Category: Securities Law

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.

How to Report Spoofing and Earn an SEC Whistleblower Award

Spoofing is a form of market manipulation where traders artificially inflate the supply and demand of an asset to increase profits. Traders engaged in spoofing place a large number of orders to buy or sell a certain stock or asset without the intent to follow through on the orders. This deceptive trading practice leads other market participants to wrongly believe that there is pressure to act on that asset and “spoofs” other participants to place orders at artificially altered prices.

Spoofing affects prices because the artificial increase in activity on either the buy or sell side of an asset creates the perception that there is a shift in the number of investors wanting to buy or sell. Spoofers place false bids or offers with the intent to cancel before executing so that they can then follow-through on genuine orders at a more favorable price. Often, spoofers use automated trading and algorithms to achieve their goals.

The Dodd-Frank Act of 2010 prohibits spoofing, which it defines as “bidding or offering with the intent to cancel the bid or offer before execution.” 7 U.S.C. § 6c(a)(5)(C). Spoofing also violates SEC rules, including the market manipulation provisions of Section 9(a)(2) of the Securities Exchange Act of 1934.

Spoofing Enforcement Actions  

In the Matter of J.P. Morgan Securities LLC

On September 29, 2020, the U.S. Securities and Exchange Commission (“SEC”) announced charges against J.P. Morgan Securities LLC, a broker-dealer subsidiary of JPMorgan Chase & Co., for fraudulently engaging in manipulative trading of U.S. Treasury securities. According to the SEC’s order, certain traders on J.P. Morgan Securities’ Treasuries trading desk placed genuine orders to buy or sell a particular Treasury security, while nearly simultaneously placing spoofing orders, which the traders did not intend to execute, for the same series of Treasury security on the opposite side of the market. The spoofing orders were intended to create a false appearance of buy or sell interest, which would induce other market participants to trade against the genuine orders at prices that were more favorable to J.P. Morgan Securities than J.P. Morgan Securities otherwise would have been able to obtain.

JPMorgan Chase & Co. agreed to pay disgorgement of $10 million and a civil penalty of $25 million to settle the SEC’s action. In addition, the U.S. Department of Justice (“DOJ”) and the U.S. Commodity Futures Trading Commission (“CFTC”) brought parallel actions against JPMorgan Chase & Co. and certain of its affiliates for engaging in the manipulative trading. In total, the three actions resulted in monetary sanctions against JPMorgan Chase & Co. totaling $920 million, which included amounts for criminal restitution, forfeiture, disgorgement, penalties, and fines.

United States of America v. Edward Bases and John Pacilio

On August 5, 2021, a federal jury convicted Edward Bases and John Pacilio, two former Merrill Lynch traders, for engaging in a multi-year fraud scheme to manipulate the precious metals market. According to the U.S. Department of Justice’s (“DOJ”) press release announcing the action, the two traders fraudulently pushed market prices up or down by routinely placing large “spoof” orders in the precious metals futures markets that they did not intend to fill.

After manipulating the market, Bases and Pacilio executed trades at favorable prices for their own gain, and to the detriment of other traders. The DOJ’s Indictment detailed how Bases and Pacilio discussed their intent to “push” the market through spoofing in electronic chat conversations.

In the Matter of Nicholas Mejia Scrivener

The SEC recently charged a California day trader with spoofing, where he placed multiple orders to buy or sell a stock, sometimes at multiple price levels that he did not intend to execute. The SEC alleged that the purpose of the false orders was to create the appearance of inflated market interest and induce other actors to trade at artificial prices. The trader then completed genuine orders at manipulated prices and withdrew the false orders. The SEC found that the trader’s conduct violated Section 9(a)(2) of the Exchange Act of 1934, and the trader settled by consenting to a cease-and-desist order and paying in disgorgement, in interest, and a civil penalty.

SEC and CFTC Whistleblower Awards for Reporting Spoofing

Under the SEC Whistleblower Program and CFTC Whistleblower Program, a whistleblower who reports spoofing to the SEC or CFTC may be eligible for an award. These practices may constitute spoofing:

  • Placing buy or sell orders for a stock or asset without the intent to execute;
  • Attempting to entice other traders to act on a certain stock or asset to manipulate market prices and profitability;
  • Creating a false appearance of market interest to manipulate the price of a stock or asset;
  • Placing deceptively large buy or sell orders only to withdraw those orders once smaller, genuine orders on the other side of the market have been filled;
  • Using false orders to favorably affect prices of a stock or asset (to increase market prices if intending to sell or to decrease market prices if intending to buy) so that one can then receive more ideal prices for a genuine order.

If a whistleblower’s information leads the SEC or CFTC to a successful enforcement action with total monetary sanctions in excess of $1 million, a whistleblower may receive an award of between 10 and 30 percent of the total monetary sanctions collected.

Since 2012, the SEC has issued nearly $1 billion to whistleblowers and the CFTC has issued approximately $123 million to whistleblowers. The largest SEC whistleblower awards to date are $114 million and $50 million. The largest CFTC whistleblower awards to date are $45 million and $30 million.

How to Report Spoofing and Earn a Whistleblower Award

To report spoofing and qualify for a whistleblower award, the SEC and CFTC require whistleblowers or their attorneys report their tips online through their Tip, Complaint or Referral Portals or mail/fax Form TCRs to the whistleblower offices. Prior to submitting a tip, whistleblowers should consider scheduling a confidential consultation with a whistleblower attorney.

