19 January 2023

Top 5 SEC Enforcement Developments For December 2022

Morrison & Foerster LLP


Known for providing cutting-edge legal advice on matters that are redefining industries, Morrison & Foerster has 17 offices located in the United States, Asia, and Europe. Our clients include Fortune 100 companies, leading tech and life sciences companies, and some of the largest financial institutions. We also represent investment funds and startups.
In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important and interesting SEC enforcement developments from the past month, with links to primary resources.
United States Finance and Banking
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In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important and interesting SEC enforcement developments from the past month, with links to primary resources. This month's topics include:

  • A rare Regulation FD action that was heading to trial settled for $6.25 million;
  • Fraud charges against the former CEO and CTO of a crypto trading platform and the former CEO of a privately-held crypto hedge fund;
  • A $413 million settlement by a global financial institution accused of misleading investors about its anti-money laundering (AML) compliance program and failing to disclose risks posed by the program's deficiencies;
  • The SEC's adoption of amendments to Rule 10b5-1 implementing new requirements for the affirmative defense to insider trading liability; and
  • An IT company and its former CFO paying a combined $185,000 to settle charges for alleged accounting, financial reporting, and controls deficiencies in the context of a SPAC-related transaction.

1. Rare Reg FD Litigation Results in the Largest-Ever SEC Settlement of Alleged Reg FD Violations for $6.25 million

On December 5, 2022, the SEC announced that AT&T agreed to pay a $6.25 million penalty, and three company executives consented to each pay a $25,000 penalty, to settle charges that the executives had selectively disclosed material nonpublic information ("MNPI") to Wall Street analysts in 2016.

As discussed in detail in MoFo's recent client alert, in March 2021, the SEC filed a complaint against AT&T and three investor relations (IR) executives alleging violations of Reg FD, which prohibits a public company from providing selective disclosures of MNPI to particular persons outside the company, without also disclosing such information to the public. The SEC alleged that, in March and April of 2016, AT&T and members of its IR department violated Reg FD by disclosing AT&T's "projected and actual financial results" to "stock analysts from approximately 20 Wall Street firms on a one-on-one basis" in an effort to lower consensus revenue estimates for Q1 2016 so that AT&T would not fall short. According to the complaint, AT&T's conduct came on the heels of missed consensus revenue estimates in two of the previous three quarters. As alleged, AT&T's selective disclosures of MNPI prompted these analysts to significantly reduce their revenue estimates for Q1 2016, and AT&T ended up exceeding these projections by 0.1%.

On September 8, 2022, Judge Engelmayer of the Southern District of New York denied cross-motions for summary judgment in SEC v. AT&T, Inc. et al. and set a Reg FD litigation on a course to trial for the first time. In a 129-page decision, Judge Engelmayer found that the SEC put forth sufficient evidence to support its claims, going so far as to note that the "evidence is . . . formidable that the information that the individual defendants selectively disclosed about AT&T in their calls to analysts was both material and nonpublic." On the other hand, Judge Engelmayer found that a reasonable jury could find that AT&T lacked the requisite intent for violating Reg FD's bar against selective disclosures of MNPI. In particular, he held that a "jury could credit defendants' uniform testimony that . . . they had not appreciated that the information they were disclosing was material and nonpublic." The court therefore held that neither side should prevail on summary judgment.

The AT&T litigation and settlement highlights the potential for Reg FD pitfalls. Our recent client alert offers some best practices for companies to consider in light of the enforcement action.

#noselectivedisclosure #MNPI #RegFDrisk #RegFDsettlement

2. The SEC Charges Former CEO and CTO of a Crypto Trading Platform and Former CEO of a Crypto Hedge Fund with Securities Fraud for Misleading Investors and Customers and Diverting Their Funds for Personal Use

On December 13, 2022, the SEC charged Samuel Bankman-Fried with defrauding investors and customers by making misleading statements about the financial health and risk management of FTX, the crypto asset trading platform of which he was CEO and co-founder, and diverting customer and investor funds for his personal benefit. According to SEC Chair Gary Gensler, "Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto." On December 21, 2022, the SEC also announced settled charges against Gary Wang, the former CTO and co-founder of FTX, and Caroline Ellison, the former CEO of Alameda Research, a crypto hedge fund owned by Bankman-Fried, for allegedly engaging in the same fraudulent scheme to deceive FTX's investors and customers.

