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Securities Enforcement & Litigation Alert March 17, 2014 Securities Enforcement & Litigation Alert SEC Speaks This year’s “SEC Speaks” conference in Washington, D.C., was most notable 2014: Charting for an obvious shift in the SEC’s enforcement priorities. Several significant issues and efforts that had been the subject of extensive discussion last a New Course year – including financial crisis and insider-trading cases and the task force for Enforcement devoted to new and structured products, among others – received little or no Efforts attention this year. On the other hand, several new initiatives received very Christian Bartholomew, substantial emphasis, including principally the Commission’s new efforts in Adam Safwat, and the public company accounting and financial statements area, and in the Brianna Benfield Ripa microcap fraud area. SEC Chair Mary Jo White highlighted the Commission’s new policy of requiring admissions of wrongdoing in certain settlements, In This Issue the public company Financial Reporting and Audit Task Force, and the new 2 Public Company Accounting Microcap Task Force; Division of Enforcement Director Andrew Ceresney and Financial Statement Fraud echoed those remarks and also noted a renewed emphasis on the role of Initiative public company “gatekeepers,” such as auditors and in-house counsel. 3 Litigation Issues Although it seems clear that this refocusing will result in different enforcement 4 Admissions Policy efforts, it is unclear whether it will result in more enforcement efforts. 4 Technology Tools The SEC came under significant criticism for its relatively flat to declining 4 Cooperation Program enforcement efforts in FY 2013, but, since assuming her post as head of the SEC, Chair White has consistently stressed that she views a very vigorous 5 Whistleblower Program enforcement program as central to the SEC’s efforts. She has spoken 5 Microcap Fraud Task Force about the SEC needing to take a broad-based “broken windows” approach 5 Specialized Units to enforcement, and recently said that 2014 “promises to be an incredibly active year in enforcement.”1 At the same time, Chair White has made clear ■■ that she thinks the SEC needs to try more cases, both against entities and Securities Enforcement & Litigation For a discussion of the SEC’s individuals.2 Taken together, these priorities could conflict, since trying more Alert has a special bullet list. Delete renewed focus on valuation issues, see our recent Alert. cases generally requires more manpower, and the primary place to get that the standard “In This Issue” and ■■ manpower is from the Enforcement staff; a further complicating factor is the Highlight bullet boxes from the Content For a discussion of the second SEC’s recent trial record, which includes several high-profile losses, e.g., layer to resolve the overset text. award issued under the SEC’s whistleblower program, please the Mark Cuban matter. Accordingly, it remains to be seen how the SEC will see our Annual Whistleblower balance these issues and execute on its new enforcement priorities. Report. ■■ For a discussion of the Whistleblower Program, see our recent Securities Enforcement Forum Presentation. Weil, Gotshal & Manges LLP Securities Enforcement & Litigation Alert Public Company Accounting and force will increase monitoring of companies’ financial Financial Statement Fraud Initiative statement reporting and may incubate matters not yet ready for an enforcement action by issuing The Task Force and AQM targeted document requests or referring matters to an Perhaps in response to significant criticism of its investigative team. recent lack of activity in this area – public company The key feature of the SEC’s Quantitative Analytic accounting and financial statements cases fell to their effort is its Accounting Quality Model (AQM), lowest level in 16 years in FY 2013 – the SEC has a program that systematically searches public revitalized its approach to such matters by forming companies’ financial statements for problematic the new Financial Reporting and Audit Task Force and filings and disclosures for further follow-up. AQM’s the new Center for Risk and Quantitative Analysis. main focus is on discretionary accounting decisions According to David Woodcock, the task force’s new in which management has substantial subjective Chair, the task force is composed of 12 members, input, such as bad-debt expense and other reserves, including lawyers, forensic accountants, and audit and fair value accounting. The AQM effort will seek accountants in nine out of 11 regional offices and the to identify problematic decisions by using certain home office. Woodcock touted the group’s combined “red flag” indicia, such as the use of off-balance “125 years of enforcement experience,” and explained sheet