The path to receiving an award is lengthy and complex. Experienced whistleblower attorneys can provide critical guidance to whistleblowers throughout this process to increase the likelihood that they not only obtain, but maximize, their awards.

SEC and CFTC Whistleblower Protections for Disclosures About Spoofing

The SEC and CFTC Whistleblower Programs protect the confidentiality of whistleblowers and do not disclose information that might directly or indirectly reveal a whistleblower’s identity. Moreover, a whistleblower can submit an anonymous tip to the SEC and CFTC if represented by counsel. In certain circumstances, a whistleblower may remain anonymous, even to the SEC and CFTC, until an award determination. However, even at the time of an award, a whistleblower’s identity is not made available to the public.

© 2021 Zuckerman Law

Article by Jason Zuckerman, Matthew Stock, and Katherine Krems with Zuckerman Law.

For more articles on the SEC and whistleblower awards, follow the NLR Financial Securities & Banking section.

No Good Deed Goes Unpunished: Growing ESG Litigation Risks

Summary

Plaintiffs are inventing new theories to attack businesses for alleged ESG-related deficiencies.  Companies need to carefully manage their ESG initiatives, performance, and representations.

Introduction

Public companies are facing increased pressure to develop and publish goals around Environmental, Social and Governance (“ESG”) objectives. A number of groups and organizations have developed scoring metrics which attempt to grade companies on their ESG performance.  Private investor groups have added pressure by indicating they will invest their dollars in companies which meet certain criteria.  For example, in his January 2021 letter to CEO’s, Blackrock Investments’ Larry Fink wrote this:

Given how central the energy transition will be to every company’s growth prospects, we are asking companies to disclose a plan for how their business model will be compatible with a net zero economy – that is, one where global warming is limited to well below 2ºC, consistent with a global aspiration of net zero greenhouse gas emissions by 2050. We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.

The Securities and Exchange Commission (“SEC”) has also weighed in, making the case for enhanced ESG disclosures.

More than 95% of the Fortune 50 now include some ESG disclosures in their SEC filings.  The topics on the rise in 2020 included Human Capital Management, Environmental, Corporate Culture, Ethical Business Practices, Board Oversight of E&S Issues, Social Impact and Shareholder Engagement.

Developing Litigation Trends

While the increased attention on ESG presents an opportunity for companies to showcase their good work, it also creates increased litigation risk.  These new challenges primarily fall into three areas: misrepresentations, unfair and deceptive trade practices, and securities fraud.

1. Misrepresentation & Breach of Warranty: Challenges to Misleading ESG Statements

While claims alleging defective products and labels are nothing new, the increased amount of publicly available ESG information has given plaintiffs’ attorneys new targets.  In Ruiz v. Darigold, Inc./Nw. Dairy Ass’n1, the dairy association highlighted the company’s social consciousness in a Social Responsibility Report.  Consumers sued stating they purchased the products in reliance on these statements, which plaintiffs contended were false.  The court dismissed the claims, finding that the statements were largely statements of opinion, and that “a reasonable consumer would not have interpreted the 2010 CSR as a promise that there were no problems at any of the 500+ dairies that make up the NDA or that Darigold’s products were generated by only healthy, happy, respected workers and cows.”2

The court reached a similar result in Nat. Consumers League v. Wal-Mart Stores, Inc.3, finding that Walmart’s “aspirational statements” were not actionable, although other claims based on detailed information about auditing programs could proceed.  The case settled before any final judgment.

After Chiquita made a number of marketing representations on its website regarding its environmentally safe business practices, including that it protects water sources by reforesting all affected natural watercourses it was sued by a non-profit.4  While the court dismissed a number of claims, the claims for unfair and deceptive trade practices and for breach of express warranty were allowed to proceed.

Governments have also asserted claims against companies which exaggerate their ESG accomplishments.  One decision which received considerable attention was brought by the Commonwealth of Massachusetts claiming that ExxonMobil had deceived both investors and consumers with a “greenwashing” campaign.5  Greenwashing refers to the practice of making false or misleading claims about sustainability or environmental compliance. The federal court declined jurisdiction, and sent the case back to Massachusetts state courts.

Another example is the 2019 settlement of an FTC complaint against Truly Organic, which advertised its product as vegan, even though they contained honey and lactose.  Truly Organic paid $1.76 million to settle the case.

2. Unfair and Deceptive Business Practices

Most states have laws designed to protect consumers from unfair and deceptive trade practices. These consumer protection laws can form the basis for greenwashing claims.6

In one landmark case, consumers brought a class action against Fiji Water, which marketed itself as carbon-negative and featured a green drop on the bottle.  After the trial court dismissed the case, plaintiffs appealed.  The California appeals court concluded that “no reasonable consumer would be misled to think that the green drop on Fiji water represents a third party organization’s endorsement or that Fiji Water is environmentally superior to that of the competition.7  This case has been cited hundreds of times by courts and commentators.8

In 2019, purchasers of StarKist tuna filed a class action alleging the company falsely claimed that its products were 100 percent “dolphin-safe” and sustainably sourced.  The court concluded that plaintiffs had stated a claim that StarKist’s fishing methods were not actually dolphin-safe.9  Discovery in this case is on-going, and the court recently required production of fishing records.10  Labels with claims such as “100 percent” are likely to draw similar attacks.

