Quarterly Securities Enforcement Briefing
- SEC Issues Guidance for Use of Social Media for Company Announcements
- Supreme Court Holds in Gabelli That Clock Starts When Fraud Is Complete, Not Discovered
- 3rd Circuit Lowers Bar for Whistleblowers to Bring Claims Under Sox 806
- 2nd Circuit Limits Short-Swing Insider Trading Claims
- Judge Refuses to Approve 2 FCPA Settlements, Indicating Deals With the SEC Will Be Closely Scrutinized
- 2 Landmark SDNY Opinions Address FCPA Jurisdiction and Statute of Limitations Issues
SEC Issues Guidance for Use of Social Media for Company Announcements
By Jeffrey B. Coopersmith
On April 2, 2013, the Securities and Exchange Commission issued a Report of Investigation under Section 21(a) of the 1934 Exchange Act in connection with closing its investigation of Netflix, Inc. and its CEO, Reed Hastings. In doing so, the SEC announced new guidance for making company announcements through social media outlets such as Facebook and Twitter. The SEC’s investigation of Netflix and Hastings arose from a post Hastings made on his personal Facebook page on July 3, 2012. Hastings’ post stated that “Netflix monthly viewing exceeded 1 billion hours for the first time ever in June.” This information was not released by Netflix in an 8-K filing, a press release, or through any other standard distribution channel, and neither Netflix nor Hastings had previously informed investors that information about the company’s metrics would be released on Hastings’ personal Facebook page. Netflix’s stock price spiked upward significantly after Hastings’ Facebook post.
The SEC’s investigation looked at whether Hastings’ Facebook post violated Regulation FD (17 C.F.R. § 243.100, et. seq.). Regulation FD generally requires company to make disclosures of material non-public information in very broad fashion to the market and prohibits selective disclosure, such as to only certain investors or analysts. In August 2008, the SEC issued guidance allowing companies to disseminate information through corporate websites, provided that the company has made its website a recognized channel of distribution, such as by alerting the market that the website would be used for that purpose.
Although it did not bring an enforcement action against Netflix or Hastings, the SEC did not condone “disclosure of material, nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the site may be used for this purpose . . .” On the other hand, the SEC did not prohibit the use of social media to disseminate material, non-public information, because it recognized the increased public use and acceptance of social media, and wished to encourage communications with investors. The SEC tried to strike a balanced approach by enabling companies to use social media sites provided that they first broadly notify investors through recognized channels about which sites will be used for disseminating information. Going forward, companies that use social media should strongly consider providing notice of which social media outlets they use on corporate websites, SEC filings, or both.
On Feb. 27, 2013, the Supreme Court unanimously reversed the 2nd Circuit and held that the “discovery rule” does not apply to Securities and Exchange Commission enforcement actions for civil penalties.
As we have previously covered here and here, the 2nd Circuit held in SEC v. Gabelli that the discovery rule applies to 28 U.S.C. § 2462 (the statute governing the statute of limitations for civil penalty actions brought by the SEC). The discovery rule is an exception to the general rule that a claim accrues when a plaintiff has a right to commence it—i.e., when the violation is complete. The exception arose in the 18th century as a solution to crimes of fraud, which are not always susceptible to immediate discovery by the victim (even with due diligence). When the discovery rule applies, a claim accrues from the point when the plaintiff could have discovered it with reasonable diligence.
The statute at issue in Gabelli requires the SEC to commence civil penalty actions within five years of accrual. The SEC brought a civil enforcement action against petitioners Bruce Alpert and Mark Gabelli in 2008—six years after the last alleged “market timing” transaction. (Market timing, which takes advantage of the valuation lag in mutual funds, is legal, but the SEC alleged that the defendants secretly allowed only one investor to market time.) The 2nd Circuit concluded that the discovery rule applied, because the underlying violations “sounded in fraud.”
