ICO Enforcement Actions Threatened, ICO Lawsuits Proliferate

According to the latest update on the Coinschedule website (here), there have been a total of 228 initial coin offerings so far this year through mid-October, raising a total of over $3.6 billion. At least five of this year’s ICOs have raised over $100 million. This burgeoning activity notwithstanding, ICOs are at the center of controversy. Among other things, China and South Korea have banned ICOs. The SEC has already shown its willingness to pursue enforcement actions against ICO sponsors, as discussed further here. And now a high-profile statement by one of the country’s leading securities regulation experts suggests even greater scrutiny may lie ahead. In the meantime, as discussed below, ICO and cryptocurrency-related litigation appears to be proliferating.

A November 26, 2017 New York Times article entitled “Initial Coin Offerings Horrify Former S.E.C. Regulator” (here) quotes Stanford Law Professor and former SEC Commissioner Joseph Grundfest as saying “ICOs represent the most pervasive, open and notorious violation of the federal securities laws since the Code of Hammurabi.” He went on to refer to the “almost comedic quality” of the securities law violation involved with ICOs. While noting that there have been relatively few enforcement actions involving ICOs, Grundfest clearly expects that there will be more. He said “We’re waiting to see a whole bunch of enforcement actions in this space, and we wonder why they haven’t happened yet,” adding “I hope what they are doing is planning on a sweep of 50 ICOs.”

The most obvious securities law objection to ICOs is that if the coin or token offered in the offering transaction is a security, the offering would be in violation of the federal securities laws if not registered with the SEC — which most are not. On the question of whether or not the coin or token is a security, ICOs sponsors will want to heed the recent words of SEC Chair Jay Clayton. As reported in the November 9, 2017 Wall Street Journal (here), Clayton commented at a recent securities law conference that “I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security.”

The Times article to which I linked above also quotes Clayton as saying that “Where we see fraud, and where we see people engaging in offerings that are not registered, we are going to pursue them because these types of things have a destabilizing effect on the market.”

So not only do you have a prominent legal scholar and former regulator calling for the SEC to crack down on ICOs but you have the current head of the SEC effectively saying that the agency intends to crack down on offerings that should have been registered but that were not.

While Professor Grundfest is critical of the SEC for not being sufficiently active in pursuing enforcement actions against ICO sponsors that should have but fail to register the offerings with the SEC, investors themselves may be taking matters in their own hands by pursuing their own remedies.

As I noted in a prior blog post about ICOs (here), investors in the Tezos ICO have launched a class action lawsuit against the offering company and certain of its executives. The July 2017 Tezos ICO, in which the sponsoring organization raised $232 million, has been mired in controversy. In early November, investors filed a purported class action lawsuit on behalf of investors who participated in the Tezos ICO. The lawsuit, which was filed in California state court, names as defendants The Tezos Foundation, which conducted the offering; Dynamic Ledger Solutions, which claims to own all Tezos-related intellectual property; and against Kathleen and Arthur Brightman, who organized the offering. In his complaint (a copy of which can be found here), the plaintiff alleges that the Tezos tokens were not registered with the SEC and that many of the representations that the offering’s sponsors made in the run-up to the offering were “either exaggerations or outright lies.”

On November 13, 2017, a second Tezos investor filed a separate class action lawsuit in connection with the Tezos ICO. This second lawsuit, filed in the Southern District of Florida, is also filed against the Tezos Foundation, Dynamic Ledger Solutions, and the Brightmans. Among other things, the Florida lawsuit seeks damages based on allegations that the defendants engaged in the unregistered offering of securities in violation of Sections 5(a) and 5© of the Securities Act of 1933, as well as in violation of the Florida securities laws. The Florida complaint (a copy of which can be found here) also alleges that the defendants engaged in fraud in connection with the sale of securities in violation of Section 17 of the ’33 Act and the equivalent section of the Florida securities statute. The complaint also asserts a count for unfair or deceptive trade practices. The Florida complaint also asserts a claim for rescission.

Now two more purported securities class action lawsuits have been filed in connection with the Tezos ICO. On November 26, 2017, another Tezos investor filed a purported securities class action lawsuit in the Northern District of California against the same defendants. A copy of the complaint in this lawsuit can be found here. This complaint also alleges that the Tezos ICO sponsors failed to register the offering with the SEC in violation of the securities laws, and the plaintiff seeks to have the transaction rescinded.

