The Investment Lawyer Covering Legal and Regulatory Issues of Asset Management

VOL. 27, NO. 7 • JULY 2020

White Collar Enforcement During the Coronavirus Crisis By Adam S. Hoffinger, Douglas I. Koff, Gary Stein, Peter H. White, Craig S. Warkol, Noah N. Gillespie, and Amanda C. Wichot

he COVID-19 pandemic has caused the “to prioritize the detection, investigation, and pros- dislocation of the world’s financial markets. ecution of all criminal conduct related to the cur- Equity markets in the United States have been rent pandemic,” considering it “essential that the T 2 incredibly volatile and at one point, had lost more Department of Justice remain vigilant.” In this than 30 percent of their value. Local and national regard, the government likely will employ a variety policies in response to the pandemic are changing of statutes and theories to prosecute abuses in the constantly, with dramatic impacts on businesses of securities markets and everywhere else that scams all sizes. At the moment, no one knows what the and schemes emerge. total impact will be or when the situation will start Insider Trading to turn around for the better. Historically, the Securities Exchange After the 2008 financial crisis, the government Commission (SEC) and the Department of Justice closely examined trading activity and aggressively (DOJ) have become very active in the aftermath pursued conduct it suspected to be insider trading. of severe market dislocations, both to enforce The DOJ instituted the most wide-ranging series of existing law and to make examples out of those insider trading prosecutions in history after the 2008 who—at least in the government’s eyes—took financial crisis to hold many companies, and impor- unfair advantage of the chaos. Following the 2008 tantly, individuals accountable. In these matters, the financial crisis, for example, the SEC instituted government sought ill-gotten gains, penalties and to proceedings against more than 200 entities and impose significant prison sentences.3 individuals, including 93 CEOs, CFOs and other In response to the current crisis, the co-direc- senior corporate officials, collecting nearly $4 bil- tors of the SEC Division of Enforcement warned lion in penalties, disgorgement, and other mon- that “a greater number of people may have access to etary relief.1 material nonpublic information than in less chal- The market volatility we are experiencing now lenging times,” increasing the potential for insider during the coronavirus crisis very likely will cause trading.4 the government to initiate numerous investigations. Four aspects of insider trading law will be key to The Attorney General has directed all US Attorneys the coming investigations. 2 THE INVESTMENT LAWYER

1. The government is likely to rely on Rule 10b5-1. 4. As in Blaszczak, the government will likely use 18 Generally, for a transaction to constitute insider U.S.C. § 1348, a criminal statute created by the trading under Rule 10b5-1, the person must Sarbanes-Oxley Act of 2002, as a further tool in make the trade “on the basis of” material non- pursuing downstream tippees and others who trade public information. Rule 10b5-1 defines this on material nonpublic information. This statute phrase to include merely being “aware” of mate- criminalizes a wide range of fraudulent practices rial nonpublic information at the time of the connected with securities and commodities. trade, even if the information was not the only Importantly, unlike Section 10(b), the Second reason for the trade. Although there is a circuit Circuit held in Blaszczak that Section 1348 split as to whether the Rule applies to insider does not require any showing that the tipper trading prosecutions,5 the language of this Rule received a “personal benefit” from passing along allows the SEC, at the very least, to bring a civil the information for criminal liability to attach.10 action against any person or firm who traded Thus, while this statute only applies to trad- while in possession of material nonpublic infor- ing in registered securities, which is a narrower mation, regardless of any separate motivation focus than Section 10(b), prosecution under they may have had for their trades.6 Section 1348 may relieve the government of 2. The government will thoroughly pursue down- proving one of the typical elements of insider stream tipping. Under Section 10(b) and Rule trading.11 10b-5, the source and the ultimate recipient of material nonpublic information