Category: Securities Law

Not Ship Shape: SEC Sues Retired Chief Petty Officer for Fraudulent Offerings to Navy-Related Victims

The U.S. Securities and Exchange Commission (“SEC”) Office of Investor Education and Advocacy (“OIEA”), which dates from last century, is concerned with explaining aspects of the capital markets for “Main Street” investors and warning them against potential risks and fraud schemes. On Sept. 25, 2017, the Commission announced the formation of the Retail Strategy Task Force (“RSTF”) in its Division of Enforcement. Its purpose is to consider and implement “strategies to address misconduct that victimizes retail investors,” according to the SEC Press Release issued that day. A primary focus area of the OIEA and RSTF is so-called “affinity investments,” i.e., investment offerings aimed at groups such as churches, ethnic communities, college alumni groups, etc.

On Wednesday, July 27, 2022, the SEC filed suit in the Federal Court for the Northern District of Ohio, Eastern Division, against Robert F. Murray, 42, a retired U.S. Navy Chief Petty Officer residing in North Canton, Ohio, for conducting an unregistered offering of securities in Deep Dive Strategies, LLC, an Ohio private pooled investment fund (the “Fund”). Murray controlled the Fund and acted as investment adviser, telling investors the fund would invest in publicly traded securities. Murray marketed the offering through a Facebook group “with over 3500 active duty, reservists and veterans of the U.S. Navy who shared an interest in investing,” according to the Complaint. Most certainly an “affinity” group. Murray also created “a channel on the Discord social media platform where he live-streamed his trading activity and posted trading advice with a focus on options.”

The Fund was organized in September 2020 and solicited investors through February 2021. Although Murray told investors they could change their minds within 15 days and get their money back, in fact he “almost immediately began spending Fund money on personal expenses.” He transferred monies to his personal checking account and even withdrew cash from the Fund, so by February 2021, $148,000, or approximately 42% of the $355,000 invested by the unsuspecting “Goats” (a nickname for the Navy affinity group), had been “misappropriated” (i.e., stolen) by Murray. By March 2021 he had ceased regular communication with the Goats and failed to respond to requests to redeem “invested” dollars. Some of that misappropriated money was lost gambling at casinos in Cleveland and elsewhere in the Midwest.

Murray provided potential investors with both a Disclosure Statement and a copy of the Fund’s Operating Agreement, and the Complaint identifies several material misstatements and omissions in the two documents. In addition, Murray made oral material misstatements and omitted material information when speaking with potential and actual investors. In fact, Murray lost most of the Fund’s brokerage account on Jan. 13, 2021, when GameStop options purchased in the account saw their value plummet. In that connection see my Feb. 2, 2021, Blog “Rupture Rapture: Should the GameStop?” When the SEC began investigating Murray and the Fund, he asserted his Fifth Amendment rights and declined to answer questions.

In the Complaint, the Commission charges Murray with seven different securities law violations, each set out in a separate Count as follows:

  1. Violation of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder by using devices, making untrue statements, and misleading omissions, and engaging in a business which operate as a fraud on securities purchasers.
  2. Violation of Section 17(a)(1) of the Securities Act of 1933, as amended (the “33 Act”), by offering and selling securities by means of interstate commerce using devices to defraud.  Violations of the 33 Act can be proven without the need to prove scienter (broadly, intent).
  3. Violation of Section 17(a)(2) of the 33 Act by obtaining money or property in connection with the sale of securities by means of untrue statements of material facts and making misleading omissions, engaging in transactions which operate as a fraud on the purchaser, where Murray was at least negligent in engaging in these activities.
  4. Violation of Sections 5(a) and 5(c) of the 33 Act by selling securities without the offering being registered (or exempt from registration), and with the use of a prospectus where the offering was not registered.
  5. Violation of Section 206(1) of the Investment Advisers Act of 1940, as amended (the “40 Act”) by acting as an investment adviser using devices to defraud clients and prospective clients.
  6. Violation of Section 206(2) of the 40 Act by acting as an investment adviser engaging in transactions which operate as a fraud on clients and prospective clients.
  7. Violation of Section 206(4) of the 40 Act and Rule 206(4)-8 thereunder by acting as an investment adviser to a pooled investment vehicle, making untrue statements of material fact and making misleading omissions and engaging in acts that are fraudulent with respect to investors in the pooled investment vehicle.

The SEC seeks entry of findings by the Court of the facts cited in the Complaint and of conclusions of law that concur with the Commission’s assertions of violations. In addition, the SEC seeks entry of a permanent injunction against future violations of the cited securities laws; an order requiring disgorgement of all Murray’s ill-gotten gains plus prejudgment interest; an order imposing a civil penalty of $1,065,000; and an order barring Murray from serving as an officer or director of any public company.

Murray preyed on his fellow Naval servicemen in violation of the unspoken understandings of the “Goats,” that a fellow Navy NCO would not seek to take financial advantage of them. That is why the SEC’s July 28, 2022, Press Release reporting this matter includes an express warning from the OIEA and the RSTF not to make “investment decisions based solely on common ties with someone recommending or selling the investment.” One wonders whether, if the Goats were to catch up with Murray, he would be keelhauled.

Article By Peter D. Hutcheon of Norris McLaughlin P.A.

For more securities and SEC legal news, click here to visit the National Law Review.

©2022 Norris McLaughlin P.A., All Rights Reserved

Is The End Of FINRA Drawing Nigh?

The Financial Industry Regulatory Authority, aka FINRA, is a non-profit Delaware corporation.  It was formed in 2007 by the combination of the National Association of Securities Dealers, Inc. and the regulatory arm of the New York Stock Exchange, Inc.  FINRA is a self-regulatory organization that primarily regulates securities broker-dealers.

Professor Benjamin P. Edwards recently reported that a complaint has been filed in Florida challenging the constitutionality of FINRA.  The lawsuit filed by two broker-dealers alleges:

However, FINRA’s current structure and operations, particularly in light of the transformation of the organization over the course of the last two decades, contravene the separation of powers, violate the Appointments Clause of the United States Constitution (the “Constitution”) and constitute an impermissible delegation of powers. Because it purports to be a private entity, FINRA is unaccountable to the President of the United States (the “President,” or “POTUS”), lacks transparency, and operates in contravention of the authority under which it was formed.  It utilizes its  own in-house tribunals in a manner contrary to Article III and the Seventh Amendment of the Constitution and deprives entities and individuals of property
without due process of law.

The plaintiffs are seeking, among other things, declaratory and injunctive relief.

