Subject to Inquiry

Subject to Inquiry

White Collar, Congressional, SEC, Energy Enforcement & Other Government Inquiries

Government, Regulatory & Criminal Investigations Group
Enforcement Actions, Financial Regulation, SEC

Still in Its Sights: The SEC Continues Its Increased Scrutiny of Hedge Funds

As we have previously reported, the SEC is increasingly scrutinizing hedge funds and other private funds and has suggested that it will pursue enforcement actions against advisers to such funds as appropriate. The SEC’s increased scrutiny flows in large part from Dodd-Frank’s elimination of the private adviser exemption, which has meant that most investment advisers to hedge funds have had to register with the SEC for the first time. Indeed, as noted in our prior post, some 1,500 previously unregistered fund advisers have registered since this provision of Dodd-Frank became effective. These newly registered advisers now find themselves subject to disclosure obligations and compliance examinations. As Chair White indicated in a speech to the Managed Funds Association last October, the SEC will be examining newly registered advisers and will pursue enforcement actions where it believes it has discovered fraud.

The SEC’s focus on hedge funds shows no signs of slowing. As reported just this week in Reuters and Law360, the SEC has now created a new private fund unit within the Office of Compliance Inspections and Examinations (OCIE) that will focus on hedge funds and private equity funds. According to those sources, the new unit will be run by former industry participants, thus demonstrating the SEC’s commitment to hiring industry insiders to use their expertise to help the Commission better regulate alternative funds. As Bruce Karpati, the former chief of the Asset Management Unit, explained in a speech back in 2012, former industry participants “know where the bodies are buried — and understand how they got there.”

Further, the reporting indicates that this unit will pay particular attention to issues such as asset valuation, fee disclosures and communications with investors. This focus is consistent with what the SEC has been stating for months. As we noted previously, Chair White advised in her October 2013 speech that in examining fund advisers, the SEC’s examination staff would focus on (1) marketing, (2) portfolio management, (3) conflicts of interest, (4) safety of client assets and (5) valuation. OCIE confirmed these same “five key focus areas of examinations” via the National Examination Program’s Examination Priorities for 2014. The Examination Priorities also reiterate the staff’s commitment to the SEC’s initiative to promptly conduct “presence exams” of a significant percentage of fund advisers who registered for the first time after Dodd-Frank.

In creating a new private fund unit within OCIE, the SEC is homing further in on the hedge fund industry. And while it’s fair to say that the Commission is trying to be transparent with newly registered fund advisers regarding the issues it is most concerned about, it’s also a fair bet that this increased scrutiny will lead to increased enforcement actions against hedge funds and private equity funds. Thus, as we’ve cautioned before, it is critical that fund advisers understand and take appropriate steps to comply with their newfound regulatory obligations. For most advisers, the question is not if the SEC will examine them, but when. The creation of a new unit focused on private funds and the continuation of the presence exams initiative suggest the answer is “soon.”

Uncategorized, White Collar Crime

Obstruction of (Contemplated) Justice

Imagine you are a federal prosecutor and the following fact pattern lands on your desk: a college student has gained unauthorized access to the email account of a candidate for federal office. He changed the email account password and then shared the new password on an Internet message board. Within one day, fearing a possible (but-not-yet-initiated) investigation, he took steps to delete information related to his unauthorized access from his computer. Based on these facts, what charges would you consider? Identity theft in violation of 18 U.S.C. § 1028? Wire fraud in violation of 18 U.S.C. § 1343? A violation of the Computer Fraud and Abuse Act (18 U.S.C. § 1030)?

Each of those charges seems like a logical choice, in no small part because they were in fact charged in the case from which that fact-pattern is taken. See United States v. Kernell, 667 F.3d 746 (6th Cir. 2012). But what about obstruction of justice, even though the deletion of the content occurred before any government investigation or proceeding had been initiated? Prosecutors can — and in several recent cases have — leveled just such anticipatory obstruction of justice charges under 18 U.S.C. § 1519, in a trend that has potentially stark implications for companies and their counsel in addressing compliance matters, internal and external investigations, and day-to-day operational activities with the potential to implicate federal issues.

Enacted as part of the Sarbanes-Oxley Act of 2002, Section 1519 substantially broadens the more familiar obstruction statutes by excluding any requirement that a proceeding be known to the accused or even pending in order for obstruction to have occurred. Section 1519 — which over the last two years has been validated against vagueness claims and clarified by several Courts of Appeals— provides:

Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both. (Emphasis added.)