Finally, on November 28, 2017, another purported securities class action lawsuit was filed in the Northern District of California in connection with the Tezos ICO. This latest complaint (a copy of which can be found here) alleges that in violation of Sections 12 and 15 of the ’33 Act the Tezos ICO sponsors offered and sold unregistered securities. This latest action also seeks rescission of the transaction.

The various Tezos lawsuits have only just been filed and it remains to be seen how they will fare. Among other interesting issues that may have to be addressed in the lawsuits are the relevance and impact of various terms and conditions of the Tezos ICO. Among other things, the ICO terms and conditions purported to designate Swiss law as the governing law; designate in a forum selection clause  “the ordinary courts of Zug, Switzerland” as the designated forum; and to prohibit offering participants from participating in class actions. The claimants in the various lawsuits have already taken the position that these provisions are void or unenforceable. The effects of these provisions are among the many interesting issues that courts likely will have to address as these cases go forward.

It is worth noting that the Tezos lawsuits are not the first cryptocurrency-related class action lawsuits. As reported in an August 1, 2017 Daily Business Review article (here) in connection with a class action lawsuit filed in the Southern District of Florida against cryptocurrency exchange Project Investors, Inc. which did business as Cryptsy, Judge Kenneth Marra ordered the return of 11,000 bitcoins worth about $30 million at the  time. (At the time, bitcoins were trading at about $2,700; more recently they have been trading for over $10,000.) The plaintiff investors alleged that the defendant had stolen their money and fled to China. A default judgment was entered against the defendant, which failed to appear. The lawsuit was originally filed in February 2016.

The same law firm that filed the Cryptsy class action lawsuit also filed a purported class action lawsuit in July 2017 against Payward Incorporated, which operates the Kraken cryptocurrency exchange. The claimants contend they lost 3,414 units of the Ethereum cryptocurrency during a market flash crash.

ICOs may represent a new phenomenon, but the ICO landscape is already crowded with ICO and cryptocurrency-related litigation, and further enforcement action may yet follow. Whatever the ultimate business and financial promise of ICOs ultimately may prove to be, they do seem to promise a great deal of business for the ICOs law firms.

For a very detailed review of the “the federal and state regulatory onslaught in store for the purveyors of ICOs is imminent and will ensnare a broad range of ICO market participants,” please review to the guest post published earlier this month on this site, here.

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Sex, Golf, and the FTC

What do golf and sex have in common? According to the old joke: They’re two things you don’t have to be good at to enjoy. Similarly, some men – ok, most men – tend to exaggerate their prowess at both. You can add one more common trait: The FTC scrutinizes online continuity offers for the accessories associated with both, as the FTC last week settled a case involving lingerie and we blogged previously about the FTC’s golf ball ROSCA case, which settled recently. One final note on the connectivity between golf and lingerie: Supermodel and actress Kelly Rohrbach appeared in lingerie on the AdoreMe site and played college golf.

On November 20th, the FTC filed suit in New York against an online seller of lingerie for violating the FTC Act and Section 5 of the Restore Online Shoppers’ Confidence Act (ROSCA). According to the complaint, AdoreMe generates most of its revenue from its “VIP members.” For $39.95 a month, VIP members receive discounted prices, but are not charged if they buy apparel within the first five days of each month or affirmatively click a button to skip that month. If a consumer forgets to click the button or buy something within the first five days, the amount becomes store credit that supposedly can be used at any time. However, according to the FTC, many consumers were surprised to learn that the store credit could not be used at any time. The FTC alleged that AdoreMe failed to disclose that if a consumer cancelled their VIP membership, their store credit would be forfeited. The FTC sought $1.3 million for the forfeited store credit.

The FTC also alleged that the company erected a veritable “chastity belt” of barriers that made it difficult to cancel and violated ROSCA’s requirement that there be a simple method of cancellation. The barriers included: for a period of time only allowing cancellations via telephone, and not on the website that consumers used to enroll; for those consumers that did call subjecting consumers to half-hour-long wait times; for those who tried to cancel online, requiring consumers to navigate through three VIP promotional webpages and a five-question “quiz” before accepting the cancellation; and declining to accept cancellations when an order was being processed.

