Tag: Securities Law

SEC Awards Whistleblower Whose Tip Led to Opening of Investigation

On May 19, the U.S. Securities and Exchange Commission (SEC) issued a whistleblower award to an individual who voluntarily provided the agency with original information that led to a successful enforcement action.

Through the SEC Whistleblower Program, qualified whistleblowers are entitled to an award of 10-30% of the sanctions collected by the government in the enforcement action connected to their disclosure.

The SEC awarded the whistleblower approximately $16,000.

According to the award order, the whistleblower “helped alert Commission staff to the ongoing fraud and his/her tip was a principal motivating factor in the decision to open the investigation.”

In determining the exact percentage of an award, the SEC weighs a number of factors including the significance of the whistleblower’s information, the law enforcement interest in the case, the degree of further assistance provided by the whistleblower, the whistleblower’s culpability in the underlying violation, and the timelines of the disclosure.

According to the award order, the SEC considered that the awarded whistleblower “provided continuing assistance by supplying critical documents and participating in at least one subsequent communication with Commission staff that advanced the investigation.”

The SEC notes that the whistleblower did not initially make their disclosure via a Form TCR. However, the whistleblower qualified for an award because they filed a Form TCR within 30 days of learning of the filing requirement.

Since issuing its first award in 2012, the SEC has awarded approximately $1.3 billion to over 270 individuals. In the 2021 fiscal year, the program set a number of records. The SEC issued a record $564 million in whistleblower awards to a record 108 individuals.

In addition to monetary awards, the SEC Whistleblower Program offers confidentiality protections to whistleblowers. Thus, the SEC does not disclose any identifying information about award recipients.

Individuals considering blowing the whistle to the SEC should first consult an experienced SEC whistleblower attorney to ensure they are fully protected and qualify for the largest possible award.

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

For more white collar business crime legal news, click here to visit the National Law Review.

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

SEC Awards $40M to Two Whistleblowers: Lessons for Prospective SEC Whistleblowers

On October 14, 2021, the SEC announced that it awarded $40M to two whistleblowers.  According to the order, both whistleblowers provided original information to the SEC that led to a successful enforcement action and provided extensive assistance during the SEC’s investigation.  The first whistleblower received an ward of approximately $32 million and the second received an award of approximately $8 million.  Why did one whistleblower receive an award that is four times greater than the award provided to the second whistleblower? And what can prospective whistleblowers learn from this award determination?

Although the SEC’s order is appropriately sparse (to protect the confidentiality of whistleblowers), it offers some important reasons for the disparity in the two awards:

  • The first whistleblower reported promptly and provided a tip that caused the SEC to open an investigation.
  • The second whistleblower provided important new information during the course of the investigation and was a valuable first-hand witness, but waited several years to report to the SEC. Due to the unreasonable delay in reporting the violations, the SEC reduced the second whistleblowers’ award percentage.
  • Both whistleblowers provided extensive, ongoing cooperation that helped the SEC to stop the wrongdoing, but the first whistleblower provided the information that enabled the SEC to devise an investigative plan and craft its initial document requests. The first whistleblower also “made persistent efforts to remedy the issues, while suffering hardships.”

Lessons for Prospective SEC Whistleblowers

Early Bird Gets the Worm

To be eligible for an award, a whistleblower must first submit “original information.” Original information can be derived from independent knowledge (facts known to the whistleblower that are not derived from publicly available sources) or independent analysis (evaluation of information that may be publicly available but which reveals information that is not generally known).  A prospective whistleblower who delays reporting a violation risks becoming ineligible for an award (another whistleblower may come forward first).

And an unreasonable delay in reporting a violation may cause the SEC to reduce an award.  In making this determination, the SEC considers:

  • whether the whistleblower failed to take reasonable steps to report the violation or prevent it from occurring or continuing;
  • whether the whistleblower was aware of the violation but reported to the SEC only after learning of an investigation into the misconduct;
  • whether the violations identified by the whistleblower were continuing during the period of delay;
  • whether investors were being harmed during that time; and
  • whether the whistleblower might profit from the delay by ultimately obtaining a larger award because the failure to report permitted the misconduct to continue, resulting in larger monetary sanctions.

According to OWB Guidance for Whistleblower Award Determinations, one or more of these circumstances, in the absence of significant mitigating factors, would likely cause the SEC to recommend a substantially lower award amount.

Common reasons that weigh against determining that a delay was unreasonable include:

  • the whistleblower engaging for a reasonable period of time in an internal reporting process;
  • the delay being reasonably attributable to an illness or other personal or family circumstance; and
  • the whistleblower spending a reasonable amount of time attempting to ascertain relevant facts or obtain an attorney in order to remain anonymous.