As courts have now recognized, the elements for an offense under § 1519 include: (1) knowingly (2) destroying or concealing a record or document (3) with the intent to impede or obstruct any matter (including those contemplated but not yet initiated) within the jurisdiction of the United States. United States v. Powell, 680 F.3d 350, 355-56 (4th Cir. 2012).
The breadth of this statute in contrast to the other obstruction statutes, and its potential application in the business setting, are striking, if for no other reason than the relative obscurity of Section 1519. Notable aspects of Section 1519 that relieve the government of several burdens include:

The defendant need not know a matter was pending or within federal jurisdiction. Instead, the “knowingly” element refers only to the obstructive conduct. United States v. Moyer, 674 F.3d 192, 208 (3rd Cir. 2012). The federal nature of the statute’s prohibition is a jurisdictional requirement, but not a substantive element under Section 1519. United States v. McRae, 702 F.3d 806, 834 (5th Cir. 2012).

No nexus requirement. Given that an investigation or matter within federal jurisdiction need not be initiated or even pending at the time of the obstructive conduct, the government need not prove any connection between the alleged obstructive conduct and the federal matter. Moyer, at 209; United States v. Gray, 692 F.3d 514, 519-20 (6th Cir. 2012).

Materiality is not an element. As an example, falsification through omission from a log or report can support a conviction, without proof of the materiality of the omission. Powell, at 356; Moyer, at 207-08.

This broad statute should be considered when advising clients at the earliest stages of an internal investigation or other compliance matter. While counsel may not recommend (and clients may resist) the issuance of a legal hold notice unless and until a government investigation or civil litigation has been initiated, Section 1519 expands the reach of such statutes to criminalize obstructive conduct undertaken in contemplation of any matter within federal jurisdiction. Should an employee alter or destroy evidence, or withhold information from the investigation, for fear that full disclosure may implicate a rule or regulation within federal jurisdiction, liability for the individual and the organization may attach.

Compliance, Corporate Compliance, Ethics Investigations, FCPA Investigations, FERC Investigation, SEC Enforcement, Securities Fraud, Securities Litigation, Uncategorized

Avoiding Waiver When Disclosing Facts to the Government

All but a handful of courts find that companies disclosing privileged communications or protected work product to the government waive both of those protections. Courts properly analyzing waiver rules also recognize that disclosing historical facts does not cause a waiver – because historical facts are not privileged.

In two related cases, Judge Francis of the Southern District of New York dealt with the intersection of these basic principles. In In re Weatherford International Securities Litigation, No. 11 Civ. 1646 (LAK) (JCF), 2013 U.S. Dist. LEXIS 170559 (S.D.N.Y. Nov. 5, 2013), Weatherford retained Latham & Watkins and Davis Polk to conduct two separate corporate investigations into material weaknesses in the company’s internal controls over financial reporting. The court acknowledged that both investigations deserved work product protection. However, the court also found that the company waived its privilege and fact (but not opinion) work product protection by disclosing information about the investigations to the SEC. In defining the scope of the resulting waiver, the court (1) rejected plaintiffs’ argument that the waiver extended to “all materials relevant” to the investigations; (2) found that the waiver covered any material actually given to the SEC, and any oral representations company lawyers made to the SEC; and (3) held that the waiver also extended to any “underlying factual material explicitly referenced” in such material or representations. Id. at *28, *27.

Perhaps not surprisingly, the parties soon disagreed about the company’s interpretation of the waiver’s scope – which resulted in another opinion one month later.

In In re Weatherford International Securities Litigation, No. 11 Civ. 1646 (LAK) (JCF), 2013 U.S. Dist. LEXIS 176278, at *7 (S.D.N.Y. Dec. 16, 2013), the court first focused on “interview materials” Davis Polk lawyers used to create four PowerPoint presentations to the SEC. The court held that the company did not have to produce any interview materials “unless those specific materials are explicitly identified, cited, or quoted in information disclosed to the SEC.” Id. at *10. Interestingly, the court rejected plaintiffs’ argument that the company crossed that line “where the presentations assert that a particular witness made a statement.” Id. at *7. The court acknowledged that such a representation to the SEC obviously implied “that an interview took place” and also provided “a strong inference that it was memorialized in some way” – but ultimately concluded that “plaintiffs have not shown that those memorializations were, themselves, explicitly referenced in communications with the SEC.” Id. at *7-8.

The court then turned to the company’s redactions in the interview summaries produced in response to the earlier ruling by addressing the plaintiffs’ complaint that the company had not fully produced those witness interview summaries that were “explicitly identified, cited, or quoted in information disclosed to the SEC.” The company explained that it had produced “only the ‘portions of summaries . . . that were . . . read or conveyed in substantial part to the SEC,’” and redacted the rest. Id. at *12 (internal citation omitted). Criticizing that as a “crabbed view of their discovery obligations,” the court ordered the company to produce all factual portions of any such interview summaries — redacting “only material that reflects an attorney’s ‘explicit mental impressions, conclusions, opinions or legal theories.’” Id. at *12-13 (citation omitted). In other words, the company had to produce all non-opinion portions of any witness interview summaries the company had quoted to the SEC.

