LA 365 Exam 3 Notes PDF

Class 8 – Rule 10b-5 Class Actions Civil lawsuit brought on behalf of a group of people / business entities who have suffered common injuries as a result of defendant conduct Advantages ○ Practical for Plaintiffs ○ Aggregate damages / Fair distribution...

Class 8 – Rule 10b-5 Class Actions Civil lawsuit brought on behalf of a group of people / business entities who have suffered common injuries as a result of defendant conduct Advantages ○ Practical for Plaintiffs ○ Aggregate damages / Fair distribution ○ Practical for courts Securities Personal Injury / Product Liability Consumer Employment Stages of Class Actions Suit Filed Class Representative Class Certification ○ Numerosity ○ Commonality ○ Typicality ○ Adequacy Notice to Class (opt-in / opt-out) Rule 10b-5 1. Plaintiff purchaser or seller of a security 2. Defendant made material misrepresentation 3. Defendant acted with scienter 4. Plaintiff relied on the misrepresentation 5. Plaintiff suffered damages caused by the false/misleading statement What is a Material Misrepresentation? Matrixx Initiatives v. Siracusano Facts: Matrixx makes and sells Zicam Cold Remedy 70% of Matrixx’s sales Matrixx Initiatives v. Siracusano (Part I) Facts, continued: Previous studies linked ingredient (Zinc) to loss of smell Presentation at medical conference about link between Zicam and loss of smell Nine plaintiffs filed four lawsuits Matrixx Initiatives v. Siracusano (Part II) Matrixx’s Public Statements: Zicam “poised for growth in the upcoming cough and cold season” Company has “very strong momentum” Revenues “be up in the excess of 50% and that earnings, per share for the full year would be in the 25 to 30 cent range” Matrixx Initiatives v. Siracusano (Part III) Matrixx’s Public Statements: 10-Q Warned for “potential material adverse effect” Product liability actions could materially affect Matrixx’s “product branding and goodwill” DID NOT disclose plaintiffs had already sued Matrixx Matrixx Initiatives v. Siracusano (Part IV) FDA Report warned of product danger and to discontinue use Matrixx shares drop 68% same day Matrixx’s Press Release after FDA report: ○ “completely unfounded and misleading” ○ “overall incidence of adverse events … was extremely low” Matrixx Initiatives v. Siracusano (Part V) Defense: Failure to plead material misstatement or omission and scienter Failure to allege a “statistically significant correlation between the use of Zicam and anosmia so as to make failure to publicly disclose complaints and University of Colorado study a material omission” Materiality Standard of Materiality: There is a substantial likelihood a reasonable investor would consider it important in making a securities-related decision (“Substantial likelihood” = probably) Matrixx Initiatives v. Siracusano (Part VI) Do you need statistical significance to establish materiality? Statistical significance is not the only reliable indication of causation Ethical considerations may limit testing to prove statistical significance Other factors relevant: strength of association, consistency of finding, temporal relationship Matrixx Initiatives v. Siracusano (Part VII) So what do you disclose? Adverse events are daily occurrences “Something more” is needed, but that something more is not limited to statistical significance Context matters Matrixx Initiatives v. Siracusano (Part VIII) Applying the standard here – who wins? Plaintiffs – Motion to Dismiss Denied Matrixx received information that plausibly indicated a reliable causal link Were made aware of previous studies 70% of their sales, so commercial viability important MD&A Disclosures Item 303 of Securities and Exchange Commission Regulation S-K requires the disclosure, in a company’s management discussion and analysis (MD&A), of “any known trends or uncertainties … that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 117 C.F.R. § 229.303(a)(3)(ii). Item 303 Liability Under 10b-5 Ninth Circuit: Item 303 does not create a duty to disclose under 10b-5 ○ Nvidia Corporation Securities Litigation Second Circuit: Item 303 creates duty to disclose material information under 10b-5 ○ Stratte-McClure v. Morgan Stanley Macquarie Infrastructure Corp. v. Moab Partners, L.P. (Part I) Failure to disclose sulfur content in No. 6 fuel oil in public offering documents Regulation adopted lowering maximum sulfur content 2018 – Macquarie announced decrease in contracts due to decline in No. 6 oil market = 41% drop in stock price Moab sued alleging 10b-5(b) failure to disclose material information about the adoption of the regulation (Item 303 of S-K) Macquarie Infrastructure Corp. v. Moab Partners, L.P. (Part II) District Court dismissed Moab’s complaint Second Circuit Court of Appeals reversed Supreme Court – “pure omissions” are not actionable under 10b-5(b) even when there is a duty to disclose omitted information under Item 303 “half truths” vs. omissions Precludes claims based on silence What About SPACs? Viability of Proprietary Technology History of Misconduct / Investigations Business Operations Inflated