Category: Corporate law

SEC’s Slimmed Down Climate-Related Disclosures Finally Adopted

On March 6, 2024, the Securities and Exchange Commission (the “SEC”) adopted regulations[1] that will require public companies to file mandatory climate-related disclosures with the SEC beginning in 2026. First proposed in March 2022, the climate-related disclosure rules were finalized after consideration of over 24,000 comment letters and active lobbying of the SEC by business and public interest groups alike. These new rules are aimed at eliciting more consistent, comparable, and reliable information for investors to make informed decisions related to climate-related risks on current and potential investments.

The new rules require a registrant to disclose material climate-related risks and activities to mitigate or adapt to those risks; information about the registrant’s oversight of climate-related risks and management of those risks; and information on any climate-related targets or goals that are material to the registrant’s business, results of operations, or financial condition. In addition, these new rules require disclosure of Scope 1 and/or Scope 2 greenhouse gas (“GHG”) emissions with attestation by certain registrants when emissions are material; and disclosure of the financial effects of extreme weather events.

Unlike the initial proposal, the EU Climate Sustainability Reporting Directive (“CSRD”) and the California Climate Data Accountability Act, the new rules do not require disclosure of Scope 3 GHG emissions. The new rules require reporting based upon financial materiality, not the double-materiality (impact and financial) standard utilized by the EU under the CSRD. Whether registrants will ultimately be required to comply with the new rules depend upon the outcome of anticipated challenges, such as the challenge to the SEC’s authority to promulgate the rule filed in the Eleventh Circuit on March 6th by a coalition of ten states.

Highlights of the New Rule

In the adopting release, the SEC notes that companies are increasingly disclosing climate-related risks, whether in their SEC filings or via company websites, sustainability reports, or elsewhere; however, the content and location of such disclosures have been varied and inconsistent.[2] The new rules not only specify the content of required climate-related disclosures but also the presentation of such disclosures.

The new rules amend the SEC rules under the Securities Act of 1933 (“Securities Act”) and Securities Exchange Act of 1934 (“Exchange Act”), creating a new subpart 1500 of Regulation S-K and Article 14 of Regulation S-X. As a result, registrants, companies that are registered under the Exchange Act, will need to:

  • File climate-related disclosures with the SEC in their registration statements and Exchange Act annual reports;
  • Provide the required climate-related disclosures in either a separately captioned section of the registration statement or annual report, within another appropriate section of the filing, or the disclosures may be included by reference from another SEC filing so long as the disclosure meets the electronic tagging requirements; and
  • Electronically tag climate-related disclosures in Inline XBRL.

The rules require a registrant to disclose:

  • Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition;
  • The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook;
  • Specified disclosures regarding a registrant’s activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices;
  • Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks;
  • Any processes the registrant has for identifying, assessing, and managing material climate-related risks and, if the registrant is managing those risks, whether and how any such processes are integrated into the registrant’s overall risk management system or processes;
  • Information about a registrant’s climate-related targets or goals, if any, that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition. Disclosures would include material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal;
  • For large accelerated filers (“LAFs”) and accelerated filers (“AFs”) that are not otherwise exempted, information about material Scope 1 emissions and/or Scope 2 emissions;
  • For those required to disclose Scope 1 and/or Scope 2 emissions, an assurance report at the limited assurance level, which, for an LAF, following an additional transition period, will be at the reasonable assurance level;
  • The capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds, disclosed in a note to the financial statements;
  • The capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (“RECs”) if used as a material component of a registrant’s plans to achieve its disclosed climate-related targets or goals, disclosed in a note to the financial statements; and
  • If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements.

Highlights of what did not get adopted

In its adopting release, the SEC described various modifications it made to its March 2022 proposed rules. The SEC explained that it made many of these changes in response to various comment letters it received. Some of the proposed rules that did not get adopted are:[3]

  • The SEC eliminated the proposed requirement to provide Scope 3 emissions disclosure.
  • The adopted rules in many instances now qualify the requirements to provide certain climate-related disclosures based on materiality.
  • The SEC eliminated the proposed requirement for all registrants to disclose Scope 1 and Scope 2 emissions in favor of requiring such disclosure only by large accelerated filers and accelerated filers on a phased in basis and only when those emissions are material and with the option to provide the disclosure on a delayed basis.
  • The SEC also exempted emerging growth companies and smaller reporting companies from the Scope 1 and Scope 2 disclosure requirement.
  • The SEC modified the proposed assurance requirement covering Scope 1 and Scope 2 emissions for accelerated filers and large accelerated filers by extending the reasonable assurance phase in period for LAFs and requiring only limited assurance for AFs.
  • The SEC eliminated the proposed requirements for registrants to disclose their GHG emissions in terms of intensity.[4]
  • The SEC removed the requirement to disclose the impact of severe weather events and other natural conditions and transition activities on each line item of a registrant’s financial statements. The SEC now requires disclosure of financial statement effects on capitalized costs, expenditures, charges, and losses incurred as a result of severe weather events and other natural conditions in the notes to the financial statements.
  • The adopted rules are less prescriptive than certain of those that were proposed. For example, the former now exclude in Item 1502(a) of Regulation S-K negative climate-related impacts on a registrant’s value chain from the definition of climate-related risks required to be disclosed. Similarly, this definition no longer includes acute or chronic risks to the operations of companies with which a registrant does business. Also, Item 1501(a) as adopted omits the originally proposed requirement for registrants to disclose (a) the identity of board members responsible for climate-risk oversight, (b) any board expertise in climate-related risks, (c) the frequency of board briefings on such risks, and (d) the details on the board’s establishment of climate-related targets or goals. Along the same lines, Item 1503 as adopted requires disclosure of only those processes for the identification, assessment, and management of material climate-related risks as opposed to a broader universe of climate-related risks. The rule as adopted does not require disclosure of how the registrant (a) determines the significance of climate-related risks compared to other risks, (b) considers regulatory policies, such as GHG limits, when identifying climate-related risks, (c) considers changes to customers’ or counterparties’ preferences, technology, or market prices in assessing transition risk, and (d) determines the materiality of climate-related risks. In the same vein, the adopted rules, unlike the proposed rules, do not require disclosure of how the registrant determines how to mitigate any high priority risks. Nor do the new rules retain the proposed requirement for a registrant to disclose how any board or management committee responsible for assessing and managing climate-related risks interacts with the registrant’s board or management committee governing risks more generally.
  • The SEC eliminated the proposal to require a private company that is a party to a business combination transaction, as defined by Securities Act Rule 165(f), registered on Form S-4 or Form F-4, to provide the subpart 1500 and Article 14 disclosures.

Timing of Implementation

The new rules will become effective 60 days after publication in the Federal Register. Compliance with the rules will not be required until much later, however.

Consistent with its earlier proposal, and in response to comments that the SEC received concerning the timing of implementing the proposed rule, the new rules contain delayed and staggered compliance dates that vary according to the registrant’s filing status and the type of disclosure.