A settlement was announced with the complaint. In addition to requiring the return of the forfeited funds, the settlement bans future misrepresentations regarding the use of store credit or the terms of any negative option program. Furthermore, the order requires a simple cancellation mechanism to be provided that is not difficult, costly, or time consuming for the consumer to: (1) avoid being charged; and (2) immediately stop recurring charges. Specifically, the order requires providing a consumer who entered an order on the Internet with a web-based method to cancel, and, similarly, a person who entered over the phone with a telephone number to cancel.

The cancellation provisions are noteworthy because of the requirement that the cancellation method match the enrollment method. Such a requirement was considered when ROSCA was enacted, but rejected. The FTC has been trying to work that provision into its settlements with mixed results. A marketer who doesn’t allow consumers to cancel via the same method in which she orders probably will have the burden of proving their method works “simply.”

It’s also worth noting that the FTC did not challenge in the complaint or address in the order the continuity disclosures or consent mechanism, which have been the focus of most of the FTC’s ROSCA cases. A review of the continuity disclosures used by AdoreMe and the disclosures challenged by the FTC in other cases leads to the conclusion that the FTC requires much more rigorous disclosures and consent mechanisms for offers marketed with a free trial that converts to a negative option program than on programs that are offered as subscription models from day one.

Determining whether you’ve complied with the “clear and conspicuous” disclosure requirements of ROSCA and provided a “simple” cancellation mechanism is a tricky and somewhat subjective business. For marketers in the continuity space, consulting with skilled counsel in this area is important to make sure you don’t get caught with your pants down…and your lingerie showing.

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Chinese Preschools’ Child Abuse Reports Lead to U.S. Securities Suit Against Recent IPO Company

As I noted in a post last week discussing the derivative lawsuit and settlement involving 21^st Century Fox, allegations of failure to prevent alleged misconduct within company operations or at company facilities can translate into potential liability exposure for the company and its senior management. Another example of this phenomenon has emerged. In the weeks just after RYB Education completed its late September 2017 IPO, news reports began circulating of alleged child abuse at company preschool education facilities in China. Now a shareholder has filed a securities class action lawsuit in the U.S. against the company and certain of its executives. As discussed below, this new lawsuit represents the latest example of several different securities class action lawsuit filing trends.

Background

RYB is an early childhood educational service company registered in the Cayman Islands and based in Beijing. The company operates preschool educational facilities and child care centers under several brand names in China. According to Wikipedia, the company is the largest provider of early childhood educational services in China. The company completed an IPO on September 27, 2017. The company raised approximately $144 million in the offering. The company’s American Depositary Receipts (ADR) trade on the NYSE under the ticker symbol “RYB.”

Within weeks of the company’s completion of its IPO, media reports began circulating of abuses at the company’s preschool facilities. As discussed in a November 10, 2017 BBC News report (here), video footage reportedly surfaced allegedly showing abusive behavior toward children at one of the company’s facilities in Shanghai. The videos quickly went viral and were viewed by millions online. Additional stories followed days later, including disturbing reports that children at one of the company’s Beijing facilities were given injections and fed drugs. The reports also included alarming suggestions that children at the Beijing facility had been forced to strip naked and possibly had been subjected to sexual abuse. Later reports followed that teachers at the facility had been arrested and that the head of the Beijing facility had been fired. The price of company’s ADR’s declined as much as 40% on the news of these revelations, although they have recovered slightly since.

The Lawsuit

On November 27, 2017, an RYB Education ADR holder filed a securities class action lawsuit in the Southern District of New York against the company, its co-founder and CEO, and its CFO. The complaint purports to be filed on behalf of a class of persons who purchased ADRs in the company’s IPO, as well as on behalf of persons who purchased the company’s ADRs in the open market between September 27, 2017 and November 22, 2017.

According to the plaintiff’s counsel’s November 27, 2017 press release (here), the plaintiff’s complaint (a copy of which can be found  here) alleges that the defendants made false and misleading statements or omissions that: “(i) RYB failed to establish safety policies to prevent sexual abuse from occurring at its schools; (ii) RYB’s failure to remedy problems within its system exposed children to harm and unreasonable risk of harm while in the Company’s care; and (iii) as a result of the foregoing, RYB securities traded at artificially inflated prices during the Class Period, and class members suffered significant losses and damages.”