Keurig, which sells millions of disposable coffee pods, labeled some pods as “recyclable.”  Consumers sued, alleging that in fact the pods were not recyclable in a practical way.  The court concluded the claims were adequately pled under the reasonable consumer test.11  In September, 2020, the court granted class certification in the matter.12  This case serves a warning to be very careful about recycling claims.

In an even more recent case, California courts considered claims against Rust-Oleum, which marketed its products as “Non-Toxic” and “Earth Friendly.”  The court concluded that these terms were not deceptive as used, because there was a sufficient allegation that the products were harmful or damaging to the earth.  The Court rejected plaintiffs’ argument that the wording amounted to an environmental claim about the packaging.13

Like other unfair and deceptive acts and practices complaints, consumer claims of greenwashing may be enforced by the FTC pursuant to 15 U.S.C.A. § 45.  The FTC has published the Green Guides, 16 C.F.R. §§ 260.1 et seq., to assist manufacturers and retailers in avoiding making false or misleading claims about the environment benefits of products and/or services.  Failing to follow these guidelines are often cited by consumer plaintiffs as a basis for liability.

3. Securities Fraud Claims

Section 10-b of the Securities Exchange Act and SEC Rule 10b-5, which form the common legal grounds for claims of securities fraud, prohibit any false or misleading statement of material fact or omission of material fact in connection with the purchase or sale of any security.14   Liability potentially extends to individual officers and directors for ESG-related misstatements or omissions about which they knew or should have known.15

Shareholders frequently bring claims under the Securities Exchange Act for statements made by public companies.  In Ramirez v. Exxon Mobil Corp.16, the court found that the plaintiffs sufficiently alleged that: (i) the company made material misstatements regarding its use of proxy costs of carbon in formulating business and investment plans; (ii) the company made material misstatements concerning the financial implications of specific projects with climate change implications; and (iii) the defendants made the requisite statements with the scienter (i.e., intent to deceive) required for securities fraud claims.

Yum! Brands, which owns Taco Bell and KFC, made a number of statements regarding the importance of food safety and strict compliance with safety standards in their securities filings.  After news broke about several instances of food contamination, shareholders sued.  The court dismissed the claim, finding “a reasonable investor would pay little, if any, attention to Defendants’ statements concerning the quality of Yum!’s food safety program.  Those statements are vague and subjective, evidencing only the opinion of management, or derived from sources that are aspirational, rather than reliable.”17

On the other hand, statements about health and safety practices made by Transocean in SEC filings led the court to deny a motion to dismiss security fraud claims filed against that company following the Deepwater Horizon disaster.18  The case remains in litigation.  Another securities fraud case was filed against Brazilian mining company Vale after two dam collapses.  The plaintiffs alleged that the safety-focused statements in Vale’s SEC filings were deceptive.  Vale ultimately settled the case for $25 million.

Action Items

1. Carefully consider Voluntary Disclosures

All public disclosures create a risk of liability.  As a result, any non-mandatory disclosure must be carefully evaluated to determine whether the benefit of the disclosure outweighs the potential risk. Aspirational statements involve less risk than concrete statements and metrics, but the line between these is often blurred.  If the benefit justifies the risk, then the company must take affirmative steps to: (i) ensure the accuracy of the disclosure, (ii) prevent inconsistencies with other company disclosures; and (iii) evaluate which party should make the disclosure and the reporting framework.

2. Review the Green Guides and other FTC Guidance

The Green Guides were first issued in 1992 and were revised in 1996, 1998, and 2012.  They remain relevant today for companies looking for guidance.  A few items to pay particular attention to include:

  • Companies should avoid general environmental benefit claims, like the term “eco-friendly.”
  • Carbon offsets must be properly quantified, and companies must disclose if they are more than two years in the future.  Offsets required by law are not a “reduction.”
  • Claims about compostability, degradability and recyclability must be carefully documented.
  • Claims of “made with renewable energy” are often deceptive, because it can be difficult to prove where the energy actually came from, unless it is generated entirely within the same facility.

3. Evaluate which Sustainability Standard will be used

For many years, companies looked to GRI’s Sustainability Reporting Framework.  However, a number of new and different standards are emerging, including SASB, TCFD and the UN Global Goals.19  While a full review of these standards is beyond the scope of this article, companies should carefully select a standard for tracking and reporting and then be in a position to demonstrate compliance with those requirements.  Particular attention must be paid to disclosures around implementation, especially as it relates to supply chain impacts.

