Financial Fraud Law Report

An A.S. Pratt & Sons Publication May 2013

Headnote: A Look Back Steven A. Meyerowitz The Past Year’s Top SEC Enforcement Events Andrew N. Vollmer, Douglas J. Davison, and Heather Mowell The FCPA in Review — Part II: Release of the Government’s Guidance Caps a Year of Disparate Developments Paul R. Berger, Sean Hecker, Andrew M. Levine, Bruce E. Yannett, Samantha J. Rowe, and Amanda M. Bartlett Fourth Circuit Applies the Wartime Suspension of Limitations Act to the Civil False Claims Act Douglas W. Baruch, Jennifer M. Wollenberg, and Kayla Stachniak Kaplan Motion to Dismiss Raising Matter of First Impression in Fcpa Context Denied in S.D.N.Y. Madeleine Moise Cassetta Ruling Dramatically Expands Scope of Whistleblower Protections Under Sarbanes-Oxley Mark D. Pollack and Christian M. Auty Signs of Spring at the U.K.’s Serious Fraud Office: Challenges, Changes, and the Impact on Global Anti-Corruption Compliance John Cunningham and Geoff Martin U.S. Federal Reserve Board Proposes Major Changes in How the U.S. Operations of Foreign Banks and Their Subsidiaries Are Supervised David L. Ansell and Gordon L. Miller Dodd-Frank Wall Street Reform and Consumer Protection Act Update David A. Elliott, Rachel Blackmon Cash, and S. Kristen Peters Editor-in-chief Steven A. Meyerowitz President, Meyerowitz Communications Inc.

Board of Editors Frank W. Abagnale William J. Kelleher III Sareena Malik Sawhney Author, Lecturer, and Consultant Corporate Counsel Director Abagnale and Associates People’s United Bank Marks Paneth & Shron LLP

Stephen L. Ascher James M. Keneally Mara V.J. Senn Partner Partner Partner Jenner & Block LLP Kelley Drye & Warren LLP Arnold & Porter LLP

Thomas C. Bogle Richard H. Kravitz John R. Snyder Partner Founding Director Partner Dechert LLP Center for Socially Bingham McCutchen LLP Responsible Accounting David J. Cook Jennifer Taylor Partner Frank C. Razzano Partner Cook Collection Attorneys Partner McDermott Will & Emery LLP Pepper Hamilton LLP David A. Elliott Bruce E. Yannett Partner Partner Burr & Forman LLP Debevoise & Plimpton LLP

The Financial Fraud Law Report is published 10 times per year by A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207, Copyright © 2013 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this journal may be reproduced in any form — by microfilm, xerography, or otherwise — or incorporated into any information retrieval system without the written permission of the copyright owner. For permission to photocopy or use material electronically from the Financial Fraud Law Report, please access www. copyright.com or contact the Copyright Clearance Center, Inc. (CCC), 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400. CCC is a not-for-profit organization that provides licenses and registration for a variety of users. For subscription information and customer service, call 1-800-572-2797. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Meyerowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, [email protected], 631.331.3908 (phone) / 631.331.3664 (fax). Material for publication is welcomed — articles, decisions, or other items of interest. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affiliated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher. POSTMASTER: Send address changes to the Financial Fraud Law Report, A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207. ISSN 1936-5586 The Past Year’s Top SEC Enforcement Events

Andrew N. Vollmer, Douglas J. Davison, and Heather Mowell

The authors examine the most significant enforcement events brought by the U.S. Securities and Exchange Commission’s Division of Enforcement during the past year.

he past year was an eventful one for the Division of Enforcement at the U.S. Securities and Exchange Commission (“SEC”). This article Treviews the top SEC Enforcement events of 2012.1 Enforcement Trends in FY 2012 The SEC Division of Enforcement filed 734 enforcement actions in fiscal year 2012, one shy of the 735 actions filed in fiscal year 2011.2 Approxi- mately 20 percent of the actions were filed in investigations that the SEC designated as National Priority Cases, meaning that the SEC had classified these matters as the most important and complex.3 Among the actions filed, 134 related to broker dealers, an area that has seen increased activity over the

Andrew N. Vollmer is a partner in the Securities Department of Wilmer Cutler Pickering Hale and Dorr LLP and a member of the firm’s Securities Litigation and Enforcement Practice Group. Douglas Davison is a vice chair of the firm’s Securi- ties Department, a member of the Securities Litigation and Enforcement Prac- tice Group and the Dodd-Frank Whistleblower Working Group and vice chair of the Consumer Financial Protection Bureau Working Group. Heather Mowell is a member of the firm’s Securities Litigation and Enforcement Practice Group. The authors can be reached at [email protected], douglas.davi- [email protected], and [email protected], respectively.