Discussion

In a post late last week about the shareholder derivative lawsuit and settlement involving 21^st Century Fox, I discussed how that case and settlement showed how the current wave of revelations of sexual misconduct in the U.S. could lead to claims against company management for failing to allowing or failing to prevent the misconduct. Although the allegations against RYB are very different from the kinds of misconduct allegations that beset 21^st Century Fox, the new securities lawsuit against RYB represents another kind of example of the way in which allegations of misconduct at company facilities or involving company personnel can translate into D&O exposure and potential liability.

The new lawsuit against RYB also represents an example of another phenomenon on which I have commented during recent months – that is, the phenomenon of event-driven securities litigation. As I discussed in an earlier post (here), there have been a number of event-driven suits filed this year, including, for example, the lawsuit filed against Arconic in wake of the Grenfell Tower fire, or the lawsuit filed against USANA Health Services after the company self-reported possible FCPA violations involving its Chinese facilities.

These cases (and the many other examples cited in the linked blog post) do not necessarily include the more traditional types of alleged securities law violations involving allegations of supposed financial misrepresentations or omissions.

Rather, these cases tend to involve situations in which the company supposedly failed to disclose an operational vulnerability or internal control weakness that subsequently resulted in an adverse development at the company causing a resulting decline in the company’s share price. These kinds of cases are one of the many causes of the increase in securities class action lawsuit filings during 2017. It is also worth noting that all of the cases I cited in my prior blog post involve the same plaintiffs’ law firm – as does the new lawsuit filed against RYB Education.

The RYB Education lawsuit also represents an example of a couple of other securities litigation filing trends. First, it is most obviously an example of the increased susceptibility to securities litigation that IPO companies face compared to companies whose shares have long been traded on the securities exchanges.

Second, it is an example of the heightened vulnerability of non-U.S. companies whose securities are listed on the U.S. exchanges to U.S. securities class action litigation. Only about 16% of the companies listed on the U.S. exchanges are non-U.S. companies. Of the 208 traditional securities class action lawsuits filed so far this year (that is, disregarding the federal court merger objection lawsuits), 48 (or about 23%) involve non-U.S. companies, suggesting that non-U.S. companies face a greater securities litigation risk than do domestic U.S. companies listed on the U.S. exchanges.

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Venable Joins GALA

We are pleased to announce that Venable has been accepted as a member of GALA (Global Advertising Lawyers Alliance). GALA is an alliance of lawyers located throughout the world with particular expertise and experience in advertising, marketing and promotion law. (Click here to go to the GALA website.) Being a GALA member will help us better serve our many clients whose marketing efforts now span the globe. Firms participating in GALA represent nearly 100 countries ranging literally from A (Anguilla) to Z (Zimbabwe). While most countries have only one member firm, the United States, given the size of its economy, has three member firms. GALA members meet periodically around the globe. Next week members from the Americas will be meeting in Panama and our own Melissa Steinman and Amy Mudge will be among the featured speakers. Venable is honored to have been invited to participate in GALA and we look forward to discussing its many benefits further with our clients.

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Guest Post: Do You Know Who Your Corporate Officers Are? An Overlooked Issue That Can Have Serious Consequences

Rachel W. Northup

Steven C. Hass

Directors and Officers liability insurance policies of course protect corporate directors and officers. Similarly, advancement and indemnification typically are available to corporate directors and officers. But who is an “officer”? As I have discussed in prior posts on this site (more recently here), this is an important question that can have significant implications. In the following guest post, Rachel W. Northup and Steven M. Haas of the Hunton & Williams law firm take a look at this important question and the significant issues it can involve. I would like to thank Rachel and Steven for their willingness to allow me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to publish a guest post. Here is Rachel and Steven’s guest post.

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An important but seldom asked question is:  do you know who your officers are?  You may think you do, but the legal answer to this question might surprise you.  Neither corporate statutes nor the courts provide a clear definition of a corporate “officer.”  In addition, many corporate charters and bylaws are unclear or even inconsistent in identifying their officers.  This can create significant issues for corporations as well as employees who erroneously assume they are officers – especially at large companies that liberally use officer-like titles throughout their ranks.