The significant disparity between the two awards announced on October 14th underscores why whistleblowers should report promptly.

A Whistleblower Can Qualify for an Award for Assisting with an Open investigation

Even though the second whistleblower delayed a few years reporting the violation to the SEC and came forward when the SEC already commenced an investigation, the whistleblower received an award for providing information and documents, participating in staff interviews, and providing the staff a more complete picture of how events from an earlier period impacted the company’s practices.  That result underscores how the SEC’s whistleblower rules permit the SEC to pay awards to whistleblowers that provide information in an existing investigation.  In other words, the fact that the SEC has already commenced an investigation should not cause a prospective whistleblower to forego providing a tip to the SEC.

A whistleblower can qualify for an award if their tip “significantly contributes” to the success of an SEC enforcement action, including where the information causes staff to (i) commence an examination, (ii) open or reopen an investigation, or (iii) inquire into different conduct as part of a current SEC examination or investigation, and the SEC brings a successful judicial or administrative action based in whole or in part on conduct that was the subject of the individual’s original information.

In determining whether an individual’s information significantly contributed to an enforcement action, the SEC considers factors such as whether the information allowed the SEC to bring the action in significantly less time or with significantly fewer resources, additional successful claims, or successful claims against additional individuals or entities.

Whistleblowers are Welcome at the SEC

The SEC issued this $40M award shortly after announcing that it reached a milestone of paying $1B in awards to whistleblowers under the Dodd-Frank SEC whistleblower program.  As of October 14, 2021, the SEC has awarded approximately $1.1B to 218 individuals.

Since assuming the position of SEC Chair earlier this year, Gary Gensler has made several public statements and taken specific actions that suggest that he is a strong proponent of the SEC whistleblower program and is determined to utilize the program to detect, investigate, and prosecute violations of the securities laws.  When the SEC announced that it paid $1B in awards, Chair Gensler stated, “The assistance that whistleblowers provide is crucial to the SEC’s ability to enforce the rules of the road for our capital markets.”

And in remarks for the National Whistleblower Day Celebration, Chair Gensler stated:

The tips, complaints, and referrals that whistleblowers provide are crucial to the Securities and Exchange Commission as we enforce the rules of the road for our capital markets . . . the whistleblower program helps us to be better cops on the beat, execute our mission, and protect investors from misconduct . . . Investors in our capital markets have benefited from the critical information provided by whistleblowers. . . . We must ensure that whistleblowers are empowered to come forward when they see misbehavior; that they are appropriately compensated according to the framework established by Congress; and that those who report wrongdoing are protected from retaliation.

Chair Gensler has also taken action to carry out his commitment to encouraging whistleblowers to come forward.  On August 2, 2021, Chair Gensler suspended the implementation of two recent amendments to the SEC whistleblower rules because these amendments could discourage whistleblowers from coming forward. He directed the staff to prepare for the Commission’s consideration potential revisions to these two rules.

© 2021 Zuckerman Law
For more on SEC and whistleblowing, visit the NLR financial Securities & Banking section.

North American Securities Administrators Association Proposes Model State Whistleblower Rewards Legislation

The North American Securities Administrators Association (NASAA) announced it released for public comment a proposed model law to help states incentivize individuals to come forward to report suspected wrongful violations of state securities laws and to protect whistleblowers.  According to NASAA President and Chief of the New Jersey Bureau of Securities Christopher W. Gerold, “The intent of this model legislation is to incentivize individuals who have knowledge of potential securities law violations to report it to state regulators in the interest of investor protection . . . [i]nformation from those with knowledge of securities law violations is a valuable enforcement tool to help regulators detect financial fraud and wrongdoing.”

The SEC whistleblower program that Congress created about 10 years ago in the Dodd-Frank Act has proven effective in combatting securities fraud and protecting investors.  Since the inception of the program, the SEC has paid more than $450 million in awards to whistleblowers.  SEC enforcement actions associated with those awards have resulted in sanctions totaling more than $2 billion.  Whistleblower awards can range from 10 percent to 30 percent of the monetary sanctions collected when the sanctions exceed $1 million.