For more Finance Legal News, click here to visit the National Law Review

© 2010-2022 Allen Matkins Leck Gamble Mallory & Natsis LLP

SEC Awards $825,000 to Whistleblower

On October 11, the U.S. Securities and Exchange Commission (SEC) announced a $825,000 whistleblower award issued to an individual who voluntarily provided the agency with original information about securities fraud.

The SEC Whistleblower Program offers monetary awards to qualified whistleblowers whose disclosures contribute to the success of enforcement actions. SEC whistleblower awards are for 10-30% of the funds collected by the government in the relevant enforcement action.

According to the SEC award order, the whistleblower “expeditiously provided detailed information that prompted the opening of the investigation.” Furthermore, the whistleblower “thereafter met with Commission staff in person and provided additional information after submitting the initial TCR.”

In addition to monetary awards, the SEC Whistleblower Program offers anti-retaliation protections to whistleblowers, including confidentiality. Thus, the SEC does not disclose any information that could identify a whistleblower.

Since the whistleblower program was established in 2010, the SEC has awarded more than $1.3 billion to over 280 individual whistleblowers. In August 2021, SEC Chair Gary Gensler stated that the program “has greatly aided the Commission’s work to protect investors” and noted that “the SEC has used whistleblower information to obtain sanctions of over $5 billion from securities law violators” and “return over $1.3 billion to harmed investors.”

Article By Mary Jane Wilmoth of Kohn, Kohn & Colapinto. Geoff Schweller also contributed to this article.

For more criminal law and business crimes legal news, click here to visit the National Law Review.

Copyright Kohn, Kohn & Colapinto, LLP 2022. All Rights Reserved.

The “Iron Curtain” has Fallen: A Radical Shift in Lawyers Representing Whistleblowers

Whistleblower Network News (WNN) recently revealed, for the first time, that major corporate law firms specializing in representing defendants before the U.S. Securities and Exchange Commission (SEC) have, in some cases, switched sides and are now representing whistleblowers who are turning in corporate fraudsters.  All but one of the firms identified by the SEC did not call public attention to their new-found client base – most likely because they did not want to upset their bread-and-butter corporate clients.  It appears that major corporate law firms now understand that the Dodd-Frank Act’s whistleblower reward provisions are incredibly effective in incentivizing corporate insiders to report fraud, even when those insiders are executives usually on the other side of a whistleblower issue.  Lawyers who traditionally represent whistleblowers understand that Dodd-Frank is well designed and is being professionally implemented by the SEC.  Corporate lawyers and their firms have apparently caught on to this new reality and are now representing whistleblowers.

That defense firms are now actively engaged in representing whistleblowers cannot be denied.  Lists of law firms that have prevailed in Dodd-Frank whistleblower cases, disclosed in response to Freedom of Information Act (FOIA) requests filed with the SEC, document that 9.3% of firms that have obtained rewards on behalf of whistleblowers were traditional defense firms.  These firms include some of the largest defense firms in the United States that represent numerous corporations subjected to SEC enforcement actions for violating securities laws as well as firms that have defended corporations against whistleblowers in retaliation cases.

If that statistic holds, it is clear hundreds of corporate defense firms or their attorneys are representing whistleblowers in confidential investigations.  Why are these cases still under review?  Dodd-Frank is still a young law, and the vast majority of cases have not yet resulted in formal reward determinations.  Cases often take five years or more to be finalized, and as of the end of Fiscal Year 2021 over 51,000 whistleblower cases had been filed with the SEC.  Furthermore, under the FOIA requests the SEC only released the names of law firms that prevailed in a whistleblower case.  The names of firms that did not prevail in a claim, or firms that represent whistleblowers in ongoing investigations, were not disclosed.

Time will tell whether defense firms’ representation of whistleblowers who accuse their employers (or other corporate wrongdoers) of fraud is a good or bad development.  But unique issues will arise whenever a firm that primarily generates its profits from representing corporations accused of wrongdoing switches sides and represents a whistleblower who has accused an executive of engaging in fraud.  Although such representations may be permitted under the attorney’s rules of ethics, this does not mean that such representations are always in the best interest of a lawyer’s clients.  There are inherent potential conflicts whenever a defense firm switches sides and decides to represent a whistleblower reporting major corporate crimes.

Regardless of where you stand on this issue, one thing is clear: the ethical, policy and legal implications of defense firms representing whistleblowers is a dramatic shift in legal practice and must be carefully evaluated.  Defense firms must understand that whenever they represent a whistleblower, they must zealously advocate on their behalf, even when the precedents set by their cases may be used against their corporate clients.  Likewise, whistleblowers need to be aware of the implications of choosing a lawyer whose primary practice is representing corporate crooks.  Conflicts of interest may not initially be visible but can unfold as a case progresses.

The Revelation

In August of 2022, Bloomberg Law and a draft non-peer-reviewed article published by University of Kansas Professor Alexander Platt raised the issue of which law firms represent whistleblowers.  Bloomberg and Platt obtained lists of law firms that prevailed in Dodd-Frank whistleblower cases.  They used the lists to identify a small number of firms, all of which could be classified as pro-whistleblower firms.  These firms’ practices are centered on fighting corporate fraud and speculated whether these firms were being given preferential treatment by the SEC. Neither publication offered proof of any wrongdoing.  But Platt and Bloomberg did not list all the law firms that prevailed in Dodd-Frank cases.  Significantly, neither even mentioned the fact that major defense law firms had already filed and won Dodd-Frank cases on behalf of whistleblowers.  Additionally, the two authors did not explore the special issues that could arise when firms dedicated to defending white-collar criminals quietly switch sides.

In response to Platt and Bloomberg, WNN filed its own Freedom of Information Act (FOIA) request to obtain access to the documents relied upon in the two articles.  The SEC released over 1000 pages of documents to WNN, including all its correspondence with Platt and all the records provided to Platt (and Bloomberg) that identified law firms that successfully represented whistleblowers.

On September 27, 2022, WNN revealed, for the first time, that the SEC had identified 64 law firms that successfully obtained a reward on behalf of a whistleblower.  Among those firms were six that primarily represent corporations and individuals accused of corporate crimes.  These defense firms included industry giants such as Winston & Strawn and Akin Gump.  Together, the defense firms have already obtained over $56 million in rewards on behalf of whistleblowers.  In response to the Platt, Bloomberg, and WNN FOIA requests, the SEC only identified firms that had already prevailed and obtained a reward on behalf of their clients. Approximately 50,000 cases are pending within the SEC’s reward program, and there is a long delay in processing whistleblower cases.  Therefore, one can assume that numerous other pending cases where these or other defense firms are actively representing whistleblowers that were not disclosed by the SEC.