The lack of certainty about who is an officer could theoretically cause trouble in determining whether a person was authorized to sign a contract on the corporation’s behalf.  But a much more significant issue arises in the area of indemnification and advancement of legal expenses.  Most corporations obligate themselves through their charters and bylaws to indemnify and advance legal expenses to their “officers” in litigation, but it may not be clear which employees are officers entitled to those benefits.  From the corporation’s perspective, being required to advance expenses and ultimately indemnify a mid-level or even junior employee can be expensive.  It can also be both frustrating and embarrassing to the company when the employee is accused of serious misconduct, such as insider trading or embezzlement.  The rights to indemnification and advancement of expenses can be invoked in shareholder litigation and government proceedings, both criminal and administrative, but they can also apply to claims brought by the company against the former “officer.”  In other words, the company may have to fund the employee’s defense against the company.

This issue is also critical to employees.  Litigation in today’s world is expensive.  It requires experienced lawyers to defend lawsuits and appeals that may last for years.  An employee with an officer-like title may assume the corporation will cover the costs of litigation, only to learn after a serious lawsuit is filed that the corporation disputes his or her coverage.  Even if the employee ultimately prevails against the company, the employee is likely to incur a significant financial burden in enforcing his or her advancement and indemnification rights.

Delaware courts generally recognize a strong public policy supporting advancement and indemnification to protect persons serving a corporation.  When organizational documents are drafted inconsistently or ambiguously, courts are likely to construe the provisions in favor of the employee.  Still, both corporations and employees have risk where indemnification and advancement is not addressed with certainty.

A brief overview of advancement and indemnification

Advancement refers to the employee’s right to have the corporation pay his or her expenses in defending a claim as they are incurred.  Though advancement is not mandated by statute, corporations typically obligate themselves in their organizational documents to advance expenses to any officer who is sued by reason of the fact he or she is an officer.  The obligation applies as the expenses are incurred, thus requiring the corporation to fund the officer’s defense until the proceeding concludes.  A mandatory advancement obligation will apply regardless of how guilty the person may appear or how harmful to the corporation his or her behavior may be (e.g., the employee is caught with the proverbial bloody knife!).

Indemnification, in contrast, obligates the corporation to pay judgments, fines, penalties, or settlement amounts on behalf of the officer.  In other words, while advancement requires the corporation to pay the officer’s legal fees while the officer is defending the suit, indemnification obligates to the corporation to pay fines or settlements imposed on the officer as a result of the proceeding.  Unlike advancement, however, state corporation laws require that the officer must have either prevailed in the litigation or met a specified standard of conduct (e.g., acted in good faith and reasonably believed he or she was acting in the best interests of the company).  If the officer does not meet the standard for indemnification, the corporation may recover all expenses previously advanced (although the officer may be insolvent by that point).  Similar to their provision of mandatory advancement, most corporations obligate themselves to indemnify their officers to the fullest extent permitted by law.

The public policy behind advancement and indemnification is to encourage capable individuals to serve as corporate officials by assuring them that, if they are sued by reason of the fact that they were serving the corporation, the corporation will bear the risks resulting from the performance of their duties.  Otherwise, directors and officers might be reluctant to make important decisions out of the fear of being personally liable.  The costs of mounting a complex legal defense against shareholder derivate suits, governmental investigations, criminal prosecutions and similar cases are often too great for an individual to bear alone.

Mandatory indemnification and advancement of expenses for corporate directors and officers is nearly universal in the United States.  Moreover, some companies go further and obligate themselves to advance and indemnify employees.  Other companies take a permissive approach in dealing with employees that allows the company to make case-by-case decisions based on the circumstances.  Whether to take a mandatory or permissive approach to protecting employees is a decision for each company to make.  But, as described below, problems can arise when a company is not clear on its position.

So, who is an “officer”?

There is no statutorily prescribed definition of “officers.”  Indemnification and advancement provisions in organizational documents often refer to coverage for “officers” generically.  In that case, the analysis often turns on the corporate bylaws governing officer appointments.  Bylaws often simply provide for a president and/or chief executive officer, secretary and treasurer, and other officers appointed by the board or by other officers to whom the board delegates appointment powers, including vice presidents.

In some cases, it will be clear that the only officers are persons whose titles are specifically authorized in the bylaws or who are elected by the board.  In other cases, it may not be clear whether a person who was not appointed by the board is nevertheless an “officer.”  This latter scenario seems to occur most often at companies that use officer-like titles liberally, such as banks and other financial institutions where it sometimes seems like anyone from middle-management has the title of “vice president.”