As alleged by the SEC, from May 2019 through November 2022, FTX raised more than $1.8 billion from equity investors based on Bankman-Fried's promotion of FTX as "a safe, responsible crypto asset trading platform" and its "sophisticated, automated risk measures to protect customer assets." The complaint alleged that, in reality, Bankman-Fried concealed from investors (1) the undisclosed diversion of FTX customers' funds to Alameda Research LLC; (2) the undisclosed special treatment afforded to Alameda on the FTX platform, including providing Alameda with a virtually unlimited "line of credit" funded by the platform's customers and exempting Alameda from certain key FTX risk mitigation measures; and (3) undisclosed risk stemming from FTX's exposure to Alameda's significant holdings of overvalued, illiquid assets such as FTX-affiliated tokens. Ellison and Wang allegedly knew or should have known that Bankman-Fried's statements were false and misleading. The SEC further alleged that Bankman-Fried used commingled FTX customers' funds at Alameda for his personal use and benefit and that both Ellison and Wang acted in furtherance of Bankman-Fried's scheme.

According to the complaint, between 2019 and 2022, Ellison, at the direction of Bankman-Fried, furthered the scheme by inflating the price of FTT, an FTX-issued exchange crypto security token which served as collateral for undisclosed loans by FTX of its customers' assets to Alameda. By manipulating the price of FTT, Bankman-Fried and Ellison allegedly caused the value of collateral on Alameda's balance sheet to be overstated and misled investors about FTX's risk exposure. The complaint further alleged that Wang created a software code that allowed Alameda to divert FTX customer funds, and that Ellison used misappropriated FTX customer funds for Alameda's trading activity.

When the crypto market declined in value in May 2022, the SEC alleges, Alameda's lenders demanded repayment on billions of dollars of loans. Even though FTX had allegedly already given Alameda billions of dollars in customer funds, Bankman-Fried, with the knowledge and consent of Ellison and Wang, directed FTX to divert billions more in customer assets to Alameda to cover those positions. The SEC alleged that Bankman-Fried, Ellison, and Wang either knew or were reckless in not knowing that Alameda and FTX were in "a precarious financial condition"; however, Bankman-fried continued to withdraw customer funds and presented a false and misleading positive account of the company to investors.

The SEC's complaints charged Bankman-Fried, Ellison, and Wang with violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

The SEC announced that Ellison and Wang have consented to bifurcated settlements, which were approved by Judge Castel of the Southern District of New York on December 23, 2022. The Commodity Futures Trading Commission and the U.S. Attorney's Office for the Southern District of New York also announced parallel civil enforcement and criminal actions against Bankman-Fried on December 13, 2022.

#crypto=securities? #cryptofraud #cryptoenforcement

3. The SEC Charges Denmark-Based Global Financial Institution with Disclosure Fraud and Obtains a $413 Million Settlement

On December 13, 2022, the SEC charged Danske Bank, a Danish global financial institution, for misleading investors about its anti-money laundering (AML) compliance program in its Estonian branch and failing to disclose the risks posed by the program's significant deficiencies in violation of the antifraud provisions of the Securities Exchange Act of 1934. Danske agreed to pay $413 million in penalties, disgorgement, and interest to settle these charges.

As alleged by the SEC, from 2009 to 2016, Danske provided banking services to suspicious customers of its Estonia Branch despite knowing there was a high degree of risk that such customers were potentially engaged in money laundering. The suspicious transactions involved more than $200 billion in funds and constituted nearly all profits earned by the Estonia branch.

The SEC also alleged that despite knowing that its internal risk management procedures were inadequate to prevent such activity and that its AML and Know-Your-Customer (KYC) procedures were not being followed and did not comply with applicable laws and rules, Danske made materially misleading statements and omissions in its publicly available reports stating that it complied with its AML obligations and that it had effectively managed its AML risks. Although Danske stopped providing services to its high-risk customers by 2016, it failed to timely disclose to investors known misconduct and its AML and KYC deficiencies.

Danske's $413 million settlement with the SEC was part of a total of more than $2 billion the company agreed to pay as part of a global resolution with the SEC, the DOJ, the United States Attorney's Office for the Southern District of New York, and Denmark's Special Crime Unit.