It can be very difficult to reconcile two basic principles: (1) disclosure of privileged communications or work product to the government generally waives those protections; and (2) disclosing historical facts does not waive either protection. As explained in these opinions by widely‑respected S.D.N.Y. Judge Francis, companies hoping to avoid a broad waiver when making disclosures to the government should limit their presentations to historical facts – without explicitly referencing, identifying, citing, or quoting any underlying material or witness interviews.


Corporate Compliance, SEC, Whistleblowers

Who is Protected by the Sarbanes-Oxley and Dodd-Frank Whistleblower Anti-Retaliation Provisions? The Supreme Court and SEC Weigh In.

The Sarbanes-Oxley Act (“Sarbanes-Oxley”) and Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) whistleblower anti-retaliation provisions have been the subject of great debate as to what categories of individuals and activities are protected. These issues have developed significantly in recent weeks with the Supreme Court’s decision in Lawson v. FMR LLC, involving the application of Sarbanes-Oxley’s anti-retaliation provision to employees of the private contractors of public companies, and the SEC’s submission of an amicus brief in Liu Meng-Lin v. Siemens AG, addressing Dodd-Frank’s anti-retaliation protections for employees who report internally. These developments serve as a reminder that government regulators and the courts take retaliation very seriously, and companies should ensure that they have appropriate policies and processes in place to address whistleblower complaints.

Does Sarbanes-Oxley’s Anti-Retaliation Provision Protect Employees of Privately Held Contractors or Subcontractors Who Work for Public Companies?

On March 4, 2014, in a 6-3 decision, the United States Supreme Court decided its first case under Sarbanes-Oxley’s whistleblower protection provision, Section 806. In Lawson v. FMR LLC, 572 U.S. __ (2014), the Court held that Sarbanes-Oxley’s whistleblower anti-retaliation protection, which prohibits public companies or any officer, employee, contractor, subcontractor, or agent of such companies from retaliating against an employee because of whistleblowing or other protected activity, extends to employees of the public companies’ contractors and subcontractors.

The plaintiffs/petitioners in Lawson are former employees of private companies that advised or managed public mutual funds. They filed separate suits against their employers claiming unlawful retaliation under Sarbanes-Oxley’s anti-retaliation provision after they reported concerns of potential fraudulent practices. The district court denied the defendant/respondent employers’ motion to dismiss, rejecting their argument that the provision applies only to the employees of public companies. The United States Court of Appeals for the First Circuit reversed the district court’s decision, acknowledging that contractors are prohibited from retaliating against employees, but holding that an “employee” refers only to employees of public companies, not the contractors’ employees. Months later, in an unrelated case, the Administrative Review Board of the Department of Labor, which administers this whistleblower provision, issued an opinion disagreeing with the court of appeals’ decision on this issue.

The Supreme Court reversed the court of appeals, ruling that the text and structure of the anti-retaliation provision, the text and purpose of parallel statutes, and the statutory purpose to “ward off another Enron debacle,” favored a broader reading of the provision to extend to the employees of the contractors and subcontractors of public companies. Justice Sotomayor (joined by Justices Kennedy and Alito) issued the dissenting opinion, describing the majority decision as “a stunning reach” that would produce “absurd results.”

Do Dodd-Frank’s Anti-Retaliation Provisions Protect Individuals Who Report Internally?

On February 20, 2014, the SEC filed an amicus brief in the United States Court of Appeals for the Second Circuit in support of whistleblowers who report actual or potential violations internally. In Liu Meng-Lin v. Siemens AG, the district court dismissed the suit of an employee of a U.S. company’s Chinese subsidiary who claimed that he was unlawfully terminated under Dodd-Frank’s anti-retaliation provision for reporting possible FCPA violations to the subsidiary’s CFO. Even though the district court dismissed the case on other grounds, the court discussed the issue surrounding whether individuals who report internally are protected under the anti-retaliation provision, identifying the tension in the statutory language. The district court noted that other courts have found that internal reporting is protected activity, and this interpretation is consistent with the SEC’s interpretation of the statute it is charged with enforcing.

In its brief, the SEC urged the court to defer to its interpretation of Dodd-Frank’s whistleblower provision. Under the SEC’s interpretation, the anti-retaliation protections extend to any individual who engages in protected whistleblowing activities, including internal reporting, regardless of whether the individual makes a separate report to the SEC. The SEC argued that protecting internal reporting is important for deterring, detecting, and stopping unlawful conduct that may harm investors and supports the core overall objective of the whistleblower provisions and rulemaking — to avoid disincentivizing individuals from reporting internally first. The SEC stressed that “if internal compliance and reporting procedures are not utilized or working, our system of securities regulation will be less effective,” and protecting internal reporting enhances the SEC’s ability to bring enforcement actions when employers take adverse employment actions for reporting securities law violations internally.