It is important to note that the Dodd-Frank provisions only apply to large fraud cases.  No reward is available unless the SEC issues sanctions against the entity being investigated in excess of $1 million.  Thus, the cases previously targeted by the defense firms and currently under investigation by the SEC would implicate major frauds.

The defense firms identified by WNN as being listed in the SEC-released materials were:

Winston & Strawn, LLP:  Winston advertises itself as defending “companies and individuals in SEC enforcement and regulatory matters related to allegations involving securities fraud.”  But not mentioned on its webpage is that it also represented a securities law whistleblower who obtained a $2.2 million reward.

Akin Gump Strauss Hauer & Feld LLP: Akin Gump also describes its practice as representing “companies and individuals” under investigation by various regulatory agencies, including the SEC.  Akin’s attorneys obtained a Dodd-Frank reward of $800,000 award.

Haynes and Boone, LLP: This 600-lawyer defense firm’s website explained that it has “represented employers” in “whistle blowing.”  However, the SEC documents revealed the firm also represented a whistleblower who obtained a “20%” award against a corporate fraudster.

Levine Lee LLP:  Although this firm markets itself as successfully representing clients accused of violating anti-fraud laws, like the other defense firms, it has apparently started a whistleblower practice and obtained a reward of $10 million on behalf of a whistleblower.

Leader Berkon Colao & Silverstein LLP:  This defense firm prevailed in cases filed on behalf of two separate whistleblowers and had considerable success.  Their whistleblower clients obtained $15 million and $27 million in awards.

Sallah Astarita & Cox, LLC: Although this firm “regularly represents financial institutions” in “fraud” cases, the firm also represented a whistleblower who obtained a $1.8 million award.  Sallah Astarita was the only firm that listed its Dodd-Frank Act whistleblower case on its website as among the victories achieved by one of its partners.

The SEC’s Dodd-Frank Whistleblower Program

Professor Platt and Bloomberg Law criticized the SEC’s Dodd-Frank program as having a bias in favor of a small number of whistleblower-rights law firms that had employed former SEC lawyers.  However, the information revealed by WNN completely refuted this negative implication raised by Platt and Bloomberg.  Instead, the FOIA documents support a finding that the SEC program is a paradigm of fairness and openness.  The extensive correspondence between Platt and the SEC demonstrates that the Commission freely disclosed the names of the firms that had won cases while carefully balancing the confidentiality needs of the whistleblower clients.  These numbers illustrate a program open to law firms regardless of their reputation or whether they employ former government lawyers.  They also reveal a program open to working directly with whistleblowers and rewarding them even if they had no lawyer.  Not one document produced provided any evidence whatsoever of wrongdoing, bias, or unprofessionalism.  The numbers speak for themselves:

  • Over 50 pro se whistleblowers won cases on their own behalf.  This high percentage of unrepresented applicants who successfully navigated the SEC’s program is remarkable.  In other legal programs, pro se whistleblowers (and other unrepresented persons) lose the vast majority of their cases.  Not so under Dodd-Frank. This demonstrates a high level of commitment by the SEC to helping individual whistleblowers who could not afford or obtain lawyers.
  • Of the 64 law firms that prevailed in a Dodd-Frank reward claim, only 12 had hired former SEC lawyers to assist in the cases.  Thus, the vast majority of successful law firms (52 of the 64) had no “insider” connection to the SEC.   This fact demonstrates the Commission’s staff’s willingness to work closely with attorneys who had no “friends” in the agency and whose information was solely merit-based. Moreover, a significant percentage of the firms that did employ former SEC or Justice Department lawyers were the very defense firms that Bloomberg Law and Platt did not discuss or analyze.
  • The Commission’s staff demonstrated no bias against firms based on their practice areas.  The Commission’s enforcement staff and Whistleblower Office worked with law firms that were defense-based (6) and law firms that traditionally represent whistleblowers or employees in lawsuits against companies (many of the remaining 58).

The FOIA documents support a finding that the Commission’s staff is open to whistleblowers, regardless of whether they represent themselves or whether or not the firms raising the concerns have any “insider” connections.   Organizations such as the National Whistleblower Center, which regularly works with whistleblowers, have widely praised the program, as have the last three Chairs of the SEC, appointed by Presidents Obama, Trump, and Biden.  The Commission itself confirmed that as of September 2021, it returned over $1.3 billion to harmed investors based on whistleblower cases.

The Future Role of Defense Firms in Dodd-Frank Cases

The SEC cannot implement special rules that would be prejudicial to traditional defense firms that file whistleblower cases.   Likewise, whistleblowers have the right to hire counsel of their choice and, in most cases, can knowingly waive potential conflicts of interest.  But the mere fact that traditional defense firms can lawfully represent whistleblowers without violating any SEC or local Bar rules does not address the special problems that may exist when a defense firm represents a whistleblower.  For example, such representations can result in significant conflicts of interest that may not be apparent at the commencement of a case. This may result in the whistleblower’s attorneys not advocating for legal precedents that could harm their other corporate clients.

Traditional defense firms should implement internal procedures to guard against potential problems based on the obvious conflicts that can arise when they represent clients on both sides of whistleblower-disclosure cases.  More significantly, it is absolutely crucial that whistleblowers fully understand the potential for conflicts of interest when deciding on the best attorneys to hire.  Attorneys working for defense firms must clearly spell out these issues and ensure that when representing a whistleblower, their prospective client is fully aware of all the risks and limitations.

Among the rules, procedures, and practices that defense firms should implement or carefully consider are:

  1. At the very least, defense firms representing whistleblowers should identify this on their websites.  Corporate clients should know that the firm also represents whistleblowers and should be able to question counsel on these matters so they feel comfortable that no conflicts would arise.
  2. Whistleblower clients need full disclosure of how the defense firm’s primary practice may impact the representation.  This is particularly true whenever a case would require advocacy on behalf of a whistleblower that could expand legal interpretations benefiting whistleblowers.  It is hard to reconcile how a law firm defending some clients against whistleblowers can effectively argue before administrative agencies or courts of law legal precedents that could expand the rights of whistleblowers.  These expanded rights could and would ultimately not be to the advantage of corporate clients accused of wrongdoing.
  3. Similarly, defense firms need to reconcile how they can advocate for a whistleblower who engaged in tactics, such as removing documents or one-party tape recording, that their corporate clients may find offensive.  This is particularly true when the zealous representation of a whistleblower requires expanding the ability of whistleblowers to obtain evidence of wrongdoing, and the precedent this advocacy establishes may be used against the firm’s current or future corporate clients.
  4. The potential for a conflict of interest needs to be fully explored in every case.  One issue that firms and clients may not be fully aware of is how the “related action” provisions of the laws impact potential conflicts.  Once the SEC obtains a sanction of over $1 million in any case, all “related actions” become eligible for a reward.  Sanctions issued by other law enforcement or regulatory agencies based on “related” claims can form the basis of a reward.   When examining whether a conflict exists, law firms need to look beyond the SEC action and determine witnesses, parties, and issues that may be implicated in a “related action.” This determination is critical even if the related action is not based on any securities law violation.
  5. Defense firms can also explore ways to refer potential whistleblower clients to attorneys whose practices are based solely on representing whistleblowers.  These referrals would help ensure that the defense firm is not conflicted (either as a matter of ethics or marketing) and that the client can obtain the best counsel.

