Tag: capital markets

SEC Commissioner Signals Need to Fulfill Mandate of Sarbanes-Oxley Act and Develop “Minimum Standards” for Lawyers Practicing Before the Commission

In remarks on March 5, 2022, on PLI’s Corporate Governance webcast, Commissioner Allison Herren Lee of the Securities and Exchange Commission stated that 20 years after its enactment, it is time to revisit the “unfulfilled mandate” of Section 307 of the Sarbanes-Oxley Act of 2002 and establish minimum standards for lawyers practicing before the Commission.1  Commissioner Lee, who announced that she will not seek a second term when her current one ends this month, took issue with what she called the “goal-directed reasoning” of some securities lawyers—that is, focusing primarily on the outcome sought by executives, rather than the impact on investors and the market as a whole.  Such lawyering, Commissioner Lee observed, has a host of negative consequences, including encouraging non-disclosure of material information, harming investors and market integrity, and stymying deterrence.  The solution, Commissioner Lee opined, is to fulfill the mandate of Section 307, which empowered the Commission to “issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers.”2

Over the last 20 years, the Commission has declined to adopt enhanced rules of professional conduct for lawyers appearing before the Commission.  There are good reasons for the Commission’s inaction, including the attorney-client privilege, the goal of zealous advocacy, the fact-specific nature of materiality determinations, and the traditionally state-law basis for the regulation of attorney conduct.  Commissioner Lee, moreover, did not propose specific new rules and recognized that the task was difficult and should be informed by the views of the securities bar and other stakeholders.  Nor did she say that action by the Commission was imminent; it is unclear whether the Commission has authority to promulgate new rules under Section 307 given a 180-day sunset under the statute that occurred in 2003.  Indeed, neither Commissioner Lee nor any of the other SEC commissioners have issued statements on this topic since the PLI webcast.  SEC Enforcement Director Gurbir Grewal has, however, indicated an increased emphasis on gatekeeper accountability in order to restore public trust in the market.3  Nonetheless, given the Commission’s existing authority to impose discipline under its Rules of Practice, practitioners should be mindful of the potential for increased scrutiny moving forward.

Background

In the wake of corporate accounting scandals involving Enron, Worldcom, and other companies, Congress enacted the Sarbanes-Oxley Act in 2002 “[t]o safeguard investors in public companies and restore trust in the financial markets.”4  The Act was aimed at “combating fraud, improving the reliability of financial reporting, and restoring investor confidence,”5 including by empowering the SEC with increased regulatory authority and enforcement power.6  To that end, the Act includes provisions to fortify auditor independence, promote corporate responsibility, enhance financial disclosures, and enhance corporate fraud accountability.7

The Sarbanes-Oxley Act was passed just six months after the collapse of Enron in December 2001, and neither the House nor Senate bills originally contained professional responsibility language.8  Hours before the Senate passed its version of the Act, however, the Senate amended the bill to include language that would eventually become Section 307.9  Around the same time, 40 law professors sent a letter to the SEC requesting the inclusion of a professional conduct rule governing corporate lawyers practicing before the Commission.10  The letter picked up on a 1996 article by Professor Richard Painter, then of the University of Illinois College of Law, which recommended corporate fraud disclosure obligations for attorneys similar to those imposed on accountants by the Private Securities Litigation Reform Act of 1995.11  Senator John Edwards, one of the sponsors of the Senate floor amendment of the bill, emphasized the importance of including professional conduct rules for attorneys in such a significant piece of legislation, stating that “[o]ne of the problems we have seen occurring with this sort of crisis in corporate misconduct is that some lawyers have forgotten their responsibility” is to the companies and shareholders they represent, not corporate executives.12

In its final form, Section 307 imposed a professional responsibility requirement for attorneys that represent issuers appearing before the Commission.  Specifically, Section 307 directed the Commission, within 180 days of enactment of the law, to “issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers,”13 and, at minimum, promulgate “a rule requiring an attorney to report evidence of a material violation of securities laws or breach of fiduciary duty or similar violation by the issuer or any agent thereof to appropriate officers within the issuer and, thereafter, to the highest authority within the issuer, if the initial report does not result in an appropriate response.”14

Since the enactment of Section 307, however, the Commission has promulgated only one rule pursuant to its authority, commonly known as the “up-the-ladder” rule.15  The up-the-ladder rule imposes a duty on attorneys representing an issuer before the Commission to report evidence of material violations of the securities laws.  When an attorney learns of evidence of a material violation, the attorney has a duty to report it to the issuer’s chief legal officer (“CLO”) and/or the CEO.16  If the attorney believes the CLO or CEO did not take appropriate action within a reasonable time to address the violation, the attorney has a duty to report the evidence to the audit committee, another committee of independent directors, or the full board of directors until the attorney receives “an appropriate response.”17  Alternatively, attorneys can satisfy their duty by reporting the violation to a qualified legal compliance committee.18  To date, the SEC has never brought a case alleging a violation of the up-the-ladder rule.

