CLOSE X
RSS Feed LinkedIn Instagram Twitter Facebook
Search:
FMG Law Blog Line

Archive for the ‘Financial Services and Securities Litigation’ Category

Supreme Court to Revisit Liability Under Rule 10b-5 – Will Prospective Justice Kavanaugh Weigh In?

Posted on: July 25th, 2018

By: Ted Peters

Section 10(b) of the Securities Exchange Act, and Rule 10b-5 promulgated under it, makes certain conduct in connection with the purchase or sale of any security unlawful.  Specifically, Rule 10b-5(a) prohibits the use of any “device, scheme, or artifice to defraud.”  10b-5(b) prohibits the use of any “untrue statement of a material fact” or the omission of any “material fact necessary in order to make the statements… not misleading.”  And 10b-5(c) prohibits “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.”

In Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), the United States Supreme Court addressed whether a mutual fund investment adviser could be held liable under Rule 10b-5 for false statements included in its client mutual funds’ prospectuses.  The Court concluded that the adviser could not be held liable under the rule because it did not make the statements in the prospectuses.

In Lorenzo v. Securities and Exchange Commission, 872 F.3d 578 (2017), the D.C. Circuit Court of Appeal considered whether a registered representative of a broker-dealer, who allegedly emailed false and misleading statements prepared by his boss to investors, could be found liable under Rule 10b-5.  Initially, the case was tried before an Administrative Law Judge who concluded that Lorenzo’s boss had drafted the emails in question; Lorenzo did not read the text of the emails; and Lorenzo had “sent the emails without even thinking about the contents.”  The judge also found that the emails were sent “at the request” of Lorenzo’s boss.  Notwithstanding these findings, the judge nevertheless concluded that Lorenzo had willfully violated securities laws (i.e., that Lorenzo had acted with an intent to deceive, manipulate or defraud).  As a sanction, the judge not only fined Lorenzo, but also imposed a lifetime suspension effectively barring him from the securities industry.

Lorenzo appealed the ruling before the Securities Exchange Commission.  The Commission affirmed, concluding that Lorenzo himself was “responsible” for the contents of the emails his boss asked him to send even though it was undisputed that Lorenzo’s boss had prepared the contents of the emails and that Lorenzo had simply “cut and pasted” the contents into the emails at issue.  Notably, the SEC found that Lorenzo’s conduct triggered liability under each of the subparts of Rule 10b-5, including 10b-5(b) which, under Janus, necessarily required an affirmative finding that Lorenzo had actually “made” the statements in question.

Lorenzo next appealed to the D.C. Circuit Court.  On September 29, 2017, a divided court upheld the SEC’s determination.  The court agreed that there was substantial evidence that the statements in Lorenzo’s emails were false or misleading and that Lorenzo possessed the requisite intent to mislead, deceive or defraud. However, the court disagreed with the SEC’s determination that Lorenzo was the “maker” of the statements as required by Rule 10b-5(b).  “We conclude that Lorenzo did not ‘make’ the false statements at issue for purposes of Rule 10b-5(b) because Lorenzo’s boss, and not Lorenzo himself, retained ‘ultimate authority’ over the statements.” [Citing Janus.]  On this basis, the court set aside the sanctions and remanded the case to enable the SEC to reassess appropriate penalties.

Judge Brett Kavanaugh, the current presidential nominee to fill the vacancy left by Justice Kennedy, penned a strongly worded dissent.  Kavanaugh criticized the conclusion reached by his colleagues that the “scheme liability” provisions of Rule 10b-5(a) and (c) may be used to find liability even where the defendant is not the “maker” of the statements (and thus not liable under 10b-5(b)).

On June 18, 2018, the U.S. Supreme Court granted the petition for writ of certiorari.  The question before the Supreme Court is simple: Can a defendant be held liable under the so-called scheme liability provisions of Rule 10b-5(a) and (c) in connection with using false or misleading statements, even if that defendant is not the “maker” of the statements?  That the Court accepted certiorari certainly suggests that the Court desires to further define the scope and limitations of Rule 10b-5.