The below table from the SEC’s new release summarizes the phased-in implementation dates.[5]

FILING STATUS

Large Accelerated Filers (“LAFs”)—a group whom the SEC believed most likely to be already collecting and disclosing climate-related information—will be the first registrants required to comply with the rule. The earliest that an LAF would be required to comply with the climate-disclosure rules would be upon filing its Form 10-K for the fiscal year ended December 31, 2025, which would be due no later than March 2026.[6]

Accelerated Filers (“AFs”) are not required to comply with the new rules for yet another year after LAFs. Climate-related disclosures for AFs must be included upon filing a Form 10-K for the fiscal year ended December 31, 2026, due no later than March 2027. Smaller Reporting Companies (“SRCs”), Emerging Growth Companies (“EGCs”), and Non-Accelerated Filers (“NAFs”) have yet another year to meet the first compliance deadline for climate-related disclosures. These types of filers need not include their climate-related disclosures until filing their Form 10-Ks for the fiscal year ended December 31, 2027, which, again, would be due no later than March 2028.

TYPES OF DISCLOSURES

The new rules also phase in the requirements to include certain disclosures over time. The requirements to provide quantitative and qualitative disclosures concerning material expenditures and material impacts to financial estimates or assumptions under Items 1502(d)(2), 1502(e)(2), and 1504(c)(2) are not applicable until the fiscal year immediately following the fiscal year in which the registrant’s initial compliance is required. LAFs, for example, are not required to report these qualitative and quantitative disclosures until filing a Form 10-K for the fiscal year ended December 31, 2026, due in March 2027. That should be one year after an LAF files its first Form 10-K with climate-related disclosures. The SEC adopted this phased-in approach to respond to commentators’ concerns regarding the availability (or current lack thereof) of policies, processes, controls, and system solutions necessary to support these types of disclosures.

Likewise, the new rules provide for a further phased-in compliance date for those registrants required to report their Scope 1 and Scope 2 GHG emissions and an even later date for those filers to obtain limited or reasonable assurance for those emissions disclosures. An LAF, for example, is not required to disclose its Scope 1 and Scope 2 emissions until filing its Form 10-K for the fiscal year ended December 31, 2026, due in March 2027. And those disclosures would not be required to be subject to the limited-assurance or reasonable-assurance requirements until filing the Form 10-K for the year ended December 31, 2029 or December 31, 2033, respectively.

In accordance with the table above, AFs, SRCs, EGCs, and NAFs have even more time to meet these additional disclosure requirements, if they are required to meet them at all.

It should be noted that the SEC recognized that registrants may have difficulty in obtaining GHG emission metrics by the date their 10-K report would be due. As a result, the rule contains an accommodation for registrants required to disclose Scope 1 and Scope 2 emissions, allowing domestic registrants, for example, to file those disclosures in the Form 10-Q for the second fiscal quarter in the fiscal year immediately following the year to which the GHG emissions disclosure relates. This disclosure deadline is permanent and not for a transition period.

Liability for Non-Compliance

In the introduction to the adopting release, the SEC explains that requiring registrants to provide certain climate-related disclosures in their filings will, among other things, “subject them to enhanced liability that provides important investor protections by promoting the reliability of the disclosures.”[7] This enhanced liability stems from the treatment of the disclosures as “filed” rather than “furnished” for purposes of Exchange Action Section 18 and, if included or otherwise incorporated by reference into a Securities Act registration statement, Securities Act Section 11.[8] According to the SEC, “climate-related disclosures should be subject to the same liability as other important business or financial information” that registrants include in registration statements and periodic reports and, therefore, should be treated as filed disclosures.[9]

In an attempt to balance concerns about the complexities and evolving nature of climate data methodologies and increased litigation risk, the SEC, in the adopting release, emphasizes certain modifications made in the new rules including:

  • limiting the scope of the GHG emissions disclosure requirement;
  • revising several provisions regarding the impacts of climate-related risks on strategy, targets and goals, and financial statement effects so that registrants will be required to provide the disclosures only in certain circumstances, such as when material to the registrant; and
  • adopting a provision stating that disclosures (other than historic facts) provided pursuant to certain of the new subpart 1500 provisions of Regulation S-K constitute “forward-looking statements” for the purposes of the PSLRA safe harbors.[10]

Registrants are subject to liability under Securities Act Section 17(a), Exchange Act Section 10(b), and/or Rule 10b-5 for false or misleading material statements in the information disclosed pursuant to the new rules.[11]

Observations

Consistent with its recent trajectory, the SEC continues to be a kinder, gentler regulator on climate disclosure requirements. Although the new rules will apply broadly to publicly traded companies, their scope is less demanding than the requirements under recent similar laws enacted in California or the EU. Under the California Climate Corporate Data Accountability Act (the “CCDA”), companies with annual revenues in excess of $1 billion and “doing business in California”[12] will be required to publicly disclose Scope 1 and Scope 2 emissions beginning in 2026, and Scope 3 emissions beginning in 2027. And because the California law applies to all companies, not just those that are publicly traded, it is also more broadly applicable and will trigger assessments and compliance for companies that are not subject to the SEC’s rule. The CCDA is currently the subject of legal challenge that includes questions of whether the required disclosures violate the First Amendment right to free speech, as well as possible federal preemption. As a result, there is a chance that the CCDA may yet be diluted or found unconstitutional. But in light of the imminent timeline for compliance, many companies subject to the CCDA are already developing programs to facilitate and ensure timely compliance with the requirements.

Similarly, the EU has broader reporting obligations under the CSRD than the SEC’s new rules. Compliance with the CSRD is required for both public and private EU companies as well as for non-EU companies with certain net annual turnovers, certain values of assets, and a certain number of employees. Under the CSRD, companies must publish information across a wide spectrum of subjects, including emissions, energy use, diversity, labor rights, and governance. Initial reporting under the CSRD begins to phase-in in 2025.

A key takeaway here is that although the SEC rules may have taken a lighter approach to climate disclosures, many large companies are likely to be subject to more stringent requirements under either the CCDA or the EU CSRD. And as some companies begin to comply to provide this information and data, the market may drive demand and an expectation that other companies, not otherwise subject to these various reporting regimes, follow suit. While the SEC rules may be a slimmed down version of what could have been, it is likely that the trend toward transparency and disclosure will continue to be driven by other regulatory bodies and market forces alike.

[1] Securities and Exchange Commission, Final Rule The Enhancement and Standardization of Climate-Related Disclosures for Investors, 17 CFR 210, 229, 230, 232, 239, and 249, adopting release available at https://www.sec.gov/files/rules/final/2024/33-11275.pdf.

[2] Id. at 48.

[3] Id. at 31-33.

[4] Id. at 225.

[5] Id. at 589.

[6] The new rules’ compliance dates apply to annual reports and registration statements. But, in the case of registration statements, compliance is required beginning with any registration statement that is required to include financial information for the full fiscal year indicated in the table above.

[7] Id. at 13.

[8] Id. at 584. At a high level, Section 18 imposes liability for false and misleading statements with respect to any material fact in documents filed with the SEC under the Exchange Act and Section 11 imposes liability for material misstatements or omissions made in connection with registered offerings conducted under the Securities Act.

