SEC Enforcement QUARTERLY

IN THIS ISSUE

SEC

Enforcement

Recent Report Highlights SEC Enforcement Trends for Public Companies A report recently released by the New York University Pollack Center for Law & Business and Cornerstone Research (the NYU Report) confirms that the SEC has increasingly opted to pursue enforcement actions against public companies using in-house administrative proceedings. The NYU Report, which analyzed actions initiated by the SEC over the past five years, also identifies apparent changes in the nature of the actions the SEC pursues, including a recent emphasis on issuer reporting and disclosure violations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) significantly expanded the range of persons who may be subject to the SEC’s in-house proceedings heard by administrative law judges (ALJs) and the penalties that may be imposed by ALJs. According to the NYU Report, these administrative proceedings are now the forum of choice for a majority of SEC enforcement actions against public companies—with the proportion of matters brought by the SEC as administrative proceedings increasing more than threefold since Dodd-Frank, jumping from 21 percent in fiscal year 2010 to 76 percent in fiscal year 2015.

Along with this increased reliance on administrative proceedings to pursue public companies, the NYU Report notes an increase in concurrent settlements before these in-house courts. Of the public companies in enforcement actions before an ALJ, 96 percent settled concurrently with the filing of the action in fiscal year 2015, up from 75 percent in fiscal year 2010. In contrast, in civil cases initiated against public companies in fiscal year 2015, only 38 percent settled concurrently. The NYU Report also finds that the majority of large penalties and disgorgements imposed by the SEC occurred in administrative proceedings. In fiscal year 2010, all fines of $100 million or more were imposed in civil actions. In fiscal years 2013 through 2015, by contrast, most fines of $100 million or more were imposed in administrative proceedings.

The NYU Report also concludes that the SEC has largely adhered to its strategy of pursuing cases involving issuer reporting and disclosure violations. In July 2013, the SEC announced the launch of a financial reporting and audit task force designed to detect and prosecute

violations involving false or misleading statements and disclosures. Since then, according to the NYU Report, these cases have represented, on average, more than 65 percent of actions against public companies. Violations of the Foreign Corrupt Practices Act (FCPA) accounted for the next highest percentage of cases brought against public companies. Together, these two areas made up at least 85 percent of all actions in NEWS

Recent Report Highlights SEC Enforcement Trends for

Public Companies �����������������������������������1 Recent Court Challenge Raises

Questions on Scope of FINRA’s

Enforcement Powers �������������������������������2 Settlement Concerning “Internal Controls over Financial Reporting” Again Highlights SEC Focus on Financial Reporting Issues ���������������������2 Supreme Court Agrees

to Hear Case on Insider Trading Standard at Issue in Newman ����������������3

RECENT SEC STAFF CHANGES ����������4 FCPA FOCUS �����������������������������������������5

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Because the Exchange Act and the Securities Act are separate enactments, the plaintiffs contend that the plain text of FINRA’s enabling legislation does not grant FINRA authority to bring disciplinary actions premised on alleged violations of the Securities Act or other federal securities laws aside from the Exchange Act.

accounted for less than five percent of the enforcement actions against public companies over the last five years.

Although the forum may have changed, the NYU Report also concludes that the number of actions against public companies remained largely unchanged over the past five years, even as overall enforcement actions have increased. The NYU Report finds that the overall increase is likely due to more independent actions, which accounted for 63 percent of enforcement actions filed in fiscal year 2015. In contrast, follow-on proceedings used to impose additional sanctions against individuals decreased to only 21 percent of actions in fiscal year 2015. Actions related to delinquent filings remained roughly constant, accounting for around 16 percent of actions in fiscal year 2015.