can be liable as Disclosure “tipper” and “tippee” assuming the appropriate elements are met. Liability attaches where the With conditions changing so rapidly, the gov- tipper breached a duty of trust or confidentiality ernment likely will scrutinize the accuracy of oral in divulging the information and received a “per- and written statements at the time they were made. sonal benefit” for doing so.7 Given how quickly The SEC has identified disclosure as a major area of new, material information is developing in the focus for 2020.12 SEC Chairman Jay Clayton recently current volatile market, the government can be advised companies to “provide investors with insight expected to scrutinize closely whether informa- regarding their assessment of, and plans for address- tion that ultimately results in well-timed trades ing, material risks to their business and operations emanates from persons who owe a duty of trust resulting from the coronavirus.”13 Information about or confidentiality. how the pandemic is affecting a company’s opera- 3. The government may return to investigating mate- tions, cash flow, asset values and customer behav- rial nonpublic information flowing through expert ior is likely of key interest to the investing public. networks. Of particular note here is the use of The government will pay careful attention to the political intelligence, which requires exceptional ultimate accuracy of the financial information itself diligence and care to ensure that any informa- as well as any statements about how the company tion one possesses relevant to a trade was prop- plans to respond to the pandemic and its goals going erly obtained.8 In fact, in the prosecution that led forward. to the Second Circuit’s recent decision in United Compliance with generally accepted accounting States v. Blaszczak, it was governmental infor- practices (GAAP) has always been an area of focus mation regarding proposed healthcare rules and for the SEC. But these investigations are not just reimbursement rates that was held to constitute limited to whether the financial statements comport material nonpublic information.9 with GAAP, but whether what the company says about VOL. 27, NO. 7 • JULY 2020 3 its compliance with GAAP is accurate. In the cur- who were simply reacting to the volatility and trying rent crisis, issuers need to analyze the extent of the to do what they could to generate some liquidity or impacts of coronavirus on their supply chain, com- profit for themselves. munication and other internal controls to determine Schemes how the crisis affects their ability to apply GAAP. Although, as a general rule, companies are sup- In times of stress, existing Ponzi schemes and posed to avoid burying the public in an avalanche pyramid schemes often unravel as they can no of trivial detail,14 a duty to disclose may arise when longer support their regular payment obligations. previous statements are no longer accurate or may Infamously, Bernard Madoff’s Ponzi scheme col- have been rendered misleading in light of later devel- lapsed during the financial crisis. Already this Spring, opments, necessitating the issuance of an updated, the SEC and DOJ put an end to a Ponzi scheme correct statement.15 Maintaining this balance will allegedly perpetrated by a Pennsylvania lawyer.18 be especially important, and subject to government By the same token, however, many fraudulent review, during this time. schemes are only getting started during the crisis, Another likely pitfall in this fast-changing taking advantage of people and companies who are environment is selective disclosure, where updates increasingly desperate for promises of cash or invest- reach some parties sooner than the market at large. ments that appear stronger than the volatile stock Regulation Fair Disclosure (Reg FD) generally market. requires public companies to disclose material non- As more businesses struggle for liquidity to con- public information to the public at the same time as tinue or salvage their operations, they may fail to pro- or before disclosing the information selectively, such vide accurate financial information when they apply as to analysts, institutional shareholders or other for financing or other liquidity, and fall subject to securities industry professionals. Principals, officers government enforcement for bank fraud. The same and directors fielding requests for up-to-date infor- challenge of keeping financial information accurate mation must