[9] Id.

[10] Id. at 803.

[11] Id.

[12] A term which is not defined in the law, but is likely intentionally very broad, and is expected to be interpreted in that way.

© 2024 Foley & Lardner LLP
For more on SEC Climate Disclosures, visit the NLR Environmental, Energy & Resources section.

The Race to Report: DOJ Announces Pilot Whistleblower Program

In recent years, the Department of Justice (DOJ) has rolled out a significant and increasing number of carrots and sticks aimed at deterring and punishing white collar crime. Speaking at the American Bar Association White Collar Conference in San Francisco on March 7, Deputy Attorney General Lisa Monaco announced the latest: a pilot program to provide financial incentives for whistleblowers.

While the program is not yet fully developed, the premise is simple: if an individual helps DOJ discover significant corporate or financial misconduct, she could qualify to receive a portion of the resulting forfeiture, consistent with the following predicates:

  • The information must be truthful and not already known to the government.
  • The whistleblower must not have been involved in the criminal activity itself.
  • Payments are available only in cases where there is not an existing financial disclosure incentive.
  • Payments will be made only after all victims have been properly compensated.

Money Motivates 

Harkening back to the “Wanted” posters of the Old West, Monaco observed that law enforcement has long offered rewards to incentivize tipsters. Since the passage of Dodd Frank almost 15 years ago, the SEC and CFTC have relied on whistleblower programs that have been incredibly successful. In 2023, the SEC received more than 18,000 whistleblower tips (almost 50 percent more than the previous record set in FY2022), and awarded nearly $600 million — the highest annual total by dollar value in the program’s history. Over the course of 2022 and 2023, the CFTC received more than 3,000 whistleblower tips and paid nearly $350 million in awards — including a record-breaking $200 million award to a single whistleblower. Programs at IRS and FinCEN have been similarly fruitful, as are qui tam actions for fraud against the government. But, Monaco acknowledged, those programs are by their very nature limited. Accordingly, DOJ’s program will fill in the gaps and address the full range of corporate and financial misconduct that the Department prosecutes. And though only time will tell, it seems likely that this program will generate a similarly large number of tips.

The Attorney General already has authority to pay awards for “information or assistance leading to civil or criminal forfeitures,” but it has never used that power in any systematic way. Now, DOJ plans to leverage that authority to offer financial incentives to those who (1) disclose truthful and new information regarding misconduct (2) in which they were not involved (3) where there is no existing financial disclosure incentive and (4) after all victims have been compensated. The Department has begun a 90-day policy sprint to develop and implement the program, with a formal start date later this year. Acting Assistant Attorney General Nicole Argentieri explained that, because the statutory authority is tied to the department’s forfeiture program, the Department’s Money Laundering and Asset Recovery Section will play a leading role in designing the program’s nuts and bolts, in close coordination with US Attorneys, the FBI and other DOJ offices.

Monaco spoke directly to potential whistleblowers, saying that while the Department will accept information about violations of any federal law, it is especially interested in information regarding

  • Criminal abuses of the US financial system;
  • Foreign corruption cases outside the jurisdiction of the SEC, including FCPA violations by non-issuers and violations of the recently enacted Foreign Extortion Prevention Act; and
  • Domestic corruption cases, especially involving illegal corporate payments to government officials.

Like the SEC and CFTC whistleblower programs, DOJ’s program will allow whistleblower awards only in cases involving penalties above a certain monetary threshold, but that threshold has yet to be determined.

Prior to Monaco’s announcement, the United States Attorney’s Office for the Southern District of New York launched its own pilot “whistleblower” program, which became effective February 13, 2024. Both the Department-wide pilot and the SDNY policy require that the government have been previously unaware of the misconduct, but they are different in a critical way: the Department-wide policy under development will explicitly apply only to reports by individuals who did not participate in the misconduct, while SDNY’s program offers incentives to “individual participants in certain non-violent offenses.” Thus, it appears that SDNY’s program is actually more akin to a VSD program, while DOJ’s Department-wide pilot program will target a new audience of potential whistleblowers.

Companies with an international footprint should also pay attention to non-US prosecutors. The new Director of the UK Serious Fraud Office recently announced that he would like to set up a similar program, no doubt noticing the effectiveness of current US programs.

Corporate Considerations

Though directed at whistleblowers, the pilot program is equally about incentivizing companies to voluntarily self-disclose misconduct in a timely manner. Absent aggravating factors, a qualifying VSD will result in a much more favorable resolution, including possibly avoiding a guilty plea and receiving a reduced financial penalty. But because the benefits under both programs only go to those who provide DOJ with new information, every day that a company sits on knowledge about misconduct is another day that a whistleblower might beat them to reporting that misconduct, and reaping the reward for doing so.

“When everyone needs to be first in the door, no one wants to be second,” Monaco said. “With these announcements, our message to whistleblowers is clear: the Department of Justice wants to hear from you. And to those considering a voluntary self-disclosure, our message is equally clear: knock on our door before we knock on yours.”

By providing a cash reward for whistleblowing to DOJ, this program may present challenges for companies’ efforts to operate and maintain and effective compliance program. Such rewards may encourage employees to report misconduct to DOJ instead of via internal channels, such as a compliance hotline, which can lead to compliance issues going undiagnosed or untreated — such as in circumstances where the DOJ is the only entity to receive the report but does not take any further action. Companies must therefore ensure that internal compliance and whistleblower systems are clear, easy to use, and effective — actually addressing the employee’s concerns and, to the extent possible, following up with the whistleblower to make sure they understand the company’s response.

If an employee does elect to provide information to DOJ, companies must ensure that they do not take any action that could be construed as interfering with the disclosure. Companies already face potential regulatory sanctions for restricting employees from reporting misconduct to the SEC. Though it is too early to know, it seems likely that DOJ will adopt a similar position, and a company’s interference with a whistleblower’s communications potentially could be deemed obstruction of justice.

© 2024 Bracewell LLP
For more on Whistleblowers, visit the NLR Criminal Law / Business Crimes section.

SEC Issues Long-Awaited Climate Risk Disclosure Rule

INTRODUCTION

On Wednesday, 6 March 2024, the Securities and Exchange Commission (SEC) approved its highly anticipated final rules on “The Enhancement and Standardization of Climate-Related Disclosures for Investors” by a vote of 3-2, with Republican Commissioners Hester Peirce and Mark Uyeda dissenting. Accompanying the final rules was a press release and fact sheet detailing the provisions of the rulemaking. The final rules will go into effect 60 days after publication in the Federal Register and will include a phased-in compliance period for all registrants.

This is likely to be one of the most consequential rulemakings of Chairman Gary Gensler’s tenure given the prioritization of addressing climate change as a key pillar for the Biden administration. However, given the significant controversy associated with this rulemaking effort, the final rules are likely to face legal challenges and congressional oversight in the coming months. As such, it remains unclear at this point whether the final rules will survive the forthcoming scrutiny.

WHAT IS IN THE RULE?