The Supreme Court disagreed, and held that the SEC has five years from when a fraud occurs to seek civil penalties—not from when the SEC discovers the fraud. Chief Justice Roberts gave several reasons for the holding in his opinion. First, nothing in the statute suggests that Congress intended the discovery rule to apply to civil penalty actions. Second, the Court has never applied the discovery rule where the plaintiff was the government seeking civil penalties, not a victim seeking compensation. Extending the discovery rule to this scenario would be particularly inappropriate, the Court noted, given that the SEC’s avowed raison d’être is to “investigat[e] potential violations of the federal securities laws.” Lastly, a practical and undesirable consequence of granting the SEC’s wish would have been to burden courts with determining when the government knew or reasonably should have known of a fraud.
3rd Circuit Lowers Bar for Whistleblowers to Bring Claims Under Sox 806
By Jeffrey B. Coopersmith and Mark W. Berry
On March 19, 2013, a three-judge panel in the 3rd Circuit Court of Appeals issued a decision in Wiest v. Lynch that significantly lowers the bar for whistleblower claims under Section 806 of the Sarbanes-Oxley Act. SOX 806 prohibits retaliation against employees for protected whistleblowing activity, and enumerates specific statutes and rules that the purported whistleblower must allege he or she thought were or were going to be violated (18 U.S.C. §§ 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders).
The question in Wiest was whether, to demonstrate that he or she engaged in protected activity, an employee’s claim under SOX 806 has to allege that his or her communication to management about alleged fraud “definitively and specifically” related to one of the enumerated statutes or rules, or whether the employee must merely allege that he or she informed management of a “reasonable belief” that the employer’s conduct violated or was going to violate one of the enumerated statutes or rules. The 3rd Circuit adopted the “reasonable belief” standard and overruled the district court’s application of the “definitively and specifically related” standard, becoming the first federal appellate court to adopt the holding of the Department of Labor’s Administrative Review Board in Sylvester v. Parexel Int’l., ARB 07-123 (May 25, 2011).
The 3rd Circuit’s decision is in conflict with other circuits, including the 1st, 5th, 6th, and 9th Circuits. The 9th Circuit decision adopting the “definitely and specifically related” standard is Van Asdale v. Int’l Game Tech., 577 F.3d 989, 996-97 (9th Cir. 2009). A case raising the issue was argued before the 10th Circuit on Sept. 19, 2012, and a decision in that case is expected shortly. A petition for en banc review was filed in the Wiest case on April 2, 2013, so it is possible that the full Third Circuit Court of Appeals will differ with the three-judge panel.
2nd Circuit Limits Short-Swing Insider Trading Claims
By John A. Goldmark
In a case of first impression, the 2nd Circuit in Gibbons v. Malone, 703 F.3d 595 (2d Cir. N.Y. 2013) ruled that federal securities laws do not require executives to disgorge profits earned by buying and quickly selling shares of different types of stock in the same company. The so-called “short-swing profit rule” under Section 16(b) of the Securities and Exchange Act of 1934 provides for disgorgement of profits that corporate insiders gain from the purchase or sale of a company security in less than six months from the transaction. The 2nd Circuit held that this rule does not apply to transactions involving separately traded, nonconvertible stocks with different voting rights.
Gibbons involved a director and large shareholder in Discovery Communications, Inc., who over a two-week period made several purchases of “Series C” voting stock and several sales of “Series A” nonvoting stock, each of which was separately registered and traded on the stock exchange. Neither series was convertible to the other. A company shareholder sued under Section 16(b) seeking disgorgement of the director’s profits from the transactions. Applying the plain language of the statute, and noting that the SEC had not issued any guidance on the issue, the 2nd Circuit found that Section 16(b) does not apply to transactions involving stocks that are “meaningfully distinguishable.” Because the transactions at issue involved one stock with voting rights and another stock without voting rights, the Court found the stocks “readily distinguishable” and not subject to the short-swing profit rule in Section 16(b).
The Gibbons decision has a number of important ramifications. Most critically, the decision clarifies the scope of Section 16(b) liability by refusing to extend its reach to different types of stock in the same company that are “meaningfully distinguishable.” In this context, so long as an insider can demonstrate that the securities have meaningfully distinct rights, Section 16(b) liability should not attach. Moreover, the 2nd Circuit signaled that, “absent SEC direction,” it would strictly adhere to the statutory text of the federal securities laws.