Sales Projections Inaccurate Production Timelines Failure of Reasonable Due Diligence Scienter (Part I) PSLRA pleading standard: State with particularity facts giving rise to a strong inference that “defendants acted with the intent to deceive or with deliberate recklessness as to the possibility of misleading investors” In re HP Securities Litigation (Part I) August 2011: HP acquired Autonomy for over $11B November 2012: HP announced it had been a victim of fraud and wrote down 85% of purchase price After November 2012: HP Stock Price declined In re HP Securities Litigation (Part II) Hewlett-Packard spent more than $10 billion to acquire Autonomy in October 2011, but subsequently wrote off $8.8 billion of the purchase as the result of what it termed to be “serious accounting irregularities” by Autonomy prior to the deal. In re HP Securities Litigation (Part III) May 23, 2012: Autonomy Whistleblower comes forward PwC Investigation launched November 2012: HP announces that it was recording an $8.8 billion impairment charge, claiming that a majority of the charge was due to accounting improprieties, misrepresentation and disclosure failures at Autonomy. In re HP Securities Litigation (Part IV) Class Action: November 2012, by lead plaintiff PGGM Vermogensbeheer B.V., alleged that HP and other named defendants "knew or should have known" that "corporate governance firms, auditors, media and analysts had questioned Autonomy's market value due to concerns about its accounting practices, and whether its reported growth rates and margins had been artificially inflated." Scienter (Part II) Did “defendants acted with the intent to deceive or with deliberate recklessness as to the possibility of misleading investors?” In re HP Securities Litigation (Part V) "First, the complaint fails to establish any coherent motive as to why Defendants would knowingly purchase a company for several times its actual value or that they knew Autonomy's accounting was problematic," Breyer wrote. "It is implausible that had Defendants known about the fraud being perpetrated on them before the deal closed that they would have gone ahead with the deal." In re HP Securities Litigation (Part VI) Court ruled that the case could only center on statements made by the defendants about Autonomy following May 23, 2012 Pre-May 23, 2012: No scienter Post-May 23, 2012: Scienter Reliance Basic v. Levinson “Fraud on the Market” Theory Assumption that in an open and developed market, price reflects all publicly available information Plaintiff must show that the misstatements made into a public securities market Loss Causation (Part I) Plaintiff must show the the lagged misrepresentation or omission resulted in the claimed losses Dura Pharmaceuticals, Inc. v. Broudo Loss Causation (Part II) Normally plaintiffs show a change in stock prices when the misrepresentation were made and then an opposite change when corrective disclosure made Dura Pharmaceuticals v. Broudo (Part I) Dura made misrepresentations about approval of medical device When Dura announced its earnings would be lower than expected, share prices dropped 8 months later, Dura announced FDA would not approve device Next day share price fell but recovered in a week Dura Pharmaceuticals v. Broudo (Part II) To prove “loss causation” in a securities fraud case, is it sufficient to show that the price of the security on the date of purchase was inflated because of misrepresentation? Dura Pharmaceuticals v. Broudo (Part III) No. The Supreme Court held that an inflated purchase price did not by itself prove "loss causation." At most, an inflated purchase price suggested that misrepresentation "touched upon" a later economic loss, but did not necessarily cause it. The Court reasoned that at the moment the transaction took place, the plaintiff had not suffered a loss because the inflated purchase price was offset by ownership of a share that possessed equivalent value at that instant. Further, the logical link between the inflated purchase price and any later economic loss was not invariably strong, because other factors may have affected the price. Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. Liability for Those That Assist Fraud No aiding and abetting liability in private right of action under §10(b) Drafting a false statement is not “making” it under 10b-5; must have authority to release and control statement Secondary Liability Reliance is required ○ Here, plaintiffs did not rely on defendant’s deceptive misconduct Defendants had no duty to disclose Their deceptive acts were not disclosed to the markets Scheme Liability (Part I) Defendants’ deception of auditors was too remote from issuer’s fraudulent financial statements Scheme Liability (Part II) PSLRA provides SEC with authority to prosecute aiding and abetting cases ○ Underlying violation ○ Secondary actor acted knowingly or recklessly ○ Substantial assistance to violator Lower courts have denied secondary liability for lawyers and other professionals who created for facilitated fraudulent transactions Cyber Security