1 Ruiz v. Darigold, Inc./Nw. Dairy Ass’n, No. C14-1283RSL, 2014 WL 5599989, at *2 (W.D. Wash. Nov. 3, 2014)
2 2014 WL 5599989, at *6.
3 Nat. Consumers League v. Wal-Mart Stores, Inc., No. 2015 CA 007731 B, 2016 WL 4080541, at *1 (D.C. Super. July 22, 2016)
4 Water & Sanitation Health, Inc. v. Chiquita Brands Int’l, Inc., No. C14-10 RAJ, 2014 WL 2154381, at *1 (W.D. Wash. May 22, 2014).
5 Massachusetts v. Exxon Mobil Corp., 462 F. Supp. 3d 31, 38 (D. Mass. 2020).
6 See Cause of Action Under State Consumer Protective Law for “Greenwashing,” 79 Causes of Action 2d 323 (Originally published in 2017).
7 B. Hill v. Roll Internat. Corp., 195 Cal. App. 4th 1295, 1301, 128 Cal. Rptr. 3d 109, 113 (2011).
8 See, e.g. Jou v. Kimberly-Clark Corp., No. C-13-03075 JSC, 2013 WL 6491158, at *7 (N.D. Cal. Dec. 10, 2013) (concluding “pure & natural” was a sufficiently specific representation).
9 Gardner v. StarKist Co., 418 F. Supp. 3d 443, 449 (N.D. Cal. 2019).
10 Gardner v. Starkist Co., No. 19-CV-02561-WHO, 2021 WL 303426, at *5 (N.D. Cal. Jan. 29, 2021).
11 Smith v. Keurig Green Mountain, Inc., 393 F. Supp. 3d 837, 847 (N.D. Cal. 2019).
12 Smith v. Keurig Green Mountain, Inc., No. 18-CV-06690-HSG, 2020 WL 5630051, at *1 (N.D. Cal. Sept. 21, 2020).
13See Bush v. Rust-oleum Corp., 2020 WL 8917154 (N.D. Cal.).
14 15 U.S.C. §§78a et seq.
15 See Growing ESG Risks: The Rise of Litigation, 50 ELR 10849 (2020).
16 Ramirez v. Exxon Mobil Corp., 334 F. Supp. 3d 832 (N.D. Tex. 2018)
17 In re Yum! Brands, Inc. Sec. Litig., 73 F. Supp. 3d 846, 864 (W.D. Ky. 2014), aff’d sub nom. Bondali v. Yum! Brands, Inc., 620 F. App’x 483 (6th Cir. 2015).
18 In re BP P.L.C. Sec. Litig., No. 4:12-CV-1256, 2013 WL 6383968, at *1 (S.D. Tex. Dec. 5, 2013).
19 The ESG Movement: Why All Companies Need to Care, Womble Bond Dickinson (US) LLP and Pamela Cone

Copyright © 2021 Womble Bond Dickinson (US) LLP All Rights Reserved.

ARTICLE BY Mark P. Henriques of  Womble Bond Dickinson (US) LLP
For more articles on ESG litigation risks, visit the NLR Litigation / Trial Practice section.

“We are not going to be moving slowly” SEC Director on ESG Disclosure Requirements

The Securities and Exchange Commission (SEC) requests public comments to be made ahead of their decision to possibly strengthen Environmental, Social, and Corporate Governance (ESG) disclosures for corporations. Specifically, this action would hold companies more accountable for their possible contributions to global climate decline. While the comment period is open until June 13th, SEC Director of the Division of Corporation Finance John Coates urges submissions sooner rather than later.

“We’re not going to be moving slowly,” Coates said in a round table discussion of the SEC action hosted by New York University Vincent C. Ross Institute of Accounting Research on April 30th. “We’re going to be moving relatively promptly on this front, and if you really want your contributions read, I would send them in earlier than June 13th.”

Coates assured that more detailed attention will go into the submissions received ahead of the deadline.

“If you get them in earlier… we will be able to spend more time carefully reading them right away. We will eventually process all of them, just to be clear, but it may take more time for the ideas of them to get into our head so sooner rather than later, would be great.”

Among the comments already submitted, there is a wide range of opinions on whether the SEC is overstepping its responsibilities in taking on climate issues by requiring more transparency from companies. While some commenters tell the SEC to leave any climate policy to elected officials, others are enthusiastic about more uniform and structured approaches to accountability.

Some opinions fall in the middle, where commenters want to see the SEC simply enforce existing guidelines, set by organizations such as the Task Force on Climate-Related Financial Disclosure (TCFD) and the Sustainability Accounting Standards Board (SASB), instead of creating new and possibly confusing procedures. This is in response to arguments that the current course of action in climate reporting is insufficient, and corporations have found ways to escape sharing climate impact with their shareholders in the past.

Kelsey Condon, a whistleblower attorney at Kohn, Kohn and Colapinto, published an article on this issue stating, “This policy change is important for whistleblowers to be aware of because a corporation’s misleading statements on these subjects are now likely to be treated as material by the SEC and may actually be prosecuted. Corporate insiders, i.e., whistleblowers, are well-positioned to report to the SEC when they know that a company’s statements about climate and ESG are false or designed to be misleading.”

And that, “Whistleblowers are a crucial source of information and evidence, providing a window into the opaque and sophisticated worlds of corporate inner workings and criminal networks, which law enforcement would otherwise not have. In this way, whistleblowers are our best hope for holding corporations to their environmental promises through such reporting. Now, the SEC may actually take action on such reports, and whistleblowers will enjoy the safeguards that come with reporting to the SEC, such as anti-retaliation protection, anonymity, and awards.”

With stricter regulations would come a greater need for those ready to blow the whistle on companies still failing to accurately communicate their environmental impact.

To read previously submitted comments, or submit your own, click here.

Copyright Kohn, Kohn & Colapinto, LLP 2021. All Rights Reserved.

ARTICLE BY Grace Schepis of Kohn, Kohn & Colapinto

For more articles on the SEC, visit the NLR Securities & SEC section.

Rulemaking Petition Seeks SEC Guidance on NFTs

A recent rulemaking petition to the SEC requests that the agency issue a concept release on nonfungible tokens, or NFTs. The petition is hopeful that an SEC rulemaking paired with an opportunity for public input will resolve regulatory uncertainty for parties looking to create NFTs and facilitate their sale.

