone line by presenting the fake ID at a cell phone provider store in Huntsville, Alabama. He then purchased a new iPhone in cash and used the two items to obtained access codes to the @SECGov X account. Council shared those codes with members of the conspiracy, who then accessed the account – and issued the fraudulent tweet on the @SECGov X account in the name of the SEC Chairman, falsely announcing the SEC’s approval of BTC ETFs. Council received BTC payment for performing the successful SIM swap. Shortly after, Council drove to Birmingham, Alabama to return the iPhone used in the SIM swap for cash.
He later conducted internet searches for “SECGOV hack,” “telegram sim swap,” “how can I know for sure if I am being investigated by the FBI,” and “What are the signs that you are under investigation by law enforcement or the FBI even if you have not been contacted by them.”
Here’s the indictment with more details. The investigation is ongoing. So, the allegations haven’t been proven. And there may be more individuals who eventually face charges….
Although eye-poppingwhistleblower awards might make you think otherwise, the SEC is not throwing bags of cash at every [Redacted] who reaches out to them. An order issued by the Commission earlier this week serves as a warning to aspiring whistleblowers that they must exercise at least some discretion with their submissions.
The order not only denied a whistleblower’s award applications – it also permanently barred them from ever participating in the whistleblower program again. Here’s the background:
Claimant submitted three of the relevant award applications to the Office of the Whistleblower (“OWB”) in [Redacted]. Claimant bases these award claims on tips Claimant submitted alleging that Claimant lost $20,000,000,000,000 and became aware of misconduct involving an unnamed investment company, through, among other sources, account statements, broker-dealer records, publicly available information, SEC filings, and social media. Claimant lists – without any explanation – numerous internet pages, most of which appear to be social media posts, including links to companies providing market insights and analysis, legal alerts of criminal misconduct, company reports, U.S. and international articles and political commentary.
Claimant further identifies a purported investment company as the perpetrator of misconduct against Claimant and also alleges a “murder” that is linked to a business where Claimant was allegedly employed as a Non-Employee Director. Claimant’s tips were closed and do not on their face bear any relation to the charges in the Covered Actions.
I have a lot of questions about how someone could lose $20 trillion. Of course we’ll never know the details, but apparently, the Staff was skeptical:
On [Redacted], pursuant to Exchange Act Rule 21F-8(e), OWB provided notice to Claimant that it had determined that these seven award applications were frivolous or noncolorable. OWB also informed Claimant that the Commission has the authority to permanently bar a claimant. Accordingly, OWB recommended that Claimant withdraw all frivolous or noncolorable claims that he/she had submitted. The 30-day deadline to withdraw the claims expired on [Redacted], and Claimant did not respond.
The Commission issued a permanent bar because the claimant’s time-wasting, frivolous claims hindered the efficient operation of the whistleblower program. The ability to issue a bar was part of 2020 rule changes – and these FAQs give more color to whistleblowers about what will be considered “frivolous” or fraudulent. The order notes the claimant had filed “3 or more applications” – but it’s not clear exactly how many. The last time the Commission issued a permanent bar, the individuals had filed hundreds of frivolous applications.
I joked in my other blog today about redactions in whistleblower orders. The reason these orders have so much information blocked out is because Exchange Act Section 21F(h)(2)(A) directs the Commission to keep identifying information about whistleblowers confidential. The SEC seems to interpret that directive very broadly – but a recent joint statement from Commissioners Peirce and Uyeda point out that going overboard with redactions may have serious consequences. Here’s an excerpt:
Despite the undeniable importance of the information the Commission includes as part of its public final orders, the Commission’s releases, statements, and labyrinthian whistleblower rules are silent on how the Commission determines what information it can and cannot disclose. From the public’s perspective, as evidenced by the appearance on the Commission’s website of heavily redacted award determinations, someone at the Commission determines that this or that information should be redacted. The public is left with only limited, curated information to consider when assessing whether the award determination raises potential legal issues related to the interpretation and application of the whistleblower statutes and whether the Commission is applying its rules in a reasonable and consistent matter when it awards substantial sums of money from the public fisc.
Unnecessary redaction of final award determinations in the name of whistleblower confidentiality limits public information about the awards, and that, in turn, insulates the awards from scrutiny. And the whistleblower program needs scrutiny. Most direct participants in the program share a common incentive—to maximize awards. Whistleblowers have incentives to obtain the largest award possible; the Division of Enforcement has an incentive to maximize awards as an inducement for whistleblowers to come forward; and the Commission has an incentive to maximize awards as a metric to illustrate the success of the program. Ensuring that the Commission’s public final award determinations disclose, to the greatest extent possible, the facts supporting the determination and articulate the legal reasoning underpinning the Commission’s interpretation and application of the whistleblower statute and rules is a necessary and helpful check on the potential negative consequences of such an alignment of incentives. The whistleblower program is important to the Commission, so we should do everything possible to protect its integrity, including allowing appropriate outside scrutiny.
I’ve always thought it would be fun to be the person who handles the redactions. It would be the closest I’d ever get to becoming a CIA agent, and until now, it had seemed there was little downside to going too far. But the Commissioners make a good point. Maybe that job is going to get more difficult in the future.