Conclusion: The Iron Curtain has Fallen

Whistleblower representation is entering a new world.  The “iron curtain” that formerly separated law firms that represent corporate crooks from those that represent whistleblowers has fallen. This new reality is not without serious risks to whistleblowers (and corporate clients).  Whistleblowers must be fully aware of the dangers of having a corporate law firm represent them.  Corporate law firms must institute procedures to guard against conflicts of interest and to ensure they can zealously represent whistleblowers.  Zealous representation is needed even when the precedents established in these cases may create trouble for their other client base.

At the end of the day, the fact that defense law firms are now representing whistleblowers affirms the success of Dodd-Frank.  It is an affirmation of the critical nature of the information whistleblowers provide to the government and the role of this insider information in stopping otherwise hard to detect corporate crimes.  The “iron curtain” has fallen, but it has fallen in the direction that helps whistleblowers.  It has fallen in the direction that affirms the quality of their disclosures. It refutes the often-repeated slander that whistleblowers are somehow simply disgruntled employees.

Whistleblowers are essential to ensuring fairness in the markets, holding wrongdoers accountable, and deterring future wrongdoing.  The SEC has publicly recognized this, and now leading corporate defense attorneys have quietly recognized it. Defense firms like Akin Gump, Winston and Strawn, and Hayes and Boone got it right when they advocated for paying whistleblowers substantial rewards.  Whistleblowers whose information holds corporate criminals accountable deserve large rewards. These rewards are in the public interest, and the SEC Dodd-Frank whistleblower program must be protected, enhanced and expanded.

Sources:

  1. Whistleblower Network News, “WNN Exclusive: SEC FOIA Documents Reveal Big Law Defense Firms are Confidentially Representing Dodd-Frank Whistleblowers,” (September 27, 2022)
  2. List of Law Firms that Obtained Rewards in Whistleblower Cases as of 2021
  3. List of Awards Obtained by the Six Defense Law Firms
  4. List of pro se Cases where Whistleblowers Obtained a Reward
  5. FAQ on the SEC’s Dodd-Frank Act program
  6. FAQ on Confidentiality of Dodd-Frank Act claims

Article By Stephen M. Kohn of Kohn, Kohn & Colapinto

For more criminal law and business crimes legal news, click here to visit the National Law Review.

Copyright Kohn, Kohn & Colapinto, LLP 2022. All Rights Reserved.

NAVEX Report Reveals Increase in Whistleblower Retaliation and Reporting of Misconduct

NAVEX’s 2022 Risk & Compliance Hotline & Incident Management Benchmark Report reveals an increase in internal reporting about misconduct and an increase in allegations of retaliation.  The analysis of data from 3,470 organizations that received more than 1.37 million individual reports identified the following trends (see the full report for a discussion of additional trends and analysis of the data):

  • “More actual allegations of misconduct, rather than inquiries about policies or possible misconduct. Ninety percent of all reports in 2021 were allegations of misconduct, up from 86 percent last year and hitting an all-time high since our first benchmark report more than ten years ago.”

  • “Reports about retaliation, harassment and discrimination jumped – especially retaliation. In 2021, reports of retaliation nearly doubled . . . Taken altogether, these findings suggest employees are more attuned to workplace civility issues. That would fit with external trends such as more talk about systemic racism, income inequality and political divisions; as well as increasing protection for whistleblowers and employees’ awareness of  those protections.”

  • “Substantiation rates continue to edge upward. Overall substantiation rates rose from 42 percent in 2020 to 43 percent in 2021, and up from 36 percent a decade ago. The reports substantiated most often were data privacy concerns (63 percent), environmental issues (59 percent), and confidential and proprietary information (54 percent). The reports substantiated least often were about retaliation (24 percent).”

  • “The substantiation rate for reports of retaliation also went up slightly, from 23 percent in 2020 to  24 percent in 2021 – the highest substantiation rate seen since 2016. While steady, this substantiation rate is significantly below the overall median case substantiation rate of 43 percent in 2021. These cases, though difficult to prove, warrant attention.”

  • “Reports of harassment exceeded levels from the height of the #MeToo movement.”

Corporate Whistleblower Protections

Whistleblower retaliation remains all too prevalent.  A September 14, 2022 Bloomberg article titled Whistleblower retaliation remains all too prevalent discusses how “choosing to be a whistle-blower can also be a lonely, risky road” and identifies many deterrents to speaking up – “[t]hey may be afraid of litigation, ruining their reputations, losing security clearances or facing jail time.”

Fortunately, federal and state laws afford corporate whistleblowers remedies to combat retaliation, and whistleblower reward laws incentivize whistleblowers to take the considerable risks entailed in reporting fraud and other wrongdoing to the government.  For example, the

SEC Whistleblower Program offers awards to eligible whistleblowers who provide original information that leads to successful SEC enforcement actions with total monetary sanctions exceeding $1 million. A whistleblower may receive an award of between 10% and 30% of the total monetary sanctions collected in actions brought by the SEC and in related actions brought by other regulatory or law enforcement authorities. The SEC Whistleblower Program allows whistleblowers to submit tips anonymously if represented by an attorney in connection with their tip.

What is Whistleblower Retaliation?