Notably, in its brief, the SEC rejected the Fifth Circuit’s decision in Asadi v. GE Energy, 720 F.3d 620 (5th Cir. 2013), which held that the anti-retaliation protection of Dodd-Frank’s whistleblower provision creates a private right of action only for individuals who report violations to the SEC. If the Second Circuit reaches this issue and agrees with the SEC’s interpretation, its decision would create a circuit split with the Fifth Circuit. However, even in the likely event that Liu is resolved on other grounds, the increasing divergence among the lower courts suggests that the issue may eventually make its way to the Supreme Court.

Compliance, Financial Regulation, Market Manipulation, SEC, Securities Litigation, Uncategorized

An Update on Rule 105 Enforcement

In September, we wrote about the SEC’s enforcement actions against 23 investment firms for violations of Rule 105 of Regulation M (“Rule 105”) in an effort to crack down on the potential manipulation of offering prices of follow-on and secondary offerings. In the last two months, the SEC has furthered Co-Director of Enforcement Andrew Ceresney’s promise to send a “clear message that firms must pay the price for violations.”

On Dec. 3, the SEC filed a complaint against Charles Raymond Langston III for insider trading. In addition to the insider trading violations, from which Langston made more than $193,108 in profits based upon the receipt of material, nonpublic information, the commission also charged Langston and two companies he owned and used to actively trade securities (“Defendants”) with three violations of Rule 105.

To prevent short-selling in connection with a public offering, 17 C.F.R. § 242.105(a)(1) provides:

In connection with an offering of equity securities for cash pursuant to a registration statement … filed under the Securities Act … it shall be unlawful for any person to sell short the security that is the subject of the offering and purchase the offered securities from an underwriter or broker or dealer participating in the offering if such short sale was effected during the period (“Rule 105 restricted period”) that is the shorter of the period:

(1) Beginning five business days before the pricing of the offered securities and ending with such pricing; or (2) Beginning with the initial filing of such registration statement … and ending with the pricing.

The SEC alleges that between November 2008 and March 2009, the Defendants engaged in three transactions where they sold short securities that were the subject of the offerings during the Rule 105 restricted period and purchased the offered securities from an underwriter, broker or dealer participating in the offering. The SEC seeks declaratory relief to find that the Defendants committed the violations of federal securities laws, a permanent injunction enjoining the Defendants from violating Rule 105, disgorgement of all profits or losses avoided as a result of the Rule 105 violations, and a civil money penalty pursuant to both the Exchange and the Securities Act. Glenn Gordon, associate director for enforcement in the SEC’s Miami Regional Office stated, “Langston and his companies executed short sales that gamed the system and resulted in illegal profits … The SEC is resolutely committed to pursuing those who violate Rule 105.”

A few months later, on Jan. 31, the SEC filed a complaint against Revelation Capital Management Ltd., a Bermuda-based exempt reporting adviser, and its chairman, CEO, CIO, founder and sole shareholder, Christopher P.C. Kuchanny. The complaint alleges that Kuchanny directed the majority of the trades that saw Revelation Capital purchase over four million shares of stock in a Canadian, closed-end fund listed on the NYSE and Toronto Stock Exchange, during a publicly marketed firm commitment follow-on offering. During the Rule 105 restricted period relating to this offering, Revelation Capital sold short nearly 1.5 million shares of the Canadian fund, with Kuchanny placing 751 of Revelation Capital’s 919 short-sale trades, resulting in a profit of nearly $1.4 million gained from illegal trading. The SEC is seeking: to permanently enjoin both Revelation Capital and Kuchanny from violating Rule 105; to order both Revelation Capital and Kuchanny, jointly and severally, to pay disgorgement, together with prejudgment interest; and the payment of civil penalties.

It is important that firms take action to promote training of their employees regarding the application of Rule 105. Firms should also develop and implement policies and procedures designed to achieve compliance with Rule 105. Once these policies and procedures are in place, firms should be very aggressive with their oversight and in-house enforcement.


Dodd-Frank, Whistleblowers

Court Holds That Dodd-Frank Whistleblowers Have No Right to Jury Trial

A federal district court recently held that employees bringing whistleblower suits under the Dodd-Frank Wall Street Reform and Consumer Protection Act are not entitled to a trial by jury. The decision in Pruett v. BlueLinx Holdings, Inc., if followed by other courts, is likely to benefit companies facing whistleblower suits, who no longer need be concerned about the risks of a jury trial.

The district court based its decision on two main points: (1) the district court conducted an analysis under the Seventh Amendment, noting in particular that the remedy sought was more equitable than legal in nature and (2) the court employed principles of statutory construction and focused on the fact that Congress had failed to specifically grant a right to jury trials in the Dodd-Frank statute, while it had done so in the related Sarbanes-Oxley Act.