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past three fiscal years with a 60-percent increase between FY 2010 and FY 2011 (an increase from 70 to 112 actions), and a 19-percent increase from FY 2011 to FY 2012 (an increase from 112 to 134 actions).4 in addition, the SEC continued to focus on delinquent filings (127 actions) and insider trading (58 actions).5 When combining the 58 insider trading actions filed in FY 2012 with those filed in FY 2011 (57) and FY 2010 (53), this period represents the highest number of insider trading actions filed by the SEC within any three consecutive years.6 In contrast, actions related to securities offerings experienced a marked decline of almost 40 percent from FY 2011(decreasing from 124 to 89 actions).7

SEC Litigation Challenges In 2012, the SEC failed to secure a favorable outcome in three cases litigated against individuals. In its case against Brian Stoker, the SEC alleged that Mr. Stoker, a former mid-level Citigroup executive, violated securities laws by failing to inform investors that the bank had selected poor-perform- ing assets for a CDO and that Citigroup was shorting the same assets.8 In July 2012, a federal jury found in favor of Mr. Stoker, while noting that the “verdict should not deter the SEC from continuing to investigate the financial industry… .”9 Shortly thereafter, in November 2012, the SEC dismissed with prejudice its suit against Edward Steffelin, a former executive of GSC Capital Corpora- tion.10 Similar to the claims alleged against Mr. Stoker, the SEC claimed that Mr. Steffelin failed to inform investors through marketing materials that the hedge fund that helped select assets underlying a CDO had also shorted a substantial portion of the assets.11 Finally, in November 2012, a federal jury found in favor of Bruce Bent Sr. and Bruce Bent II, both managers of the Reserve Management Fund, on all claims of civil fraud.12 The SEC had accused the Bents of lying to investors and fund trustees in attempts to stop a run on the Reserve Fund after the September 2008 bankruptcy of Lehman Brothers.13 Despite finding in favor of the Bents on the civil fraud charges, the jury found Bruce Bent II liable for negligently violating Section 17(a)(2) or (3) of the Securities Act. Following these three cases, the SEC’s ability to litigate against individu-

388 The Past Year’s Top SEC Enforcement Events als came under fire. In particular, John Coffee critiqued the SEC’s regular practice of not suing individuals at large financial institutions, the SEC’s fre- quent losses litigating against individuals when the agency breaks free of its regular practice, and the declining settlement values with institutions and defendants.14 Coffee’s proposed solution was for the SEC to retain private counsel on a contingent-fee basis for large cases that involve complex institu- tional structures and multiple actors. The SEC’s Robert Khuzami and George Canellos disagreed with Cof- fee’s assessment of the SEC’s enforcement division and the proposed rem- edy.15 In a January 2013 article, Khuzami and Canellos asserted that Coffee inaccurately stated the median SEC settlement amount, was incorrect that the SEC rarely brought cases against individuals, and mistakenly focused on cases that did not represent the SEC’s litigation success. In support of the latter two points, the article noted that the SEC did not charge individual defendants in only eight cases related to the financial crisis, and that the SEC had won its case against 23 out of 24 defendants who went to trial in FY 2012.16

Appellate Court Decisions Affecting SEC Enforcement: SEC v. Apuzzo & SEC v. Bartek Two notable 2012 decisions came from the Courts of Appeals for the Second and Fifth Circuits. In SEC v. Apuzzo, the Second Circuit clarified that to prove one of the requisite elements of aiding and abetting liability — that the defendant “substantially assisted” the violation — the SEC does not need to allege that a defendant proximately or directly caused a securities law violation.17 Instead, in order to satisfy this element, the SEC must establish that the defendant associated himself with the venture, participated in it as something that he wished to bring about, and sought by his action to make it succeed.18 The Second Circuit held that the SEC had satisfied this burden by alleging that the defendant, Joseph Apuzzo, formerly the CFO of Terex Corp., was aware of and actively participated in the fraudulent accounting scheme orchestrated by the former CFO of United Rentals, Inc., one of Ter- ex’s customers.19 There are two key takeaways from Apuzzo.