therefore be especially careful to speak can also lead to accounting fraud or tax fraud issues accurately and keep the public properly informed.16 when the mismatch between the financial statements Market Manipulation and reality is revealed. Scams The government has a strong interest in maintaining the integrity of the markets and policing any Scams emerging during the coronavirus crisis— conduct that alters prices or that creates some false and the government’s desire to shut them down and appearance of supply, volume or demand to some- punish those responsible—are not limited to the one’s unfair advantage. For example, the govern- financial markets.19 ment frequently uses this theory to prosecute “pump Price gouging emerged as a major phenomenon and dump” schemes in which sellers go to extensive as the coronavirus appeared in the United States, as efforts to advertise a particular stock while acquiring prices for high-demand items reached multiples of it cheaply, only to rapidly sell off their stores when their normal rates on online shopping platforms. the price swings upwards. Although many platforms have taken action to cut The SEC already has suspended trading for two down on these listings, the issue is likely far from issuers and continues to monitor the market closely.17 resolved. In response, President Trump recently The government may investigate trading practices it signed an Executive Order and the Attorney General believes unfairly take advantage of volatility, which announced an initiative to tackle price gouging and could sweep in a wide swath of market participants hoarding of medical supplies.20 Nonetheless, as

Copyright © 2020 by CCH Incorporated. All Rights Reserved. 4 THE INVESTMENT LAWYER the shelves of local stores increasingly lay bare and themselves, even from their families, in the hopes health authorities advise minimizing contact with of preserving their health. These scams have count- others, online shopping platforms may face antitrust less incarnations and will be vigorously prosecuted enforcement inquiries if they misuse their market under elder law statutes as well as the highly flexible power or conspire with the gouging sellers. wire fraud and mail fraud criminal statutes. The Antitrust Division, which already had been In the midst of the high demand for healthcare very active in the financial services arena,21 is get- and the possible overwhelming of our healthcare ting ready to handle this expected influx of cases. In system in many parts of the country, regulators will late February, it requested funding to hire 55 addi- be vigilant about investigating state and federal pro- tional attorneys for fiscal year 2021.22 The Attorney gram fraud, including Medicare and Medicaid, false General has asked the public to be on the lookout insurance claims and other false claims as people take for coronavirus fraud and set priorities for antitrust advantage of the chaos. If the government itself takes enforcement.23 on an increased role as a provider of health services On online platforms and elsewhere, counter- or supplies, there will likely be an increase in signifi- feit goods are increasingly entering the marketplace, cant False Claim Act lawsuits, with a corresponding seeking to profit by meeting the extreme demand for uptick in intervention by the DOJ. particular items even when the product itself does Moreover, if the President activates any author- not meet the stated specifications. This is particu- ity under the Defense Production Act, that will cre- larly concerning when it comes to protective mea- ate entirely new avenues for enforcement, as that sures the public is relying on to stem the pandemic, statute criminalizes willful violations of the Act.27 like masks for health professionals and hand sani- The government may seek to apply these provisions tizer. Alarmingly, purported coronavirus cures are on broadly to ensure that no one defrauds the govern- sale, none of which have received approval; some of ment or the public in ways that hamper the purpose these may well be unsafe to take, and all are unsafe of the President’s orders. to the extent they do nothing to limit the spread of Finally, as employees—including officers, the virus. The US Attorney’s Office for the Western directors and other senior officials—begin to District of Texas acted quickly, obtaining an injunc- believe their enterprises are failing, some may trans- tion to shut down a website promising a vaccine