First, under the Seventh Amendment, the court was required to determine if the action was more legal or equitable in nature, as the Constitution guarantees jury trials only to actions at law. For the court, this involved two primary questions. As an initial matter, the court examined whether the issues present in a whistleblower action were more similar to an 18th century action at law or equity. The parties did not dispute that a whistleblower action was most similar to a common law action for wrongful discharge. This factor thus suggested that the plaintiff should have a right to a jury trial. Additionally the court noted that the more important consideration was the type of remedy the action sought and whether that remedy was more of a legal or equitable remedy. Dodd-Frank provides for three remedies for a successful whistleblower claim: reinstatement at the seniority the employee would have had if not discharged or disciplined; double back pay with interest; and compensation for costs, expert fees and attorneys’ fees. The court determined that these remedies were intended to make the employee whole and so were equitable in nature. Plaintiff argued that the fact that Dodd-Frank provided for doubling back pay made the remedy more like legal damages and less an attempt to make the plaintiff whole, but the court rejected this argument because doubling was automatic and did not require any complicated calculation of damages that might be appropriate for a jury.

Second, although the court was considering whether the plaintiff had a constitutional right to a jury trial, and therefore the intent of Congress should not have affected the analysis, the court’s decision was also grounded in statutory construction principles, namely the fact that Dodd-Frank differed from Sarbanes-Oxley in not expressly providing for jury trials. The court stated that Sarbanes-Oxley initially was silent on whether a jury trial was available and, similar to its own analysis of Dodd-Frank, many courts concluded that there was no such a right under the Constitution because the Sarbanes-Oxley remedies were equitable. Congress subsequently amended Sarbanes-Oxley to provide a right to a jury trial, but did not do so in Dodd-Frank despite the fact that the bill was being considered at the same time as the Sarbanes-Oxley amendment. The court reasoned that Congress must have known of the controversy surrounding jury trials at the time it enacted Dodd-Frank, and by its silence must have been choosing not to grant a jury trial right.

The court’s decision will be beneficial to companies facing Dodd-Frank whistleblower claims. Most companies are likely to prefer a bench trial in front of a judge to a jury trial for three reasons. First, juries are thought to be more likely to be sympathetic to a whistleblower who has lost his or her job or been disciplined. Second, to the extent that the case involves highly technical issues of accounting or corporate governance, companies may feel more comfortable that the judge has the necessary sophistication to understand the issues, as compared to a jury. Third, a defendant is likely to have some sense of how best to present its case to the judge by the time trial occurs, whereas the members of a jury are randomly selected and their thinking unpredictable. It remains to be seen whether other courts will follow the BlueLinx decision and hold that there is no jury trial right, but the decision, which is apparently the first to address the issue, provides defendants with a persuasive argument against granting a jury trial. Defendants will likely want to use the decision to argue against granting a jury trial in Dodd-Frank whistleblower cases.

Enforcement Actions, News, SEC, Securities Litigation

“Where Does He Get Those Wonderful Toys!” SEC Update on Technology and Enforcement

You may recall this line from the original Batman movie, where Jack Nicholson, playing the role of Joker/Jack Napier in a Golden Globe-nominated performance, shouted in awe at the various gadgets employed by the Caped Crusader. I am not suggesting that the SEC has a Batmobile or Batarang at its disposal, but comments made by SEC Chairwoman Mary Jo White at the 41st Annual Securities Regulation Institute (Institute) held in Coronado, California, on Jan. 27–29, suggest that the SEC is deploying new technology to better carry out the SEC’s mission. Her comments come after the recent rejection of the SEC’s budget request for a 26 percent increase for fiscal year 2014. Though the agency received only a 2 percent increase over last year’s fiscal year budget, the new technological tools described by White now at the agency’s disposal may make up for any staffing shortcomings created by budget expectations. White believes this technology will help the agency “keep pace with this rapidly changing [securities] environment…to harness and leverage advances in technology to better carry out our mission.”

White discussed two new tools now utilized by the SEC to help the SEC work through the seemingly endless amounts of trading data created by firms in today’s digitally driven world.


The National Exam Program has a Quantitative Analytics Unit utilizing an instrument called NEAT (National Exam Analytics Tool), which enables examiners to access and analyze large amounts of a firm’s trading information in considerably less time than the SEC has spent in the past. White provided an example whereby NEAT was used by examiners to analyze in only a day and a half, 17 million transactions executed by one investment adviser. The SEC is using NEAT to compare databases of corporate activity to search for potential securities violations, such as insider trading, front running, window dressing and improper allocations of investment opportunities.