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First, it is unclear whether the test applied by the Second Circuit — that an aider and abettor must consciously and actively assist in the specific violation — eases the SEC’s pleading standard for aiding and abetting claims. While some commentators have asserted that the court applied a more le- nient pleading standard, this may not be correct in light of the Second Cir- cuit’s application of the standard and discussion of the SEC’s allegations, which alleged a high degree of knowledge and active participation on the part of the defendant. Second, Apuzzo highlights the potential risks a third party doing business with a publicly reporting company faces, especially in light of the SEC only having to plead “recklessness” instead of “knowing” substantial assistance to another under Section 20(e) of the Securities and Exchange Act of 1934, as amended by Dodd-Frank. in SEC v. Bartek, the SEC sought remedial relief that included permanent injunctions, civil penalties, and officer and director bars against defendants accused of backdating stock options.20 The district court granted summary judgment for the defendants, holding that all of the remedies constituted “penalties” and were outside of the five-year statute of limitations provided by 28 U.S.C. § 2462. The Fifth Circuit affirmed, first finding that the discovery rule does not apply and that the limitations period begins to run on the date of violation.21 Second, the court held that the sought-after remedies were punitive in nature because they “would have a stigmatizing effect and long-lasting reper- cussions”, and failed to “address[] past harm allegedly caused by the Defen- dants [or]…address the prevention of future harm in light of the minimal likelihood of similar conduct in the future.”22 The Fifth Circuit affirmed the dismissal of the case because the claims were brought outside of the five-year period. The Bartek decision accurately captures the punitive nature of some injunctions in SEC enforcement cases and director and officer bars, and, going forward, may reasonably limit the SEC’s ability to seek such relief years after the alleged misconduct.

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Judicial Developments on Insider Trading: SEC v. Obus & US v. Contorinis In SEC v. Obus, the Second Circuit examined the scienter requirement as it applies to the tipper, the first-level tippee, and any subsequent tippee who either trades or further relays the information.23 regarding the tipper, the court held that scienter is part of the first three of the four required elements for insider trading: “(1) tip (2) material nonpublic information (3) in breach of a fiduciary duty of confidentiality owed to shareholders (classical theory) or the source of the information (misappro- priation theory) … .”24 regarding the first and second element, the tipper must deliberately tip and know, or be reckless in not knowing, that the tipped information is both non-public and material. The same scienter standard applies for the third element, in that the tipper must know, or be reckless in not knowing, that tipping the information violates a confidence.25 with respect to the first-level tippee, the person must know that the information is material and non-public and that by “trading on the information the tippee is a participant in the tippers’ breach of fiduciary duty.”26 In estab- lishing the requisite scienter for both elements, the Second Circuit attempted to square the “knows or should know” standard applied in Dirks v. SEC,27 which resembles a negligence standard, with Ernst & Ernst v. Hochfelder,28 which held that negligence does not satisfy the scienter requirement.29 To do this, the Second Circuit explained that the tippee must know or have a reason to know that the tipper breached a duty by providing the confidential information (applying Dirks’ negligence standard), and “intentionally or recklessly traded while in knowing possession of that information.”30 The same scienter standards apply to the final tippee. While Obus is helpful in that the court clarifies the application of scienter to the elements of tipper liability, applying the holding to tippee liability may prove difficult because of the different, yet intertwined, degrees of scienter. In U.S. v. Contorinis, the Second Circuit determined whether jury instructions provided in a criminal insider trading case accurately defined nonpublic information.31 In concluding that the instructions adequately con- veyed the standard, the court confirmed that information from insiders, even

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if that information is consistent with rumors or press reports, is material and nonpublic because the insider information is “sufficiently more reliable, and …alters the mix by confirming the rumor or reports.”32 in addition, the Second Circuit stressed that the key inquiry is whether the information is publicly available, a standard that is not necessarily the same as whether the information is widely disseminated. In the jury instructions, the district court explained how information could be publicly available without being widely disseminated: “Sometimes a corporation is willing to make information available to securities analysts, prospective investors, or members of the press who ask for it even though it may never have appeared in any newspaper publication or other publication. Such information would be public.”33 The court of appeals seemingly agreed with the instruction, explaining further that information “is also deemed public if it is known only by a few securities analysts or professional investors. This is so because their trading will set a share price incorporating such information.”34

SEC Whistleblower Program under Section 922 of the Dodd-Frank Wall Street Reform and Con- sumer Protection Act, the SEC is directed to make a monetary award where the SEC successfully brings an enforcement action imposing sanctions of over $1,000,000 as a result of an individual voluntarily providing original information.35 The awards, which are required to be 10-30 percent of the monetary sanctions collected, are paid from the SEC’s Investor Protection Fund. in November 2012, the SEC released the annual report on the Dodd- Frank whistleblower program, which covered the first full year of the program.36 In FY 2012, the SEC received 3,001 tips.37 The most common complaint categories reported by whistleblowers were corporate disclosures and financials (547 tips, 18.2 percent), offering fraud (465 tips, 15.5 percent), manipulation (457 tips, 15.2 percent), and insider trading (190 tips, 6.3 percent).38 Tips were received from residents of all 50 states, with the largest number coming from California (435 tips), New York (246 tips), and Florida (202 tips).39

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The SEC made its first award under the program in FY 2012.40 As a result of the whistleblower’s information, the SEC stopped an ongoing multi- million dollar fraud and obtained a judgment involving over $1 million in sanctions.41 At the end of the fiscal year, the SEC had collected $150,000 of the judgment, and provided the whistleblower with 30 percent of the amount collected, the maximum payment allowed.