According to the SEC’s fact sheet:

  • “The final rules would require a registrant to disclose, among other things: material climate-related risks; activities to mitigate or adapt to such risks; information about the registrant’s board of directors’ oversight of climate-related risks and management’s role in managing material climate-related risks; and information on any climate-related targets or goals that are material to the registrant’s business, results of operations, or financial condition.
  • Further, to facilitate investors’ assessment of certain climate-related risks, the final rules would require disclosure of Scope 1 and/or Scope 2 greenhouse gas (GHG) emissions on a phased-in basis by certain larger registrants when those emissions are material; the filing of an attestation report covering the required disclosure of such registrants’ Scope 1 and/or Scope 2 emissions, also on a phased-in basis; and disclosure of the financial statement effects of severe weather events and other natural conditions including, for example, costs and losses.
  • The final rules would include a phased-in compliance period for all registrants, with the compliance date dependent on the registrant’s filer status and the content of the disclosure.”

NEXT STEPS

The final rules are likely to face significant opposition, including legal challenges and congressional oversight. It is expected that there will be various lawsuits brought against the final rules, which are likely to receive support from several industry groups, or potentially GOP-led state attorneys general who have been active in litigating against environmental, social and governance (ESG) policies and regulations. It is also possible that the final rules could face criticism from some climate advocates that the SEC did not go far enough in its disclosure requirements.

Further, it is expected that the House Financial Services Committee (HFSC) will conduct oversight hearings, as well as introduce a resolution under the Congressional Review Act (CRA), to attempt to block the regulations from taking effect. HFSC Chairman Patrick McHenry (R-NC) indicated that the Oversight and Investigations Subcommittee will hold a field hearing on March 18 and the full Committee will convene a hearing on April 10 to discuss the potential implications of the rules. If a CRA resolution were to pass the House and garner sufficient support from moderate Democrats in the Senate to pass, it would likely be vetoed by President Biden.

Ultimately, the SEC climate risk disclosure rules are unlikely to significantly change the trajectory of corporate disclosures made by multinational companies based in the U.S., most of whom have already been making sustainability disclosures in accordance with the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures. The ongoing problem for investors is that such disclosures are not standardized and therefore are not comparable. Consequently, many of these large issuers may continue to enhance their sustainability disclosures in accordance with standards issued by the International Sustainability Standards Board and the Global Reporting Initiative as an investor relations imperative notwithstanding the SEC’s timetable for implementation of these final rules.

A more detailed analysis of the SEC rules is forthcoming from our Corporate and Asset Management and Investment Funds practices in the coming days.

Copyright 2024 K & L Gates
For more news on the SEC’s Climate Disclosure Rule, visit the NLR Environmental, Energy & Resources section.

U.S. Corporate Transparency Act: CTA is Declared Unconstitutional in U.S. District Court Case

The Corporate Transparency Act has been declared unconstitutional. On March 1, 2024, U.S. District Court Judge Liles C. Burke issued a 53-page opinion[1] granting summary judgment for the National Small Business Association and held that the Corporate Transparency Act “exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals.”

As a result, Judge Burke found the CTA to be unconstitutional because it exceeds the Constitution’s limits on Congress’ power, without even reaching a decision on whether it violates the First, Fourth, and Fifth Amendments. The Court then permanently enjoined the government from enforcing the CTA against the named plaintiffs and ordered a further hearing on the award of costs of litigation.

While it is likely that this litigation will continue to play out in the federal court system, the initial victory has gone to small business and importantly that means that compliance with this now unconstitutional regulatory regime can be set aside for the current time being.

[1] Nat’l Small Bus. United v. Yellen, No. 5:22-cv-01448-LCB (N.D. Ala. 2022)

Copyright ©2024 Nelson Mullins Riley & Scarborough LLP
For more on the Corporate Transparency Act, visit the NLR Corporate & Business Organizations section.

Federal Court Strikes Down the Corporate Transparency Act as Unconstitutional

On March 1, 2024, the federal judge presiding over the lone case testing the validity of the Corporate Transparency Act (CTA) struck down the CTA as unconstitutional. As we have explained, through the CTA, Congress imposed mandatory reporting obligations on certain companies operating in the United States, in an effort to enhance corporate transparency and combat financial crime. Specifically, the CTA, which took effect on January 1, 2024, requires a wide range of companies to provide personal information about their beneficial owners and company applicants to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). More than 32.5 million existing entities are expected to be subject to the CTA, and approximately 5 million new entities are expected to join that number each year. By mid-February, approximately a half million reports had been filed under the CTA according to FinCEN.

The CTA’s enforceability is now in doubt. In National Small Business United d/b/a National Small Business Association v. Yellen, the Honorable Liles C. Burke of the United States District Court for the Northern District of Alabama held that the CTA exceeded Congress’s authority to regulate interstate commerce, and that the CTA was not necessary to the proper exercise of Congress’ power to regulate foreign affairs or its taxing power. The Court issued a declaratory judgment—stating that the CTA is unconstitutional—and enjoined the federal government from enforcing the CTA’s reporting requirements against the plaintiffs in that litigation. A nationwide injunction, which would have raised its own enforceability concerns, was not included in the Court’s ruling.

The Court focused on three aspects of the CTA. First, the Court highlighted that the CTA imposes requirements on corporate formation, which is traditionally left to state governments as matters of internal state law. Second, the Court observed that the CTA applies to corporate entities even if the entity conducts purely intrastate commercial activities or no commercial activities at all. Third, the Court concluded that the CTA’s disclosure requirements could not be justified as a data-collection tool for tax officials as that would raise the specter of “unfettered legislative power.”

What the Decision Means for Entities Subject to the CTA

The Court’s decision creates uncertainty on entities’ ongoing obligations under the CTA. Although the Court purported to limit its injunction to the parties in the litigation before it, the lead plaintiff in the suit is the National Small Business Association (NSBA). In its opinion, the Court held that the NSBA had associational standing to sue on behalf of its members. Based on precedent, this means the Court’s injunction likely benefits all of the NSBA’s over 65,000 members. If so, the government is prevented from enforcing the CTA’s reporting requirements against any entity that is a member of the NSBA.

Regardless of membership in the NSBA, however, the Court’s declaratory judgment that the CTA is unconstitutional also raises serious doubts about the government’s ability to enforce the CTA’s reporting requirements. This could amount to a de facto moratorium on CTA enforcement, depending on the government’s view of the decision.

What Happens Next

The government will likely appeal this decision, but the Court’s injunction and declaration will remain in effect unless a stay is granted. To receive a stay, the government will first likely need to file a motion in the district court, which will consider (1) how likely it is that the government will succeed on appeal; (2) whether the government will be irreparably harmed without a stay; (3) whether a stay will injure other parties interested in the litigation; and (4) whether a stay would benefit the public interest. If the district court denies a stay, the government will be able to seek a stay from the Atlanta-based United States Court of Appeals for the Eleventh Circuit.

