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Quarterly Securities Enforcement Briefing

April 2014
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From the Horse’s Mouth: Highlights of “SEC Speaks” 2014 
By Jeffrey B. Coopersmith
On Feb. 21 and 22, 2014, the SEC held its annual “SEC Speaks” conference featuring speeches by a number of senior SEC officials. The conference provided valuable insights into the SEC’s enforcement concerns and priorities, and these are summarized below.

Renewed focus on financial fraud cases
Financial fraud cases, such as accounting fraud cases against public companies and their officers and directors, have made up a declining percentage of the SEC’s workload in recent years. At the conference, the director of the SEC’s Fort Worth office, David Woodcock, explained that, in response to this trend, the SEC created a new task force, the “Financial Fraud and Audit Task Force.” Woodcock noted that this new task force would seek to increase enforcement in this area by, among other things, relying on whistleblowers and ramping up the use of data mining. For example, Woodcock described a tool known as the “Accounting Quality Model,” or AQM, being developed by the SEC’s Division of Economic and Risk Analysis. Details of the AQM are not clear, but it appears to be an earnings quality tool designed to examine such things as differences between actual cash flows and book income, in an effort to identify companies that may have improved their earnings using discretionary accounting judgments.

Increased use of administrative actions
The SEC’s Assistant Chief Counsel, Charlotte Buford, spoke about the SEC’s interest in bringing more cases as administrative actions instead of federal district court cases. Buford pointed to recent legislative changes that now allow administrative law judges as well as federal district judges to impose disgorgement and penalties against any company or individual rather than just regulated persons. Many defense lawyers perceive the administrative forum as a home court advantage for the SEC, although Buford did not mention that as a factor in her speech. Rather, Buford said that the SEC would elect to pursue cases through the administrative or federal court route depending on such factors as the need for speed in resolving the matter, the need for extensive discovery available in federal court actions, and the likelihood of settlement that may be more favorable to a defendant in the administrative forum.

FCPA enforcement
The SEC’s FCPA Chief, Kara Brockmeyer, discussed the SEC’s continued focus on FCPA cases. Brockmeyer noted that issues with travel and entertainment expenses make up the bulk of the SEC’s current FCPA investigations. Brockmeyer also went through the factor that led the SEC to enter into a non-prosecution agreement with Ralph Lauren Corporation in connection with alleged bribes to government officials in Argentina. The company did not face formal enforcement because it very promptly self-reported to the SEC after discovering the issue through its internal compliance procedures, fully cooperated with the SEC’s investigation including by translating documents and bringing foreign witnesses to the United States, and undertook a worldwide compliance review that concluded that the issues were limited to Argentina. The SEC’s press release on the Ralph Lauren matter is available here. The release notes that the company did have to pay over $700,000 in penalties and interest to the SEC pursuant to the agreement, as well as an additional $882,000 penalty to the Department of Justice pursuant to a parallel criminal non-prosecution agreement.

Remarks by SEC Chair Mary Jo White
The SEC Chair, Mary Jo White, focused on her decision to require defendants “in appropriate cases” to admit wrongful conduct when settling with the SEC. We reported on this development previously —see here. Chair White said that the “appropriate cases” would be those that are “particularly egregious,” harmed many investors, placed markers at significant risk, or involved conduct that undermined the investigative process. Chair White also said that the SEC might require admissions if it would “send a particularly important message to the markets.” Obviously, these factors give the SEC a great deal of discretion in deciding when to require admissions of wrongdoing in settlements.

SEC Warns In-House Counsel Against Using Incentives to Deter External Whistleblowing
By John A. Goldmark

During a recent panel discussion at the 18th Annual Corporate Counsel Institute, the SEC’s whistleblower chief, Sean McKessy, warned companies and their in-house counsel against drafting contracts that discourage employees from reporting potential securities fraud violations to the agency. Mr. McKessy explained that incentives to keep whistleblower complaints in-house may run afoul of federal law and subject the drafting attorney to discipline.

The SEC Whistleblower Program is a product of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which allows eligible whistleblowers who report potential securities violations to the SEC to collect a bounty of up to 30 percent of any monetary sanctions collected as a result of the tip. To protect whistleblowers from adverse employment actions, Dodd-Frank prohibits employers from discharging, demoting, suspending, threatening, harassing, or discriminating against a whistleblower for engaging in protected activity.

Although Dodd-Frank prohibits punishing an employee for engaging in protected whistleblowing activity, the courts have not addressed whether the Act also prohibits employers from encouraging confidential or internal reporting through financial rewards or other incentives. Mr. McKessy’s recent comments at the Corporate Counsel Institute, however, make clear the SEC believes that any incentive discouraging employees from bringing potential violations to the agency is improper and unlawful under the SEC’s broad interpretation of Dodd-Frank and the no-waiver provisions of the Sarbanes-Oxley Act. McKessy warned in-house counsel:

Be aware that this is something we are very concerned about. If you’re spending a lot of your time trying to come up with creative ways to get people out of our programs, I think you’re spending a lot of wasted time and you run the risk of running afoul of our regulations. . . . And we are actively looking for examples of confidentiality agreements, separates agreements, employee agreements that . . . in substance say “as a prerequisite to get this benefit you agree you’re not going to come to the commission or you’re not going to report anything to a regulator.”