SEC Cooperation Initiative In May 2011, the SEC entered into its first-ever deferred prosecution agreement (“DPA”) as part of its cooperation initiative. In July 2012, the SEC entered into its second DPA. The agreement was with the Amish Help- ing Fund (“AHF”), a nonprofit that offered and sold contracts to investors within the Amish community.42 according to the agreement, the offering memorandum for these investment contracts failed to reflect changes that had occurred since the inception of the fund in 1995, including the fund’s history, the fund’s cash reserves, the use of investor funds, and the ability of investors to redeem their invest- ments.43 The SEC entered into the DPA as a result of AHF’s immediate cooperation and the significant remedial measures it undertook after it became aware of its misconduct, including updating its offering memorandum.44 As of May 2011, no fund investors had realized any losses, and almost no investors accepted the AHF’s offer to rescind the contracts.45 in addition, the SEC declined to charge Credit Suisse and Morgan Stanley because of the entities’ cooperation with the SEC in two unrelated matters. in February 2012, the SEC charged four investment bankers and traders at Credit Suisse Group for engaging in a scheme to fraudulently overstate the prices of subprime bonds in 2007 and 2008.46 The press release stated that the SEC’s decision not to charge Credit Suisse was influenced by several factors, including: the isolated nature of the wrongdoing, Credit Suisse’s immediate self-reporting to the SEC and public disclosure of corrected financial results, Credit Suisse voluntarily terminating the four investment bankers and implementing enhanced internal controls to prevent a recurrence of the misconduct, and Credit Suisse providing the SEC timely access to witnesses and evidence.47

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in addition, in April 2012, the SEC announced that it was bringing a settled enforcement action against a Morgan Stanley employee who allegedly violated the Foreign Corrupt Practices Act, as well as other securities laws.48 The release indicated that the SEC would not charge Morgan Stanley because it “cooperated with the SEC’s inquiry and conducted a thorough internal investigation to determine the scope of the improper payments and other misconduct involved.”49

SEC and DOJ Release FCPA Guide in November 2012, the Enforcement Division of the SEC and the criminal division of the U.S. Department of Justice published the long-awaited Resource Guide to the U.S. Foreign Corrupt Practices Act.50 The Guide covers an expansive set of topics, including the scope and application of the FCPA’s anti-bribery and accounting provisions, distinctions between proper and improper gifts, travel and entertainment expenses, and hallmarks of ef- fective compliance programs. in addition, the Guide contains several hypotheticals used to illustrate FCPA jurisdiction, appropriate gifts, travel and entertainment expenditures, successor liability, and the due diligence required to properly vet consultants, distributors and local partners.

“Neither Admit Nor Deny” Settlements in January 2012, Director of Enforcement Khuzami announced that the SEC had modified its “neither admit nor deny” approach for cases involving criminal convictions or other circumstances where the defendant has admitted violations of the law.51 In such cases, the settlement agreement does not provide that the defendant “neither admits nor denies” the allegation, and instead, recites the facts and nature of the admission, criminal conviction, or criminal non-prosecution or deferred prosecution agreement.52 The SEC expects the change in policy to only affect a minority of cases that involve related admissions or criminal convictions.53 For 2012, the minority of cases affected by the policy change included the SEC’s suit against Goldman, Sachs & Co., where Goldman admitted to the factual findings in

394 The Past Year’s Top SEC Enforcement Events its consent order with the Massachusetts Securities Division regarding Gold- man’s trade huddles,54 and the SEC’s settlement with BP.