The petition opens by noting that the federal securities laws, first written in the 1930s, “provide a crude mechanism for the regulation of NFTs.” It then uses the SEC’s Howey guidance to consider whether NFTs should be deemed securities for purposes of the federal securities laws. The petition observes that if NFTs are deemed securities, platforms facilitating their sale and secondary trading may be deemed exchanges, broker-dealers or alternative trading systems under SEC rules. However, consistent with the market’s current approach to the issue, the petition also posits that if an NFT “relates to an existing asset and is marketed as a collectible with a public assurance of authenticity on the blockchain, it should not be deemed a security.”

To allay any potential uncertainty in the future, the petition urges the SEC to issue a concept release (which is the SEC’s term for an advance notice of proposed rulemaking under the Administrative Procedure Act) on the status and regulation of NFTs under the federal securities laws. Because NFTs do not typically function as traditional securities, the petition advocates that the SEC provide guidance that defines when an NFT is a security and what type of registration is required by firms facilitating the trading of NFTs. Doing so will, according to the petition, stimulate innovation and promote market integrity, capital formation, and protection of investors.

As we have previously noted, new SEC Chairman Gary Gensler brings a deep understanding of blockchain and digital assets to the agency. The crypto community has been hopeful that he will also bring a more progressive attitude towards the regulation of digital asset securities. Mr. Gensler is scheduled to testify for the first time as SEC chairman before the full House Financial Services Committee on May 6, 2021, but his prepared testimony does not address digital assets. As NFTs continue to proliferate, weighing in on this asset class will provide a great deal of insight to Chairman Gensler’s broader approach to the crypto space in his new role.

Copyright © 2021, Hunton Andrews Kurth LLP. All Rights Reserved.

ARTICLE BY Scott H. Kimpel of Hunton Andrews Kurth
For more articles on NFTs, visit the NLR Corporate & Business Organizations

How a CEO Can Be Liable for a Noncompliant Business

Your company is being targeted in a civil lawsuit. A whistleblower has filed a complaint with the U.S. Securities and Exchange Commission (SEC). The Internal Revenue Service’s Criminal Investigations Division (IRS-CI) is investigating your company for tax fraud. As the company’s chief executive, are you at risk for personal liability exposure?

Maybe. While most corporate liabilities reside exclusively at the corporate level, there are circumstances in which CEOs can be held liable for their companies’ noncompliance. In certain circumstances, CEOs can face personal civil, or criminal liability for acts taken by, or on behalf of, their companies. Litigation and investigations targeting businesses’ noncompliance can also lead to the discovery of wrongs committed by CEOs in their individual capacities, and these discoveries can lead to personal liability as well.

“CEOs can potentially face personal liability in a broad range of circumstances. As a result, CEOs need to take adequate steps to mitigate their risk, and they must be prepared to defend themselves during (and in some cases after) corporate investigations, litigation, and enforcement proceedings. ” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C. 

3 Types of Scenarios in Which CEOs Can Face Personal Liability Arising Out of Corporate Noncompliance

There are three main types of scenarios in which CEOs can face personal liability arising out of corporate noncompliance. However, within each of these three broad areas, there are numerous possible examples; and, as discussed below, CEOs need to implement appropriate measures to mitigate their personal risk. The three main types of scenarios in which CEOs can face personal liability are:

  • Piercing the corporate veil
  • Acts and omissions in the CEO’s corporate capacity
  • Acts and omissions in the CEO’s personal capacity

1. Piercing the Corporate Veil

Even outside of the legal and corporate environments, it seems that most people are familiar with the phrase, “piercing the corporate veil.” However, few people (including people in the legal and corporate environments) have a clear understanding of what this phrase actually means.

Piercing the corporate veil refers to the act of holding a company’s owners and executives liable for the company’s debts. This can include either debts owed to commercial creditors, debts owed to judgment creditors, or both.

Corporations, limited liability companies (LLCs), and certain other types of business entities insulate owners and executives from personal financial responsibility for corporate debts. Owners and executives enjoy “limited liability” based on the existence of the business entity, which itself is classified as a “person” for most legal purposes. If the company gets sued, the limited liability protection afforded to its owners and executives means that they are not at risk for facing judgments in their personal capacities—in most cases.

But, there are various circumstances in which the veil of limited liability can be pierced (or, in plain English, in which a CEO can be held financially responsible for a company’s debts). Three of the most common circumstances that allow for piercing are:

  • Commingling – If a CEO commingles his or her personal assets with the assets of the business, a court may find that there is an insufficient distinction between the two. For example, if a small business owner/CEO deposits payments for accounts receivable into his or her personal account, a judge might determine that since the business owner/CEO is not respecting the company’s existence, the court should not respect it, either.
  • Failure to Observe Corporate Formalities – In addition to commingling, failure to observe other corporate formalities can lead to piercing as well. This includes failure to observe formalities such as preparing meeting minutes and resolutions, making annual filings, and separately purchasing assets for personal and business use.
  • Insufficient Corporate Assets – Judges have also allowed piercing in circumstances in which companies are grossly undercapitalized. Essentially, if a company is undercapitalized and takes on more debt or risk than it can reasonably handle, then a judge might hold the company’s owner and/or CEO personally liable as a result of failing to endow the company with the funds it needed to operate in good faith.

In piecing cases, CEOs can face full liability for debts incurred at the corporate level. Theoretically, this is true even if the CEO did not personally participate in the conduct that gave rise to the liability. The CEO’s personal liability attaches not as a result of the underlying wrong, but as a result of the CEO’s failure to observe and respect the requirements for securing limited liability protection.

