This article is part of the PLC Global Finance September 2010 e-mail update for the United States.
In July, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which contained numerous provisions intended to enhance regulatory enforcement and the remedies available to the agency. The new legislation not only effectively doubled the SEC's budget over the next five years, but also adopted new laws that give "teeth" to and complement the agency's latest round of reforms. This article highlights three that are particularly relevant to issuers, lawyers, accountants, financial institutions and other secondary actors who work with publicly-traded companies.Close speedread
At the midpoint of 2010, the SEC stood at a crossroads. It had announced a series of reforms designed to substantially strengthen the agency's ability to police the markets and had also adopted an increasingly aggressive posture towards insider trading, allegedly misleading and inadequate disclosures involving sub-prime investments, and "pay to play" practices.
Together, the agency's transformation and embrace of a more aggressive approach gave rise to some of the largest cases in its history. However, serious questions remained about whether the 'new' SEC's aggressive campaign would be successful, and for how long. The agency faced numerous obstacles, including limited resources and the fact that it had gambled on novel or expansive theories as the basis for prosecuting some of its higher profile cases (see Global Finance Update for February 2010).
Over the summer, Congress came to the SEC's aid. In July, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which contained numerous provisions intended to enhance regulatory enforcement and the remedies available to the agency. The new legislation not only effectively doubled the SEC's budget over the next five years, but also adopted new laws that give "teeth" to and, in many ways, complement, the agency's latest round of reforms. Three are particularly relevant to issuers and the lawyers, accountants, financial institutions and other secondary actors who work with publicly-traded companies:
Incentivising and protecting whistleblowers.
In January 2010, the SEC announced the creation of the Office of Market Intelligence, which is responsible for the collection and analysis of tips, complaints and other potential leads received from market participants. The Dodd-Frank Act complements this initiative by creating extraordinary incentives for whistleblowers to provide information to the SEC while affording them greater protection from retaliation. (See Sections 922, 923, 924 and 929A.)
In particular, the Act mandates that the SEC must pay a whistleblower who voluntarily provides "original information" to the Commission that leads to the successful enforcement of a judicial or administrative action resulting in monetary sanctions of $1 million or more an award of 10-30% of the amount of that sanction. Bounties are available to an expansive class of whistleblowers, including even persons who themselves violated the federal securities laws (unless they have been criminally convicted). In combination with the new cooperation initiative adopted by the SEC, which armed the agency with the ability to enter into deferred prosecution and non-prosecution agreements, the incentives to work with the agency are powerful.
And the protections afforded to those who do cooperate are substantial. The SEC (and any other government agency with whom the SEC shares information) is now required by law to protect the whistleblower's identity until disclosure is necessary to a public proceeding. In addition, whistleblowers are given greater protection from retaliation by their employers. Dodd-Frank not only prohibits employers from retaliating against a person who provides information to the SEC or otherwise assists the SEC in an investigation, but grants whistleblowers a private right of action against employers.
Expanding the scope of liability.
In the wake of the US Supreme Court's landmark decision in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), which held that there is no private right of action for aiding and abetting a violation of Section 10(b), Congress passed legislation that expressly granted the SEC authority to bring actions under the Securities Exchange Act of 1934 against secondary actors who knowingly aid and abet securities fraud. Congress, however, did not create a cause of action for aiding and abetting under either the Securities Act of 1933 or the Investment Company Act of 1940. Dodd-Frank significantly expands the reach of the SEC's authority to prosecute claims against aiders and abettors in two ways:
the Act lowers the state of mind the SEC must plead and prove to hold a defendant liable for aiding and abetting a violation of Section 10(b) (see Section 929O). The SEC no longer need show actual knowledge; rather, under Dodd-Frank, the agency must only demonstrate that a defendant "recklessly" provided substantial assistance to a person who violated Section 10(b) to hold it liable for aiding and abetting securities fraud;
Congress created aiding and abetting liability under the Securities Act of 1933 and the Investment Company Act of 1940 (see Sections 929M and 929N). And as with the Exchange Act, the SEC may plead and prove a claim for aiding and abetting violations of the Securities Act of 1933 and the Investment Company Act of 1940 merely by demonstrating "recklessness".
Penalties in administrative proceedings.
While the SEC was previously permitted to seek a variety of sanctions through the administrative proceeding process (including cease-and-desist orders and disgorgement) the agency was only allowed to seek penalties against "regulated entities", such as broker-dealers and investment advisers. The SEC is now authorised to seek such penalties against all defendants in administrative proceedings (see Section 929P(a)). While this development will allow the SEC to avoid suing in federal court where defendants have the right to extensive pre-trial discovery and the right to a jury, it also allows public companies and the SEC to agree to settlements that include civil penalties that do not have to be approved by a federal judge.
What the SEC will do with its enhanced authority remains to be seen. One thing, however, is clear: Congress has removed many of the obstacles that prevented the SEC from taking full advantage of the reforms it recently adopted while also giving the agency even more new tools to use in its latest campaign. With more money and the ability to pursue a new class of cases in an administrative forum, one should expect that the SEC will continue to be aggressive in attempting to extract large settlements from high-profile defendants.