Class Actions Dish Network ○ Overstated operational efficiency and maintained a deficient cybersecurity framework ○ Disclosed “network” outage but later admitted to cyber incident (6% decline in stock) Block (formerly known as “Square”) ○ Failure to disclose December 2021 material data data breach affecting millions of customers ○ January 31, 2022: Afterpay acquisition Class 9 – Government Enforcement of Securities Violations Non-Judicial Enforcement: SEC Stop Offering Suspend Trading Cease and Desist Orders Bar Officers and Directors Broker-Dealer Sanctions Regulatory Exams Rules and Regulations SEC and FINRA Examinations ○ Produce policies, procedures, records, complaints, board/committee minutes ○ Remediation plan submitted and approved “Supervisory Guidance” ○ Designed to create a safe harbor, NOT create new rules SEC Settlements and Consent Decrees 90% of SEC enforcement actions are settled by consent decree ○ Why? Target neither admits nor denies SEC allegations / fault Wells Notice from SEC Wells Submission from target In the Matter of Mattel 2017: Material misstatements in valuation allowance: $109 MM uncorrected Error 2019: Form 8K - Whistleblower Letter Restated 2017 Financials Disclosed material weaknesses in internal controls CFO Fired / $3.5 MM Fine In the Matter of Abrahams Individual action against Mattel’s auditor $109 MM accounting error No materiality analysis conducted No internal control deficiency analysis Failed to inform Mattel Audit Committee SEC v. Jarkesy On June 27, 2024, the U.S. Supreme Court issued its long-awaited decision in SEC v. Jarkesy. In its holding, the Court found that when the Securities Exchange Commission seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial and thus the SEC must bring the action in federal court. While the SEC has limited the number of enforcement actions it brings in the administrative process in recent years, given the substantial costs associated with federal court litigation, Jarkesy may force the SEC to be more selective in its future enforcement efforts. More broadly, the Jarkesy decision calls into question whether any federal regulatory agency—not just the SEC—can bring in-house proceedings to enforce civil penalties. This is particularly noteworthy, because although some agencies (such as the SEC) may choose whether to pursue civil penalties in federal court or via an in-house administrative proceeding, other agencies, such as the Occupational Safety and Health Review Commission, are only statutorily authorized to pursue enforcement through in-house proceedings. WILLFULLY Securities Act § 24(a) Willful violation of Registration requirements or antifraud standards Up to… ○ 5 years in prison and… ○ $10,000 fine Exchange Act § 32(a) Market fraud and insider trading Up to… ○ 20 years in prison and ○ $5M fine for individuals or… ○ $25M fine for corporations WILLFULLY: U.S. v. Kaiser Kaiser's argument re: Willfully? ○ Willfulness require knowledge of illegality What does the Court decide? ○ Willful does not require knowledge of violation of the law in securities cases ○ Higher standard in insider trading doesn’t require higher standard here: insider trading doesn’t necessarily involve deception Final standard on willful? ○ Prosecution must show that defendant knew his actions were wrongful US v. Berman Facts of the case 10b-5 Violations Other charges? On April 12, 2024, defendant Berman was sentenced to 84 months of imprisonment to be followed by 3 years of supervised release. The government has been ordered to provide a restitution figure to the Court 60 days after sentencing. SOX: 18 U.S.C. § 1348 (Part I) Whoever knowingly executes, or attempts to execute, a scheme or artifice… (1) To defraud any person in connection with … any security of an issuer with a class of securities registered under section 12 …; or (2) To obtain, by means of fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of … any securities of an issuer … Shall be fined under this title, or imprisoned not more than 25 years, or both." SOX: 18 U.S.C. § 1348 (Part II) Section 807: Officer Liability Section 802: alter / falsify / destroy records Knowing may be a lower standard than willful Broader than Rule 10b-5 because no trading required ○ But only in public companies Mail and Wire Fraud: 18 U.S.C. §§ 1343 and 1341 Criminal prosecution of any person who: 1. Engages in fraudulent scheme or falsely obtains property or money, and 2. Accomplishes the scheme or false pretenses through the use of interstate wire communications or the mails Prison up to 20 years Carpenter v. U.S. Heard on the Street column Discussed stocks or groups of stocks Potential of affecting the price of stocks Misappropriation Theory: “Frontrunning” Carpenter v. U.S.: Securities Violations Who was the victim of the Fraud? ○ The Wall Street Journal Why was the fraud in connection with the purchase or sale of securities? ○ Scheme’s purpose for to buy and sell securities at a profit based on the column ○ Doesn’t matter that the newspaper had no interest in the securities traded Carpenter v. U.S.: Mail & Wire Fraud (Part I) Mail and Wire Fraud requires scheme to defraud of property rights What property rights were stolen here? ○ Journal’s business information (contents of the column) does not make it any less property ○ Intangible property is protected under Mail and Wire Fraud statutes Carpenter v. U.S.: Mail & Wire Fraud (Part II) What about the mail and wire? ○ Sending the Wall Street Journal to its customers Class 10 – Broker-Dealer and Investment Advisor Regulation Regulation of Securities Professionals SEC Registration Financial Industry Regulatory Authority Stock Exchange Rules SEC Anti Fraud Rules State Laws Definitions Broker: Any person engaged in the regular business of effecting securities transactions for the account of others Dealer: Any person engaged in buying and selling securities for his own account Investment Advisor: Any person who, for compensation, engages in the business of advising others as to investing, purchasing, or selling securities Who NEEDS to Register as a Broker-Dealer? Anyone who executes securities transactions for others Includes Private Placements (Reg. D) Finders / Business Brokers Marketers of Real Estate Investments Persons that Provide Support Services Who DOES NOT NEED to Register as a Broker-Dealer? Issuers Intrastate Broker Dealers Limited to Excluded/Exempted Securities Certain Foreign Broker Dealers (Rule 15a-6) Licenses Series 6 License: Limited Investment Securities License: can sell packaged investment products such as mutual funds, variable annuities, etc. Series 7 License: General Securities Representative License: can sell virtually any type of security. Series 63 License: Uniform Securities Agent License: required by each state and authorizes licensees to transact business. Required of all Series 6 and 7 License holders. Series 65 License: Financial planners, investment advisors, and brokers that handle managed money accounts. Finders The SEC currently requires finders who receive fees based on the size or successful completion of securities transactions to register as broker-dealers. To help startups that need assistance in fundraising, the SEC has proposed an exemptive order that would allow finders to receive transaction-based fees without broker-dealer registration, under certain circumstances. The proposed order could help facilitate capital-raising efforts by startup and early-stage companies. SEC and FINRA Supervision Form BD: All securities firms as well as non-associated individuals that operate as a broker or dealer in interstate securities markets must register with the SEC Operating standards, training, experience, and competence Subject to Examinations and Audits Form U5 Defamation Disputes CRD Central Registration Depository (CRD), which is the system FINRA oversees for licensing and registration of member firms and associated persons. Information in the CRD is relied upon for several important functions, including alerting FINRA and other state regulators where there could be disciplinary matters. In addition, the general public, including prospective employers and investors, also can view CRD-generated reports for detailed information about financial advisors and broker-dealer firms, on BrokerCheck. Form U5 (Part I) Filed within 30 days of termination event Voluntary / Deceased Permitted to Resign / Discharged / Other: A member firm is required to provide a narrative explanation of the reason for the associated person’s separation. If the terminated employee violated any securities industry rules or regulations, the employer must provide an explanation of the violations. The employer must explain if the terminated employee was under any internal investigation for the violation. Form U5 (Part II) If the termination of the employee is a full termination, firms also are required to complete the disclosure questions located in Questions 7(A) through 7(F) of the Form U5. Firms must disclose whether a terminated representative was: 1. The subject of an investigation by a governmental body or self-regulatory organization concerning investment-related business; 2. Under internal review for fraud or wrongful taking of property, or violating investment-related statutes, regulations, rules, or industry conduct standards; 3. Charged, convicted, or pleaded no contest to any felonies, or to certain misdemeanors; 4. The subject of any disciplinary action by a governmental body or self-regulatory organization with jurisdiction over investment-related business; 5. Named in customer-initiated arbitration or civil action alleging they engaged in certain sales practice violations; or 6. Discharged, permitted to resign, or voluntarily resigned after allegations were made accusing the representative of fraud or wrongful taking of property, or violating investment-related statutes, regulations, rules or industry conduct standards, or failing to supervise in connection with investment-related statutes, regulations, rules, or industry conduct standards. Regulation of Public Offerings Gun Jumping Rules Underwriter Liability: Accuracy of offering