#internalcontrols #AMLrisks #knowyourcustomer #DisclosureFraud

4. >SEC Adopts Amendments to Modernize Rule 10b5-1 Insider Trading Plans and Related Disclosures

On December 14, 2022, the SEC adopted amendments to Rule 10b5-1(c) under the Securities Exchange Act of 1934 and new disclosure requirements applicable to issuers and insiders. As discussed in further detail in a recent MoFo client alert, the SEC's adopted amendments:

  • Add new requirements for the affirmative defense to insider trading liability by:
    • Imposing a cooling-off period before trading can commence under a Rule 10b5-1 plan as follows:
      • For directors and officers, 90 days after the adoption of the Rule 10b5-1 plan;
      • For persons other than directors, officers or the issuers, 30 days following the adoption or modification of a Rule 10b5-1 plan;
    • Prohibiting overlapping Rule 10b5-1 plans; and
    • Limiting single-trade Rule 10b5-1 plans to one trading plan per 12-month period.
  • Require directors and officers to include a representation in their Rule 10b5-1 plan certifying that: (i) they are not aware of any material nonpublic information; and (ii) they are adopting the trading plan in good faith and not as part of a plan or scheme to evade the prohibitions in Rule 10b-5.
  • Impose a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to that plan.
  • Require issuers to provide:
    • Quarterly disclosure regarding the use of Rule 10b5-1 plans and certain other written trading arrangements by an issuer's directors and officers for the trading of securities;
    • Annual disclosure of an issuer's insider trading policies and procedures;
    • Certain tabular and narrative disclosures regarding awards of options close in time to the release of material nonpublic information and related policies and procedures; and
    • Tagging of the required disclosures using Inline XBR.
  • Require that Form 4 and Form 5 filers identify transactions made pursuant to a plan intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose all bona fide gifts of securities on Form 4.

The final amendments will be effective on February 27, 2023 (60 days following their publication in the Federal Register on December 29, 2022). Issuers must comply with the new disclosure requirements in Form 10-Q and Form 10-K filings that cover the first full fiscal period that begins on or after April 1, 2023. Section 16 reporting persons will be required to comply with the amendments to Form 4 and Form 5 for reports filed on or after April 1, 2023. The amendments to Rule 10b5-1(c)(1) will not affect the availability of an affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the revised rule's effective date, except to the extent that such a plan is modified.

#Rule10b5-1plan #Rule10b5-1(c)amendments #cooloffbeforetrading #nooverlappingplans

5. SEC Charges IT Company and Its Former CFO for SPAC-Linked Reporting Failure

On December 19, 2022, the SEC announced a settled enforcement action against Exela Technologies, Inc, for accounting, financial reporting and controls deficiencies, including its failure to properly account for and report exposure to a shareholder lawsuit and to disclose and account for related party transactions, and against its former CFO, James Reynolds, for causing Exela's failure to report two related party transactions in one quarter.

According to the SEC, Exela was created in 2017 through a merger by which SourceHOV and another private company combined with a publicly listed SPAC. The deal struggled to close because there were more redemptions by SPAC investors than anticipated, and the parties arranged a revised transaction structure. Under the revised structure, a new special purpose entity called Ex-Sigma LLC was established to hold the merger consideration of SourceHOV's shareholders, which was used as collateral for a margin loan that funded the close of the deal. SourceHOV, which became an Exela subsidiary after the transaction, agreed to reimburse Ex-Sigma for some costs related to the margin loan, and in 2019, Exela made several payments to Ex-Sigma.

The SEC alleged that Ex-Sigma was a related party to Exela because Reynolds and other members of senior leadership had "an indirect ownership and financial interest through their control of its then-largest shareholder." Exela allegedly failed to disclose in quarterly filings that two payments to Ex-Sigma were related party transactions. According to the SEC, Reynolds "was a member of Exela's disclosure committee, which was responsible for identifying related party transactions each quarter" and as CFO "Reynolds was required to identify related parties such as Ex-Sigma in an annual [directors and officers] Questionnaire, yet he failed to do so."

The SEC also alleged that, from mid-2017 through 2019, Exela failed to properly account for and report liabilities it incurred when it was sued in an appraisal action by minority shareholders who dissented from the 2017 SPAC merger and sought the fair value of their shares. While Exela had disclosed the existence of appraisal claim in its SEC filings when the suit was pending, it did not accrue for potential payment it might have to make to those dissenting shareholders. As subsequently determined by Exela's auditor, however, Exela should have accrued an estimated liability at the time the action was filed, even though it could not predict the outcome of the appraisal action. The SEC noted in its order that "the rights conveyed to the dissenting shareholders represented a financial instrument within the scope of [Accounting Standards Codification] 480 that should have been initially measured at fair value and reclassified as a liability."

Exela and Reynolds agreed to pay penalties of $175,000 and $10,000, respectively, to settle the claims against them.

#deSPAC=realIPO? #SPACenforcementrisks #deSPACdisclosure #payattentiontoaccounting 

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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