Commissioner Lee’s Remarks

In her remarks, Commissioner Lee stated that it is time to revisit the “unfulfilled mandate” of Section 307 and consider whether the Commission should adopt and enforce minimum standards for lawyers who practice before the Commission.  Commissioner Lee criticized “goal-directed reasoning” employed by sophisticated counsel in securities matters, and cited as an example Bandera Master Fund v. Boardwalk Pipeline,19 a recent decision in which the Delaware Court of Chancery rebuked the attorneys involved for their efforts to satisfy the aims of a general partner instead of their duty to the partnership-client as a whole.  The Court, specifically, stated that counsel “knowingly made unrealistic and counterfactual assumptions, knowingly relied on an artificial factual predicate, and consistently engaged in goal-directed reasoning to get to the result that [the general partner] wanted.”20  Bandera and cases like it, according to Commissioner Lee, are emblematic of a “race to the bottom” caused by pressure on securities lawyers to compete with each other for clients, while failing to give due consideration to the potential impact on investors, market integrity, and the public interest.

In Commissioner Lee’s view, “goal-directed” lawyering not only falls short of ethical standards but causes harm to the market and reduces deterrence.  Commissioner Lee expressed concern that, in an effort to give management the answer it wants, lawyers may downplay or obscure material information.21  Although recognizing that materiality determinations are fact-intensive, Commissioner Lee said that should not provide blanket cover for legal advice aimed at concealing material information from the public.  Non-disclosure has a host of negative consequences, including distorting market-moving information, interfering with price discovery, misallocating capital, impairing investor decision-making, and eroding confidence in the financial markets and regulatory system.  Further, such lawyering diminishes deterrence by creating a legal cover for inadequate disclosure, making it more difficult for regulators to hold responsible individuals accountable.  This type of legal counsel, in Commissioner Lee’s view, “is merely rent-seeking masquerading as legal advice, while providing a shield against liability.”

Commissioner Lee stated that the existing framework governing professional conduct is not adequate to hold lawyers accountable for such “reckless” advice.  According to Commissioner Lee, state bars—the principal source for lawyer discipline nationwide—are not up to the task because they lack resources, expertise in securities matters, and the ability to impose adequate monetary sanctions.  Additionally, Commissioner Lee noted that state law standards focused mostly on the behavior of individual lawyers, assigning few responsibilities to the firm for quality assurance.  Indeed, state law standards are mostly drafted in a “one-size-fits-all fashion” according to Commissioner Lee, and do not take into account the different issues faced at large firms that represent public companies, which are quite different from a solo practitioner handling personal injury or estate law matters.  Likewise, although the SEC has the power under Rule 102(e) of its Rules of Practice to suspend or bar attorneys whose conduct falls below “generally recognized norms of professional conduct,” there has been little effort to define or enforce that standard.22  Nor has the SEC rigorously enforced standards of attorney conduct under the one rule it has issued under Section 307, the “up-the-ladder” rule.

Commissioner Lee stated that it was time for the Commission to fulfill its mandate under Section 307.  Although not proposing any specific rules, Commissioner Lee offered the following concepts as a starting point:

  • Greater detail on lawyers’ obligations to a corporate client, including how advice must reflect “the interests of the corporation and its shareholders rather than the executives who hire them”;
  • Requirements of “competence and expertise” (as an example, disclosure lawyers should not opine on materiality “without sufficient focus or understanding of the views of ‘reasonable’ investors”);
  • Continuing education for securities lawyers advising public companies (similar to requirements set by the Public Company Accounting Oversight Board for minimum hours of qualifying continuing professional education for audit firm personnel);
  • Oversight at the firm level (similar to quality-control measures implemented at audit firms);
  • Emphasis on the need for independence in rendering advice (similar to substantive and disclosure requirements implemented in Rule 2-01 of Regulation S-X for auditors);
  • Obligations to investigate red flags and ensure accurate predicates for legal opinions (similar to the obligations that an auditor must perform to certify to the accuracy of their client’s financial statements); and
  • Retention of contemporaneous records to support the reasonableness of legal advice.

Commissioner Lee noted that the content of any specific rules or standards will require “careful thought,” as well as assistance from the securities bar, experts on professional responsibility, and other interested parties and market participants.  She invited input from the legal community and other stakeholders and noted that she appreciated the complexity of the task and concerns of the American Bar Association and others regarding protection of the attorney-client privilege.  Indeed, outside auditors are generally regarded as “public watchdogs” and such communications between the corporation and an auditor are not entitled to the affirmative attorney-client privilege afforded to legal counsel.  Accordingly, regulating the legal profession using a similar framework to that applied to the accounting profession has sparked more controversy.  Nonetheless, in Commissioner Lee’s view, those concerns should be weighed against “the costs of there being few, if any, consequences for contrived or tortured advice.”