Whistleblower retaliation laws prohibit a broad range of retaliatory actions against whistleblowers, including any act that would dissuade a worker from engaging in protected whistleblowing.  Examples of actionable whistleblower retaliation include:

  • Terminating a whistleblower;

  • Constructively discharging a whistleblower;

  • Demoting a whistleblower;

  • Suspending a whistleblower;

  • Harassing a whistleblower or subjecting the whistleblower to a hostile work environment;

  • Reassigning a whistleblower to a position with significantly different responsibilities;

  • Issuing a performance evaluation or performance improvement plan that supplies the necessary foundation for the eventual termination of the whistleblower’s employment, or a written warning or counseling session that is considered discipline by policy or practice and is routinely used as the first step in a progressive discipline policy;

  • Placing the whistleblower on administrative leave;

  • Threatening to take an adverse action against a whistleblower;

  • Subjecting a whistleblower to a retaliatory investigation or retaliatory surveillance;

  • Suing a whistleblower for the purpose of retaliating against the whistleblower;

  • Outing a whistleblower;

  • Intimidating a whistleblower;

  • Initiating a law enforcement investigation or facilitating an employee’s detention by U.S. ICE after the employee reported a serious injury; or

  • Discriminating against a whistleblower in the terms and conditions of employment because of whistleblowing.

The DOL Administrative Review Board has emphasized that statutory language prohibiting discrimination “in any way” must be broadly construed and therefore a whistleblower need not prove that a retaliatory act had a tangible impact on an employee’s terms and conditions of employment.

What Damages Can a Whistleblower Recover in a Whistleblower Retaliation Case?

Whistleblower retaliation can exact a serious toll, including lost pay and benefits, reputational harm, and emotional distress.  Indeed, whistleblower retaliation can derail a career and deprive the whistleblower of millions of dollars in lost future earnings.

Whistleblowers should be rewarded for doing the right thing, but all too often they suffer retaliation and find themselves marginalized and ostracized.  Federal and state whistleblower laws provide several remedies to compensate whistleblowers that have suffered retaliation, including:

  • back pay (lost wages and benefits);

  • emotional distress damages;

  • damages for reputational harm;

  • reinstatement or front pay in lieu thereof;

  • lost future earnings; and

  • punitive damages.

Combating Whistleblower Retaliation: How to Maximize Your Recovery

Whistleblower protection laws can provide a potent remedy, but before bringing a retaliation claim, it is crucial to assess the options under federal and state law and develop a strategy to achieve the optimal recovery.  Key issues to consider include the scope of protected whistleblowing, the burden of proof, the damages that a prevailing whistleblower can recover, the forum where the claim would be litigated, and the impact of the retaliation claim on a whistleblower rewards claim.

Scope of Protected Whistleblowing

There is no federal statute that provides general protection to corporate whistleblowers.  Instead, federal whistleblower protection laws protect specific types of disclosures, such as disclosures of securities fraud, tax fraud, procurement fraud, or consumer financial protection fraud.  The main sources of federal protection for corporate whistleblowers include the whistleblower protection provisions of the following:

  • The False Claims Act (FCA) — protecting disclosures about fraud directed toward the government, including actions taken in furtherance of a qui tam action and efforts to stop a violation of the FCA;

  • The Defense Contractor Whistleblower Protection Act (DCWPA) — protecting whistleblowing about gross mismanagement of a federal contract or grant; a gross waste of federal funds; an abuse of authority relating to a federal contract or grant or a substantial and specific danger to public health or safety, or a violation of law, rule, or regulation related to a federal contract;

  • The Sarbanes-Oxley Act (SOX) — protecting disclosures about mail fraud, wire fraud, bank fraud, securities fraud, a violation of any SEC rule, or shareholder fraud;

  • The Dodd-Frank Act (DFA) — protecting whistleblowing to the SEC about potential violations of federal securities laws;

  • The Taxpayer First Act (TFA) — protecting disclosures about tax fraud or tax underpayment;

  • The Consumer Financial Protection Act (CFPA) — protecting disclosures concerning violations of Consumer Financial Protection Bureau rules or federal laws regulating unfair, deceptive, or abusive practices in the provision of consumer financial products or services; and

  • The Anti-Money Laundering Act (AMLA) — protecting disclosures about violations of the Bank Secrecy Act.

While most of these anti-retaliation laws protect internal disclosures (e.g., reporting to a supervisor), whistleblower protection under the DFA is predicated on a showing that the whistleblower disclosed a potential violation of federal securities law to the SEC prior to suffering an adverse action.

State law may also provide a remedy, including the anti-retaliation provisions in state FCAs.  And approximately 42 states recognize a common law wrongful discharge tort action (a public policy exception to at-will employment), which generally protects refusal to engage in illegal activity and the exercise of a statutory right.

Burden of Proof

To maximize the likelihood of winning a case (or at least getting the case before a jury), it is useful to select a remedy with a favorable causation standard (the level of proof required to link the protected whistleblowing to the adverse employment action).  SOX has a favorable “contributing factor” causation standard, i.e., the whistleblower prevails by proving that their protected whistleblowing affected in any way the employer’s decision to take an adverse action.  In contrast, the FCA and DFA require the whistleblower to prove “but for” causation, i.e., the adverse action would not have happened “but for” the protected whistleblowing (albeit there is no need to prove that it was the sole factor).

Damages and Remedies in Whistleblower Retaliation Cases

Variations in the remedies available to whistleblowers under federal anti-retaliation laws may warrant bringing more than one claim.  For example, the DCWPA authorizes an award of back pay (the value of lost pay and benefits), and the FCA authorizes an award of double back pay.  If the whistleblower’s disclosures are protected under both statutes, then the whistleblower should bring both claims.

While a prevailing whistleblower can recover back pay under both the DFA and SOX (double back pay under the former and single back pay under the latter), the DFA does not authorize special damages, i.e., damages for emotional distress and reputational harm.  In contrast, SOX authorizes uncapped compensatory damages.  Therefore, a whistleblower protected under both statutes should bring the SOX claim within the much shorter SOX statute of limitations (180 days) to recover both double back pay and special damages.

State law may also provide a remedy, and if the whistleblower can pursue both a statutory remedy and a wrongful discharge tort, the latter may offer the opportunity to seek punitive damages.

Forum Selection and Administrative Exhaustion

When selecting the optimal remedy to combat retaliation, a whistleblower should consider the forum where the claim would be tried and determine whether the claim must initially be investigated by a federal agency before the whistleblower can litigate the claim.  SOX provides an unequivocal exemption from mandatory arbitration, but Dodd-Frank claims are subject to arbitration.  Accordingly, a whistleblower protected both by SOX and Dodd-Frank should file a SOX claim within the 180-day statute of limitations to preserve the option to try the case before a jury.

Several of the corporate whistleblower protection laws require that the whistleblower file the claim initially at a federal agency and permit the agency to investigate the claim before the whistleblower can litigate the claim.  This is called administrative exhaustion, and failure to comply with that requirement can waive the claim.  In contrast, the FCA and DFA do not require administrative exhaustion.