2. Personal Liability for Acts and Omissions Committed in the CEO’s Corporate Capacity

Even when piercing is not warranted, CEOs can still face personal liability if they commit certain wrongful acts in their corporate capacity. CEOs can also face criminal culpability for crimes committed in their corporate capacity (including crimes purportedly committed for or in the name of the company).

For example, this has come up multiple times recently in federal Paycheck Protection Program (PPP) loan fraud investigations. In these investigations, companies are facing penalties for fraudulently obtaining (or even just applying for) PPP loans during the pandemic. But, in many cases their CEOs are facing personal liability as well. Typically, this liability is the result of either (i) the CEO submitting a fraudulent PPP loan on the company’s behalf, or (ii) simply being at the helm of an organization that fraudulently applied for and/or obtained federally-backed funds from a financial institution.

In most cases, in order for a CEO to be held liable for an act or omission committed in the CEO’s corporate capacity, the act or omission must either:

  • Have been committed intentionally;
  • Constitute gross negligence;
  • Constitute a criminal act; or
  • Fall outside of the CEO’s actual or apparent authority.

In addition to federal law enforcement investigations, this type of liability exposure frequently arises in civil litigation (where plaintiffs will often pursue claims against multiple related parties and individuals) and in shareholder derivative cases. If a plaintiff or group of shareholders believe that a CEO is directly responsible for the company’s conduct or performance, then the CEO will need to engage his or her own defense counsel for the litigation.

3. Investigations and Litigation Targeting CEOs in Their Personal Capacity

The third main type of scenario in which CEOs will face personal liability for business noncompliance is when litigation or an investigation at the corporate level leads to scrutiny of the CEO’s conduct in his or her personal capacity. For example, if IRS-CI investigates a company for tax fraud and there is evidence to suggest that the CEO may have been embezzling funds or withholding income from his or her own returns, then the CEO could face an investigation as well.

What Can CEOs Do to Protect Themselves from Personal Liability?

Given the risk of facing personal liability, what can – and should – CEOs do to protect themselves? Just as CEOs need to manage their companies’ risk effectively, they need to manage their own risk as well. Similar to corporate risk mitigation strategies, CEOs’ risk mitigation strategies should focus on (i) understanding their risks, (ii) understanding what it takes to maintain compliance, (iii) purchasing adequate insurance coverage, and (iv) knowing what to do in the event that a liability risk arises.

  • Understanding CEOs’ Risks – Mitigating risk starts with understanding the risks that need to be mitigated. For CEOs, while some of these risks mirror those that exist at the corporate level, others do not. While CEOs don’t necessarily need to implement risk mitigation practices that are on par with those of their companies, they do need to ensure that they have a clear understanding of the acts and omissions that have the potential to lead to trouble.
  • Understanding and Maintaining Compliance – CEOs need to have a clear understanding of what it takes to maintain compliance in both their corporate and individual capacities. At the corporate level, this ensures that CEOs don’t make mistakes that have the potential to be classified as criminal, intentional, or grossly negligent conduct. At the individual level, this helps mitigate against the risk of facing personal liability as a follow-on to a corporate-level lawsuit or investigation.
  • Purchasing Insurance Coverage – CEOs can purchase directors and officers (D&O) liability insurance coverage to mitigate against the risk of facing personal financial responsibility for noncompliance. However, CEOs also need to understand the limitations of D&O coverage. Policies often exclude claims based on gross negligence or failure to exercise the duties of a CEO’s office in good faith—and this means that lawsuits often target allegations based on gross negligence and bad-faith conduct so that plaintiffs can seek damages beyond CEOs’ D&O policy limits.
  • Knowing How to Respond to Liability Risks – Finally, CEOs need to know how to respond to liability risks. Just as companies should have policies and procedures for responding to lawsuits and investigations, CEOs should have discussions with their personal legal counsel so that they know what to do when a claim or inquiry arises. While there is certainly the possibility that a reactive response could be too little too late, when coupled with the other mitigation strategies discussed above, acting quickly in response to a threat can help reduce the likelihood of facing a civil judgment and/or criminal charges.

Oberheiden P.C. © 2021

ARTICLE BY Dr. Nick Oberheiden of Oberheiden P.C.
For more articles on compliance, visit the NLR Corporate & Business Organizations Section.

Oops: NASDAQ Seeks to Correct a 2009 Error Re: ADR Listing Requirements

On Wednesday, April 7, 2021, the U.S. Securities and Exchange Commission (“SEC”) issued Release No. 34-91492 publishing a Proposed Rule Change by NASDAQ to amend the requirements for listing ADRs on each of NASDAQ’s Global Select AND Global Markets.

American Depository Receipts

“ADRs” are American Depository Receipts. They have a long history in the U.S. capital markets, having been invented by J.P. Morgan in 1927 to facilitate access to the American stock market by Selfridges, an iconic British department store organized and managed by an American expatriate as the second-largest (after Harrod’s) department store in the UK in 1909 (and featured in a BBC TV series of that name about both the store and Mr. Selfridge). ADRs are depository receipts issued by an American bank when the underlying securities are deposited in a foreign depository bank. There are some interesting complexities about ADR’s depending on whether the ADR is a Level 1 ADR, or whether it is a Level 2 Sponsored ADR, which requires filing a separate registration statement with the SEC. And then there are Level 3 ADRs that require the foreign company to not only file a Form F-1 with the SEC but to adhere either to U.S. GAAP accounting standards OR IFRS as published in the IASB. The April 7 NASDAQ Proposal does not directly impact any of these ADR complexities.