Implications

The Commission has declined to adopt enhanced rules of professional conduct for lawyers appearing before it in the 20 years since the enactment of the Sarbanes-Oxley Act.  Commissioner Lee’s call for minimum standards, however, potentially signals increased scrutiny by the SEC with respect to lawyers who “practice before the Commission.”  As Commissioner Lee noted, that means “counsel involved in the formulation and review of issuers’ public disclosure, including those who address the many legal questions that often arise in that context.”23  Nonetheless, Commissioner Lee cautioned that she did “not intend with these comments to address the conduct of attorneys serving as litigators or otherwise representing their client(s) in an advocacy role in an adversarial proceeding or other similar context, such as in an enforcement investigation.”24

Although framing her call for standards in terms of Section 307 of the Sarbanes-Oxley Act, it is not clear that the Commission will—or even can—promulgate any further rules under that authority.  Commissioner Lee did not state that she was speaking on behalf of the Commission or indicate that the Commission would be taking concrete, imminent steps to adopt such standards.  The Commission has not put its imprimatur on the remarks by incorporating them into a formal release or statement of policy.  Moreover, the text of Section 307 appears to foreclose the possibility of further rulemaking, as it provides that the Commission shall issue any such rules “[n]ot later than 180 days after the date of enactment of this act,” i.e., January 27, 2003.  Consistent with that constraint, the SEC proposed the up-the-ladder requirements on November 21, 2002, in Release No. 33-8150, and the rule became final on January 29, 2003.25  But the SEC has not issued any other rule under Section 307 to date.

Even if official action under Section 307 may not be forthcoming, Commissioner Lee’s call for action should not be discounted.  Setting aside the up-the-ladder requirements, the SEC has authority under Rule 102(e) of the SEC’s Rules of Practice to censure or bar a lawyer from appearing or practicing before the Commission if found, among other things, “[t]o be lacking in character or integrity or to have engaged and unethical or improper professional conduct.”26  Commissioner Lee cited prior SEC guidance to indicate that Rule 102(e) may apply to attorney conduct that falls below “generally recognized norms of professional conduct,”27 a standard that has been left undefined to date.28  In practice, the SEC “will hold attorneys who practice before it to the standards to which they are already subject, including state bar rules.”29  At a minimum, then, Commissioner Lee’s objective of greater accountability may be achieved through a more aggressive application of Rule 102(e), which, as she noted, has generally only been applied as a follow-on penalty for primary violations of the securities laws by lawyers.

Commissioner Lee’s term expires on June 5, and she has announced that she intends to step down from the Commission once a successor has been confirmed.30  Should the Commission nonetheless take up her call to action in the future, it will be no easy task to adopt clear standards that can be implemented in a predictable manner.  In particular, Commissioner Lee’s focus on the role of lawyers in advising issuers on determinations of materiality and disclosure does not lend itself well to oversight or enforcement.  The well-established standard for materiality—whether “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”—is far from clear-cut.31  The Supreme Court, moreover, long has recognized that materiality “depends on the facts and thus is to be determined on a case-by-case basis.”32  As such, and as evidenced by the sundry cases concerning disclosure issues reversed on appeal, disagreement between litigants—as well as jurists—on matters of materiality and disclosure are par for the course.  If that is so, how can a lawyer’s advice on such matters (which will inevitably turn on the facts and the lawyer’s judgment and experience) be subject to oversight in any objective sense?

Even if lawyers’ materiality advice could be evaluated under objective standards, there are other difficulties.  First and foremost is that oversight of legal advice implicates the attorney-client privilege and the underlying benefit of candid advice from securities disclosure and corporate counsel.  As the Supreme Court has observed, the attorney-client privilege “is founded upon the necessity, in the interest and administration of justice, of the aid of persons having knowledge of the law and skilled in its practice, which assistance can only be safely and readily availed of when free from the consequences or the apprehension of disclosure.”33  Aside from situations in which the client has voluntarily waived privilege (as sometimes occurs in SEC investigations) or where another exception to the privilege applies, it is unclear how the SEC could evaluate legal advice without invading privilege.  Such attempts could have led to an increase in corporate wrongdoing as corporate executives could be more reluctant to seek expert legal advice.  In addition, it is unclear how regulators assessing materiality advice would—or could—balance an assessment of whether a lawyer has given the “correct” advice with a lawyer’s ethical obligations of zealous representation of the client.34  The divide between overreaching “goal-directed” reasoning and permissible zealous advocacy for the client is often murky, and reasonable minds can differ depending on the circumstances.  Moreover, it is already well-accepted that a corporate lawyer’s obligation is to the corporation as its client, not to any individual officer or director.35  That obligation carries with it ethical duties to “proceed as is reasonably necessary for the best interest” of the corporation, including when the lawyer is aware of violations of the law or other misconduct by senior management.36  In that sense, Commissioner Lee’s proposal could be viewed as a call for the SEC to take on enforcement of existing ethical rules, rather than for the development of novel “minimum standards.”