Recent Court Challenge Raises Questions on Scope of FINRA’s Enforcement Powers A recent federal court challenge raises questions about the authority of the Financial Industry Regulatory Authority (FINRA) to enforce some of the federal securities laws. On March 22, 2016, Scottsdale Capital Advisors Corporation (Scottsdale), its founder and two officers filed a lawsuit in Maryland federal court seeking to preclude FINRA from further proceedings against them. The plaintiffs contended that FINRA exceeded its expressly articulated authority under the Securities Exchange Act of 1934 (the Exchange Act) when it initiated a disciplinary proceeding against plaintiffs based on potential violations of Section 5 of the Securities Act of 1933 (the Securities Act), which generally prohibits the public distribution of unregistered securities absent an applicable exemption. On April 26, 2016, the district court dismissed the case without reaching the merits, reasoning that it did not have jurisdiction under the Exchange Act and that the plaintiffs should instead raise the issue in the ongoing FINRA proceeding.

The plaintiffs’ challenge focuses on the Exchange Act as the source of FINRA’s disciplinary authority. According to the plaintiffs, the Exchange Act empowers FINRA to discipline its member only for violations of rules promulgated under the Exchange Act. Specifically, plaintiffs point to the language in Section 15A(h) of the Exchange Act providing that “[a] determination by the association to impose a disciplinary sanction shall be supported by a statement setting forth…the specific provision of this Act, the rules or regulations thereunder,…or the rules of the association which any such act or practice, or omission to act, is deemed to violate.” Plaintiffs similarly point to Section 19(g) of the Exchange Act, which requires an entity like FINRA “to comply with the provisions of this Act, the rules and regulations thereunder, and its own rules” and grants that entity the power to “enforce compliance[,] in the case of a registered securities association [such as FINRA], with such provisions.” Because the Exchange Act and the

Securities Act are separate enactments, the plaintiffs contend that the plain text of FINRA’s enabling legislation does not grant FINRA authority to bring disciplinary actions premised on alleged violations of the Securities Act or other federal securities laws aside from the Exchange Act. As a result, plaintiffs argue, FINRA does not have the legal authority to bring disciplinary proceedings premised on Section 5 violations.

The plaintiffs have appealed the district court’s decision, but it is unclear whether an appeals court would look beyond the jurisdictional question to reach the merits of the plaintiffs’ claim at this point. In any event, it is likely that plaintiffs will also continue to assert their claims in the FINRA proceeding under the review process proscribed by the Exchange Act, which could ultimately result in a review by a federal appeals court that would reach the merits. The plaintiffs’ case may also encourage similar challenges to the scope of FINRA’s authority. If plaintiffs or other challengers were ultimately to prevail on the merits of their claims, it could significantly constrain FINRA’s enforcement powers.

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Moreover, the SEC contended that internal management, including the CFO and CAO, ignored evidence of “material weakness” in its evaluation of the accountants’ conclusions and ultimate affirmation that the ICFR was sufficient.

Settlement Concerning “Internal Controls over Financial Reporting” Again Highlights SEC Focus on Financial Reporting Issues

On March 10, 2016, the SEC reached a settlement with Magnum Hunter Resources Corporation (MHR) for its failure to properly identify and report deficiencies in its internal controls over financial reporting (ICFR). At the same time, the SEC also settled with MHR’s former chief financial officer (CFO) and former chief accounting officer (CAO), as well as an outside consultant and outside audit engagement partner.

MHR is a public company, currently in bankruptcy, that is headquartered in Irving, Texas and involved in the exploration and production of oil and gas. As a publicly traded company, MHR had an obligation under the Exchange Act to devise and maintain an internal accounting control apparatus sufficient to provide reasonable assurance that transactions were recorded in accordance with GAAP accounting standards. Rules promulgated under the Exchange Act require public companies like MHR to maintain ICFR and place the onus on firm management to evaluate annually the effectiveness of those measures. Indeed, management must produce an annual report to the SEC assessing the company’s ICFR. The report is required to divulge any “material weakness,” which is defined as “a deficiency, or combination of deficiencies in [ICFR], such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.” In contrast, companies are not required to report a “significant deficiency,” which is a “deficiency, or a combination of deficiencies, in [ICFR] that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting.”