Notes 1 wilmerHale represented clients in some of the matters discussed in this article. 2 Year-by-Year SEC Enforcement Statistics, available at http://www.sec.gov/ news/newsroom/images/enfstats.pdf. 3 Fiscal Year 2012 Agency Finance Report, at 13 (Nov. 2012), available at http://www.sec.gov/about/secpar/secafr2012.pdf. 4 Year-by-Year SEC Enforcement Statistics, supra n. 2. 5 Id. 6 SEC Press Release 2012-227, SEC’s Enforcement Program Continues to Show Strong Results in Safeguarding Investors and Markets (Nov. 14, 2012), available at http://www.sec.gov/news/press/2012/2012-227.htm. 7 Year-by-Year SEC Enforcement Statistics, supra n. 2. 8 complaint, SEC v. Stoker, 1:11-cv-7388, Doc. No. 1 (S.D.N.Y. Oct. 19, 2011). 9 Id. Tr. of Proceedings held on July 31, 2012 at 11-12, Doc. No. 118 (Aug. 9, 2012). 10 Stipulation of Dismissal with Prejudice, SEC v. Steffelin, 1:11-cv-4204 (S.D.N.Y Nov. 16, 2012). 11 Id. Complaint, Doc. No. 1 (June 21, 2011). 12 Verdict Form, SEC v. Reserve Management Co., 1:09-cv-04346, Doc. No 571 (Nov. 12, 2012). 13 Id. Complaint, Doc. No. 1 (May 5, 2009). 14 John C. Coffee Jr., SEC enforcement: What has gone wrong?, Nat’l L. J. (Dec. 3, 2013). 15 robert S. Khuzmi & George S. Cannellos, Unfair Claims, untenable solution, Nat’l L. J. (Jan. 14, 2013). 16 The SEC counts a trial as a win only if the SEC prevails on the most serious charge against the defendant. Presumably, the SEC did not include the case against Bruce Bent and Bruce Bent II in this statistic because the jury verdict was rendered in November 2012, outside of FY 2012. 17 SEC v. Apuzzo, 689 F.3d 204 (2d Cir. 2012). 18 Id. at 212. 19 Id. at 214.

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20 SEC v. Bartek, 2012 WL 3205446 (5th Cir. 2012). 21 Id. at *3-5. 22 Id. at *6. 23 SEC v. Obus, 693 F.3d 276 (2d Cir. 2012). 24 Id. at 286. 25 Id. 26 Id. at 287. 27 463 U.S. 646, 660 (1983) (“Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.”). 28 425 U.S. 185 (1976). 29 693 F.3d at 288. 30 Id. 31 U.S. v. Contorinis, 692 F.3d 136 (2d Cir. 2012). 32 Id. at 144. 33 Id. at 142. 34 Id. at 143. 35 annual Report on the Dodd-Frank Whistleblower Program, Fiscal Year 2012 (Nov. 2012), available at http://www.sec.gov/about/offices/owb/annual- report-2012.pdf. 36 Id. 37 Id. at 4. 38 Id. Appendix A. 39 Id. Appendix B. 40 Id. at 8. 41 Id. 42 SEC Deferred Prosecution Agreement (Jul. 17, 2012), available at http://www. sec.gov/news/press/2012/2012-138-dpa.pdf. SEC Press Release 2012-138, SEC Announces Deferred Prosecution Agreement with Amish Fund (Jul. 18, 2012), available at http://www.sec.gov/news/press/2012/2012-138.htm. 43 SEC Deferred Prosecution Agreement, at 3-4. 44 Id. at 5. 45 Id. 46 SEC Press Release 2012-23, SEC Charges Former Credit Suisse Investment Bankers in Subprime Bond Pricing Scheme During Credit Crisis (Feb. 1, 2012),

396 The Past Year’s Top SEC Enforcement Events available at http://www.sec.gov/news/press/2012/2012-23.htm. 47 Id. 48 SEC Press Release 2012-78, SEC Charges Former Morgan Stanley Executive with FCPA Violations and Investment Advisor Fraud (Apr. 25, 2012), available at http://www.sec.gov/news/press/2012/2012-78.htm. 49 Id. 50 a Resource Guide to the U.S. Foreign Corrupt Practices Act (Nov. 2012), available at http://www.justice.gov/criminal/fraud/fcpa/guide.pdf. 51 robert Khuzami, Public Statement by SEC Staff: Recent Policy Change (Jan. 7, 2012), available at http://www.sec.gov/news/speech/2012/spch010712rsk.htm. 52 Id. 53 robert Khuzami, Testimony on “Examining the Settlement Practices of U.S. Financial Regulators” (May 17, 2012), available at http://www.sec.gov/news/ testimony/2012/ts051712rk.htm#P103_20983. 54 SEC Press Release 2012-61, SEC Charges Goldman, Sachs & Co. Lacked Adequate Policies and Procedures for Research “Huddles” (Apr. 12, 2012), available at http://www.sec.gov/news/press/2012/2012-61.htm.

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