As part of its “Operation Shell Expel” initiative, the SEC today suspended trading in 61 “shell” companies – companies that are dormant and frequently used as fraud vehicles. As part of its crackdown on shell companies, the SEC suspended trading in 379 companies on a single day in May 2012.
The SEC yesterday charged the City of Harrisburg, Pennsylvania with securities fraud based on misleading public statements concerning the city’s financial condition in the city’s budget report, annual and mid-year financial statements, and a State of the City address. This enforcement action marked the first time the SEC has charged a municipality for misleading statements made outside of its securities disclosure documents. Harrisburg agreed to settle the charges.
Separately, the SEC issued an investigative report addressing the obligations of public officials relating to secondary market statements. The SEC cautioned public officials to be mindful that their public statements, whether written or oral, may affect the total mix of information available to investors and to understand that these public statements, if materially misleading, can lead to liability under the federal securities laws. Given this potential for liability, the SEC advised public officials to consider taking steps to reduce the risk of misleading investors. At a minimum, public officials should consider:
In an April 16th speech, Commissioner Aguilar made clear that he supports Commission action under Section 921 of the Dodd-Frank Act to restrict or prohibit pre-dispute arbitration provisions in broker and adviser customer agreements:
“Currently, almost all customer agreements with brokerage firms include an arbitration clause requiring customers to arbitrate their claims in an arbitration forum– and they’re now popping-up in the investment advisory industry. By adding such provisions, brokerage and advisory firms are essentially requiring their clients to give up their legal rights before the client even knows about the nature of a dispute, and before the client has had the opportunity to consider whether giving up those rights would be in their interest. The inclusion of such provisions in brokerage and advisory contracts diminishes investor protection.
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In passing the Dodd-Frank Act, Congress recognized the need to protect investors from abusive practices in the financial services industry. As many of you know, Section 921(a) of the Dodd-Frank Act authorizes the Commission to prohibit or restrict mandatory pre-dispute arbitration provision in customer agreements, if such rules are in the public interest and protect investors. The authority covers broker-dealers and investment advisers. I believe the Commission needs to be proactive in this important area. We need to support investor choice.”
The SEC sued St. Anselm, an oil and gas exploration and development company, its three principals, and one other individual, in March 2011 alleging that the defendants engaged in a Ponzi-like scheme. The SEC also alleged that the defendants misrepresented or failed to disclose information to investors about its deteriorating financial condition. The parties tried the case in July and August 2012 and, on March 29, 2013, Judge Blackburn of the U.S. District Court for the District of Colorado issued his decision. In that decision, Judge Blackburn found that St. Anselm had none of the true hallmarks of a Ponzi scheme. Judge Blackburn summarized his findings as follows:
“What this court perceives from the evidence presented in this case is not fraud, whether intentional or reckless, or even negligence, but a company that got too far out over its skis. [St. Anselm’s] business model worked well for years, and there was nothing inherently suspect about relying on investor financing as one piece among several to service debt and operate a business. Beginning in 2007, the confluence of several promising opportunities that seemed likely to yield enormous returns enticed the company to take on additional debt in order to acquire additional assets. Yet with the economic downtown of 2008 and the sudden decline in the relevant markets, the company’s historical ability to sell assets to fund operations was compromised. No defendant is charged with clairvoyance in the prediction of such external events. When defendants realized their business model no longer worked in the then-current economy, they moved with appropriate speed to revamp it and save investors’ principal. That strategy worked, as [St Anselm] is still operating today.”
The SEC’s downfall seems to have been in focusing on […]
The SEC recently issued a so-called “21(a) report” concerning the application of Reg FD to corporate disclosures made through social media. The report arose out of a SEC investigation into whether Netflix CEO Reed Hastings violated Reg FD by using his personal Facebook page to announce Netflix streaming metrics.
Reg FD prohibits public companies, or persons acting on their behalf, from selectively disclosing material, nonpublic information to certain securities professionals, or shareholders where it is reasonably foreseeable that they will trade on that information, before it is made available to the general public. Reg FD requires that companies and those acting on their behalf distribute the information in a manner reasonably designed to achieve effective, broad and non-exclusionary distribution to the public.
In its report, the SEC made the following two main points: First, companies must examine communications through social media for compliance with Reg FD. Second, the principles outlined in the SEC’s 2008 Reg FD guidance concerning the use of websites to disseminate corporation information apply with equal force to corporate disclosures made through social media channels. Most notably, companies must ensure that the social media channel is a “recognized channel of distribution” by alerting the market to the fact that the company will use the social media channel to disseminate corporate information.
The limitations period for penalty claims in SEC enforcement actions is governed by 28 U.S.C. Section 2462, which states that “an action … for the enforcement of any civil fine, penalty, or forfeiture” must be brought “within five years from when the claim first accrued.” In Gabelli v. SEC, the Supreme Court rejected the SEC’s argument that the “discovery rule” applies to SEC penalty claims. That rule, which is an exception to the standard rule that a claim accrues when the plaintiff has “a complete and present cause of action,” delays accrual until a plaintiff has “discovered” his cause of action. The Court distinguished lawsuits by fraud victims, in which the discovery rule has been applied, from government enforcement actions. Unlike fraud victims, who may have no reason to suspect fraud, the SEC’s very purpose is to root out fraud, and it has many legal tools at hand to aid in that pursuit. Also, the government in enforcement cases seeks a different type of relief than fraud victims: A fraud victim seeks compensation for his injuries, whereas the government seeks civil penalties, which go beyond compensation and are intended to punish and label defendants wrongdoers.