in fer assets to themselves in the hopes of getting paid exchange for credit card information to cover pur- before the business goes bust. These transfers may ported shipping charges.24 be criminally prosecuted under statutes prohibit- There already has been a marked increase in ing embezzlement, bankruptcy fraud, wire fraud cybercrime, involving fake maps of the spread of and mail fraud. This same conduct may also result the virus, malicious links purporting to provide in civil liability, regulatory enforcement, and addi- important public safety announcements and phish- tional penalties in a bankruptcy or liquidation con- ing attempts hoping to take advantage of workforces text (for example, fraudulent conveyances, transfers continuing their daily tasks from home.25 There and preferences). will be significant prosecution activity under the Given all of this activity, caution is clearly war- Computer Fraud and Abuse Act and other statutes ranted for everyone to remain vigilant for potential for this conduct.26 scams. To the extent the government manages to Several scams target older individuals and recover ill-gotten gains, however, the government those who care for them, taking advantage of their often seeks to return those funds to victims as well as fear of the coronavirus’s more severe impact on the whistleblowers who assist the government in detect- elderly and the fact that older persons are isolating ing and rooting out illegal behavior. VOL. 27, NO. 7 • JULY 2020 4

In the wake of the current crisis, a heavy wave 5 Compare United States v. Rajaratnam, No. 11-4416- of enforcement is likely on the way. Many will be CR, 2013 U.S. App. LEXIS 12885, at *4-6 (2d Cir. subject to investigation for their conduct during the June 24, 2013) (following Rule 10b5-1 to hold that coronavirus crisis, both intentional and acciden- “knowing possession” is sufficient but noting that tal wrongdoers. In this regard, history tells us that the jury instructions at issue contained a component the SEC, DOJ and other agencies will seek to make that required the “use” of the material nonpublic examples out of those they perceive crossed a line, information), with United States v. Jun Ying, No. especially during a public health emergency and 1:18-cr-74-AT, 2018 WL 6322308, at *5 (noting the unprecedented global pandemic. Eleventh Circuit does not follow Rule 10b5-1 in civil or criminal actions but instead requires “use” of the material nonpublic information). Mr. Hoffinger, Mr. Koff, Mr. Stein, Mr. 6 For more information, see Gary Stein and Martin L. White, and Mr. Warkol are partners, and Mr. Perschetz, Chapter 5, “Scienter and Trading ‘On the Gillespie and Ms. Wichot are associates, at Basis Of,’” in Answer Book, supra n.4. Schulte Roth & Zabel LLP. 7 For more information, see Howard Schiffman, Chapter 10, “Tipper and Tippee Liability,” in Answer NOTES Book, supra n.4; see also, “Second Circuit, in Split 1 SEC, “Enforcement Actions Addressing Misconduct Decision, Overrules Limitation on Insider Trading that Led to or Arose From the Financial Crisis” (Oct. Liability Established in U.S. v. Newman,” SRZ Alert. 7, 2016), available at sec.gov/spotlight/enfo-actions-fc. 8 “Enforcement Update: Insider Trading and COVID- shtmal. 19 Political Intelligence,” SRZ Alert. 2 Att’y Gen. William Barr, Memo to all US Attorneys, 9 United States v. Blaszczak, 947 F.3d 19, 26-29 (2d “COVID-19—Department of Justice Priorities” Cir. 2019). (March 16, 2020), available at justice.gov/ag/page/ 10 Id. at 35. file/1258676/download. 11 “Insider Trading Law in Flux—What Advisers Need 3 The SEC pursued 528 actions against 1,093 indi- to Know,” SRZ Alert. viduals and entities for insider trading during the 12 Chairman Jay Clayton, SEC, “Proposed Amendments period 2008-2018. During that same period, the to Modernize and Enhance Financial Disclosures; US Attorney for the Southern District of New York Other Ongoing Disclosure Modernization Initiatives; alone secured the conviction, by trial or guilty plea, Impact of the Coronavirus; Environmental and of 105 defendants in insider trading cases. Taleah Climate-Related Disclosure” (Jan. 30, 2020), E. Jennings, “Penalties, Short-Swing Profits, and available at sec.gov/news/public-statement/clayton- Whistleblower Awards at 21-3,” in Harry S. Davis, mda-2020-01-30; see also SEC Office of Compliance ed., Insider Trading Law and Compliance Answer Inspections and Examinations, “2020 Examination Book (Practising Law Institute 