Court decisions interpreting who is an officer do not add much clarity.  One of the most publicized cases in this area involved a former computer programmer and vice president of a large financial institution who was criminally prosecuted for stealing valuable computer code before leaving his job.  The computer programmer was one of many vice presidents within the financial institution, was given the title of vice president in his offer letter signed by another vice president, and had no management or supervisory functions.  A federal appeals court found the corporation’s bylaws to be ambiguous in defining officers, but it refused to resolve the ambiguity in favor of the employee’s eligibility for advancement of expenses.  In a separate but related proceeding, the Delaware Court of Chancery held that because of the federal court’s ruling on the issue, the state court could not allow the employee to re-litigate whether he was an officer.  However, the Delaware judge did offer his rationale for why he would have ruled for the employee, including the following:

• the corporation drafted its bylaws unilaterally and was in the best position to remove ambiguities;
• a slate of officers including a vice president is common;
• a person with the title of “vice president” could normally assume he or she was an officer entitled to advancement;
• the corporation’s bylaws included vice presidents in its set of officers and also allowed officers who were elected by the board to appoint other officers;
• the corporation was responsible for the ambiguity by liberally designating its employees as “vice presidents”;
• a vice president does not need to have supervisory or managerial functions to be an officer; and
• public policy favors advancement and indemnification.

 

Other Delaware court decisions analyzing officer status involving alleged serious misconduct by employees have likewise emphasized the corporation’s unilateral control over drafting organizational documents and its ability to ensure its officers are defined clearly and consistently.

Conclusion

The question of who, exactly, is a corporate officer is rarely asked, but it could have significant consequences.  A corporation may unexpectedly find itself obligated to cover a present or former employee’s hefty litigation expenses arising from serious misconduct.  Conversely, an employee who thought he or she had protection in litigation may be surprised to be left footing the bill – which, for an individual, could result in bankruptcy.  Many corporations would benefit from a closer review of their bylaws and use of officer titles.  Revising the bylaws with greater specificity can set expectations now and avoid protracted litigation later.  Moreover, there is nothing that prohibits the company from voluntarily covering its employees’ legal expenses on a case-by-case basis.

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Rachel Northup is of counsel and Steven Haas is a partner at Hunton & Williams LLP.  The views expressed in this article are solely those of the authors and do not necessarily represent their firm or its clients.

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Government-judiciary tug of war on public display again http://ift.tt/2Adqkyl

Government-judiciary tug of war on public display again http://ift.tt/2jomnPu;

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The ruling establishment appears less than enthusiastic about submitting itself to the highest forum of our democracy http://ift.tt/2AdqhTb

The ruling establishment appears less than enthusiastic about submitting itself to the highest forum of our democracy http://ift.tt/2jpwR0N;

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Divide between the higher judiciary & Law Ministry shows http://ift.tt/2AAdBc4

Divide between the higher judiciary & Law Ministry shows http://ift.tt/2A8pV2G;

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SEC Fiscal Year Enforcement Statistics Reflect an Agency in Transition

On November 15, 2017, when the SEC Enforcement Division released its annual report detailing its enforcement activity during the preceding fiscal year, the report included a statement by the division’s co-directors detailing the division’s priorities for the coming year. As detailed below, the enforcement statistics in the report clearly reflect an agency in transition. The changes under the new administration are particularly apparent with regard to the agency’s enforcement activities involving publicly traded companies. The Enforcement Division’s annual report can be found here. The division’s November 15, 2017 press release about the report can be found here.

FY 2017 Enforcement Activity

The division’s overall FY 2017 enforcement statistics appear to reflect a drop in enforcement actions compared to the prior fiscal year, but this apparent drop is largely a reflection of activity during the prior year related to the Commission’s Municipalities Continuing Disclosure Cooperation (MCDC) initiative. Thus, with the MCDC actions taken into account, the agency’s 446 standalone actions during the 2017 FY appear to be significantly below the 548 standalone actions in FY 2016. However, if the MCDC actions are disregarded, the 446 standalone actions in FY 2017 are only slightly below the 464 standalone enforcement actions in FY 2016, representing a year-over-year drop of only about 4%. Again disregarding the MCDC actions, the 754 total actions in 2017 is only slightly below the 784 total number of actions in FY 2016, also representing a drop of about 4%.