Ultimately, there are good reasons for the Commission’s reluctance to date to formally adopt minimum standards of professional conduct for lawyers appearing before it, including the attorney-client privilege, the goal of zealous advocacy, and the fact-specific nature of materiality inquiries.  The manipulation of facts and bad reasoning targeted by Commissioner Lee are not only the exception, and difficult if not impossible to eliminate completely, but are largely covered by existing rules and practices.  Nonetheless, Commissioner Lee’s call for lawyers to strive for higher legal and ethical standards in their counsel should be welcomed.  Sound legal advice is not only important for issuer clients, but also for the financial well-being of investors, the integrity of the markets, and public confidence in the regulatory system and capital markets.  Enhancements in ethical standards for the legal profession could also lead to reputational benefits and greater integrity in the profession.  It remains to be seen whether Commissioner Lee’s remarks will serve as an aspirational goal for securities lawyers, or translate into concrete action by the Commission.

1 Commissioner Allison Herren Lee, Send Lawyers, Guns and Money: (Over-) Zealous Representation by Corporate Lawyers Remarks at PLI’s Corporate Governance – A Master Class 2022 (Mar. 4, 2022), [hereinafter “Commissioner Lee Remarks”].

2 See Sarbanes‑Oxley Act, § 307, 15 U.S.C. § 7245 (2002).

3 Gurbir Grewal, Director, Division of Enforcement, Remarks at SEC Speaks 2021 (Oct. 13, 2021).

4 Lawson v. FMR LLC, 571 U.S. 429, 432 (2014).

5 Stephen Wagner and Lee Dittmar, The Unexpected Benefits of Sarbanes-Oxley, Harvard Bus. Rev. (Apr. 2006).

6 See Sarbanes–Oxley Act, § 3, 15 U.S.C. § 7202 (2002).

7 See Sarbanes–Oxley Act, § 1, 15 U.S.C. § 7201 (2002).

8 Jennifer Wheeler, Securities Law: Section 307 of the Sarbanes-Oxley Act: Irreconcilable Conflict with the ABA’s Model Rules and the Oklahoma Rules of Professional Conduct?, 56 Okla. L. Rev. 461, 464 (2003).

9 Id.

10 Id. at 468-69.

11 See generally Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996).

12 Wheeler, supra note 8, at 465 (quoting 148 Cong. Rec. S6551 (daily ed. July 10, 2002) (statement of Sen. Edwards)).

13 See Sarbanes‑Oxley Act, § 307, 15 U.S.C. § 7245 (2002).

14 Final Rule: Implementation of Standards of Professional Conduct for Attorneys, Securities Act Rel. No. 8185 (Sept. 26, 2003).

15 17 C.F.R. §§ 205.1-205.7.

16 17 C.F.R. § 205.3(b)(1).

17 17 C.F.R. §§ 205.3(b)(3), (b)(4).

18 17 C.F.R. § 205.3(c).

19 Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, No. CV 2018-0372-JTL, 2021 WL 5267734, at *1 (Del. Ch. Nov. 12, 2021).  In Bandera, plaintiffs brought suit against a general partner for breach of a partnership agreement stemming from the general partner’s exercise of a call right without satisfying two requisite preconditions.  The court held for the plaintiffs and found the general partner had engaged in willful misconduct.  Id. at *51.  Contributing to the misconduct was the general partner’s outside counsel, who drafted an opinion letter justifying the general partner’s exercise of the call right.  Id.  Throughout the drafting process, the court found, that the outside counsel manipulated the facts in order to achieve the general partner’s desired conclusion.  Id. at *18-*47.

20 Id. at *51.

21 Commissioner Lee specifically cited, among other matters, environmental, social, and governance (“ESG”) disclosures.  The Commission is currently considering additional climate change-related disclosures to Regulation S-K and Regulation S-X.  See Jason Halper et al., SEC Proposes Climate-Related Changes to Regulation S-K and Regulation S-X, Cadwalader, Wickersham & Taft LLP (Mar. 23, 2022); see also Paul Kiernan, SEC Proposes More Disclosure Requirements for ESG Funds, The Wall Street Journal (May 25, 2022, 6:26 pm ET).