The government has 60 days to appeal, though it will likely file its appeal sooner given the grant of an injunction and decision’s far-reaching consequences. The grant or denial of stay should be resolved in the coming weeks, but the timing of any final decision from the Court of Appeals is uncertain. In 2023, the median time for the Eleventh Circuit to resolve a case was over 9 months. However, the key deadline by which tens of millions of companies otherwise must file their initial report under the CTA is January 1, 2025.

© 2024 Varnum LLP
For more news on the Constitutionality of the Corporate Transparency Act, visit the NLR Corporate & Business Organizations section.

An Update on the SEC’s Cybersecurity Reporting Rules

As we pass the two-month anniversary of the effectiveness of the U.S. Securities and Exchange Commission’s (“SEC’s”) Form 8-K cybersecurity reporting rules under new Item 1.05, this blog post provides a high-level summary of the filings made to date.

Six companies have now made Item 1.05 Form 8-K filings. Three of these companies also have amended their first Form 8-K filings to provide additional detail regarding subsequent events. The remainder of the filings seem self-contained such that no amendment is necessary, but these companies may amend at a later date. In general, the descriptions of the cybersecurity incidents have been written at a high level and track the requirements of the new rules without much elaboration. It is interesting, but perhaps coincidental, that the filings seem limited to two broad industry groups: technology and financial services. In particular, two of the companies are bank holding companies.

Although several companies have now made reports under the new rules, the sample space may still be too small to draw any firm conclusions or decree what is “market.” That said, several of the companies that have filed an 8-K under Item 1.05 have described incidents and circumstances that do not seem to be financially material to the particular companies. We are aware of companies that have made materiality determinations in the past on the basis of non-financial qualitative factors when impacts of a cyber incident are otherwise quantitatively immaterial, but these situations are more the exception than the rule.

There is also a great deal of variability among the forward-looking statement disclaimers that the companies have included in the filings in terms of specificity and detail. Such a disclaimer is not required in a Form 8-K, but every company to file under Item 1.05 to date has included one. We believe this practice will continue.

Since the effectiveness of the new rules, a handful of companies have filed Form 8-K filings to describe cybersecurity incidents under Item 8.01 (“Other Events”) instead of Item 1.05. These filings have approximated the detail of what is required under Item 1.05. It is not immediately evident why these companies chose Item 8.01, but presumably the companies determined that the events were immaterial such that no filing under Item 1.05 was necessary at the time of filing. Of course, the SEC filing is one piece of a much larger puzzle when a company is working through a cyber incident and related remediation. It remains to be seen how widespread this practice will become. To date, the SEC staff has not publicly released any comment letters critiquing any Form 8-K cyber filing under the new rules, but it is still early in the process. The SEC staff usually (but not always) makes its comment letters and company responses to those comment letters public on the SEC’s EDGAR website no sooner than 20 business days after it has completed its review. With many public companies now also making the new Form 10-K disclosure on cybersecurity, we anticipate the staff will be active in providing guidance and commentary on cybersecurity disclosures in the coming year.

Copyright © 2024, Hunton Andrews Kurth LLP. All Rights Reserved.
For news on SEC Cybersecurity Regulations, visit the NLR Securities & SEC section.

Commerce Department Launches Cross-Sector Consortium on AI Safety — AI: The Washington Report

  1. The Department of Commerce has launched the US AI Safety Institute Consortium (AISIC), a multistakeholder body tasked with developing AI safety standards and practices.
  2. The AISIC is currently composed of over 200 members representing industry, academia, labor, and civil society.
  3. The consortium may play an important role in implementing key provisions of President Joe Biden’s executive order on AI, including the development of guidelines on red-team testing[1] for AI and the creation of a companion resource to the AI Risk Management Framework.

Introduction: “First-Ever Consortium Dedicated to AI Safety” Launches

On February 8, 2024, the Department of Commerce announced the creation of the US AI Safety Institute Consortium (AISIC), a multistakeholder body housed within the National Institute of Standards and Technology (NIST). The purpose of the AISIC is to facilitate the development and adoption of AI safety standards and practices.

The AISIC has brought together over 200 organizations from industry, labor, academia, and civil society, with more members likely to join in the coming months.

Biden AI Executive Order Tasks Commerce Department with AI Safety Efforts

On October 30, 2023, President Joe Biden signed a wide-ranging executive order on AI (“AI EO”). This executive order has mobilized agencies across the federal bureaucracy to implement policies, convene consortiums, and issue reports on AI. Among other provisions, the AI EO directs the Department of Commerce (DOC) to establish “guidelines and best practices, with the aim of promoting consensus…[and] for developing and deploying safe, secure, and trustworthy AI systems.”

Responding to this mandate, the DOC established the US Artificial Intelligence Safety Institute (AISI) in November 2023. The role of the AISI is to “lead the U.S. government’s efforts on AI safety and trust, particularly for evaluating the most advanced AI models.” Concretely, the AISI is tasked with developing AI safety guidelines and standards and liaising with the AI safety bodies of partner nations.

The AISI is also responsible for convening multistakeholder fora on AI safety. It is in pursuance of this responsibility that the DOC has convened the AISIC.

The Responsibilities of the AISIC

“The U.S. government has a significant role to play in setting the standards and developing the tools we need to mitigate the risks and harness the immense potential of artificial intelligence,” said DOC Secretary Gina Raimondo in a statement announcing the launch of the AISIC. “President Biden directed us to pull every lever to accomplish two key goals: set safety standards and protect our innovation ecosystem. That’s precisely what the U.S. AI Safety Institute Consortium is set up to help us do.”

To achieve the objectives set out by the AI EO, the AISIC has convened leading AI developers, research institutions, and civil society groups. At launch, the AISIC has over 200 members, and that number will likely grow in the coming months.

According to NIST, members of the AISIC will engage in the following objectives:

  1. Guide the evolution of industry standards on the development and deployment of safe, secure, and trustworthy AI.
  2. Develop methods for evaluating AI capabilities, especially those that are potentially harmful.
  3. Encourage secure development practices for generative AI.
  4. Ensure the availability of testing environments for AI tools.
  5. Develop guidance and practices for red-team testing and privacy-preserving machine learning.
  6. Create guidance and tools for digital content authentication.
  7. Encourage the development of AI-related workforce skills.
  8. Conduct research on human-AI system interactions and other social implications of AI.
  9. Facilitate understanding among actors operating across the AI ecosystem.

To join the AISIC, organizations were instructed to submit a letter of intent via an online webform. If selected for participation, applicants were asked to sign a Cooperative Research and Development Agreement (CRADA)[2] with NIST. Entities that could not participate in a CRADA were, in some cases, given the option to “participate in the Consortium pursuant to separate non-CRADA agreement.”

While the initial deadline to submit a letter of intent has passed, NIST has provided that there “may be continuing opportunity to participate even after initial activity commences for participants who were not selected initially or have submitted the letter of interest after the selection process.” Inquiries regarding AISIC membership may be directed to this email address.

Conclusion: The AISIC as a Key Implementer of the AI EO?