In terms of monetary recoveries, the enforcement division recovered a total of $3.789 billion during FY 2017, representing a drop of about 7 percent from the $4.083 billion recovered in FY 2016. Interestingly the amount recovered in disgorgements in FY 2017 actually increased slightly compared to the prior year; in FY 2017, the agency recovered $2.957 billion in disgorgements in FY 2017, compared to $2.809 billion in FY 2016. The amount recovered in terms of penalties declined in the most recent year; the agency recovered $832 million in penalties in FY 2017 compared to $1.273 billion in FY 2016. The report details how the vast bulk of the amounts recovered are attributable to a very small number of large cases. In terms of both penalties and disgorgements, well over two thirds of the amounts recovered are attributable to the top 5% largest cases.

Enforcement Trends Involving Public Companies

While the statistics appear to reflect activity levels during FY 2017 largely consistent with the prior year, a more detailed look at the division’s activity reveals significant declines in several activity measures during the second half of the year, particularly with respect to enforcement activity involving public companies.

A November 14, 2017 report from Cornerstone Research and the NYU Pollack Center for Law & Business entitled “SEC Enforcement Activity: Public Companies and Subsidiaries, Fiscal Year 2017 Update” (here) shows that while there were 62 new enforcement actions filed against public companies and subsidiaries in FY 2017, there were only 17 new actions in the fiscal year’s second half, compared to 45 in the year’s first half. As the report notes, “the timing of this drop corresponds with leadership changes at the SEC.”

Overall, the number of new enforcement actions against public companies and their subsidiaries declined by 33 percent in FY 2017 compared to the prior year. While there were 10 FCPA actions filed against public companies and their subsidiaries in FY 2017, only two were filed after February 2017. The decline in the number of FCPA actions corresponds with the departure of the head the SEC’s FCPA unit, who had led the unit since 2011.

In a November 14, 2017 Law 360 article commenting on the SEC’s FY  2017 enforcement activity (here), NYU Law Professor Stephen Choi (one of the contributing authors to the Cornerstone Research and NYU report) also notes a decline in penalties against public companies and their subsidiaries both between FY 2016 and FY 2017 and between the first half of FY 2017 and the second half of the year. In FY 2016, the average public company settlement was $26.7 million in fines and disgorgements and in 2017 it was $21 million. But in the first half of 2017 the average settlement was $23.2 million, compared to only $14 million in the second half.

The Law 360 article also quotes Professor Choi as saying that activity levels and recoveries involving public companies in the second half of the year represent a “pretty dramatic drop” that clearly means that “something has changed.” However, he also cautioned that it’s too early to tell if these sudden declines are due to leadership shakeups at the agency, a drier pipeline of cases, or a broad policy shift in the enforcement program.

The New Administration’s Changing Enforcement Priorities

However the enforcement statistics may be interpreted and whatever they may foretell about future enforcement activity and trends, the enforcement division’s leadership has in fact been signaling a change in approach to enforcement in general. For example, as detailed in an October 26, 2017 Wall Street Journal article (here), SEC Enforcement Divisions co-director Steven Peikin, speaking at a recent securities conference, indicated that the agency will “pivot away from the prosecutorial approach” the agency has pursued since the financial crisis. In particular the agency will drop the “broken windows” strategy of pursuing many cases over even the smallest violations. Because of budget constraints, the Journal quotes Peikin as saying, the agency is going to have to be selective and bring a few cases to send a broader message rather than sweep the entire field.

In the enforcement division’s recent annual report, Peikin and his fellow division co-director, Stephanie Avakian, did lay out their overall enforcement priorities that will guide the agency’s activities going forward. The division’s priorities will be built around five “core principles” that will guide the division’s decision making: focus on the Main Street investor; focus on individual accountability; keep pace with technological change, impose sanctions that most effectively further enforcement goals; and constantly assess the allocation of resources.

The co-directors’ point about individual accountability is reinforced in the statistics in the division’s annual report. Consistent with the co-directors’ statement that “pursuing individuals has continued to be the rule not the exception,” since new SEC Chair Jay Clayton took office earlier this year, one of more individuals has been charged in more than 80% of standalone enforcement actions that the agency has brought. In FY 2017, 73 percent of the agency’s standalone enforcement actions involved charges against one or more individuals, the same percentage as in FY 2016.