22 Rule 102(e) states, in relevant part:

(1) Generally. The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter:

(i) not to possess the requisite qualifications to represent others; or

(ii) to be lacking in character or integrity or to have engaged in unethical or improper professional conduct; or

(iii) to have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder.

17 C.F.R. § 201.102(e)(1).

23 Commissioner Lee Remarks, supra note 1.

24 Id.

25 Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys, Securities Act Rel. No. 8150 (Nov. 21, 2002); Final Rule: Implementation of Standards of Professional Conduct for Attorneys, Securities Act Rel. No. 8185 (Sept. 26, 2003); see also 2 Legal Malpractice § 14:114 (2022 ed.).

26 17 C.F.R. § 201.102(e).  The Rules of Practice generally “govern proceedings before the Commission under the statutes that it administers.” 17 C.F.R. § 201.100.  The SEC has the authority to administer and enforce such rules pursuant to the Administrative Procedures Act, 5 U.S.C. § 551 et. seq. See Comment to Rule 100, SEC Rules of Practice (July 2003).

27 In the Matter of William R. Carter Charles J. Johnson, 47 S.E.C. 471 (Feb. 28, 1981) (“elemental notions of fairness dictate that the Commission should not establish new rules of conduct and impose them retroactively upon professionals who acted at the time without reason to believe that their conduct was unethical or improper.  At the same time, however, we perceive no unfairness whatsoever in holding those professionals who practice before us to generally recognized norms of professional conduct, whether or not such norms had previously been explicitly adopted or endorsed by the Commission.  To do so upsets no justifiable expectations, since the professional is already subject to those norms.”).

28 In the past, the Commission has sought to discipline lawyers for violating securities laws with scienter, rendering misleading opinions used in disclosures and engaged in otherwise liable conduct, but not for giving negligent legal advice to issuers. See In the Matter of Scott G. Monson, Release No. 28323 (June 30, 2008) (collecting cases).

29 In the Matter of Steven Altman, Esq., Release No. 63306 (Nov. 10, 2010).

30 Statement of Planned Departure from the Commission (Mar. 15, 2022).

31 TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).

32 Basic Inc. v. Levinson, 485 U.S. 224, 250 (1988).

33 Upjohn Co. v. United States, 449 U.S. 383, 389 (1981) (quoting Hunt v. Blackburn, 128 U.S. 464, 470 (1888)).

34 Rule 1.3: Diligence, American Bar Association, (last visited Mar. 18, 2022) (“A lawyer shall act with reasonable diligence and promptness in representing a client.”); Rule 1.3 Diligence – Comment 1, American Bar Association,  (last visited Mar. 18, 2022) (“A lawyer must also act with commitment and dedication to the interests of the client and with zeal in advocacy upon the client’s behalf.”).

35 See, e.g., Upjohn, 449 U.S. at 389.

36 Rule 1.13: Organization As Client, American Bar Association, cmt. 2  (last visited April 19, 2022).

Article By Jason M. Halper, William P. Mills, Erica Hogan, Adam Magid, James Orth, and Jayshree Balakrishnan of Cadwalader, Wickersham & Taft LLP

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Preparing to Testify in Response to an SEC Subpoena

When investigating companies, brokerage firms, investment advisors, and other entities and individuals, the U.S. Securities and Exchange Commission (SEC) relies heavily on its subpoena power. Once the SEC launches a formal investigation, it can issue administrative subpoenas to the company executives, brokers, and others. These subpoenas may be a subpoena duces tecum which compels the person to whom it is addressed to produce documents in his possession or control, or a subpoena ad testificandum which compels the person to whom it is addressed to appear at a specific time and place and testify under oath or affirmation. Crucially, while these subpoenas do not require judicial approval, they are subject to judicial enforcement.

With this in mind, receiving an SEC subpoena is not a matter to be taken lightly. Individuals who have been subpoenaed to testify must thoroughly prepare their testimony, and they need to make sure they know what to expect when the day arrives.

Testifying before the SEC is fraught with potential risks. It is imperative that subpoena recipients devote the necessary time to their preparations, and that they work with their counsel to proactively identify and address all potential areas of concern.

Understanding Why You Have Received an SEC Subpoena

When preparing to testify before the SEC, a key first step is to understand why you have been subpoenaed. Broadly speaking, the SEC focuses its enforcement efforts on two areas: (i) protecting U.S. investors, and (ii) preserving the integrity of U.S. capital markets. As a result, most SEC investigations target allegations of fraud, misrepresentation, conspiracy, and other offenses in one (or both) of these areas.

The SEC’s subpoena should provide at least some insight into the focus and scope of the SEC investigation. However, gathering the information you need to make informed decisions may require examination of other sources as well. For example, it will be helpful if you can identify anyone else who has received a subpoena or Wells Notice related to the investigation, and it may be prudent to conduct an internal compliance audit focused on uncovering any issues that could come to light.