Proposed Model State Securities Whistleblower Rewards Legislation

The proposed state whistleblower rewards legislation is modeled on the Dodd-Frank Act’s SEC whistleblower rewards provisions. Some of the key features include:

  • A whistleblower could obtain 10 to 30% of the monetary sanctions collected in any related administrative or judicial action stemming from original information that the whistleblower voluntarily provides to a state securities regulator.
  • Factors that would determine the award percentage include:
    • the significance of the original information provided by the whistleblower to the success of the administrative or judicial action;
    • the degree of assistance provided by the whistleblower in connection with the administrative or judicial action; and
    • the programmatic interest of the [Securities Administrator] in deterring violations of the securities laws by making awards to whistleblowers who provide original information that leads to the successful enforcement of such laws.
  • Information that could reasonably be expected to reveal the identity of a whistleblower would be exempt from public disclosure.
  • There are approximately 11 categories of whistleblowers that would be ineligible to receive an award, including (1) a whistleblower convicted of a felony in connection with the administrative or judicial action for which the whistleblower otherwise could receive an award; (2) a whistleblower who acquires the original information through the performance of an audit of financial statements required under the securities laws; (3) a whistleblower who knowingly or recklessly makes a false, fictitious, or fraudulent statement or misrepresentation as part of, or in connection with, the original information provided or the administrative or judicial proceeding for which the original information was provided; and (4) a whistleblower who has a legal duty to report the original information.

The model legislation also includes a whistleblower protection provision that would prohibit an employer from terminating, discharging, demoting, suspending, threatening, harassing, directly or indirectly, or in any other manner retaliating against, a whistleblower because of any lawful act done by the whistleblower:

  • in providing information to the [Securities Division] in accordance with this Act;
  • in initiating, testifying in, or assisting in any investigation or administrative or judicial action based upon or related to such information; or
  • in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.); the Securities Act of 1933 (15 U.S.C. 77a et seq.); the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.); 18 U.S.C. 1513(e); any other law, rule, or regulation subject to the jurisdiction of the Securities and Exchange Commission; or [the Securities Act of this State] or a rule adopted thereunder.

Remedies for a whistleblower prevailing in a retaliation claim include:

  • reinstatement with the same compensation, fringe benefits, and seniority status that the individual would have had, but for the retaliation;
  • two (2) times the amount of back pay otherwise owed to the individual, with interest;
  • compensation for litigation costs, expert witness fees, and reasonable attorneys’ fees;
  • actual damages; or
  • any combination of these remedies.

Role of State Securities Regulators

Although the SEC is the primary securities market regulator and enforces federal securities laws, state securities regulators enforce “blue sky” laws designed to protect investors against fraudulent sales practices and activities that fall outside of the SEC’s jurisdiction, e.g., offerings that are not required to be registered with the SEC.  Most of the state securities laws are based on the Uniform Securities Act, which is intended to prevent the fraudulent sale of securities to investors.

Securities law enforcement at the state level plays a vital role in protecting investors.  According to the NASAA’s 2018 Enforcement Report, in 2017 state securities regulators received 7,988 complaints, took 2,105 enforcement actions, and ordered $486 million returned to investors. Incentivizing whistleblowers to report securities fraud could significantly enhance the ability of state securities regulators to protect investors.

The proposed model act is open for public comment through June 30, 2020.

© 2020 Zuckerman Law

For more on securities laws, see the National Law Review Securities & SEC law section.

Final Section 336(e) Regulations Allow Step-Up in Asset Tax Basis in Certain Stock Acquisitions

Sheppard Mullin 2012

Final regulations were issued last month under IRC Section 336(e). These regulations present beneficial planning opportunities in certain circumstances.

For qualifying transactions occurring on or after May 15, 2013, Section 336(e) allows certain taxpayers to elect to treat the sale, exchange or distribution of corporate stock as an asset sale, much like a Section 338(h)(10) election. An asset sale can be of great benefit to the purchaser of the stock, since the basis of the target corporation’s assets would be stepped up to their fair market value.

To qualify for the Section 336(e) election, the following requirements must be met:

  1. The selling shareholder or shareholders must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder or shareholders.
  2. The selling shareholder or shareholders must own at least 80% of the total voting power and value of the target corporation’s stock.
  3. Within a 12-month period, the selling shareholder or shareholders must sell, exchange or distribute 80% of the total value and 80% of the voting power of the target stock.

Although the rules of Section 338(h)(10) are generally followed in connection with a Section 336(e) election, there are a few important differences between the two elections:

  1. Section 336(e) does not require the acquirer of the stock to be a corporation. This is probably the most significant difference; and, to take advantage of this rule, purchasers other than corporations may wish to convert the target without tax cost to a pass-through entity (e.g., LLC) after the purchase.
  2. Section 336(e) does not require a single purchasing corporation to acquire the target stock. Instead, multiple purchasers—individuals, pass-through entities and corporations—can be involved.
  3. The Section 336(e) election is unilaterally made by the selling shareholders attaching a statement to their Federal tax return for the year of the acquisition. Purchasers should use the acquisition agreement to make sure the sellers implement the anticipated tax strategy

Section 336(e) offers some nice tax planning opportunities, by allowing a step up in tax basis in the target’s assets where a Section 338(h)(10) election is not allowed.