With respect to the co-directors’ stated priority to keeping pace with technological change, the division’s report notes that at the end of the fiscal year, the division announced the creation of a Cyber Unit that will focus on what the co-directors called “among the greatest risks facing our securities markets. The unit will focus, among other things, on market manipulation schemes and activities by hackers to access material nonpublic information, as well as violations involving distributed ledger technology and initial coin offerings (ICOs). The division’s September 25, 2017 press release announcing the formation of the Cyber Unit can be found here.

Please also see the accompanying post about SEC whistleblower activity in FY 2017.

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SEC Whistleblower Program Continues to Surge

The SEC’s whistleblower program is now entering its seventh year. The SEC’s Office of the Whistleblower’s November 15, 2017 annual report to Congress underscores that the agency’s whistleblower program continues to grow and remains an important part of the agency’s enforcement efforts. The number of whistleblower reports submitted to the agency once again increased in the 2017 FY, and the whistleblower reports continue to lead to significant enforcement recoveries, as well as to significant bounty awards to the whistleblowers, as detailed below. The Office of the Whistleblower’s 2017 report can be found here.

According to the report, there were 4,484 whistleblower reports to the SEC in FY 2017, representing an increase of about 6.3% over the prior fiscal year. The number of whistleblower report in FY 2017 is nearly 50 percent greater than the number of reports in FY 2012, the first full-year period in the whistleblower program. Since the program’s inception in August 2011, the agency has received 22,818 whistleblower reports. The number of reports the agency has received has increased each year that the program has been in existence.

During the 2017 FY, the most common complaint in whistleblower reports  involved corporate disclosures and financials (19%), offering fraud (18%), and manipulation (12%). 210 of the reports during the 2017 FY (about 4.6%) related to the Foreign Corrupt Practices Act.

The agency received whistleblower reports from all 50 states and from the District of Columbia. The states with the highest number of whistleblower reports were California (500), New York (438), Texas (250), and Florida (229).

Many of the whistleblower reports come from abroad. The agency received whistleblower reports from 72 different countries. Since the program’s inception, the agency has received reports from individuals in 114 different countries outside the U.S. During FY 2017, the agency received over 550 reports from foreign individuals, representing about 12 percent of reporting individuals in FY 2017. The non-U.S. countries with the highest number of reporting individuals were the United Kingdom (84); Canada (73); Australia (48); China (39); and Russia and Mexico, both with 26.

The vast majority of whistleblower reports (62%) come from insiders (including current or former employees, consultants, and affiliates), with other reports coming from investors or prospective investors (19%) and various outsiders (15%).

The report emphasizes that the “demonstrable benefits of the program continue to materialize” and that the program has “provided tremendous value to the SEC’s enforcement efforts.” The agency has returned hundreds of millions of dollars to investors as a result of actionable information that whistleblowers brought to the agency. The report notes that the agency has ordered wrongdoers in enforcement matters involving whistleblower information to pay over $975 million  in total monetary sanctions, including more than $671 million in disgorgement of ill-gotten gains and interest, the majority of which has been (or will be) returned to harmed investors.

These many recoveries have also lead to a number of whistleblower bounty awards. During the program’s existence the agency has awarded approximately $160 million to 46 individuals. In the most recent fiscal year, the awards totaled nearly $50 million to 12 individuals. Three of the ten largest all-time whistleblower awards were made during FY 2017, including the third-largest all-time award, an award of more than $20 million in November 2016.

A significant part of the report is devoted to reporting on the agency’s efforts to battle actions taken in retaliation against whistleblowers, as well as actions by employers’ use of confidentiality, severance, and other measures and practices to “interfere with individuals’ ability to report potential wrongdoing to the SEC.” The report notes that during the 2017 FY, the SEC brought a number of enforcement actions to address instances where companies unlawfully retaliated against their employees or impeded their ability to report to the SEC.

As detailed in a November 22, 2017 Law 360 article discussing the SEC’s whistleblower report (here), it remains unclear whether or to what extent the Trump administration and the SEC’s new leadership will continue to support the whistleblower program. However, as a number of commentators in the article note, it seems unlikely that the administration would move to cut or eliminate a program that has led to nearly $1 trillion in recoveries.

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