Questions You Should Be Prepared to Answer During Your SEC Testimony

When preparing SEC testimony, it is important to keep in mind that you could easily be fielding questions for six hours or longer. While this can seem overwhelming, SEC subpoena recipients can generally expect to be asked questions in seven main categories. These main categories are:

  • Preliminary Matters
  • Background and Personal Information
  • Your Role Within Your Company or Firm
  • The Scope of Your Duties
  • Investors
  • Due Diligence
  • Clarifying and Closing the Record

1. Questions Regarding Preliminary Matters

SEC subpoena recipients can initially expect a series of questions that are designed to provide the SEC with insight into the steps they took to prepare their testimony. While these questions are largely procedural, some can present traps for the unwary. At the beginning of the session, you should be prepared to succinctly and confidently answer questions such as:

  • Did you get the opportunity to review the Formal Order associated with this matter?
  • Do you have any questions regarding the Formal Order?
  • Did you complete the Background Questionnaire by yourself?
  • Are the contents within the Background Questionnaire truthful and accurate?
  • Is there any information you wish to add to the Background Questionnaire?
  • Do you understand the rules and procedures of the SEC testimony process?
  • Do you have any questions on the rules and procedures of the SEC testimony process?

2. Questions Regarding Background and Personal Information

After dispatching these preliminary matters, the focus will shift to the SEC subpoena recipient’s background and personal information. Keep in mind that the SEC likely has much (if not all) of this information already—so if you omit information or provide misleading answers, this will not go unnoticed. During this phase of your testimony, you can expect to be asked questions such as:

  • What is your educational background?
  • Do you hold any professional or financial licenses?
  • Have you ever worked for a financial firm or investment advisory firm?
  • When did you first meet the other individual(s) involved in this matter?
  • Who introduced you?
  • What was the purpose of your first meeting (e.g., social meeting or business planning)?
  • Do your families know each other?
  • Where are you employed now?

3. Questions Regarding Your Role Within Your Company or Firm

If the SEC is investigating your company or firm (perhaps in addition to investigating you personally), you can expect several questions regarding your role within the organization. Depending on your position, the SEC’s investigators may ask you questions regarding the company or firm itself. Some examples of the questions you should be prepared to answer (as applicable) include:

  • When did you start working at the company?
  • What is your position at the company?
  • Can you describe the company’s corporate structure?
  • What are your title and position at the company?
  • Have your title and position changed over time?
  • What are the duties at the company?
  • Have your duties changed over time?
  • How is the company funded?
  • What is your salary at the company?
  • Who makes the majority of the decisions for the company?
  • Does the company sell securities?
  • Does the company pay dividends?
  • Does the company have voting rights?

4. Questions Regarding the Scope of Your Duties

After gaining an understanding of your role within your company or firm, the questioning will likely shift toward examining the scope of your duties in greater detail. In most cases, this is where the questions asked will begin to focus more on the substance of the SEC’s investigation. During this phase of your testimony, potential questions may include:

  • Can you describe your access to investor funds, financial statements and records, and investor details?
  • Are you aware of or do you have access to the sources of the company´s income?
  • What are the sources of the company´s revenue and projected revenue?
  • Can you describe or do you have access to the sources of the company´s expenses?
  • Who is responsible for preparing the company´s financial statements?
  • Do you have any role in preparing or compiling the company´s financial statements?
  • Who is responsible for preparing the company´s projected financial statements, including projected capital contributions, projected expenses, and projected revenues?
  • Do you have any role in preparing or compiling the company´s projected financial statements?
  • Does the company have its financial statements audited on an annual basis?
  • Did you ever act as a point of contact or intermediary between the company and third parties, such as investors or banks?
  • Do you ever serve as a representative of the company?
  • Are you involved in any of the company’s promotional efforts to the public?
  • Do you know or do you have access to details of the company’s anticipated monetization plans?
  • Are you aware of any complaints against the company?

5. Questions Regarding Investors

Once the scope of your duties has been established, the SEC’s investigators may next focus on your company’s or firm’s communications and relationships with investors. Here too, the investigators’ questions are likely to be tailored to the specific allegations at issue—and you could get yourself into trouble if you aren’t careful. To the extent of your knowledge, you should be prepared to accurately answer questions such as:

  • Does the company have investors?
  • Who are the investors?
  • What types of customers and/or investors do the company target or appeal to?
  • Do you communicate with investors?
  • How did the company attract capital contributions for its formation, project funding, and subsequent business plans?
  • Does the company adopt targeted marketing strategies, or does the company engage in general advertising?
  • What is the average contribution of the company’s investors?
  • Did you create, or do you have access to, a cap table?
  • Did you assist in the preparation of a cap table?
  • Did the company issue stock certificates or provide any other proof of equity ownership to investors?
  • Did the company register any of its investments?
  • Did the company issue a private placement memorandum or file a Form D?
  • Do you know if any investors already knew the company´s directors and officers before investing?
  • Does the company solicit investors or advertise to the general public (e.g., retail investors)?
  • Are you aware of what the company does with investor funds?
  • Can you describe your role in preparing any promotional or marketing materials?
  • Has the company distributed any investor documents or marketing/solicitation materials to the public?
  • Does the company have any plan to show, or did it show, promotional documents to investors?
  • Does the company hold regular investor calls?