Impact of Whistleblower Retaliation Claim on Whistleblower Rewards Claim

Another important consideration is the potential impact of a retaliation case on a qui tam or whistleblower rewards case.  Filing an FCA retaliation claim while a qui tam suit is under seal poses some risk of violating the seal, which could bar the whistleblower from recovering a relator share.  Therefore, counsel should consider filing the FCA retaliation claim under seal along with the qui tam suit.

Further, whistleblowers pursuing rewards claims at federal agencies (e.g., SEC or IRS whistleblower claims) while simultaneously pursuing related retaliation claims (e.g., a SOX or TFA claim) should assess the potential impact of the retaliation claim and the potential discoverability of submissions to the SEC or IRS on the rewards claim(s).

Although the patchwork of whistleblower protection laws fails to protect disclosures about certain forms of fraud, there are important pockets of protection.  To effectively combat retaliation, whistleblowers should avail themselves of all appropriate remedies.

Article By Jason Zuckerman and Matthew Stock of Zuckerman Law

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© 2022 Zuckerman Law

Accounting Cases Involving SPACs

The Accounting Class Action Filings and Settlements—2021 Review and Analysis report features a spotlight section on accounting-related SPAC cases.

Special purpose acquisition companies (SPACs) have become an increasingly popular way for private companies to become publicly traded. The process typically proceeds through four phases:

  1. The SPAC initial public offering (IPO), when the SPAC becomes public as a shell company;
  2.  the search for a merger target, which typically involves a definitive time period (e.g., two years);
  3. the merger closing, during which time the SPAC sponsor and target company announce the merger, file a proxy statement, and solicit shareholder approval; and
  4. the period when the equity of the combined company becomes publicly traded, often referred to as the “De-SPAC” period.

Commentators have cited various reasons for the popularity of SPACs, including the perception of market participants that a private company may have more certainty as to pricing and control over the deal terms through a SPAC as compared to a traditional IPO.1 During 2021, there were 613 SPAC IPOs—nearly twice the number of traditional IPOs—and the $144.5 billion of capital raised was record-setting.2

SPAC filings that include accounting allegations tripled in 2021 as compared to the prior year.

SEC Statements Regarding Financial Accounting and Reporting

The increased popularity of SPACs has led to certain concerns from regulators. For example, the U.S. Securities and Exchange Commission (SEC) issued an investor bulletin on SPACs highlighting that the increased number of SPACs seeking to acquire an operating business may result in fewer attractive initial acquisitions.3 As of December 31, 2021, 575 SPACs were still searching for a merger target.4

The SEC has also highlighted concerns related to financial accounting and reporting issues that SPACs may face. For example, the SEC’s Acting Chief Accountant, Paul Munter, issued a statement on March 31, 2021, that raised questions about whether private company targets have the people and processes in place and the time that is needed to successfully transition to public company reporting requirements. Mr. Munter highlighted examples of complex financial accounting and reporting issues, including accounting for complex financial instruments and the need to comply with public company requirements for reporting on internal controls.5

Shortly after his March 31 statement, Mr. Munter and John Coates, the Acting Director of the SEC’s Division of Corporation Finance, issued a statement on April 12, 2021, that addressed accounting and reporting considerations for warrants issued by SPACs.6 The statement resulted in almost 500 SPACs restating their accounting for warrants by June 22, nearly all of which identified a material weakness in internal controls.7

Recent Trends in SPACs Involving Accounting Issues

During 2019 and 2020, only a handful of federal securities class actions involving SPACs were filed, but in 2021, federal filings involving SPACs became the dominant filing trend.8 Consistent with that overall trend, SPAC filings that include accounting allegations tripled in 2021 as compared to the prior year.

There are several trends in SPAC cases involving accounting issues over the past three years:

  • Approximately one in three initial complaints involving SPACs from 2019 through 2021 included accounting issues.
  • Three law firms—The Rosen Law Firm, Glancy Prongay & Murray LLP, and Pomerantz LLP—were associated with almost 80% of accounting case filings involving SPACs from 2019 through 2021.
  • Short-seller reports were commonly cited in cases involving SPACs. However, those reports were cited over one and a half times more often in accounting cases as compared with non-accounting cases filed during 2019 through 2021.
  • The median filing lag after a De-SPAC transaction was much greater in 2019–2020 (450 days) than it was in 2021 (106 days) for accounting case filings from 2019 through 2021 involving SPACs.
  • Inappropriate revenue recognition and weaknesses in internal controls were the most common allegations in SPAC accounting cases, followed by allegedly omitted disclosures of related-party transactions.

Because filings of SPAC cases have largely occurred very recently, based on our research only one of these cases had reached settlement as of the end of 2021, and this case included accounting allegations. As more of these cases progress, SPAC cases may play a role in future accounting case settlement trends.

1     “What You Need to Know About SPACs – Updated Investor Bulletin,” U.S. Securities and Exchange Commission, May 25, 2021, https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

2     Jay R. Ritter, “Initial Public Offerings: Updated Statistics,” Warrington College of Business, University of Florida, p. 48, https://site.warrington.ufl.edu/ritter/files/IPO-Statistics.pdf, accessed April 8, 2022.

3   “What You Need to Know About SPACs – Updated Investor Bulletin,” U.S. Securities and Exchange Commission, May 25, 2021, https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

4   SPACs still searching for a target are those that have completed their IPO but not yet announced a De-SPAC transaction target. See SPAC Insider.

5  Paul Munter, Acting Chief Accountant, “Financial Reporting and Auditing Considerations of Companies Merging with SPACs,” U.S. Securities and Exchange Commission, March 31, 2021, https://www.sec.gov/news/public-statement/munter-spac-20200331.

6  John Coates, Acting Director, Division of Corporation Finance, and Paul Munter, Acting Chief Accountant, “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (‘SPACs’),” U.S. Securities and Exchange Commission, April 12, 2021, https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

7   See Will SPAC Restatement Wave Trigger Shareholder Litigation?, Cornerstone Research (2021), for further discussion.

8   See Securities Class Action Filings—2021 Year in Review, Cornerstone Research (2022), for further discussion.

Article By Elaine M. Harwood, Laura E. Simmons, Frank T. Mascari, and Sally Bai of Cornerstone Research

For more SEC and securities legal news, click here to visit the National Law Review.