Example: An S corporation with two shareholders wishes to sell all of its stock to several buyers, all of which are either individuals or pass-through entities with individual owners. A straight stock purchase would not increase the basis of the assets held inside the S corporation, and an LLC or other entity buyer would terminate the pass-through tax treatment of the S corporation status of the target. A Section 338(h)(10) election is not available since the purchaser is not a single corporation. However, a Section 336(e) election may be available, whereby the purchase of the stock would be treated as a purchase of the corporation’s assets (purchased by a “new” corporation owned by the purchasers). The purchasers could then convert the purchased corporation (the “new” corporation with the stepped-up assets basis) into an LLC, without tax, thereby continuing the business in a pass-through entity (single level of tax) with a fully stepped-up tax asset basis.

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OFAC Settles Alleged Sanctions Violations for $88.3 million

Posted in the National Law Review an article by Thaddeus Rogers McBride and Mark L. Jensen of Sheppard Mullin Richter & Hampton LLP regarding OFAC’s settlements with financial institutions:

 

On August 25, 2011, a major U.S. financial institution agreed to pay the U.S. Department of Treasury, Office of Foreign Assets Control (“OFAC”) $88.3 million to settle claims of violations of several U.S. economic sanctions programs. While OFAC settlements with financial institutions in recent years have involved larger penalty amounts, this August 2011 settlement is notable because of OFAC’s harsh—and subjective—view of the bank’s compliance program.

Background. OFAC has primary responsibility for implementing U.S. economic sanctions against specifically designated countries, governments, entities, and individuals. OFAC currently maintains approximately 20 different sanctions programs. Each of those programs bars varying types of conduct with the targeted parties including, in certain cases, transfers of funds through U.S. bank accounts.

As reported by OFAC, the alleged violations in this case involved, among other conduct, loans, transfers of gold bullion, and wire transfers that violated the Cuban Assets Control Regulations, 31 C.F.R. Part 515, the Iranian Transactions Regulations, 31 C.F.R. Part 560, the Sudanese Sanctions Regulations, 31 C.F.R. Part 538, the Former Liberian Regime of Charles Taylor Sanctions Regulations, 31 C.F.R. Part 593, the Weapons of Mass Destruction Proliferators Sanctions Regulations, 31 C.F.R. Part 544, the Global Terrorism Sanctions Regulations, 31 C.F.R. Part 594, and the Reporting, Procedures, and Penalties Regulations, 31 C.F.R. Part 501.

Key Points of Settlement. As summarized below, the settlement provides insight into OFAC’s compliance expectations in several ways:

1. “Egregious” conduct. In OFAC’s view, three categories of violations – involving Cuba, in support of a blocked Iranian vessel, and incomplete compliance with an administrative subpoena – were egregious under the agency’s Enforcement Guidelines. To quote the agency’s press release, these violations “were egregious because of reckless acts or omissions” by the bank. This, coupled with the large amount and value of purportedly impermissibly wire transfers involving Cuba, is likely a primary basis for the large $88.3 million penalty.

OFAC’s Enforcement Guidelines indicate that, when determining whether conduct is “egregious,” OFAC gives “substantial” weight to (i) whether the conduct is “willful or reckless,” and (ii) the party’s “awareness of the conduct at issue.” 31 C.F.R. Part 501, App. A. at V(B)(1). We suspect that OFAC viewed the conduct here as “egregious” and “reckless” because, according to OFAC, the bank apparently failed to address compliance issues fully: as an example, OFAC claims that the bank determined that transfers in which Cuba or a Cuban national had interest were made through a correspondent account, but did not take “adequate steps” to prevent further transfers. OFAC’s emphasis on reckless or willful conduct, and the agency’s assertion that the bank was aware of the underlying conduct, underscore the importance of a compliance program that both has the resources to act, and is able to act reasonably promptly when potential compliance issues are identified.

2. Ramifications of disclosure. In this matter, the bank voluntarily disclosed many potential violations. Yet the tone in OFAC’s press release is generally critical of the bank for violations that were not voluntarily disclosed. Moreover, OFAC specifically criticizes the bank for a tardy (though still voluntary) disclosure. According to OFAC, that disclosure was decided upon in December 2009 but not submitted until March 2010, just prior to the bank receiving repayment of the loan that was the subject of the disclosure. Although OFAC ultimately credited the bank for this voluntary disclosure, the timing of that disclosure may have contributed negatively to OFAC’s overall view of the bank’s conduct.

This serves as a reminder that there often is a benefit of making an initial notification to the agency in advance of the full disclosure. This also serves as reminder of OFAC’s very substantial discretion as to what is a timely filing of a disclosure: as noted in OFAC’s Enforcement Guidelines, a voluntary self-disclosure “must include, or be followed within a reasonable period of time by, a report of sufficient detail to afford a complete understanding of an apparent violation’s circumstances.” (emphasis added). In this regard, OFAC maintains specific discretion under the regulations to minimize credit for a voluntary disclosure made (at least in the agency’s view) in an inappropriate or untimely fashion.