2020). Priorities,” available at sec/gov/about/offices/ocie/ 4 Stephanie Avakian & Steven Peikin, SEC, “Statement national-examination-program-priorities-2020.pdf. Regarding Market Integrity” (Mach 23, 2020), 13 Press Release, SEC, “SEC Provides Conditional available at sec.gov/news/public-statement/statement- Regulatory Relief and Assistance for Companies enforcement-co-directors-market-integrity. For more Affected by the Coronavirus Disease 2019” (COVID- detail on this nuanced area of the law, see Harry S. 19) (March 4, 2020), available at https://www.sec. Davis, ed., Insider Trading Law and Compliance gov/news/press-release/2020-53; see also SEC Division Answer Book (Practising Law Institute 2020) of Corporate Finance, “Coronavirus (COVID- (Answer Book). 19) Disclosure Guidance” (March 25, 2020)

(highlighting several areas to consider in formulating 21 For example, Deputy Ass’t Att’y Gen. Richard A. appropriate disclosure during the pandemic). Powers, “Remarks on the State of Criminal Antitrust 14 Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988) Enforcement in 2020” (Miami, Fl. Feb. 7, 2020), (quoting TSC Indus., Inc. v. Northway, Inc., 426 available at https://www.justice.gov/opa/speech/deputy- U.S. 438, 448-449 (1976)). assistant-attorney-general-richard-powers-delivers- 15 See Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. remarks-state-criminal (highlighting several recent 27, 38 (2011) (an omission becomes “material” if a prosecutions directed at “combatting collusion in reasonable investor would find the omitted fact would global financial markets”). have altered the “total mix” of information avail- 22 DOJ Antitrust Division, “FY 2021 Budget Request able); Gallagher v. Abbott Labs., 269 F.3d 806, 807- at a Glance,” available at https://www.justice.gov/doj/ 810 (7th Cir. 2001) (finding no duty to correct and page/file/1246781/download. requiring positive law to impose the duty to disclose). 23 Press Release, DOJ, “Attorney General William P. 16 For more information, see Douglas I. Koff, Chapter Barr Urges American Public to Report COVID-19 11, “Regulation Fair Disclosure,” in Answer Book, Fraud (March 20, 2020), available at https://www. supra n.4. justice.gov/opa/pr/attorney-general-william-p-barr- 17 SEC, “Coronavirus (COVID-19) Response” (last urges-american-public-report-covid-19-fraud; DOJ updated March 24, 2020), available at https://www. Antitrust Division & FTC Bureau of Competition, sec.gov/sec-coronavirus-covid-19-response. Joint Antitrust Statement Regarding COVID-19” 18 Press Release, DOJ, “Pennsylvania Attorney Indicted (March 2020), available at https://www.justice.gov/atr/ for Role in $2.7 Million Ponzi Scheme” (March 24, joint-antitrust-statement-regarding-covid-19. 2020), available at https://www.justice.gov/opa/pr/penn- 24 Press Release, DOJ, “Justice Department Files Its sylvania-attorney-indicted-role-27-million-ponzi-scheme. First Enforcement Action Against COVID-19 19 DOJ’s initial analysis of the pandemic goes so far Fraud” (March 22, 2020), available at https://www. as to consider charging persons who intention- justice.gov/opa/pr/justice-department-files-its-first- ally spread the virus with terrorism. Deputy Att’y enforcement-action-against-covid-19-fraud. Gen. Jeffrey Rosen, Memo, “Department of Justice 25 “Homeland Security Warns of Coronavirus-Related Enforcement Actions Related to COVID-19” Cybersecurity Risks—Considerations for Private (March 24, 2020), available at https://www.politico. Fund Managers; Broker-Dealers: B-D Guidance on com/f/?id=00000171-128a-d911-aff1-becb9b530000. Increased Cybersecurity Risks Due to the COVID- 20 Makini Brice & Sarah N. Lynch, “U.S. launches 19 Pandemic,” SRZ Alerts. probes as Trump bans hoarding, price goug- 26 For example, “Different Strokes: Interpreting ing to combat coronavirus,” Reuters (March 23, Computer Fraud and Abuse Act,” New York Law 2020), available at https://www.reuters.com/article/ Journal. us-health-coronavirus-usa-order/u-s-launches-probes- 27 50 U.S.C. § 4513 (the willful performance of a pro- as-trump-bans-hoarding-price-gouging-to-combat- hibited act or failure to perform a required act is pun- coronavirus-idUSKBN21A3Q8. ishable by a fine of $10,000, a year in prison, or both).

Copyright © 2020 CCH Incorporated. All Rights Reserved. Reprinted from The Investment Lawyer, July 2020, Volume 27, Number 7, pages 12–17, with permission from Wolters Kluwer, New York, NY, 1-800-638-8437, www.WoltersKluwerLR.com