6. Questions Regarding Due Diligence

Due diligence is often a key topic of discussion. SEC investigators are well aware that many company executives, brokers, and others are not sufficiently familiar with their companies’ and firms’ due diligence obligations, and charges arising out of due diligence violations are common. With this in mind, you should be prepared to carefully navigate inquiries such as:

  • Does the company have any identity verification procedures in place?
  • What kinds of identity verification procedures does the company use for its investors?
  • Can you describe the company´s know-your-customer (“KYC”) policies?
  • Do you assist with verifying investors or capital contributions?
  • Does the company maintain a compliance program?

7. Questions to Clarify and Close the Record

Finally, at the end of the session, the SEC’s investigators will ask if you want to clarify or supplement any of the answers you have provided. It is important not to let your guard down at this stage. While your testimony is nearly over, you need to remain cognizant of the risk of providing unnecessary information (or omitting information) and exposing yourself to further scrutiny or prosecution. With this in mind, it is best to consult with your counsel before answering questions such as:

  • Is there anything you wish to clarify from today´s testimony?
  • Is there anything you wish to add to your testimony before we close and go off the record?

Practicing your answers to these questions (among others) in a mock interview with your legal counsel or SEC defense attorney will help ensure that you are prepared for the SEC as possible.

Article By Dr. Nick Oberheiden of Oberheiden P.C.

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

Oberheiden P.C. © 2022

London–IBOR’s Falling Down, Falling Down

The IRS has released proposed regulations that provide a fluid transition to the use of references rates other than the interbank offered rates, such as the London Interbank Offered Rate (LIBOR), in debt instruments and financial products. In July 2017, the UK Financial Conduct Authority announced that the LIBOR might be phased out after 2021. The announcement came amid concerns of manipulation, a decline in the volume of funding from which the LIBOR is calculated, and recommendations for the development of a reference rate based on transactions in a more robust market. The Alternative Reference Rates Committee (ARRC), a group of private-market participants convened by the Federal Reserve Board and the New York Fed, recommended the Secured Overnight Financing Rate (SOFR) as a replacement to the LIBOR, and petitioned the IRS for guidance on the tax consequences of the transition from the LIBOR to the SOFR.

In an effort to “minimize potential market disruption and . . . facilitate an orderly transition in connection with the phase-out” of the LIBOR and other similar reference rates, the IRS issued flexible proposed regulations based on the ARRC’s recommendations. The regulations address seven key areas of the Internal Revenue Code and Treasury Regulations impacted by the change in reference rates. These areas include: (1) the potential gain recognized on modification of debt instruments to change the reference rate; (2) the dissolution of integrated instruments as a result of termination or legging out of an integrated hedge; (3) the source and character of one-time payments used as an alternative to an adjustment to the spread between the LIBOR and SOFR; (4) the conversion of grandfathered debt instruments to registration-required obligations; (5) whether debt-instruments referencing the SOFR will qualify as variable rate debt instruments; (6) the preclusion of “regular interest” classification in a real estate mortgage investment conduit; and (7) foreign bank corporations’ use of the SOFR to calculate interest expense allocable to excess US-connected liabilities.

The regulations generally allow the SOFR to be a replacement for the LIBOR and provide guidance that ensures the tax impacts of the transition from LIBOR to SOFR will be minimal. For example, the parties may generally modify debt instruments to change the reference rate without triggering potential gain or loss that may normally result from material changes to the interest rate of a debt instrument under the significant modification rules.

Taxpayers may rely on these proposed regulations for changes made to debt instruments on or after October 9, 2019.

© 2019 Jones Walker LLP

The Effects Of The SEC Shutdown On The Capital Markets

Although EDGAR continues to accept filings, the government shutdown has now eclipsed its 28th day and the SEC continues to operate with limited staff which is having a crippling effect on the ability of many companies to raise money in the public markets. This is particularly due to the fact that the SEC is unable to perform many of the critical functions during the lapse in appropriations, including the review of new or pending registration statements and/or the declaration of effectiveness of any registration statements.