While at the time of writing NIST has not announced concrete initiatives that the AISIC will undertake, it is likely that the body will come to play an important role in implementing key provisions of Biden’s AI EO. As discussed earlier, NIST created the AISI and the AISIC in response to the AI EO’s requirement that DOC establish “guidelines and best practices…for developing and deploying safe, secure, and trustworthy AI systems.” Under this general heading, the AI EO lists specific resources and frameworks that the DOC must establish, including:

It is premature to assert that either the AISI or the AISIC will exclusively carry out these goals, as other bodies within the DOC (such as the National AI Research Resource) may also contribute to the satisfaction of these requirements. That being said, given the correspondence between these mandates and the goals of the AISIC, along with the multistakeholder and multisectoral structure of the consortium, it is likely that the AISIC will play a significant role in carrying out these tasks.

We will continue to provide updates on the AISIC and related DOC AI initiatives. Please feel free to contact us if you have questions as to current practices or how to proceed.

Endnotes

[1] As explained in our July 2023 newsletter on Biden’s voluntary framework on AI, “red-teaming” is “a strategy whereby an entity designates a team to emulate the behavior of an adversary attempting to break or exploit the entity’s technological systems. As the red team discovers vulnerabilities, the entity patches them, making their technological systems resilient to actual adversaries.”

[2] See “CRADAs – Cooperative Research & Development Agreements” for an explanation of CRADAs. https://www.doi.gov/techtransfer/crada.

Raj Gambhir contributed to this article.

©1994-2024 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
For more on AI Safety, visit the NLR Communications, Media & Internet section.

SEC Enforcement Targets Anti-Whistleblower Practices in Financial Firm’s Settlement Agreements with Retail Clients by Imposing Highest Penalty in Standalone Enforcement Action Under Exchange Act Rule 21 F-17(a)

As the year gets underway, the Securities and Exchange Commission (SEC or Commission) is continuing its ongoing enforcement efforts to target anti-whistleblower practices by pursuing a broader range of entities and substantive agreements, including the terms of agreements between financial institutions and their retail clients. The most recent settlement with a financial firm signifies that the SEC is imposing increasingly steep penalties to settle these matters while focusing on confidentiality provisions that do not affirmatively permit voluntary disclosures to regulators. We discuss below the latest SEC enforcement actions in the name of whistleblower protection and offer some practical tips for what firms and companies may do to proactively mitigate exposure.

On 16 January 2024, the SEC announced a record $18 million civil penalty against a dual registered investment adviser and broker-dealer (the Firm), asserting that the use of release agreements with retail clients impeded the clients from reporting securities law violations to the SEC in violation of Rule 21F-17(a) of the Securities Exchange Act of 1934 (Exchange Act).1

The SEC found that from March 2020 through July 2023, the Firm regularly required its retail clients to sign confidential release agreements in order to receive a credit or settlement of more than $1,000. Under the terms of these releases, clients were required to keep confidential the existence of the credits or settlements, all related underlying facts, and all information relating to the accounts at issue, or risk legal action for breach of the agreement. The agreements “neither prohibited nor restricted” the clients from responding to any inquiries from the SEC, the Financial Industry Regulatory Authority (FINRA), other regulators or “as required by law.” However, the agreements did not expressly allow the clients to initiate voluntary reporting of potential securities law violations to the regulators. The SEC found that this violated Rule 21F-17(a) “which is intended to ‘encourag[e] individuals to report to the Commission.’”2 While the Firm did report a number of the underlying client disputes to FINRA, the SEC found this insufficient to mitigate the lack of language in the release agreements that expressly permitted the clients to report potential securities law violations to the SEC.

The SEC initiated a settled administrative proceeding against the Firm, which neither admitted nor denied the SEC’s findings. In addition to the $18 million civil monetary penalty, the settlement requires that the Firm cease and desist from further violations of Rule 21F-17(a). Notably, the SEC credited certain remedial measures promptly undertaken by the Firm, including revising the at-issue release language and affirmatively alerting affected clients that they are not prohibited from communicating with governmental and regulatory authorities.

This enforcement action is significant for several reasons. First, it signals a broader enforcement focus by the SEC with respect to Rule 21F-17(a) in that this is the first action involving the terms of agreements between a financial institution and its retail clients, which are prevalent throughout the financial services industry. Previously, enforcement had focused squarely on restrictive confidentiality provisions involving employees, such as those found in employment or severance agreements or in connection with internal investigation interviews.

Second, the unprecedented magnitude of the penalty in a standalone Rule 21F-17(a) case underscores the SEC’s emphasis on preventing practices that it views as obstructions of whistleblower rights. SEC Enforcement Director Gurbir Grewal’s statement announcing the settlement reflects this position, “Whether it’s in your employment contracts, settlement agreements or elsewhere, you simply cannot include provisions that prevent individuals from contacting the SEC with evidence of wrongdoing.” Companies (public and private), broker-dealers, investment advisers, and other market participants should expect to see continued enforcement investigations in connection with the SEC’s ongoing attention toward compliance with Rule 21F-17(a), as discussed further below.

The SEC’s Whistleblower Protection Program

Established in 2011 pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC Whistleblower Program provides monetary awards to individuals who “tip” the SEC with original information that leads to an enforcement action resulting in monetary sanctions that exceed $1 million. Through the end of the SEC’s FY2023, the SEC has awarded almost $2 billion to 385 whistleblowers.3 In FY2023 alone, the SEC received over 18,000 whistleblower tips and awarded more than $600 million in whistleblower awards to 68 individuals.4

In furtherance of the Whistleblower Program, the SEC also issued Exchange Act Rule 21F-17(a), which provides that “no person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.”5

SEC Struck Several Blows in 2023 Against Companies that Failed to Carve out Whistleblower Protections in Their Confidentiality Agreements

The SEC has been aggressively enforcing Rule 21F-17(a) since its first enforcement action in 2015 with respect to that Rule,6 through several waves of enforcement actions. During 2023, the SEC was especially active with a number of settled enforcement actions asserting violations of Rule 21F-17(a) in which the respondents neither admitted nor denied the SEC’s findings:

  • In February 2023, the SEC fined a video game development and publishing company $35 million for violating federal securities laws through its inadequate disclosure controls and procedures. The settled action also included a finding that the company had violated Rule 21F-17(a) by executing separation agreements in the ordinary course of its business that required former employees to provide notice to the company if they received a request for information from the SEC’s staff.7
  • In May 2023, the SEC imposed a $2 million fine on an internet streaming company for: (i) retaliating against an employee who reported misconduct to the company’s management prior to and after filing a complaint with the SEC; and, (ii) impeding the reporting of potential securities law violations, by including provisions in employee severance agreements requiring that departing employees waive any potential right to receive a whistleblower award, in violation Rule 21F-17(a).8
  • In September 2023, in another standalone enforcement action for violations of Rule 21F-17(a), the SEC imposed a $10 million civil monetary penalty on a registered investment adviser (RIA) for requiring that its new employees sign employment agreements that prohibited the disclosure of “Confidential Information” to anyone outside of the company, without an exception for voluntary communications with the SEC concerning possible securities laws violations.9 Further, the RIA required many departing employees to sign a release in exchange for the receipt of certain deferred compensation and other benefits affirming that, among other things, the employee had not filed any complaints with any governmental agency. Although the RIA later revised its policies and issued clarifications to employees that they were not prevented from communicating with the SEC and other regulators, the RIA failed to amend its employment and release agreements to provide the carve out.
  • Also in September 2023, the SEC charged two additional firms with violations of Rule 21F-17(a). In one case imposing a $375,000 civil penalty, the SEC found that a commercial real estate services and investment firm impeded whistleblowers by requiring its employees, as a condition of receiving separation pay, to represent that they had not filed a complaint against the firm with any federal agency.10 In another case, the SEC imposed a $225,000 civil penalty against a privately-held energy and technology company for requiring certain departing employees to waive their rights to monetary whistleblower awards.11 This particular action underscores that Rule 21F-17 applies to all entities, and not only to public companies.