Although courts have typically rubber-stamped FCPA settlements, a federal judge has signaled a growing hostility to that practice by recently blocking two SEC deals. U.S. District Court Judge Richard Leon has refused to approve two SEC settlements under the FCPA, demanding that the companies agree to comply with stricter reporting and disclosure obligations. This uncommon move reflects increased judicial pushback and questioning of the SEC’s FCPA settlement practice, which began with U.S. District Judge Jed Rakoff’s now infamous November 2011 decision blocking the SEC’s $285 million settlement with Citigroup.
Following the example set by Judge Rakoff in the Citigroup decision, the so-called “Rakoff effect,” Judge Leon blocked the SEC’s $10 million settlement with IBM Corp. and its $13 million settlement with Tyco, International Ltd. A common thread between the two settlements is that both companies are repeat offenders. IBM and Tyco both settled FCPA claims in 2000 and 2006, respectively, and agreed never to violate the FCPA again. Judge Leon appears to be focused on this repeat offender issue, insisting that IBM agree to make additional disclosures in the future about any new FCPA investigations or violations. IBM has complained that such disclosures would be overly burdensome, putting the settlement on hold. (Judge Leon has not explained why he has refused to approve the Tyco settlement.)
This Rakoff effect could have a significant impact on the government’s FCPA enforcement program. Most FCPA cases filed by the SEC and DOJ are immediately settled without litigation or trial. If courts continue pushing the government to impose tougher reporting and disclosure provisions, however, companies may be less willing to settle FCPA claims.
Two recent New York federal district court decisions—SEC v. Straub, et al. and SEC v. Sharef, et al.—offer the first insight into due process limits on personal jurisdiction in Foreign Corrupt Practices Act (“FCPA”) cases against foreign nationals. The main takeaway from the opinions is that companies should not assume that U.S. courts will not exercise personal jurisdiction over foreign personnel in civil FCPA actions—even if the only meaningful U.S. contact involves misleading an issuer’s auditors.
Straub involved a 2005 Securities and Exchange Commission (“SEC”) action against three executives of a Hungarian telecommunications company, Magyar Telekom. The executives allegedly bribed Macedonian public officials and signed false representation letters to Magyar’s auditors in 2005. Magyar’s securities are publicly traded on the New York Stock Exchange and registered with the SEC, but the three executives lived and worked in Hungary and are Hungarian citizens. The executives moved to dismiss on lack of personal jurisdiction and statute of limitations grounds.
The Court rejected both arguments. Under International Shoe Co. v. Washington and its progeny, due process requires that a foreign defendant must have certain minimum contacts with the forum such that the exercise of personal jurisdiction does not offend traditional notions of fair play and substantial justice. Judge Richard J. Sullivan held that the Straub defendants had sufficient minimum contacts with the U.S. to justify exercising personal jurisdiction. The Court reasoned that the defendants knew or had reason to know that prospective U.S. purchasers of Magyar’s U.S. securities would receive financial reports based on the defendants’ misleading representations to the company’s auditors. The defendants therefore directed their conduct toward the U.S.—even if not principally so.
As for the statute of limitations issue, 28 U.S.C. § 2462 provides for a five-year statute of limitations, but only “if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.” Congress added the “is found” language to the statute in 1839; since then, other provisions and treaties have allowed for service of process on defendants abroad. Nevertheless, the Court held, the statutory language is clear: The five years do not begin to run until defendants are physically present in the U.S.
Sharef applied the same minimum contacts test for personal jurisdiction as Straub, but came out the other way. The SEC alleged that Siemens Aktiengesellschaft paid an estimated $100 million in bribes to top Argentinian government officials, and filed false certifications under the Sarbanes-Oxley Act. The individual defendants—former senior executives at Siemens—allegedly made these payments to renew a lucrative Argentinian contract and to prevent the bribes from coming to light. One defendant, a 74-year-old German citizen named Herbert Steffen, moved to dismiss for lack of personal jurisdiction.
The Court granted Steffen’s motion, largely because his alleged role in the bribery scheme was limited to pressuring others to pay the bribes, and participating in a phone call initiated by another defendant in connection with the scheme. The Court distinguished Straub by explaining that Steffen had participated only tangentially in the Siemens scheme. In particular, Steffen played no apparent role in falsifying or manipulating financial statements relied on by U.S. investors—unlike the Straub defendants.