3. Size of the penalty. The penalty amount—$88.3 million—is substantial. Yet the penalty is only a small percentage of the much larger penalties paid by Lloyds TSB ($350 million), Credit Suisse ($536 million), and Barclays ($298 million) over the past few years. In those cases, although the jurisdictional nexus between those banks and the United States was less clear than in the present case, the conduct was apparently more egregious because it involved what OFAC characterized as intentional misconduct in the form of stripping wire instructions. The difference in the size of the penalties is at least partly attributable to the amount of money involved in each matter. It also appears, however, that OFAC is distinguishing between “reckless” conduct and intentional misconduct.

4. Sources of information. As noted, many of the violations in this matter were voluntarily disclosed to OFAC. The press release also indicates that certain disclosures were based on information about the Cuba sanctions issues that was received from another U.S. financial institution (it is not clear whether OFAC received information from that other financial institution). The press release also states that, with respect to an administrative subpoena OFAC issued in this matter, the agency’s inquiries were at least in part “based on communications with a third-party financial institution.”

It may not be the case here that another financial institution (or institutions) blew the proverbial whistle, but it appears that at least one other financial institution did provide information that OFAC used to pursue this matter. Such information sharing is a reminder that, particularly given the interconnectivity of the financial system, even routine reporting by financial institutions may help OFAC identify other enforcement targets.

5. Compliance oversight. As part of the settlement agreement, the bank agreed to provide ongoing information about its internal compliance policies and procedures. In particular, the bank agreed to provide the following: “any and all updates” to internal compliance procedures and policies; results of internal and external audits of compliance with OFAC sanctions programs; and explanation of remedial measures taken in response to such audits.

Prior OFAC settlements, such as those with Barclays and Lloyds, have stipulated compliance program reporting obligations for the settling parties. While prior agreements, such as Barclay’s, required a periodic or annual review, the ongoing monitoring obligation in this settlement appears to be unusual, and could be a requirement that OFAC imposes more often in the future. (Although involving a different legal regime, requirements with similarly augmented government oversight have been imposed in recent Foreign Corrupt Practices Act settlements, most notably the April 2011 settlement between the Justice Department and Johnson & Johnson. See Getting Specific About FCPA Compliance, Law360, at:http://www.sheppardmullin.com/assets/attachments/973.pdf).

Conclusions. We think this settlement is particularly notable for the aggression with which OFAC pursued this matter. Based on the breadth of the settlement, OFAC seems to have engaged in a relatively comprehensive review of sanctions implications of the bank’s operations, going beyond those allegations that were voluntarily self-disclosed to use information from a third party. Moreover, as detailed above, OFAC adopted specific, negative views about the bank’s compliance program and approach and seems to have relied on those views to impose a very substantial penalty. The settlement is a valuable reminder that OFAC can and will enforce the U.S. sanctions laws aggressively, and all parties—especially financial institutions—need to be prepared.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

 

Senate Passes Sweeping Patent Reform Legislation

Recently posted in the National Law Review an article by Linda C. Emery, Mark F. Foley, Alexander M. Gerasimow, and Gottlieb John Marmet regarding the new legislation on September 8, 2011  designed to significantly overhall the US patent system:  

 

The U. S. Senate passed sweeping legislation on September 8, 2011, designed to significantly overhaul the U.S. patent system. The Leahy-Smith America Invents Act (“Act”) (HR 1249) makes numerous changes to the U.S. patent laws, most notably conforming U.S. patent law to the laws of most other countries by granting patent protection to the first person to file for patent protection rather than the first to invent, as it is now. Portions of the Act will take effect immediately, while others will become effective in 12 to 18 months. President Obama is expected to sign the bill into law promptly.

Other notable changes to the patent laws include:

  • Third parties are given the opportunity to challenge the Patent Office’s decision to grant a patent.
  • Third parties may cite prior art to the Patent Office during prosecution of a patent application.
  • Strategies to reduce taxes are not patentable.
  • Only the government and those suffering a competitive injury will be allowed to sue for false patent marking.
  • Failure to obtain the advice of counsel cannot be used to prove willful infringement.
  • Creates a mechanism by which the Patent Office will reevaluate and possibly invalidate previously issued business method patents.
  • Eliminates the requirement that inventors describe the “best mode” of making and using the invention as a basis for challenging the validity of a patent.
  • Allows individual inventors or very small companies to file patent applications at significantly lower fees, allowing those small companies and inventors to afford filing a patent application where they might not otherwise be able to afford such an application.