According to the SEC’s order, in the years before 2011, MHR experienced rapid growth resulting from significant acquisitions. But as the overall firm grew, MHR’s accounting department did not. Thus, the firm lacked the amount of staff required to do the work of auditing a company of its new size. According to the SEC, both the outside consultant and outside audit engagement partner separately concluded there were flaws in the ICFR at MHR based on insufficient staffing, but both mischaracterized those shortcomings as “significant deficiencies” rather than “material weaknesses.” Moreover, the SEC contended that internal management, including the CFO and CAO, ignored evidence of “material weakness” in its evaluation of the accountants’ conclusions and ultimate affirmation that the ICFR was sufficient.

According to the SEC, these oversights led to a material error in stock-based compensation. MHR first disclosed this error in its November 14, 2012 amended 10-Q filing restating the June 30, 2012 financials, which noted three material weaknesses. The following third quarter 10-Q filing disclosed the same material weaknesses and MHR’s delinquently filed annual 10-K enumerated some 11 more material weaknesses.

The settlement ordered MHR to pay $250,000 (subject to the approval of the bankruptcy court), the former CFO to pay $25,000 and the outside consultant to pay $15,000. The CAO and outside audit engagement partner were both suspended for at least one year from appearing before the SEC as accountants. The settlement again highlights the SEC’s commitment to pursuing transparency in the financials of publicly traded companies by holding professionals personally responsible for attesting to the accuracy of financial reports. Supreme Court Agrees to Hear Case on Insider Trading Standard at Issue in Newman On January 19, 2016, the Supreme Court granted certiorari in United States v. Salman to review the Ninth Circuit’s decision concerning the “personal benefit” standard in an insider trading conviction. In Salman, the defendant, Bassam Salman, was found to have traded on

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The Supreme Court had rejected the government’s petition for review in

Newman just a few months

prior to agreeing to hear

Salman, despite the

government’s citation in the Newman petition to the circuit split created by Salman.

had received the information from his own brother, an investment banker. The Ninth Circuit held that the close family relationship between the brothers meant that the tipper provided the tippee with a sufficient personal benefit to establish insider trading, relying on the Supreme Court’s 1983 decision in Dirks v. SEC, which held that the “elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.”

Salman argues that a close family relationship is insufficient and that the Court should rule in accordance with the Second Circuit’s decision in United States v. Newman, which read Dirks

to require “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” The Supreme Court had rejected the government’s petition for review in Newman just a few months prior to agreeing to hear

Salman, despite the government’s citation in the Newman petition to the circuit split created

by Salman. The author of the Ninth Circuit’s unanimous opinion was Judge Jed Rakoff of the

U.S. District Court for the Southern District of New York. Although Judge Rakoff normally sits as a district judge in Manhattan, and therefore is bound by the Second Circuit’s rulings, including Newman, in Salman he was serving as a visiting judge on the Ninth Circuit. As a result, he was not bound by the Second Circuit’s reading of Dirks. The Court will hear oral arguments in Salman during its next term.

RECENT SEC STAFF CHANGES

■ On January 11, 2016, the SEC announced that Julie M. Riewe, Co-Chief of the Enforcement

Division’s Asset Management Unit, would leave the SEC in February. Riewe had been promoted to assistant director in the newly formed Asset Management Unit in 2010 and was appointed Co-Deputy Chief of the unit in 2012 and Co-Chief in 2013. Co-Chief Marshall Sprung will continue to lead the unit following Riewe’s departure.

■ On January 20, 2016, the SEC announced that Susan Nash, Associate Director in the

Division of Investment Management, would leave the agency at the end of January. Nash had been a key architect of disclosure policy for mutual funds and other investment companies and had led the division’s oversight of variable annuity and variable life insurance products.

■ On February 3, 2016, the SEC announced that Jane Jarcho has been named Deputy

Director of the Office of Compliance Inspections and Examinations (OCIE). Jarcho had been the National Director of OCIE’s Investment Adviser/Investment Company

examination program since 2013 and will continue in that role.