McKessy also warned compliance attorneys of the risk of drafting such contracts: “And if we find that kind of language, not only are we going to go to the companies, we are going to go after the lawyers who drafted it . . . We have powers to eliminate the ability of lawyers to practice before the commission.”

Given McKessy’s recent comments, companies and their inside counsel should carefully review their employment agreements to identify any provisions that could be construed as incentives to avoid sharing information with the SEC. Until the courts define the scope of Dodd-Frank’s anti-retaliation provision, the risks of including such a provision likely outweigh its benefits.

SEC and Supreme Court Broaden Protections for Whistleblowers
By Conner G. Peretti

Both the SEC and the U.S. Supreme Court recently acted to broaden protections for whistleblowers. In February, the SEC filed an amicus brief in the 2nd Circuit, arguing that the anti-retaliation provisions of the Dodd-Frank Act apply to both employees who report misconduct internally and those who report it to the Commission. Liu v. Siemens AG, No. 13-4385. In March, the Supreme Court issued its decisions in Lawson v. FMR LLC, 571 U.S. __ (2014), holding that whistleblower protections of Section 806 of the Sarbanes-Oxley Act of 2002 (“SOX”) protect employees of a public company’s contractors and subcontractors.

With regard to the 2nd Circuit brief, the SEC expressed concern that an adverse ruling could hamper the effectiveness of internal compliance programs—fewer protections for whistleblowers who report internally means fewer reports, and therefore less overall compliance. The chief of the SEC’s whistleblower office said in a statement that, “We need strong internal compliance programs to ensure that companies are doing the right thing. They play a vital role in the overall policy space . . . We can’t be everywhere.” We previously reported on the SEC’s related whistleblower award program under Dodd-Frank here.

The Supreme Court decision in Lawson significantly expands the universe of companies regulated by the SOX whistleblower protections from about 5,000 public companies to potentially 6 million private ones who serve as the public companies’ contractors and subcontractors. Now, potential SOX whistleblower retaliation claims can be brought against any company that is a contractor or subcontractor of a public company.

For more detailed analysis of the Lawson decision, see here.

ALJ Bars the Big Four’s China Units from SEC Practice for Six Months
By Candice M. Tewell

On Jan. 22, 2014, SEC Administrative Law Judge Cameron Elliot issued a strongly worded ruling censuring the “Big Four” China accounting firms. They are Ernst & Young Hua Ming LLP, KPMG Huazhen, Deloitte Touche Tohmatsue CPA Ltd., and PricewaterhouseCoopers Zhong Tian CPAs Ltd. The ruling bars the Big Four China units from the privilege of practicing or appearing before the Commission for six months. The order also censured BDO China Dahua CPA Co., but did not bar Dahua from practice before the Commission. The ruling is suspended pending an appeal.

The dispute between the SEC and the Big Four arose when the firms failed to provide U.S. regulators with audit work papers for certain Chinese companies under investigation for alleged accounting fraud. The Big Four claimed they could not turn over the papers for fear of violating Chinese secrecy laws.

The SEC has spent years attempting to gain access to audit work conducted by Chinese accounting firms for Chinese companies that list in the U.S. markets with little success. The SEC has tried to delist or de-register some troubled companies over the years, but has stated that investigations into possible fraud were stymied by the Big Four’s failure to turn over audit work papers. After years of strained negotiations with the Big Four’s China units, the SEC decided to pursue sanctions late last year.

The judge found that a six-month bar was in the public interest and indicated that he had “little sympathy” for the firms. “Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law," he said. “Such behavior does not demonstrate good faith, indeed, quite the opposite—it demonstrates gall.” The judge did keep large portions of the 112-page order under seal to avoid adding strain to U.S.-China diplomatic ties.

The Big Four argue that the SEC is pressuring them in an attempt to influence Chinese regulators. They insist that the only way to resolve the dispute is government-to-government or regulator-to-regulator discussions between the U.S. and China.

The ruling will have little effect today, but if it is upheld on appeal, U.S.-listed Chinese companies relying on the Big Four to review their books could be in trouble. Those companies would either need to find a new auditor during the suspension period or would be unable to file accounts, which could result in a suspension of trading. Because the Big Four handle such significant accounts, companies are expected to have trouble finding enough auditors to cover their business if the bar is upheld. Companies cannot trade on U.S. exchanges or sell securities in the U.S. without audited financial statements.

The Big Four’s appeal is currently pending before the full Commission, which could uphold, overturn, or modify the judge’s ruling, or send it back for further proceedings. Any SEC decision could then be appealed up to the U.S. Court of Appeals for the D.C. Circuit.

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