Companies and individuals who already have patents or pending patent applications should review their current practices and bring them in-line with the new patent laws in order to maintain their competitive edge. Inventors should also file an application as soon as possible, and must take additional steps to avoid disclosure or commercialization of their inventions prior to filing a patent application or risk losing the right to seek patent protection.

©2011 von Briesen & Roper, s.c

Justice Department Investigation of S&P

Recently posted in the National Law Review an article by Jared Wade of Risk and Insurance Management Society, Inc. (RIMS) regarding the Justice Department investigating S&P:

The Justice Department is investigating Standard & Poor’s for improperly rating the garbage mortgage-backed securities that tanked the economy once the world caught on that they were toxic assets.

The anonymous folks who leaked this info to the press claim that the inquiry began prior to S&P’s downgrade of U.S. debt, but many have speculated that the fervor and depth of the probe has ratcheted up since the nation lost its AAA-status.

Either way, the law dogs are — finally — poking around in the ratings world.

The Justice Department has been asking about instances in which the company’s analysts wanted to award lower ratings on mortgage bonds but may have been overruled by other S.& P. business managers, according to the people with knowledge of the interviews. If the government finds enough evidence to support such a case, which is likely to be a civil case, it could undercut S.& P.’s longstanding claim that its analysts act independently from business concerns.

It is unclear if the Justice Department investigation involves the other two ratings agencies, Moody’s and Fitch, or only S.& P.

Any inquiry should of course involve looking at all three. Each overrated the used diaper mortgage-backed securities to a baffling degree. Whether or not it was incompetence or something more insidious is really the only question, I have. I presume they are capable of both.

But if this investigation focuses solely on S&P then it falls even more into how one talking head on MSNBC’s The Daily Rundown described it: more of a Washington story than a Wall Street one.

Honestly, the only weird thing about hearing today about an investigation going on right now is that it was something I expected to hear in 2008.

In related news, and not just to toot our own horn, but I would feel remiss not to mention that our Risk Management magazine cover story this month was titled “The Future of Ratings” and examines “how rating agencies gained so much power, helped tank the economy and figure into the future of risk assessment.”

I’m not going to pretend that I knew just how much play rating agencies would be getting in August when I commissioned the piece a few months ago. I’m many things, but clairvoyant is not one of them. But the piece speaks to many of the questionable issues surrounding the ratings world that have been curiously dormant in the mainstream media for years until recently.

A wonderful writer, Lori Widmer, did a fine job so please do give it a read.

Risk Management Magazine and Risk Management Monitor. Copyright 2011 Risk and Insurance Management Society, Inc. All rights reserved.

Unclaimed Property Audits: No Laughing Matter

Posted on August 8, 2011 in the  National Law Review an article about several  states’ increased focus on unclaimed property and companies needing to be proactive in monitoring and improving their unclaimed property compliance practices.   This article was written by Marc J. Musyl, Micah Schwalb and Sarah Niemiec Seedig of Greenberg Traurig, LLP

Failure to Comply with Unclaimed Property Laws Can Cost a Company Millions in Interest and Penalties Alone

Many states continue to turn to unclaimed property as a source of revenue in the face of budget shortfalls. During the last two years, some state regulators have pursued non-traditional types of unclaimed property and state legislatures have revised their unclaimed property statutes to reduce dormancy periods, effectively causing companies to remit more unclaimed property in a shorter time frame. In New York, for example, the legislature lowered dormancy periods from five to three years for a number of different asset classes typically held by financial institutions.

Acting upon provisions in the Dodd-Frank Act, the SEC recently proposed to expand rules that would require brokers and dealers to escheat sums payable to security holders. Failure to comply with these laws can mean millions of dollars in interest and penalties for a company, which can negatively impact a company’s bottom line. For example, a growing number of life insurers are being audited by multiple states to assess their compliance with unclaimed property laws. One state regulator estimated that these life insurer audits could transfer “north of $1 billion” from the audited life insurers into the pockets of consumers, in the form of benefit payments, and revenue to the states, in the form of unclaimed property, interest and fines.

Unclaimed Property and State Audits

Unclaimed property laws require the remittance of certain types of property to the state for safekeeping if a business is unable to contact the owner of that property after a specified period, known as the dormancy period. Each state has its own set of laws that set forth the types of property subject to escheat, the dormancy period for each category of property, and reporting rules. Examples of items that can constitute unclaimed property include unused gift cards, uncashed payroll checks, uncashed stock dividend checks, abandoned corporate stock, and abandoned trust funds.