Should Kavanaugh be confirmed as the next Supreme Court Justice, it remains to be seen whether he will recuse himself on the grounds that he heard the case below.  If he does, then the Court could well end up with a 4-4 split, which would effectively affirm the lower court’s ruling.  The Court’s four more liberal justices (Breyer, Ginsburg, Sotomayor and Kagan) each dissented from Janus.  On the other hand, if Kavanaugh is confirmed and does not recuse himself, the majority of the Court will likely endorse a more restrictive interpretation of scheme liability under Rule 10b-5.

If you have questions or would like more information, please contact Ted Peters at [email protected].

Loss of SEC Commissioners Piwowar and Stein May Wreak Havoc on SEC’s Proposed Fiduciary Regulations

Posted on: June 1st, 2018

By: Ted Peters

On May 7, 2018, Republican SEC Commissioner Michael Piwowar announced that he will resign effective July 7, 2018.  Piwowar’s five-year term expires on June 5, but SEC commissioners are permitted to remain in office for up to 18 months following the end of their term.  Democratic Commissioner Kara Stein’s term expired in 2017 and she too is expected to leave the Commission this year.

Piwowar was admittedly a harsh critic of the U.S. Department of Labor’s fiduciary rule (calling it a “terrible, horrible, no good, very bad” rule), which has since been struck down by the Fifth Circuit Court of Appeal.  He also expressed significant misgivings with the Commission’s April 18, 2018 proposals which attempt to establish standards of conduct for financial advisors.  Despite such concerns, Piwowar wholeheartedly voted in favor of putting the proposals out for public comment lest anyone criticize the SEC for failing to take action.  Stein, however, voted against the proposals, finding them too weak and suggesting they be called “Regulation Status Quo.”

Regardless of their personal views, the loss of Commissioners Piwowar and Stein will undoubtedly put further pressure on the SEC as the agency takes comments on the proposals. On the other hand, the SEC might have an easier go in reaching a compromise with the decision being left to just three commissioners.  In theory, the White House and Senate could quickly take action to replace Piwowar and Stein, as it is customary for the Senate to consider commissioners in pairs (Republican and Democrat).  In the meantime, between the departures of Piwowar and Stein, the SEC will operate with four commissioners including two Democrats, which could lead to deadlocked votes, something for which the SEC is well known.

If you have questions or would like more information, please contact Ted Peters at [email protected].

“Senior Safe Act” Encourages Reporting of Senior Investor Fraud

Posted on: May 25th, 2018

By: Ted Peters

On May 22, 2018, the Senior Safe Act, authored by U.S. Senators Susan Collins (R-ME) and Claire McCaskill (D-MO), passed in the House of Representatives as part of a bipartisan banking reform package after previously being passed by the Senate (67-31) in March.  The Act seeks to curb financial exploitation of senior investors by establishing a safe harbor in which advisors and their firms can report abuses without fear of liability for violation of privacy laws.

The Act extends legal immunity to banks, credit unions, investment advisors, broker-dealers, insurance companies and insurance agencies for reporting suspected exploitation or fraud, provided that they have established controls and procedures that will help employees and advisors identify and report suspected abuses, and provided further that they make the report in good faith and with reasonable care.

The Act has been broadly endorsed by the securities industry and has received bipartisan support.  Says FSI (Financial Services Institute) President and CEO, Dale Brown, “We applaud the House for taking a significant step toward the prevention of elder financial abuse by passing the Senior Safe Act… Financial advisors and financial firms are often the first to detect possible financial abuse, so it is critical that they have proper training to identify potential abuse as well as the ability to report it without fear of violating privacy laws.”

President Trump is expected to sign the Act into law as he tweeted that he would do so.

If you have questions or would like more information, please contact Ted Peters at [email protected].