The Market Information Data Analytics System (MIDAS) is another tool the SEC is using to collect and analyze huge amounts of trading data across multiple markets at once, based on both the familiar consolidated tapes (what casual investors usually see across the bottom of TV screens showing every trade of 100 shares or more in listed equities) and separate, proprietary feeds made individually available by each equity exchange. MIDAS allows the SEC to collect one billion records of trading every day, time-stamped to the microsecond — a process that used to take staff members weeks or even months. MIDAS collects posted orders and quotes on national exchanges, modifications/cancellations of those orders, trade executions against those orders and off-exchange trade executions. It also collects and processes data on equity options and futures contracts. The SEC believes this type and amount of trading data may reduce speculation about the behavior of the current market structure, specifically, monitoring and understanding mini-flash crashes, reconstructing market events and developing a better understanding of long-term market trends.

During her Jan. 27 speech at the Institute, White outlined the agency’s plans for “vigorous enforcement” in 2014. She noted the recent change in the SEC’s admissions of wrongdoing policy and provided insight on the types of violations for which the SEC may seek such admissions — which was the subject of an earlier Subject to Inquiry article — in the attempt to achieve greater public accountability while sending a message to the public that the enforcement and safety of our markets are strong. Such admissions may be pursued in cases involving:

  • egregious conduct by wrongdoers;
  • large numbers of investors harmed;
  • market or investors were placed at significant risk;
  • wrongdoers pose a particular future threat to market or investors; and
  • the defendant engaged in unlawful obstruction during agency actions.

The SEC predicts that 2014 will see an increase in the number of cases involving admissions of wrongdoing.

White also highlighted the formation of the Financial Reporting and Audit Task Force under the SEC’s Enforcement Division. The task force, made up of both accountants and attorneys, strengthens the agency’s goal to identify and prosecute violations of securities laws relating to audit failures and financial reporting. Their efforts include ongoing reviews of financial statement restatements and revisions, analysis of performance trends by industry, and the use of technology-based tools. White noted that enforcement will focus not only on the auditors of every financial reporting case, but also “on senior executives for possible misconduct warranting charges.”

To quote another famous exchange from one of the more recent Batman iterations:

“There’s a storm coming.”
“You sound like you’re looking forward to it.”
“I’m adaptable.”

This is a bit extreme, of course, but companies must adapt to this new securities law environment, exercise and maintain compliance efforts, and employ their own tools of oversight to identify any ongoing or potential violations. Strong internal controls and training programs for employees are useful in preparing for today’s securities climate. We will continue to use our Bat-Tracer and monitor developments at the SEC, and report back, hopefully with a better movie analogy.


This morning at SEC Speaks 2014, Chairwoman Mary Jo White elaborated on the new admissions protocol, Financial Fraud Task Force, and MIDAS tool we discuss above. Of note, White highlighted the Enforcement Division’s “unparalleled record of successful cases arising out of the financial crisis.” This includes:

  • 169 individuals or entities charged with wrongdoing, 70 of whom were CEOs, CFOs, or other senior executives;
  • Landmark insider trading cases pursuing complex cases against investment advisers, broker dealers and exchanges, as well as FCPA violations, state pension funds, and municipal bonds; and
  • Return of $3.4 billion in disgorgement and civil penalties in 2013 alone.

White expects a “strong, busy, and proactive” 2014 for the SEC.

We also anticipate a very active year for the SEC’s Enforcement Division.

We look forward to keeping you informed on the latest trends in securities laws and enforcement, as well as working with you to meet the compliance challenges you or your company may face this upcoming year.

Campaign Finance, Election Law, Export Controls, News

The Bedeviling Question of Willfulness in the Criminal Context

Courts have long struggled with interpreting (and thus instructing a jury on) the statutory element of willfulness. This frequently manifests in the challenge of expressing what level of knowledge the defendant must possess about the law he is accused of violating. Reflective of this challenge, courts have characterized the element of willfulness as “bedeviling,” turning as it does on a “chameleon” word whose construction is often dependent on its context1. Embracing the chameleon concept, courts have created varying standards that become increasingly difficult for the government to prove as the statutory proscription in question becomes more complex and less intuitive. The following three standards (in order of increasing proof) have emerged as leading candidates:

  1. Baseline level: Simple intentionality (where ignorance of the law is no excuse).
  2. Intermediate level (Bryan standard): The defendant intended to violate some law (general intent) but need not have known of the charged law’s specific commands.
  3. Heightened level (Ratzlaf / Cheek standard): The defendant knew of the legal duty but voluntarily and intentionally violated it.2

The purpose of applying a heightened standard of willfulness is to avoid ensnaring individuals engaged in apparently innocent activity — although defendants often (and understandably) take a home-run swing and urge courts to apply the heightened standard.