States have the ability to audit companies to determine their compliance with the unclaimed property laws. If an audit reveals improperly held or abandoned assets, states can seize the property, hold it in trust for a rightful owner, and impose costs, fines, and interest against the offending entity. In severe cases, the interest and fines can exceed the amount of unclaimed property at issue. These audits are often conducted by third-party auditors paid on a contingency basis, thus creating an incentive for them to maximize the unclaimed property uncovered. What’s more, the lack of a statute of limitations on escheat in most jurisdictions can lead to decades of accumulated unclaimed property liabilities.

35 States: How Does an Audit Get So Large?

Typically, an audit begins when a state engages a third-party auditor and provides a company with notice that it is under audit. The third-party auditor, being paid on a contingency basis, can expand its compensation by adding additional states to the audit. If only one state has authorized an unclaimed property audit, the thirdparty auditor only receives a percentage of the unclaimed property that was required to be reported to that state. However, if 20 states have authorized the audit, the third-party auditor now receives a percentage of the unclaimed property that should have been reported to 20 states, significantly increasing the auditor’s overall compensation.

This snowball effect is exactly what happened to some life insurers, and what could happen to any company. For example, the State of California initiated anaudit of John Hancock in 2008. This audit was undertaken by Verus Financial L.L.C. Fast forward three years to 2011, and Verus has now been authorized by 35 states and the District of Columbia to investigate and audit numerous insurance companies. These audits center around life insurers’ claims handling processes. The Social Security Administration publishes a Death Master File, updated weekly, which can be used to verify deaths. Insurers have been using the Death Master File to find dead annuity holders in order to stop payments. On the flip side, the insurers have not been using the Death Master File to find deceased policy insureds in order to pay the policy beneficiaries. The states and Verus have seized upon this disparate use of the Death Master File in their investigation of whether the funds should have been paid out to beneficiaries, in the form of benefit payments, or the states, in the form of unclaimed property.

Why Should I Be Concerned?: John Hancock as an Example

As a result of the Verus audit discussed above, John Hancock reportedly negotiated a global resolution agreement with 29 states which took effect June 1. As part of John Hancock’s settlement with the State of Florida, John Hancock will pay over $2.4 million in investigative costs and legal fees to Florida, and will establish a $10 million fund to pay death benefits and interest owed to beneficiaries. The amounts owed to beneficiaries that cannot be located will be turned over to Florida’s unclaimed property division. In addition, John Hancock has agreed to change its claims-handling procedures. Throughout the process, John Hancock has maintained that it has not violated the law. Given the number of insurance companies currently under audit, news of further settlements should be expected in the future.

In light of success with life insurers, recent legislative changes and continued state budget crunches, it is reasonable to expect an expansion of audits to other industries. It is widely estimated that a significant percentage of companies are not in full compliance with unclaimed property laws. There is no statute of limitations in most jurisdictions, as mentioned above, so the look-back period can be fairly lengthy and cover periods for which the company no longer has adequate records. The auditor may estimate the unclaimed property liability for such periods, which can lead to a company paying more than it would have otherwise owed. Further, interest and penalties can be severe. For example, in California interest is calculated by state statute at 12% per annum from the date the property should have been reported.

Taking Control of Unclaimed Property Compliance

As a result of the states’ increased focus on unclaimed property, companies need to be proactive in monitoring and, if necessary, improving their unclaimed property compliance practices. As a preliminary step, companies should determine whether or not they are currently in compliance with the unclaimed property laws. Many states have voluntary compliance programs for companies that are out of compliance. Oftentimes, by entering into a voluntary disclosure agreement with the appropriate authorities, a company can retain control of the process, limit the look-back period (remember, there is often no statute of limitations!), and limit the penalties and/or interest that may be owed for non-compliance. Typically, these voluntary programs are not available to companies once they have been selected for audit. Analyzing a target’s unclaimed property liability exposure should also be part of the due diligence process in a potential acquisition. Attention to unclaimed property compliance now can save valuable company resources later.

 

D.C. Circuit Invalidates SEC's Proxy Access Rules

Posted on Sunday, July 24, 2011 in the National Law Review an article by John D. Tishler  and Evan Mendelsohn of Sheppard, Mullin, Richter & Hampton LLP regarding the  United States Court of Appeals for the District of Columbia Circuit’s decision invalidating the SEC’s proxy access rules adopted in August 2010:

July 22, in Business Roundtable v. Securities & Exchange Commission, No. 10-1305 (D.C. Cir. July 22, 2011), the United States Court of Appeals for the District of Columbia Circuit issued its decision invalidating the SEC’s proxy access rules adopted in August 2010 with the intention that they be effective for the 2011 proxy season (see our blog here). The Business Roundtable and U.S. Chamber of Commerce filed the lawsuit in September 2010 challenging the SEC’s adoption of proxy access rules and separately requesting for the SEC to stay implementation of the rules pending the outcome of the lawsuit. The SEC granted the request for stay in October 2010 and issuers were relieved of the burdens of proxy access for the 2011 proxy season. (See our blog posts here and here.)