■ On February 9, 2016, the SEC announced that C. Dabney O’Riordan and Alka Patel had

been named Associate Directors for Enforcement in the Los Angeles Regional Office. In their new roles, they will oversee the Los Angeles office’s enforcement efforts in Southern California, Arizona, Nevada and Hawaii.

■ On February 17, 2016, the SEC announced that Daniel S. Kahl had been named

Chief Counsel of OCIE. In this role, Kahl will oversee a staff of 15 lawyers and advise OCIE’s leadership on legal, technical and policy matters regarding the agency’s National Exam Program.

■ On March 8, 2016, the SEC announced that Peter B. Driscoll had been named to lead the

newly created Office of Risk and Strategy within OCIE. The new office will consolidate and streamline OCIE’s risk assessment, market surveillance and quantitative analysis teams and provide operational risk management and organizational strategy for OCIE. Driscoll’s title at the new office will be Chief Risk and Strategy Officer.

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■ On March 8, 2016, the SEC announced that Robert M. Fisher had been named Managing

Executive of OCIE. In this role, Fisher will be responsible for overseeing OCIE’s business operations, technology services, examiner training and Tips, Complaints and Referrals programs. Fisher succeeded Peter B. Driscoll, who became Chief Risk and Strategy Officer for OCIE.

■ On March 10, 2016, the SEC announced that Anthony S. Kelly had been named Co-Chief

of the Enforcement Division’s Asset Management Unit, which focuses on misconduct by investment advisers, investment companies and private funds. Kelly joined Marshall Sprung as Co-Chief of the unit and succeeded Julie Riewe, who left the agency in February.

■ On March 21, 2016, the SEC announced that Keith E. Cassidy had been named Director of

the Office of Legislative and Intergovernmental Affairs. Cassidy succeeded Tim Henseler, who was named Office Chief in the Division of Corporation Finance’s Office of

Enforcement Liaison.

FCPA FOCUS

The FCPA continues to be a high enforcement priority of the SEC. Here are some highlights of FCPA enforcement from the past quarter. For more information on the FCPA, please see Sidley’s Anti-Corruption Quarterly.

January 6, 2016

Ensco plc, a UK-based oil and gas services company, told the SEC that its customer,

Petrobas, had cancelled a contract for a DS-5 drillship. The SEC filing indicates that Petrobas believed the services contract for the DS-5 drillship was void, potentially as a result of alleged payment irregularities involving a former third-party marketing consultant. February 1, 2016

SAP SE, a software manufacturer, settled allegations by the SEC that it paid $145,000 in bribes to a senior Panama official in exchange for sales contracts in violation of the internal controls and books and records provisions of the FCPA. SAP agreed to disgorge $3.7 million in profits and pay $188,896 in prejudgment interest to settle the charges.

February 4, 2016

U.S.-based SciCline Pharmaceuticals agreed to pay $12.8 million—comprising $2.5 million in penalties, $9.426 million in disgorgement of profits and $900,000 in prejudgment interest— to settle charges with the SEC. The SEC alleged that SciCline’s employees in China had inflated sales by making improper payments, in the form of money, gifts, trips and golf games, to employees of state health institutions in violation of the anti-bribery, books and records and internal control provisions of the FCPA.

February 4, 2016

The CEO of LAN Airlines paid a $75,000 penalty to settle charges with the SEC that he violated the FCPA’s internal controls and books and records provisions. The SEC alleged that the CEO had authorized $1.15 million in improper payments to a third-party consultant in relation to LAN’s attempt to settle labor disputes between one of its subsidiaries and its employees.

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February 16, 2016

Two Chinese subsidiaries of PTC Inc., a Massachusetts-based software company, entered into a non-prosecution agreement with the Department of Justice (DOJ) and paid a $14.5 million criminal penalty to resolve an investigation into payments for recreational travel by Chinese government officials. The travel was supposed to be for training at PTC Inc.’s headquarters in Massachusetts but was primarily recreational travel to other parts of the United States. PTC Inc. also reached a civil settlement with the SEC that required the parent company to disgorge $11.8 million in profits.