Although Section 8(a) of the Securities Act of 1933, as amended, creates an avenue whereby a registration statement will automatically become effective 20 calendar days after the filing of the latest pre-effective amendment that does not include “delaying amendment” language, many companies seeking to raise money in the public markets, including through an initial public offering, are reluctant to use this route for the following reasons. First, any pre-effective amendment which removes the “delaying amendment” language must include all information required by the form including pricing information relating to the securities being sold as Rule 430A is not available in the absence of a delaying amendment. This means that companies must commit to pricing terms at least 20 days in advance of the offering which may be difficult due to the volatility in the markets. In the event pricing terms change, companies must file another pre-effective amendment which restarts the 20-day waiting period. Second, companies run the risk that the SEC may, among other things, issue a stop order. Finally, companies may run into issues with FINRA, Nasdaq or the NYSE as these organizations may not agree to list securities on such exchanges without the SEC confirming that they have reviewed and cleared such filing and affirmatively declared the registration statement effective. These risks, among others, associated with using Section 8(a) as a means by which a registration statement can become effective after the 20-day waiting period, seem to outweigh the benefits of pursuing this alternative despite the fact that many companies with a December 31st year end will soon be required to file audited financial statements for the year ended December 31, 2018 pursuant to Rule 3-12 of Regulation S-X which will further delay the process resulting in an increase in both cost and time related to the offering.

Although companies seeking to raise money in the public markets, including through initial public offerings or shelf registration statements, may be reluctant to rely upon Section 8(a), some companies have already chosen to remove the “delaying amendment” language. For example, some companies which appear to have cleared all comments from the SEC prior to the partial government shutdown have elected to remove the “delaying amendment” and proceed with their offerings after the 20-day waiting period. In addition, other companies conducting rights offerings, such as Trans-Lux Corporation and Roadrunner Transportation Systems, Inc., are also relying on Section 8(a) as a means of raising money. Finally, some special purpose acquisition companies (“SPACs”), including Andina Acquisition Corp. III, Gores Metropoulous, Inc., Pivotal Acquisition Corp. and Wealthbridge Acquisition Limited, are among the issuers that are using Section 8(a) as a way to procced with their offerings during this partial government shutdown since SPACs, in particular, are not sensitive to price volatility in the markets because they have no operations.

Companies and underwriters that may be considering filing a pre-effective amendment to a registration statement to take advantage of Section 8(a) of the Securities Act should discuss the effects of removing the “delaying amendment” language with securities counsel before proceeding down such path.

 

Copyright © 2019, Sheppard Mullin Richter & Hampton LLP.
Read more legal news on the Government Shutdown at the National Law Review.

Exclusive Study Analyzes 2015 IPOs

Proskauer’s Global Capital Markets Group presents the third annual IPO Study, a comprehensive analysis of U.S.-listed initial public offerings in 2015 and identification of three-year comparisons and trends of U.S.-listed initial public offerings over the same period.

The study examines 90 U.S.-listed 2015 IPOs with a minimum initial deal size of $50 million, and includes industry analysis on health care; technology, media & telecommunications; energy & power; financial services; industrials and consumer/retail. The study also includes a focus on foreign private issuers. It also makes year-over-year comparisons of extensive data about deal structures and terms, SEC comments and timing, financial profiles, accounting disclosures, corporate governance and deal expenses.

Underlying the study is the global Capital Markets Group’s proprietary IPO database, which is a valuable resource for sponsors and companies considering an IPO as well as for IPO market participants and their advisors.

Download Proskauer’s 2016 IPO Study

Article By Frank Lopez of Proskauer Rose LLP
© 2016 Proskauer Rose LLP.

Attend the 2nd Annual Bank and Capital Markets Tax Institute West – December 2-3 in San Francisco

The National Law Review is please to give you information on the 2nd Annual Bank and Capital Markets Tax Institute WestBank and Captial Markets Tax Institute Dec 2-3 San Francisco, CA - Register Now!

Register today!

WHEN

December 2-3, 2-14

WHERE

San Francisco, CA

Due to the success of last year’s first ever west coast Bank and Capital Markets Tax Institute (BTI), we are proud to announce that BTI West will be coming back for a second year! For 48 years the annual BTI East in Orlando has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry, and from now on professionals on the west coast can expect the same benefits on a regular basis

The tax landscape is continually changing; you need to know how these changes affect your organization and identify the most efficient and effective plan of action. At BTI West you will have access to the same exceptional content, networking opportunities and educational value that have made the annual BTI East the benchmark event for this industry.

In an industry that thrives on both coasts, we will continue to offer exceptional educational and networking opportunities to ALL of the hard-working banking and tax professionals across the country. Join us at the 2nd Annual Bank and Capital Markets Tax Institute WEST, where essential updates will be provided on key industry topics such as General Banking, Community Banking, GAAP, Tax and Regulatory Reporting, and much more.