Lessons Learned from the SEC’s Order in the Yahoo! Data Breach Enforcement Action

Posted on: May 22nd, 2018

By: Jennifer Lee

On April 24, 2018, the SEC issued an order in the enforcement action against Altaba Inc., formerly Yahoo! Inc., and imposed a $35 million fine relating to the 2014 data breach which affected more than 500 million Yahoo! user accounts.

SEC’s Findings

The SEC found that Yahoo! violated federal securities laws by failing to disclose the 2014 data breach for almost two years. The SEC focused on the fact that despite its knowledge of the data breach, Yahoo!’s annual and quarterly reports made no mention of the data breach as a risk factor. Instead, the reports represented that the company only faced the risk of potential future data breaches that may expose its users’ personally identifiable information which may lead to litigation, loss of revenue, and damage to its reputation.

In addition, Yahoo! management’s analysis of the company’s financial condition also omitted changes to revenue that were expected to result from the public disclosure of the 2014 data breach.

Lastly, the stock purchase agreement between Yahoo! and Verizon entered into on July 23, 2016 and filed with the SEC on July 25, 2016 was misleading because it contained affirmative representations denying the existence of any significant data breaches.

The data breach was not disclosed until September 2016 in a press release filed as an attachment to a Form 8-K. After the public announcement of the data breach, Yahoo!’s stock price decrease by 3%, resulting in a $1.3 billion drop in its market cap.

Lessons Learned

Disclosures regarding cybersecurity risk factors that discuss potential incidents are misleading if they do not discuss known incidents that have already occurred. The SEC found that the omission of the 2014 data breach in the risk factor disclosures were misleading because it suggested that a significant data breach had not yet occurred, which in turn implied that any negative effects that may result from future breaches are merely speculative.

Companies should perform regular assessments of cybersecurity threats and their likely impact on the business to determine whether such issues should be disclosed as a risk factor. Regulation S-K item 303 requires companies to include trends or uncertainties reasonably likely to have a material impact on their business. Item 503(c) requires companies to disclose the most significant risk factors that make the company speculative or risky. Because cybersecurity incidents have the potential to and often do, in fact, lead to a significant depreciation in a company’s stock price and market cap, failing to perform regular assessments of cybersecurity threats and their likely impact on the business will inevitably lead companies to run afoul of Regulation S-K.

Be mindful of other state, federal, and international regulations that govern disclosure of data breaches and other cybersecurity incidents. Currently, data breach notification obligations in the United States consist of a patchwork of individual state statutes. In addition, the EU’s General Data Protection Regulation, which takes effect on May 25, 2018, contains a whole new set of rules regarding the disclosure of data breaches and other cybersecurity incidents. Companies that operate on a national or international level must be aware of their disclosure obligations under these regulatory structures and how they may affect companies’ disclosure obligations under federal securities laws.

If you have any questions or would like more information, please contact Jennifer Lee at [email protected].

 

DOL Fiduciary Rule Suffers a Slow Death

Posted on: May 15th, 2018

By: Ted Peters

In 2016, the U.S. Department of Labor (“DOL”) promulgated a set of rules and regulations now infamously referred to as the “Fiduciary Rule.”  After multiple criticism and legal challenges, the Fifth Circuit Court of Appeal struck down the Fiduciary Rule effective May 7, 2018.  Surprising many, the DOL elected not to challenge the Fifth Circuit ruling.  Even more surprising, however, was the bulletin issued by the DOL on the effective date of the court’s order.

The court’s ruling, which was not opposed by the DOL, left many unanswered questions.  Enter the DOL’s field bulletin.  Rather than admitting the total defeat of the Fiduciary Rule, however, the DOL seeks to maintain the status quo.  Specifically, the DOL announced that pending further guidance, advisors will not be penalized for either complying with the Fiduciary Rule, or ignoring it in favor of pre-existing standards.  Unfortunately, this announcement leaves the single most important question unanswered – what is the standard to which advisors will be held?  With the U.S. Securities and Exchange Commission working on its own set of rules, and the wait-and-see approach embraced by the DOL notwithstanding, only time will tell.

If you have questions or would like more information, please contact Ted Peters at [email protected].