In the recent case United States v. Bishop, the 4th Circuit affirmed a conviction for willfully attempting to export ammunition without a license under the Arms Export Control Act (AECA). The defendant argued, unsuccessfully, that he did not know that the particular ammunition he was shipping to Jordan (9 mm and 7.62×39 mm rounds used in AK-47 assault rifles) was subject to export controls under the AECA and International Traffic in Arms Regulations (ITAR). The defendant argued that, without such statutory knowledge, he could not have willfully violated the statute. The court rejected the defendant’s argument that the heightened standard for willfulness articulated in Cheek v. United States and Ratzlaf v. United States should apply, distinguishing those cases as involving “highly technical” subjects (federal income tax and financial transaction structuring). Accordingly, in order to prevent capturing innocent conduct, conviction under those laws required proof that the defendants were aware of the specific statutory commands they were alleged to have violated.

Instead, the 4th Circuit in Bishop applied the standard articulated in Bryan v. United States, in which the U.S. Supreme Court announced: “the willfulness requirement [of the Firearms Owners’ Protection Act (FOPA)] does not carve out an exception to the traditional rule that ignorance of the law is no excuse; knowledge that the conduct is unlawful is all that is required.”

In articulating its rationale for applying the Bryan general awareness of unlawfulness standard, the 4th Circuit appears to have borrowed from the law of torts, inquiring into the mind of the reasonable man to determine whether an enhanced mens rea is required to avoid criminalizing the conduct of innocent, unwitting actors. The court reasoned that “the export of 9mm and AK-47 ammunition to Jordan would quickly strike someone of ordinary intelligence as potentially unlawful.” This statement rings true insofar as shipping nearly “10,000 rounds of small-arms ammunition” overseas via government contract carrier probably should give someone pause in an era when the USPS broadly prohibits shipping hazardous materials internationally.

Moving statute-by-statute, there is little clarity as to what standard of willfulness will apply until a court decodes the statutory context. Courts have been reluctant, however, to extend the heightened standard. Bishop is just the most recent case to reject the heightened standard of willfulness in favor of the Bryan “intermediate” standard3. For example, in 2013 two courts considering the Federal Election Campaign Act (FECA)4 determined that this statutory structure is sufficiently complex to risk criminalizing seemingly innocent conduct, but applied the intermediate Bryan standard rather than the heightened standard of Ratzlaf and Cheek.5

For defendants, the Bryan intermediate standard still requires proof of some awareness that the conduct in question violated the law. This awareness may be shown “by conduct that is ‘not consistent with a good-faith belief in the legality of the enterprise.’”6 In Bishop, this conduct was satisfied through proof that the defendant failed to disclose the presence of ammunition in his personal effects, certified that his belongings did not contain “any unauthorized explosives, destructive devices or hazardous materials,” and admitted that he attempted to ship the ammunition because it was prohibitively expensive to purchase in Jordan (contradicting his statement to the contract carrier that the ammunition was a gift).


1United States v. Danielczyk, 788 F. Supp. 2d 472, 486-87 (E.D. Va. 2011).
2For a discussion of these standards, see id. at 487-89; see also United States v. George, 386 F.3d 383 (2d Cir. 2004).
3Though in light of the court’s observation that someone of ordinary intelligence should recognize that the law may regulate the international shipment of ammunition, coupled with the maxim that ignorance is no excuse for the law, one wonders whether the baseline standard of willfulness would have been sufficient to shield innocent conduct from prosecution under the AECA.
4See United States v. Whittemore, 944 F. Supp. 2d 1003 (D. Nev. 2013); United States v. Danielczyk, 917 F. Supp. 2d 573 (E.D. Va. 2013); see also Danielczyk, 788 F. Supp. 2d.
5The second Danielczyk case is particular noteworthy because the court affirmed its application of the intermediate standard of willfulness despite the fact that “both Defendants and the Government . . . seemed to take as a given that ‘willfulness’ in this case required that Defendants knowingly violate the law’s specific commands, citing Ratzlaf.” 917 F. Supp. 2d at 576.
6Whittemore, F. Supp. 2d at 1010 (citing Bryan, 524 U.S. at 189 n.8).

Anti-Corruption, Compliance, FCPA, FCPA Investigations, UK Bribery Act

Brazil’s Clean Companies Act Comes into Effect

On Jan. 29, 2014, Brazil’s new Clean Companies Act came into effect, bringing with it a new wave of anti-corruption implications for companies operating in one of the largest economies in the world. Although the law shares many features with the U.S. Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act (UKBA), it once again brings to light the necessity for multinational companies to keep up with the changes in the anti-corruption world. 

As previously reported on this blog, Brazil’s new law imposes civil and administrative liability on companies for wide-ranging corrupt activities, including bribery of Brazilian or foreign public officials. Fines can range up to 20 percent of a company’s gross revenue for the fiscal year ending prior to the initiation of the investigation. If, for whatever reason, a fine cannot be calculated based on revenue, a company may face a fine up to BRL 60 million (or approximately $25 million). Other administrative penalties may include forcing a company to relinquish any benefits received from the illegal conduct, limiting a company from participating in public bidding processes or even forcing dissolution.