Mr. Grewal, in an October 2023 speech before the New York City Bar Association Compliance Institute, emphasized that potential impediments to the SEC’s Whistleblower Program would be a continued focus of the agency’s enforcement efforts, stating, “we take compliance with Rule 21F-17 very seriously, and so should each of you who work in a compliance function or advise companies. You need to look at these orders and the violative language cited by the Commission and think about how those actions may impact your firms. And if they do, then take the steps necessary to effect compliance.”12

Key Take-Aways

The SEC’s recent enforcement actions demonstrate that violations of Rule 21F-17(a) can carry significant fines and reach virtually any confidentiality agreement that does not carve out communications between a firm’s current or former employees or customers and the SEC or other regulators about potential securities violations. Moreover, although many of the enforcement actions relate to language in agreements, Rule 21F-17 is not so limited and can also apply to language in internal policies, procedures, guidance, manuals, or training materials. The message from the SEC is clear: it will continue to enforce Rule 21F-17 with respect to public companies, private companies, broker-dealers, investment advisers, and other financial services entities.

The SEC in its recent orders has provided credit to companies for cooperation as well as for instituting remedial actions.13 Being proactive in identifying and correcting potential violations in advance of any investigation by the SEC can result in mitigation of any action or penalties.

Legal and compliance officers may want to consider the following steps in order to evaluate and potentially mitigate any potential exposure to an enforcement action:

  • Conduct a review of all employee-facing and client-facing documents or contracts with confidentiality provisions and remove or revise any content that may be viewed as impeding (even unintentionally) a person’s ability to report potential securities law violations to the SEC. Depending on the circumstances, this may involve including a reference expressly permitting communications with the SEC and other government or regulatory entities without advance notice or disclosure to the company.
  • Remove any language from the templates that could be interpreted as hindering an employee’s or client’s ability to communicate with the SEC concerning potential securities law violations, including language threatening disciplinary action against employees for disclosing confidential information in their communications with government agencies when reporting potential violations.
  • Prepare addenda or updates to current employee- and client-facing agreements that reflect the revised confidentiality clauses.
  • Include reference in written anti-retaliation policies that employees’ communications and cooperation with the SEC and other government agencies will not result in retaliation from the company.
  • Conduct trainings for company managers and supervisors regarding appropriate communications to employees regarding their interactions with the government.
  • Implement policies that prevent any company personnel from taking steps to block or interfere with an employee’s use of company platforms or systems to communicate with the SEC and other government agencies.14

1 In the Matter of JP Morgan Securities LLC, Admin. Proc. No. 3-21829 (Jan. 16, 2024), https://www.sec.gov/files/litigation/admin/2024/34-99344.pdf.

2 Id. (quoting Securities Whistleblower Incentives and Protections Adopting Release, Release No. 34-63434 (June 13, 2011)).

3 SEC Office of the Whistleblower Annual Report to Congress for Fiscal Year 2023 (Nov. 14, 2023), https://www.sec.gov/files/2023_ow_ar.pdf; SEC Whistleblower Office Announces Results for FY 2022 (Nov. 15, 2022), https://www.sec.gov/files/2022_ow_ar.pdf; 2021 Annual Report to Congress Whistleblower Program (Nov. 15, 2021), https://www.sec.gov/files/owb-2021-annual-report.pdf; 2020 Annual Report to Congress Whistleblower Program (Nov. 16, 2020), https://www.sec.gov/files/2020_owb_annual_report.pdf.

4 SEC Office of the Whistleblower Annual Report to Congress for Fiscal Year 2023 (Nov. 14, 2023), https://www.sec.gov/files/2023_ow_ar.pdf.

5 17 C.F.R. § 240.21F-17.

6 In the Matter of KBR, Inc., Admin. Proc. No. 3-16466 (Apr. 1 2015), https://www.sec.gov/files/litigation/admin/2015/34-74619.pdf (imposing a US$130,000 fine on a company in a settled enforcement action for requiring that witnesses in certain internal investigations sign confidentiality agreements warning that they could be subject to discipline if they discussed the matters at issue outside the company without prior approval of the company’s legal department).

7 In the Matter of Activision Blizzard, Inc. Admin. Proc. No. 3-21294 (Feb. 3, 2023), https://www.sec.gov/files/litigation/admin/2023/34-96796.pdf.

8 In the Matter of Gaia, Inc. et. al., Admin. Proc. No. 3-21438 (May 23, 2023), https://www.sec.gov/files/litigation/admin/2023/33-11196.pdf.

9 In the Matter of D.E. Shaw & Co., L.P., Admin. Proc. No. 3-21775 (Sep. 29, 2023), https://www.sec.gov/files/litigation/admin/2023/34-98641.pdf.

10 In the Matter of CBRE Inc., Admin. Proc. No. 3-21675  (Sept. 19, 2023), https://www.sec.gov/files/litigation/admin/2023/34-98429.pdf.

11 In the Matter of Monolith Res., LLC, Admin. Proc. No. 3-21629 (Sept. 8, 2023), https://www.sec.gov/files/litigation/admin/2023/34-98322.pdf.

12 Gurbir S. Grewal, Remarks at New York City Bar Association Compliance Institute (Oct. 24, 2023), https://www.sec.gov/news/speech/grewal-remarks-nyc-bar-association-compliance-institute-102423.

13 See, e.g., In the Matter of CBRE Inc., Admin. Proc. No. 3-21675  (Sept. 19, 2023), https://www.sec.gov/files/litigation/admin/2023/34-98429.pdf (crediting respondent’s remediation program, which included, among other measures, an audit of relevant agreements, updates to policies with respect to Rule 21F-17, and mandatory trainings); In the Matter of Monolith Res., LLC, Admin. Proc. No. 3-21629 (Sept. 8, 2023), https://www.sec.gov/files/litigation/admin/2023/34-98322.pdf (crediting respondent’s prompt remedial acts including revisions to the at-issue release language and affirmatively alerting affected clients that they are not prohibited from communicating with governmental and regulatory authorities.)

14 Cf.  In the Matter of David Hansen, Admin Proc. 3-20820 (Apr. 12, 2022), https://www.sec.gov/enforce/34-94703-s (settled SEC enforcement action against former Chief Information Officer of a technology company for violating Rule 21F-17(a) by, among other things, removing an employee’s access to the company’s computer systems after the employee raised concerns regarding misrepresentations contained in the company’s public disclosures).

