Publications
Litigation

Quarterly Securities Enforcement Briefing

July 2015
Print this page
Articles  

SEC Grants Second-Ever Whistleblower Award to Compliance Officer
By John A. Goldmark

In April 2015, the SEC announced a $1.5 million whistleblower award to a compliance officer who provided information assisting in an enforcement action against the officer’s company.

Allowing a compliance officer to obtain a whistleblower award is rare—indeed, this was only the second time the SEC has granted such an award. Under the SEC’s whistleblower program, compliance officers are generally not eligible for whistleblower awards, unless: (1) disclosure to the SEC is necessary to prevent the company from causing substantial injury to its own or its investors’ financial interests, (2) the entity is impeding an investigation of the misconduct, or (3) 120 days have elapsed since the company’s management received the information. The only prior award to a compliance officer occurred in August 2014, under the third exception, when the employee reported to the SEC after reporting alleged wrongdoing to the company and, after the lapse of 120 days, the company failed to take appropriate action.

In this case, the compliance officer apparently reported to the SEC when management failed to stop the misconduct upon learning of it. The SEC found the officer met the first exception because he had a reasonable basis to believe that reporting to the SEC was necessary to prevent “imminent misconduct from causing financial harm to investors or the company itself.”

The SEC’s award provides a reminder to companies to ensure they have adequate internal mechanisms to assess and investigate credible reports of misconduct, particularly those by compliance officers, and promptly take steps to address any potential or actual violations.

Possible Circuit Split as 9th Circuit Declines 2nd Circuit’s Invitation to Narrow Insider Trading Liability
By Conner G. Peretti

On July 6, 2015, the 9th Circuit upheld a conviction in a family insider trading scheme in U.S. v. Salman, departing from the 2nd Circuit’s landmark U.S. v. Newman decision that narrowed the definition of “personal benefit” to the tipper sufficient to sustain a conviction (we reported on Newman here). The possible Circuit split increases the likelihood that the U.S. Supreme Court will decide the issue. The 9th Circuit’s opinion in Salman is available here. 

In Newman, the 2nd Circuit dismissed indictments against two individual “tippees” convicted of insider trading because the government failed to prove that they knew that the insiders who tipped them the information received a “personal benefit” for the tips. The 2nd Circuit departed from earlier case law and found that a “personal benefit” is sufficient only if it “generates an exchange that is objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”

In Salman, the 9th Circuit reverted to earlier Supreme Court case law on the issue, Dirks v. SEC, and declined to adopt the 2nd Circuit’s analysis. In Salman, the first tipper worked at an investment bank and provided confidential information to his brother, who tipped Salman, who was engaged to the first tipper’s sister. The 9th Circuit applied the holding in Dirks in finding that “personal benefit” included “[p]roof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend.”

The U.S. Attorney’s Office for the Southern District of New York, which prosecuted the Newman case, lost its petitions for en banc and panel review in the 2nd Circuit. The Salman case may motivate them to seek certiorari from the Supreme Court given a fair argument for a Circuit split after Salman.

Also of note is the fact that the author of the Salman decision was Judge Jed Rakoff. Judge Rakoff is a district judge from the Southern District of New York who was sitting by designation in Salman. It is well known that Judge Rakoff did not agree with the 2nd Circuit’s Newman decision, but he is bound by that decision sitting as a district judge in New York. By sitting by designation in the 9th Circuit, Judge Rakoff had the opportunity to differ with the reasoning of the 2nd Circuit that usually oversees his work.  The 9th Circuit policy is to assign judges to panels randomly. 

SEC Proposes New Executive Compensation Rules
By Jeffrey B. Coopersmith

The SEC has recently proposed new rules concerning two aspects of executive compensation. On April 29, 2015, the SEC proposed rules under the Dodd-Frank Act requiring companies to disclose the relationship between the pay of top executives and the company’s financial performance. A summary of the proposed rules and a link to the text can be found here. Under the SEC’s proposal, companies would have to disclose executive pay and performance information for itself and companies in a peer group in a table and tag the information in an interactive data format. Depending on the size of the company, the information would have to be disclosed for the past three or five fiscal years. 

On July 1, 2015, the SEC proposed rules directing national securities exchanges to establish listing standards requiring companies to adopt policies to claw back incentive-based executive compensation that would not have been earned based on an accounting restatement.  A summary and the proposed rules are available here. The rules are designed to implement Section 954 of the Dodd-Frank Act, which added Section 10D to the Securities Exchange Act of 1934. The rules would require claw-back from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare restated financials to correct a material error. Failure to adopt a recovery policy would subject the company to delisting. 

Under the proposed rule, the definition of executive officer would include the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division, or function, and any other person who performs policy-making functions.  This is substantially broader than section 304 of the Sarbanes-Oxley Act, 15 U.S.C. § 7243, which applies only to a company’s CEO and CFO, and requires forfeiture of certain compensation and profits from securities sales only for the 12-month period following the issuance of the financial statement that need to be restated.  Under the proposed rules, recovery would be required if the restated financials do not support the incentive-based compensation, regardless of fault or scienter.  Section 304 similarly does not require fault or scienter.

FINRA Fines Morgan Stanley and Scottrade for Weak Security
By Jeffrey B. Coopersmith

On June 22, 2015, the Financial Industry Regulatory Authority (FINRA) announced that it had reached an agreement with Morgan Stanley Smith Barney on a $650,000 penalty, and with Scottrade on a $300,000 penalty, for failing to appropriately monitor the transmittal of customer funds to third party accounts. In the case of Morgan Stanley, three representatives in two branch offices sent fraudulent wire transfers totaling almost $500,000 from customer accounts to third party accounts (such as the representatives’ own personnel bank accounts).

In the Scottrade matter, the company failed to obtain any customer confirmations for wire transfers less than $200,000, and did not have appropriate personnel authorize transfers of between $200,000 and $500,000. No specific fraudulent conduct was announced in the Scottrade matter. In both cases, FINRA alleged that the companies failed to establish and implement reasonable supervisory systems and procedures to review and monitor funds transfers to third parties. Neither company admitted liability.
 
The case demonstrates the importance of maintaining a robust internal controls environment to prevent fraudulent activity as well as to avoid penalties when lack of controls are discovered during audits.

Related Articles