Listing requirements are just that: the conditions a company must meet in order to have its securities traded on NASDAQ. NASDAQ has three market tiers: the Global Select Market, the Global Market, and the Capital Market. The Capital Market is the trading tier with the least stringent requirements for listing. The NASDAQ Global Market requires that the companies seeking to list on it must have some international attributes and substantially higher financial and governance features. The NASDAQ has the most rigorous listing requirements and is the tier for leading international companies.

NASDAQ Listing Requirements

Until 2009, NASDAQ required that at least 400,000 ADRs be issued in order to be listed on any of the three NASDAQ tiers, insure that there would be sufficient liquidity and “depth in the market” to support public trading. Then in 2009, as part of a “housekeeping,” NASDAQ moved the listing requirements for ADRs on the Global Market AND the Global Select Market to a new section of NASDAQ listing requirements that had NO minimum number of ADRs in order to be listed on those tiers. Ironically, the least restricted trading tier RETAINED the 400,000 ADR requirement. Recently, someone at NASDAQ noticed the disparity. Fortunately, NO issue with fewer than 400,000 ADRs has been listed on either the Global Select or Global Market tiers in the 12 years since 2009. Now, NASDAQ seeks to reimpose the 400,000 minimum ADR requirement for ALL NASDAQ tiers. As this proposed change to the listing requirements is a simple reinstatement of a condition accidentally omitted in the 2009 “housekeeping,” and as no present listing will be adversely affected, NASDAQ requested, and the SEC granted, a waiver of the normal 30-day period before a change might take effect.

While, as Alexander Pope wrote: “To err is human, to forgive, divine;” to correct may even be better.

©2021 Norris McLaughlin P.A., All Rights Reserved

ARTICLE BY Peter D. Hutcheon of Norris McLaughlin P.A.
For more articles on the SEC, visit the NLR Securities & SEC section.

SEC Ventures Into The Dark Web, But Can It Establish A Connection?

In March, the Securities and Exchange Commission announced its first securities enforcement action involving the “dark web”.  The SEC’s complaint describes the “dark web” as referring to “a subset of the deep web that is intentionally hidden, requiring specific software to access content”.   The SEC states that the “deep web” refers to “anything on the internet that is not indexed by, or accessible via, a search engine like Google”.

The SEC’s complaint alleges that the defendant “offered and sold on one of the dark web marketplaces various purported
‘insider tips’ that he falsely described as material, nonpublic information from the insider trading forum or corporate insiders”.  I found this interesting because the SEC wasn’t charging the defendant with insider trading but with selling false insider tips.  This may be fraudulent, but is it it a securities law violation?  Stock tips, whether false or true, are not themselves securities.  How does the SEC bring the defendant’s allegedly fraudulent conduct under the securities laws?

To establish a violation of Rule 10b-5, the SEC must prove that the defendant’s activities were “in connection with” the purchase or sale of a security.  Here, the defendant’s deception did not relate to securities that he sold to investors.  The SEC’s complaint attempts to connect the defendant’s activities to securities transactions by alleging  that traders paid for the tips using Bitcoin, and used the fake insider information to purchase and sell stock of various publicly traded companies.  In SEC v. Zandford, 535 U.S. 813 (2002), the U.S. Supreme Court found that the person deceived do not have to be counterparties to the person committing the fraud.  However, the defendant in this case might argue that his fraud was complete when he sold the false tips and therefore the SEC cannot establish the requisite connection.  I will be interested to learn whether this becomes a contested issue at trial.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP

ARTICLE BY Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on the SEC, visit the NLR Securities & SEC section.

Three Critical Questions That Will (Hopefully) be Answered by the SEC’s Lawsuit against Ripple

Late last year, the SEC filed a litigated action in the U.S. District Court for the Southern District of New York against Ripple Labs Inc. and two of its executive officers (collectively, “Ripple”), alleging that Ripple raised over $1.3 billion in unregistered offerings of the digital asset known as XRP. Ripple opted not to file a motion to dismiss the complaint, and based on recent filings it appears that the parties do not believe a pre-trial settlement is likely. The SEC’s complaint alleges that, beginning in 2013, Ripple raised funds through the sales of XRP in unregistered securities offerings to investors in the U.S. and abroad. Ripple also allegedly exchanged billions of XRP units for non-cash consideration, including labor and market-making services. The SEC’s complaint also named as defendants two executives of Ripple who allegedly effected personal, unregistered sales of XRP totaling approximately $600 million. According to the SEC, during all of this, Ripple failed to register its offers and sales of XRP, or satisfy any exemption from registration, in violation of Section 5 of the Securities Act of 1933.

The SEC’s case rests on the proposition that XRP is a security – if it is not, the SEC lacks jurisdiction. In SEC v. Howey, the Supreme Court provided a framework for determining whether certain assets are “investment contracts,” and therefore, are securities (Section 3(a)(10) of the Securities Act defines the term “security” to include an “investment contract”). In what is now known as the “Howey Test,” the Court explained that an asset is a security if it represents an investment in a common enterprise with the expectation of profits derived solely from the efforts of others. In its complaint, the SEC argues that XRP is a security because investors who purchased XRP anticipated that profits would be dependent upon Ripple’s efforts to manage and develop the market for XRP. Ripple has disputed the SEC’s allegations, arguing that XRP is a “fully functioning currency that offers a better alternative to Bitcoin.”