Copyright ©2022 Cornerstone Research

The SEC Remains in Search of and Is Looking for Finders

Much has been written on the topic of finders and arrangers of securities transactions, including when a person or entity acting as a finder (i.e., someone who merely makes an introduction) has crossed the line and engaged in activities or conduct that requires registration as a broker-dealer. Shortly before the end of Jay Clayton’s term as Chairman of the Securities and Exchange Commission (SEC), he issued a proposed order providing an exemption from broker-dealer registration requirements for certain “finders” who limit their activities in accordance with the conditions set forth in the proposed order.1 Ultimately, the proposal was not adopted. Today, finders and unregistered securities transaction activity continue to be on the SEC’s radar. The states also closely regulate unregistered securities activities.

Recently, the SEC brought several actions in the federal courts against unregistered finders, confirming that the activity of unregistered persons and entities participating in capital raising remains squarely on the SEC agenda. In SEC v. Sky Group USA, LLC, et al.,2 the SEC brought suit against Sky Group, a payday loan firm, and four of its employees in the US District Court for the Southern District of Florida, alleging numerous violations of the federal securities laws arising out of a Ponzi scheme in which sales agents sold Sky Group securities to retail investors, collecting millions of dollars in commissions on their sales, even though the sales agents were not registered as broker-dealers. The SEC found indicia of activities requiring registration because, among other actions, the sales agents engaged in the sale of securities in the form of unregistered promissory notes and “earned a commission of one percent of each dollar the investors they recruited invested in the [promissory notes].” Many of the more than 500 alleged victims were low-income members of the South Florida Venezuelan-American community.

The allegations in the complaint are salacious and include charges of fraudulently selling $25 million of unregistered promissory notes and misappropriating at least $2.9 million of investor funds for personal use, “several hundred thousand dollars” of which were used to pay for a wedding of one of the defendants at a chateau on the French Riviera. The complaint alleges that additional amounts were used to pay personal credit card debt of one of the principals and diverted to friends and relatives for “no apparent legitimate business purpose.” The relief requested in the SEC’s complaint includes permanent injunctions, disgorgement plus prejudgment interest, civil penalties and an officer and director bar against one of the defendants. Although it appears that there was a flurry of early motion practice after the complaint was filed, the defendants consented to entry of a final judgment on June 29, 2022, which includes disgorgement, interest and civil penalties totaling $39,288,990. The other related defendants also consented to entries of final judgement resulting in disgorgement, interest and civil penalties totaling $8,391,676, and a permanent injunction and officer and director bar against one of the defendants.

In SEC v. Richard Eden, et al.,3 the SEC brought suit against Richard Eden and an affiliated company in the US District Court for the Central District of California, alleging that Eden violated the federal securities laws by engaging in conduct that requires registration with a qualified broker-dealer. The complaint alleges that Eden is a recidivist and the conduct at issue in the present lawsuit occurred while Eden was subject to a previously imposed associational bar arising from his participation in multiple unregistered securities offerings. According to the complaint, Eden started as an “opener” and eventually morphed into a “finder/closer” role. The SEC alleges that Eden engaged in broker-dealer activity requiring registration because he was “responsible for both identifying potential investors and attempting to secure their investments in the [offering],” and was paid on a success fee basis. The relief requested includes a permanent injunction restraining Eden and his affiliated company from soliciting any person or entity to purchase or sell any security, disgorgement and civil penalties. As of this writing, the defendants have yet to file answers to the complaint.

It is not surprising that the factual allegations in these cases would attract regulatory attention. The fact that the SEC remains vigilant in its monitoring of firms and individuals engaged in capital raising requires firms and agents to learn the rules and stay within the permissible boundaries. In addition, they must be mindful of the less-than-crystal clear regulatory guidance on unregistered finders, and more specifically, at what point is a person or entity “engaged in the business of effecting transactions in securities for the account of others.” Persons in this business must understand that no-action letters in this subject area are fact-specific and often tailored to narrow and unique fact patterns. Finders in violation of broker-dealer registration requirements may be subject to severe penalties under federal securities laws. Courts and the SEC have looked to certain factors when determining whether a finder has violated the federal securities laws by failing to register as a broker-dealer. Each determination is very fact-specific, but in general, the SEC will consider:

  • Does the person’s compensation depend on the outcome or size of the transaction (i.e., transaction-based compensation)?
  • Does the person participate in important parts of a securities transaction, including solicitation, negotiation or execution of the transaction or assistance in structuring payments?
  • Does the person actively engage in the marketing of the securities?
  • Does the person give advice on the investment’s structure or suitability?

1 Notice of Proposed Exemptive Order Granting Conditional Exemption from the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, Exchange Act Release No. 34-90112 (Oct. 7, 2020) (available here).

2 SEC v. Sky Group USA, LLC, et al., SEC Docket No. 21-cv-23443 (Sept. 27, 2021), https://www.sec.gov/litigation/complaints/2021/comp25234.pdf.

3 SEC v. Richard Eden, et al., SEC Docket No. 22-cv-04833 (July 14, 2022), https://www.sec.gov/litigation/complaints/2022/comp25444.pdf.

Article By Paul McCurdy, Susan Light, and Aileen Z. Tan of Katten

For more SEC and securities legal news, click here to visit the National Law Review.

©2022 Katten Muchin Rosenman LLP

Draft SEC Five-Year Strategic Plan Emphasizes Importance of Climate Disclosures

Recently, the SEC issued its five-year strategic plan for public comment.  This strategic plan covers a wide variety of topics, ranging from adapting to new technology to plans for increasing internal SEC workforce diversity.  Significantly, this draft strategic plan stated that “the SEC must update its disclosure framework,” and highlighted three areas in which it should do so: “issuers’ climate risks, cybersecurity hygiene policies, and their most important asset: their people.”

The SEC has already undertaken steps to enact these proposed updates to its disclosure requirements for public companies.  Notably, this past March it proposed draft climate disclosure rules, which provoked a significant response from the public–including widespread criticism from many companies (as well as praise from environmental organizations).  The fact that the SEC chose to highlight these rules in its (draft) five-year strategic plan indicates the depth of the commitment it has made to these draft climate disclosures, and further suggests that the final form of the climate disclosures is unlikely to be significantly altered in substance from what the SEC has already proposed.  This statement reinforces the commitment of Chairman Gensler’s SEC and the Biden Administration to financial disclosures as a method to combat climate change.