Copyright 2024 K & L Gates
For more news on SEC enforcement, visit the NLR Securities and SEC section.

Supreme Court Upholds Corporate Whistleblower Protections in Landmark Ruling

Today, the U.S. Supreme Court issued a unanimous ruling holding that whistleblowers do not need to prove that their employer acted with “retaliatory intent” to be protected under the Sarbanes-Oxley Act (SOX). The decision in the case, Murray v. UBS Securities, LLC, has immense implications for a number of whistleblower protection laws.

“This is a major win for whistleblowers and thus a huge win for corporate accountability,” said leading whistleblower attorney David Colapinto, a founding partner of Kohn, Kohn & Colapinto.

“A ruling in favor of UBS would have overturned more than 20 years of precedent in SOX whistleblower cases and made it exceedingly more difficult for whistleblowers who claim retaliation under many similarly worded federal whistleblower statutes,” Colapinto continued.

“Thankfully, the Court was not swayed by UBS’ attempt to ignore the plain meaning of the statute and instead upheld the burden of proof that Congress enacted to protect whistleblowers who face retaliation,” added Colapinto.

In an amicus curiae brief filed in the case on behalf of the National Whistleblower Center, the founding partners of Kohn, Kohn & Colapinto outlined the Congressional intent behind the burden of proof standard in SOX.

“In crafting the unique ‘contributing factor’ test for whistleblowers, Congress left an incredibly straight-forward legislative history documenting the value of whistleblowers’ contributions, the risks and retaliation whistleblowers faced, the barriers the previous burden of proof presented for whistleblowers, and Congress’ explicit intention to lower that burden of proof for whistleblowers,” the brief states.

In the Court’s opinion, Justice Sonia Sotomayor likewise pointed to the Congressional intent of SOX’s contributing-factor burden of proof standard:

“To be sure, the contributing-factor framework that Congress chose here is not as protective of employers as a motivating-factor framework. That is by design. Congress has employed the contributing-factor framework in contexts where the health, safety, or well-being of the public may well depend on whistleblowers feeling empowered to come forward. This Court cannot override that policy choice by giving employers more protection than the statute itself provides.”

This article was authored by Geoff Schweller.

Copyright Kohn, Kohn & Colapinto, LLP 2024. All Rights Reserved.
For more news on Supreme Court Whistleblower Rulings, visit the NLR Labor & Employment section.

Three Individuals Sentenced for $3.5 Million COVID-19 Relief Fraud Scheme

Three Individuals Sentenced for $3.5 Million COVID-19 Relief Fraud Scheme

On February 6, three individuals were sentenced for fraudulently obtaining and misusing Paycheck Protection Program (PPP) loans that the US Small Business Administration (SBA) guaranteed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

According to court documents and evidence presented at trial, in 2020 and 2021, defendants Khadijah X. Chapman, Daniel C. Labrum, and Eric J.O’Neil submitted falsified documents to financial institutions for fictitious businesses to fraudulently obtain $3.5 million in PPP loans intended for small businesses struggling with the economic impact of COVID-19. Chapman was convicted in November 2023 of bank fraud. Labrum and O’Neil pleaded guilty in 2023 to bank fraud. Following their convictions, Chapman was sentenced to three years and 10 months in prison, Labrum was sentenced to two years in prison, and O’Neil was sentenced to two years and three months in prison.

Read the US Department of Justice’s (DOJ) press release here.

False Claims Act Complaint Filed Against Former President and Co-Owner of Mobile Cardiac PET Scan Provider

The DOJ filed a complaint in the US District Court for the Southern District of Texas under the False Claims Act (FCA) against Rick Nassenstein, former president, chief financial officer, and co-owner of Illinois-based Cardiac Imaging Inc. (CII), which provides mobile cardiac positron emission tomography (PET) scans.

The complaint alleges that Nassenstein caused CII to pay excessive, above-market fees to doctors who referred patients to CII for cardiac PET scans. The government alleges that the compensation arrangements violated the Stark Law, which prohibits health care providers from billing Medicare for services referred by a physician with whom the provider has a compensation arrangement unless the arrangement meets certain statutory and regulatory requirements. Claims knowingly submitted to Medicare in violation of the Stark Law also violate the federal FCA.

The complaint alleges that CII provided cardiac PET scans on a mobile basis and paid the referring physicians, usually cardiologists, to provide physician supervision as required by Medicare rules. From at least 2017 through June 2023, Nassenstein allegedly caused CII to enter into compensation arrangements with referring cardiologists that provided for payment to the cardiologists as if they were fully occupied supervising CII’s scans, even though they were actually providing care to other patients in their offices or patients who were not even on site. CII’s fees also allegedly compensated the cardiologists for additional services the physicians did not actually provide. The complaint alleges that CII paid over $40 million in unlawful fees to physicians and submitted over 75,000 false claims to Medicare for services provided pursuant to referrals that violated the Stark Law.

The lawsuit was originally a qui tam complaint filed by a former billing manager at CII, and the United States, through the DOJ, filed a complaint in partial intervention to participate in the lawsuit.

The case, captioned US ex rel. Pinto v. Nassenstein, No. 18-cv-2674 (S.D. Tex.), follows an $85.5 million settlement in October 2023 by CII and its current owner, Sam Kancherlapalli, for claims arising from this conduct.

Read the DOJ’s press release here.

San Diego Restaurant Owner Charged with Tax and COVID-19 Relief Fraud Schemes

On February 2, a federal grand jury in San Diego returned a superseding indictment charging a California restaurant owner with wire fraud, conspiracy to commit wire fraud, tax evasion, filing false tax returns, conspiracy to defraud the United States, conspiracy to commit money laundering, and failing to file tax returns.

According to the indictment, Leronce Suel, the majority owner of Rockstar Dough LLC and Chicken Feed LLC, conspired with a business partner to underreport over $1.7 million in gross receipts on Rockstar Dough LLC’s 2020 federal corporate tax return. From March 2020 to June 2022, Suel and the business partner then allegedly used this fraudulent return to qualify for COVID-19-related loans pursuant to the PPP and Restaurant Revitalization Funding program. In connection with those loans, Suel also allegedly certified falsely that he used the loan money for payroll purposes only. The indictment alleges that Suel and his business partner laundered the fraudulently obtained funds through cash withdrawals from their business bank accounts and stashed more than $2.4 million in cash in their home.

The indictment further charges that Suel failed to report millions of dollars received in cash and personal expenses paid for by his businesses as income, in addition to reporting false depreciable assets and business losses.

If convicted, Suel faces prison sentences up to 30 years for each count of wire fraud and conspiracy to commit wire fraud, 10 years for each count of conspiracy to commit money laundering, five years for tax evasion and conspiracy to defraud the United States, three years for each count of filing false tax returns, and one year for each count of failing to file tax returns.

Read the DOJ’s press release here.

© 2024 ArentFox Schiff LLP
For more on Regulated Industries, visit the NLR Biotech, Food, Drug section.