The Ripple case raises three very important questions regarding digital assets, and may provide a vehicle for the SEC or the court to offer answers to those questions:

  1. When does a digital asset transition from a security to a currency (or something else)? At one end of the spectrum, the SEC has made it clear that it views almost any initial coin offering (ICO) to involve the offer of securities. At the other end, there is Ether, which today relies on a distributed ledger without a centralized administrator. In 2018, then Director of the SEC’s Division of Corporation Finance, William Hinman, stated publicly that “putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.” XRP probably falls somewhere in between those two extremes. Because of that, this case may present a unique opportunity for the SEC or the court to shed further light on how and where to draw the line between a security and a currency.
  2. How will President Biden’s administration approach digital assets? Under Chairman Clayton’s leadership, the SEC took a deliberate approach towards digital assets and, as reflected by the Ripple case, was not hesitant to bring enforcement actions in this space. President Biden has nominated Gary Gensler to the be the next SEC Chair. For the past few years, Mr. Gensler has been a Professor at MIT, teaching courses on blockchain and crypto assets. He will almost certainly have strong views on how the SEC should approach digital assets. As this litigation progresses, we may gain some insight into those views.
  3. How should disgorgement be calculated for a violation of Section 5 (and only Section 5) after the Supreme Court’s decision last year in Liu? In the Ripple case, the SEC has alleged that the company raised over $1.3 billion from sales of XRP, and the two individual defendants sold approximately $600 million of XRP. In the past, the SEC has often argued that all proceeds of an offering made in violation of Section 5 were subject to disgorgement as ill-gotten gains. In Liu, however, the Supreme Court explained that courts should deduct “legitimate expenses” when calculating disgorgement. The Ripple case could provide the SEC or the court the opportunity to explain how to calculate legitimate expenses, particularly in this case, where there are no allegations that the company or executives engaged in fraud, and it looks like the company will be able show substantial expenses from operating its business and the executives will be able to show that they provided legitimate employment services to Ripple.

Hopefully, the Ripple case will provide answers to one or more of these questions. Stay tuned.

© 2020 Proskauer Rose LLP.
For more, visit the NLR Securities & SEC section.

Stumbling Through Securities Law Challenges for COVID-19 Vaccine Developers

As the world waits to overcome the COVID-19 pandemic, publicly traded pharmaceutical companies waging in that fight are facing the multifaceted challenge of developing COVID-19 responses, informing the public of their progress, and managing legal challenges related to their efforts. Enter AstraZeneca.

AstraZeneca partnered with Oxford University to develop a COVID-19 vaccine in April 2020, which it later called “AZD1222.” On May 21, 2020, the company announced that the United States government was providing more than $1 billion for the development, production and delivery of the vaccine. Over the course of the next six months, the company continued to make public announcements on further financial support agreements and interim development results on its vaccine progress.

On January 26, 2021, an institutional holder of AstraZeneca’s American depositary shares (“ADSs”)” filed a putative securities class action complaint in the United States District Court for the Southern District of New York. The plaintiff claims that between May 21, 2020, and November 20, 2020, AstraZeneca failed to disclose certain alleged errors and flaws in AZD1222’s clinical trials.  According to the complaint, analysts and industry experts began to raise questions after AstraZeneca’s November 23, 2020 disclosure of an interim analysis of two smaller scale trials of the vaccine in disparate locales with two different dosing regimens. This disclosure purportedly resulted in a decline of nearly $2 per ADS during the trading day on November 23, 2020.

The complaint goes on to allege that post-class period reports revealed that AstraZeneca failed to disclose (i) that initial AZD1222 clinical trials had suffered from a critical manufacturing error, resulting in a substantial number of trial participants receiving half the designed dosage; (ii) that clinical trials for AZD1222 consisted of a patchwork of disparate patient subgroups, each with subtly different treatments, undermining the validity and import of the conclusions that could be drawn; (iii) that certain clinical trial participants for AZD1222 received the second dose up to several weeks after the dose had been scheduled to be delivered according to the original trial design; (iv) that AstraZeneca had failed to include a substantial number of patients over 55 years of age in its clinical trials for AZD1222; and (v) that AstraZeneca’s clinical trials for AZD1222 had been hamstrung by widespread flaws in design, errors in execution, and a failure to properly coordinate and communicate with regulatory authorities and the general public.  Based on these purported problems, the complaint contends that the data and conclusions that could be derived from the clinical trials were of limited utility, and AZD1222 was unlikely to be approved for commercial use in the United States in the short term. The complaint also alleges that AstraZeneca’s disclosures undermined confidence in AZD1222 and may have eroded public trust in the COVID-19 vaccine development process.

Interestingly, this complaint was filed the day after Merck & Co., Inc. announced its discontinuation of development of its own SARS-Cov-2/COVID-19 vaccines, following review of Phase 1 clinical trials  As of the date of this post, Merck’s stock price trades at $75.60 as compared to $80.98 on January 22, 2021.

Nevertheless, on February 10, 2021, the World Health Organization published interim recommendations for use of the AZD1222 vaccine developed by AstraZeneca and Oxford University, concluding that “the known and potential benefits of AZD1222 outweigh the known and the potential risks” and recommends “an interval of 8 to 12 weeks between the doses.” That announcement came after the complaint against AstraZeneca was filed, but may alter the course of the litigation as it moves forward.

© 2020 Proskauer Rose LLP.
ARTICLE BY Mee (Rina) Kim of Proskauer Rose LLP