accounting, changes in auditors, adoption of that the task force has five principal goals: aggressive accounting policies, and the degree to which accounting income outstrips reported taxable ■■ to seek to better understand accounting and financial reporting fraud in terms of how and where income. The last of these factors may suggest that it is happening by reviewing cases the SEC has management may be more afraid of lying to the IRS previously brought, and by reviewing the work of than to the SEC. academics and other third parties (which we take Operation Broken Gate to mean investors and short-sellers) that have looked at these issues in depth; Through Operation Broken Gate, the task force is also focusing on bringing cases against auditors by ■ ■ to develop a system to identify and investigate examining audits and determining whether auditors accounting and financial reporting fraud; missed or ignored red flags, failed to maintain or ■■ to share within the law enforcement community request proper documentation, and/or failed to follow best practices for identifying accounting and professional audit standards.3 Woodcock cited the financial fraud; SEC’s recent $8.2 million settlement with KPMG as an example: That matter involved allegations that ■■ to collaborate with other regulators and law KPMG had violated the independence rules and found enforcement partners; and that, from 2007 to 2011, KPMG provided non-audit ■■ to engage public partners, including working with services, such as restructuring and corporate finance, academic and other third party institutions that to several of its audit clients.4 focus on market integrity issues and encouraging whistleblowers in financial reporting fraud cases. Importance of the Audit Committee In a particularly interesting disclosure, Woodcock Finally, it is noteworthy that, later in the conference, said the task force would also look at companies that the SEC’s Chief Accountant, Paul Beswick, gave a have a pattern of filing multiple financial statement detailed presentation regarding audit committees, revisions because, although the underlying issues and his was the only staff presentation posted on 5 may not have been sufficiently material to warrant a the SEC’s website. Beswick emphasized that audit restatement, they may reflect substantial weaknesses committees are in a unique position to represent in internal controls. Woodcock also noted the task investors and play an important role in promoting Weil, Gotshal & Manges LLP March 17, 2014 2 Securities Enforcement & Litigation Alert high-quality, transparent financial reporting to For the second year in a row, Brenner stated that as investors. He noted that monitoring independence is a result of the Supreme Court’s 2011 Janus decision, an ongoing responsibility of the audit committee, and holding that only the “maker” of a statement is subject he stressed that frequent dialogue with management to Section 10(b) liability,11 the Enforcement Division and a direct line of communication with the auditor are will bring claims under Section 20(b) of the Exchange important parts of the committee’s oversight role. He Act, which imposes liability for securities violations encouraged audit committees to think critically about caused indirectly through others.12 Brenner stated that disclosures to investors about the committee’s work. Section 20(b) will be used in a case this year. Litigation Issues Choice of Forum Issues Brenner’s colleague, Charlotte Buford, Assistant New Provisions Used Chief Counsel, noted that the Enforcement Division As he did last year, Joseph K. Brenner, the Chief will increasingly seek to use the administrative forum Counsel to the Division of Enforcement, discussed for litigated cases and will no longer be “bound by the Enforcement Division’s use of statutes and false ties to outdated presumptions” that certain rules that have rarely, if ever, been used before. For categories of cases must be brought as administrative example, the SEC recently used Exchange Act Rule proceedings and others must be brought in federal 17a-25, which requires broker-dealers to submit district court. She cited as a classic example insider- securities transaction information upon request by trading cases, which the SEC has historically the SEC, against Scottrade for failing to provide the always brought in federal court. Buford explained agency with complete and accurate “blue sheet” that, going forward, the staff would examine several data, i.e. information about trades by the firm and its factors in determining whether to proceed before customers.6 This past year the SEC also used Section an ALJ or a district court, including the relative 20(d) of the Exchange Act, which prohibits trading speed and efficiency of the forum (as an ALJ must in
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