Like the FCPA and UKBA, the Clean Companies Act has an international impact, allowing Brazilian enforcement agencies to enforce the law against acts occurring inside and outside Brazil, and against Brazilian companies and foreign companies with a registered office, affiliate or branch in Brazil. Although the Clean Companies Act brings strict liability and does not provide for an UKBA-style “adequate procedures” defense that could eliminate fines altogether, companies are able to mitigate potential fines based on cooperation and the existence of an effective compliance program. Unlike the FCPA and UKBA, the new law does not impose criminal liability on companies — but its civil and administrative penalties are potentially severe enough to result in similar effects. Also, it does not provide for a facilitating payments exception, such as the one found under the FCPA.

Even with a comprehensive compliance program and well-trained employees, companies falling under the Clean Companies Act’s jurisdiction face potentially challenging situations based on two key aspects of the law. First, the Clean Companies Act is enforced by multiple levels of government in Brazil, which raises the question of whether such multilevel enforcement will actually create more possibilities for illegal conduct in light of competing enforcement interests and Brazil’s culture. In fact, one European company has publicly commented about its concerns that some Brazilian government bodies may extort money or other things of value in exchange for looking the other way when it comes time to apply the law. Practically speaking, multiple enforcement fronts may also impose significant investigative costs on companies.

Second, the Clean Companies Act also provides for leniency agreements to be executed with companies that self-report violations or that otherwise qualify under the law. In effect, these agreements can potentially reduce a company’s fines by up to two-thirds, while also protecting the company from other administrative penalties. Unlike the FCPA, the Clean Companies Act contemplates full transparency about exactly how self-reporting may impact the bottom-line for a company. The decision to self-disclose with Brazilian authorities may backfire, however, because it is entirely possible that companies that admit wrongdoing under the Clean Companies Act will face greater scrutiny under other Brazilian laws. Also, just as with a decision to self-disclose with U.S. authorities under the FCPA and especially because so many more countries are expanding the scope of their anti-corruption laws, a company must be mindful that more corruption-related investigations may be on the horizon as other countries take notice.

White Collar Crime

A Tale of Two Coasts: Handling Whistleblower Investigations

As 2013 drew to a close, would-be tipsters across California received tidings of great joy in the form of new laws that took effect Jan. 1, 2014, greatly expanding whistleblower protections in their state. Meanwhile, their New Jersey counterparts received a resounding “bah-humbug” via a late December ruling from a New Jersey appeals court (see link at page 7) that had the opposite effect. These parallel events highlight the need for employers and their in-house and outside counsel to account for potentially significant differences in whistleblower protections from state-to-state when planning for and initiating internal investigations triggered by whistleblower complaints.

 The new California statutes — which modify an already robust set of whistleblower protections in that state — are designed to encourage employees to identify potentially illegal activity without fear of retaliation. Among other things, California’s amended whistleblower regime now protects employees (including internal auditors) from retaliation for reporting suspected activity internally, as well as externally. The changes also expand the scope of what constitutes prohibited retaliation, particularly emphasizing anticipatory retaliation against a potential or suspected whistleblower. It is hoped that these changes will encourage more internal reporting, allowing organizations to address potential issues in an earlier and less disruptive fashion than would occur via an external report of concerns.

By contrast, in State v. Saavedra, the Superior Court of New Jersey, Appellate Division ruled that state whistleblower protections did not apply to an employee charged criminally for taking confidential documents related to the alleged wrongdoing. The defendant, a Board of Education clerk, filed a complaint against her employer alleging, inter alia, retaliation due to her highlighting pay irregularities. She provided her civil lawyer with a number of confidential documents in support of her allegations, which the board reported to a county prosecutor, who secured an indictment. Relying on an earlier decision of the state’s Supreme Court holding that an employer could not terminate an employee for the unauthorized taking of documents to support an employment discrimination case, the defendant moved to dismiss the indictment. The appeals court agreed with the trial court that this ruling did not extend to criminal cases. The court’s opinion expressed serious concerns about self-help measures supplanting the judicially supervised discovery process in discrimination claims. The state supreme court may yet weigh in.

What these developments suggest for companies handling internal investigations is that employers should tread carefully when faced with potential whistleblower claims. Whistleblower statutes can vary significantly from state to state, with those like California providing extensive protections to employees reporting issues in a variety of settings and circumstances. A thorough, thoughtfully- designed and well-documented internal investigation is essential before making adverse personnel decisions with respect to any potential whistleblower, regardless of jurisdiction or subject matter. But as Saavedra illustrates, these claims do not give employees carte blanche to take any action they want to support their claims. Employers should be vigilant in understanding and abiding by their obligations with respect to whistleblowers, but should also understand and consider the availability of legal remedies designed to protect their critical interests as well — including, in the right circumstances, reporting questionable whistleblower conduct to law enforcement authorities.