The Court found that the Commission “neglected its statutory responsibility to determine the likely economic consequences of Rule 14a-11 and to connect those consequences to efficiency, competition, and capital formation.” The Court also criticized the SEC’s reliance on empirical data that purported to demonstrate that proxy access would improve board performance and increase shareholder value by facilitating the election of dissident nominees, pointing out numerous studies submitted in the rule comment process that reached the opposite result.

The SEC’s proxy access rules also included an amendment to Rule 14a-8 that would authorize stockholder proposals to establish a procedure for stockholders to nominate directors. The SEC stayed implementation of the changes to Rule 14a-8 at the same time it stayed implementation of Rule 14a-11; however, the changes to Rule 14a-8 were not affected by the Court’s decision.

The SEC will now need to decide whether to propose new regulations for proxy access and whether to permit Rule 14a-8 to go effective.  However the SEC decides to proceed, it seems unlikely that public companies will face mandatory proxy access for the 2012 proxy season. 

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

Payments by Enron are "Settlement Payments" under the Bankruptcy Code's Safe Harbor Provisions

An interesting article recently published in the National Law Review  by David A. Zdunkewicz of  Andrews Kurth LLP  regarding the Second Circuit Court of Appeals protecting  payments made by Enron to redeem commercial paper prior to maturity as “Settlement Payments” under the Bankruptcy Code’s Safe Harbor Provisions.

In a matter of first impression in In Re: Enron Creditors Recovery Corp., v. ALFA, S.A.B. DE C.V., et al., No. 09-5122-bk(L) the United States Court of Appeals for the Second Circuit sided with two holders of Enron’s commercial paper who received prepetition payments redeeming the paper prior to its stated maturity. The price paid by Enron to redeem the debt was considerably higher than the market value of the debt.

Enron argued that the payments were either preferential or constructively fraudulent transfers and were not “settlement payments” under section 546(e) of the Bankruptcy Code because (i) the payments were not “commonly used in the securities trade,” (ii) the definition of “settlement payment” includes only transactions in which title to the securities changes hands and, therefore, because the redemption was made to retire debt and not to acquire title to the commercial paper, no title changed hands and the redemption payments are not settlement payments, and (iii) the redemption payments are not settlement payments because they did not involve a financial intermediary that took title to the transacted securities and thus did not implicate the risks that prompted Congress to enact the safe harbor.

The Second Circuit rejected each of Enron’s arguments, holding that the payments qualified as “settlement payments” under the Bankruptcy Code’s safe harbor provisions.

As to Enron’s first argument, the Court disagreed that the payments must have been common in the securities trade to qualify as a settlement payment under the Bankruptcy Code. Section 741(8) of the Bankruptcy Code defines “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.” Enron argued that the phrase “commonly used in the securities trade” modified each of the preceding terms in section 741(8), not only the immediately preceding term. The Second Circuit disagreed and held that the phrase “commonly used in the securities trade” only modified the immediately preceding term in Section 741(8), i.e. it only modified “similar payment.” Thus there is no requirement that the payments made to the holders be common in the securities trade.

As to Enron’s second argument, the Second Circuit found nothing in the Bankruptcy Code or the relevant caselaw to exclude the redemption of debt securities from the definition of a settlement payment. Accordingly, there is no requirement, as Enron argued, that title to the securities change hands for the payment to be considered a settlement payment under the Bankruptcy Code.

Finally, the Second Circuit rejected the third argument advanced by Enron. Enron argued that the redemption of debt did not constitute a settlement payment because it did not involve a financial intermediary that took a beneficial interest in the securities during the course of the transaction. Thus, the argument goes, the redemption would not implicate the systemic risks that motivated Congress to enact the safe harbor provision for settlement payments.

The Second Circuit rejected the argument and held that the fact that a financial intermediary did not take title to the securities during the course of the transaction is a proper basis to deny safe-harbor protection, joining the Third, Sixth, and Eighth Circuits in rejecting similar arguments. The Court stressed that § 546(e) applies to settlement payments made “by or to (or for the benefit of)” a number of participants in the financial markets and it would be inconsistent with this language to restrict the definition of “settlement payment” to require that a financial intermediary take title to the securities during the course of the transaction.

While each case must be determined on a case-by-base analysis, the Second Circuit’s ruling in Enron reflects a continued trend among the Court of Appeals to broadly interpret the safe harbor provisions of the Bankruptcy Code and protect covered transactions.

© 2011 Andrews Kurth LLP