In connection with the same investigation, in the agency’s first-ever deferred prosecution agreement (DPA) with an individual in an FCPA case, the SEC settled with Yu Kai Yuan, a former employee at one of PTC’s Chinese subsidiaries. The SEC deferred Yuan’s civil charges as a result of the “significant cooperation he provided during the SEC’s investigation.” According to the SEC, Yuan caused PTC Inc. to violate the books and records and internal control provisions of the FCPA.

February 19, 2016

The Illinois-based snack food company Mondelˉez International, Inc. disclosed that the company had received a Wells notice from the SEC recommending an enforcement action against the company for violations of the books and records and internal controls provisions of the FCPA in connection with operations in India and a factory it bought from Cadbury there. Kraft Foods, Inc. acquired Cadbury in 2010 and in 2012 changed its name to Mondelˉez after spinning off Kraft’s North American grocery business.

February 22, 2016

HSBC Holdings disclosed that the SEC is investigating “multiple financial institutions, including HSBC, in relation to hiring practices of candidates referred by or related to government officials or employees of state-owned enterprises in Asia-Pacific.” HSBC said that the company cannot predict “the resolution of this matter, including the timing or any possible impact on HSBC, which could be significant.”

March 1, 2016

Pennsylvania-based Olympic Corporation of the Americas, a wholly owned subsidiary of Olympus Corporation based in Tokyo, Japan, announced that the company, through its Latin American subsidiary Olympus Latin America, resolved an FCPA investigation with the DOJ in a DPA requiring the company to pay $22.8 million and retain a compliance monitor for three years. According to the DPA, Olympus Latin America provided “cash, money transfers, personal or non-Olympus medical education travel, free or heavily discounted equipment, and other things of value” to doctors working at government hospitals and clinics in Brazil, Bolivia, Chile, Columbia, Argentina, Mexico and Costa Rica between 2006 to 2011.

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AND REGULATORY PRACTICE OF SIDLEY AUSTIN LLP

Sidley’s Securities & Derivatives Enforcement and Regulatory group advises and defends clients in a wide range of securities- and derivatives-related matters. With more than 150 lawyers in 10 offices worldwide, we provide comprehensive regulatory, enforcement and litigation solutions in matters involving the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Financial Industry Regulatory Authority (FINRA), self-regulatory organizations (SROs), state attorneys general and state securities regulators. Our team is distinctive in that it combines the strength of nationally recognized enforcement lawyers with the skills of equally prominent counseling lawyers. We work collaboratively to provide our clients with informed, efficient and effective representation. Our team features many prominent practitioners and former officials from the SEC, FINRA and CFTC, as well as state regulators. Our lawyers include a former associate director of the SEC’s Division of Enforcement, a former co-head of enforcement and associate regional director of the SEC’s Northeast Regional Office, a former deputy director of the SEC’s Division of Trading and Markets, a former SEC senior trial counsel, the former head of enforcement for FINRA and the former chief of the Massachusetts Securities Division. We also understand the “inside” perspective, as our team includes former general counsels of Charles Schwab and UBS Financial (Paine Webber).

Effective representation of our clients has earned us acknowledgement in numerous industry publications, including Chambers USA, which, in 2015, ranked us among the best U.S. law firms for Securities Regulation. In a recent edition, the publication noted that our practice is “highly respected in the securities regulation space, with market-leading practitioners in enforcement defense and a strong advisory capability.” Sources told Chambers that the firm has “a very strong market regulation practice with trading and markets expertise.” Sidley was also named the 2011 U.S. News –Best Lawyers®_{“Law Firm of the Year” for Securities Regulation.}

CONTACTS Paul V. Gerlach Senior Counsel +1 202 736 8582 [email protected] Barry W. Rashkover Partner +1 212 839 5850 [email protected] Neal E. Sullivan Partner +1 202 736 8471 [email protected]