“The markets have begun to embrace the necessity of providing a greater level of disclosure to investors. From time to time, the SEC must update its disclosure framework to reflect investor demand. Today, investors increasingly seek information related to, among other things, issuers’ climate risks, cybersecurity hygiene policies, and their most important asset: their people. In order to catch up to that reality, the agency should continue to update the disclosure framework to address these areas of investor demand, as well as continue to take concrete steps to modernize the systems that support the disclosure framework, to make public disclosures easier to access and analyze and thus more decision-useful to investors. . . . Across the agency, the SEC must continually reassess its risks, including in new areas such as climate risk, and document necessary controls.”

Article By Jacob H. Hupart of Mintz

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©1994-2022 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.

SEC Proposes to Clear-Up Clearing Agencies’ Governance to Mitigate Directors’ Potential Conflicts of Interest

Clearing agencies registered with the Securities and Exchange Commission (SEC) will have to make governance changes to their boards of directors under a new rule proposed by the SEC on August 8, 2022.

The SEC proposed the new rule1 to mitigate the conflicts of interests inherent in clearing agency relationships. The rule follows episodes of market volatility in 2021 that included large fluctuations surrounding COVID-19 and the meme stock craze.

The new rule would amend Section 17Ad-25 of the Securities Exchange Act of 1934 (Exchange Act) to require additional management and governance requirements for clearing agencies that register with the SEC. The proposed rules provide specific new governance requirements on clearing board composition, independent directors, nominating committees and risk management committees. The rule also requires the board to oversee relationships with critical service providers and includes a board obligation to consider various stakeholder views and inputs.

Rationale

The SEC’s rationale for proposing Rule 17Ad-25, titled Clearing Agency Governance and Conflicts of Interest, is to reduce the risk that conflicts of interest inherent in various clearing agency relationships substantially harm the security-based swaps or larger financial market. The SEC is proposing this rule to mitigate conflicts of interest, promote the fair representation of owners and participants in the governance of a clearing agency, identify responsibilities of the board, and increase transparency into clearing agency governance.

The SEC noted that those episodes of increased market volatility revealed certain vulnerabilities in the US securities market and the essential role clearing agencies play in managing the risk if securities transactions fail to clear.

The SEC observed three potential sets of conflicts of interest that the proposed rule attempts to address.

  1. The proposed rule addresses the different perspectives the various stakeholders involved in clearing agencies might have. In particular, a clearing agency owner’s potential interest in protecting the equity and continued operation of the clearing agency diverges from a participant’s potential interest in avoiding the allocation of losses from another defaulting participant. For instance, in the event of a loss, clearing agency participants might prefer to limit access to clearing, while owners may choose to expand the scope of products offered to collect fees.

  2. Larger clearing agency participants’ priorities may diverge significantly from the interests of smaller clearing agency participants. In particular, when a small number of dominant participants exercise control over a registered clearing agency concerning services provided by that clearing agency, those participants might promote margin requirements that are not commensurate with the risks they take, thereby indirectly limiting competition and increasing profit margins for themselves. In other words, a registered clearing agency dominated by a small number of large participants might make decisions designed to provide them with a competitive advantage.

  3. Certain participants may exert undue influence to limit access to the clearing agency based on their own interests, and thus could limit the benefits of the clearing agency to indirect participants.

Rule Requirements

The proposed rule would impose these seven requirements:

  1. define independence in the context of a director serving on the board of a registered clearing agency and require that a majority of directors on the board be independent, unless a majority of the voting rights distributed to shareholders of record are directly or indirectly held by participants of the registered clearing agency, in which case at least 34 percent of the board must be independent directors;

  2. establish requirements for a nominating committee, including with respect to the composition of the nominating committee, fitness standards for serving on the board, and documenting the process for evaluating board nominees;

  3. establish requirements for the function, composition, and reconstitution of the risk management committee;

  4. require policies and procedures that identify, mitigate or eliminate, and document the identification and mitigation or elimination of conflicts of interest;

  5. require policies and procedures that obligate directors to report potential conflicts promptly;

  6. require policies and procedures for the board to oversee relationships with service providers for critical services; and

  7. require policies and procedures to solicit, consider, and document the registered clearing agency’s consideration of the views of its participants and other relevant stakeholders regarding its governance and operations.

The proposing release will be published on SEC.gov and in the Federal Register. The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.

FOOTNOTES

1 https://www.sec.gov/rules/proposed/2022/34-95431.pdf

Article By Susan Light of Katten. Jacob C. Setton, an associate in the Financial Markets and Funds practice and candidate for admission to the New York State bar, also contributed to this advisory.

For more SEC and securities legal news, click here to visit the National Law Review.

©2022 Katten Muchin Rosenman LLP

Supreme Court’s Decision In Famous Hale & Norcross Mining Case

Having read Professor Stephen Bainbridge‘s post about the origins of the judicial doctrine that directors must act on an informed basis, I passed along a reference to the California Supreme Court’s in Fox v. Hale & Norcross Silver Mining Co.,  108 Cal. 369, 41 P. 308 (1895).   The Hale and Norcross mine was a famous silver and gold mine in Nevada’s Comstock mining district.  Samuel Clemens (aka Mark Twain), who had worked in Virginia City, Nevada, even bought shares in the mine on margin, as he related in Chapter 15 of his autobiography:

“One day I got a tip from Mr. Camp, a bold man who was always making big fortunes in ingenious speculations and losing them again in the course of six months by other speculative ingenuities. Camp told me to buy some shares in the Hale and Norcross. I bought fifty shares at three hundred dollars a share. I bought on a margin, and put up twenty per cent. It exhausted my funds. I wrote Orion [his brother and the first and only Secretary of the Nevada Territory] and offered him half, and asked him to send his share of the money. I waited and waited. He wrote and said he was going to attend to it. The stock went along up pretty briskly. It went higher and higher. It reached a thousand dollars a share. It climbed to two thousand, then to three thousand; then to twice that figure. The money did not come, but I was not disturbed. By and by that stock took a turn and began to gallop down. Then I wrote urgently. Orion answered that he had sent the money long ago–said he had sent it to the Occidental Hotel. I inquired for it. They said it was not there. To cut a long story short, that stock went on down until it fell below the price I had paid for it. Then it began to eat up the margin, and when at last I got out I was very badly crippled.”

Samuel Clemens disappointing investment predated by a number of years the litigation that resulted in the California Supreme Court’s opinion.

The Hale and Norcross mine was located in Nevada, but the corporation that owned it was incorporated in California.  That is why the shareholders sued the directors in the Golden, rather than the Silver, state.  The Supreme Court’s decision was big news.  The day after the decision was issued, The San Francisco Call published this lengthy article that not only described the case, but also published the decision itself and a drawing of the plaintiff, M.W. Fox.

Article By Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP

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