information (subject to due diligence defense) Dealer Liability: Accuracy of investor communications (prospectus / oral communications) Disclosure Rule 10b-5 Exchange Act Section 15(c)(1) Securities Act Section 17(a) Disclosure of Conflicts Rules of Conduct Know the Customer Know the Security Suitability of Investments ○ Department of Labor – Fiduciary Standard? Reasonable Commissions Churning – When is trading excessive in a discretionary account? ○ Annual Turnover Ratio Regulation Best Interest Disclosure: Written disclosures of scope and terms of customer relationship Duty of Care: Must exercise reasonable diligence, care, and skill when making recommendations Conflicts of Interest: Written policies and practices to address conflicts of interest Compliance: Must establish, maintain, and enforce written compliance policies Penny Stocks and Boiler Rooms Classic Pump and Dump Scams Other Market Manipulation Scams Stifel, Nicholas & Company, Qatalyst Partners, Inc. Issues? Why were the outcomes in these matters different? Message from SEC? Inspire Investing, LLC Inspire’s Investment Strategy? What went wrong? Remedial Actions? Analyst Conflicts Potential conflicts when recommendations involve companies with which the firm has an investment banking relationship Merrill Lynch Fraud ○ Analyst Compensation ○ Creation of Firewall ○ Disclosure of Client Relationships SEC v. Blodget 1. The Commission brings this action against defendant Henry McKelvey Blodget to redress his violations of the Securities Exchange Act of 1934 ("Exchange Act"), pertinent rules thereunder, and pertinent rules of NASD Inc. ("NASD") and the New York Stock Exchange, Inc. ("NYSE"). 2. During the period January 1, 1999 to December 31, 2001 (the "relevant period"), Blodget was a Managing Director and the senior research analyst at Merrill Lynch Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), covering the Internet sector. 3. During the relevant period, Blodget issued research reports on one Internet company, GoTo.com, that violated antifraud provisions of the federal securities laws, and issued research reports on six other Internet companies that expressed views inconsistent with privately expressed negative views as discussed below. These reports violated NASD and NYSE rules that require, among other things, that published research reports have a reasonable basis, present a fair picture of the investment risks and benefits, and not make exaggerated or unwarranted claims. Customer Rights Customer Arbitration Clauses FINRA Arbitration 3 Person Panel – Industry Experts Limited Discovery Suitability Cases ○ KYC Customer at account opening: Risk Tolerance Investment Experience Investment Style Investment Advisor Regulation Investment Advisors Act of 1940 Any person who, for compensation, engages in the business of advising others as to securities values or the advisability of securities investments Mutual Fund Regulation Governed by the 1940 Act Open-End Funds  Closed-End Funds Exchange Traded Funds (ETFs) Mutual Fund Fees Shareholder Fees ○ Sales charge (front-end load) ○ Deferred sales charge (back-end load) Operating Fees; Management Fees Marketing Fees: 12b-1 Fees Disclosure Requirements Impact of Fees on Fund 12b-1 Fees: NPB Financial The SEC's order finds that from January 2014 through March 2019, NPB purchased, recommended, or held for advisory clients mutual fund share classes that charged 12b-1 fees, including when lower-cost share classes of the same funds were available to the clients. According to the order, NPB and its associated persons received 12b-1 fees in connection with these investments, but NPB did not disclose this practice or the conflict of interest. The order also finds that NPB breached its duty to seek best execution by causing certain advisory clients to invest in fund shares that charged 12b-1 fees when share classes of the same funds were available to the clients that presented a more favorable value under the particular circumstances in place at the time of the transactions, and that NPB failed to adopt and implement written compliance policies and procedures reasonably designed to prevent these violations. Private Funds Venture Capital Funds Hedge Funds Private Equity Funds Impact of Dodd-Frank Act ○ Must now register with SEC as Investment Advisors ○ Carve out for venture capital advisors and funds with less than $150MM AUM Credit Rating Agencies 2008 Financial Crisis - CDOs Dodd-Frank Act: New rules for credit agencies ○ Accountability 1933 Securities Act Section 11 Liability 1934 Exchange Act Liability ○ Internal Controls Must maintain effective internal controls SEC reporting obligations  Class 11 – Insider Trading What is Insider Trading? The buying or selling of company stock or securities for a profit based upon information that is not readily available to the public Violation of civil law and criminal law Why is insider trading illegal? Market efficiency Unfair advantage Encourage investment Others? What would ethical frameworks say about insider trading? Social Justice: Insiders have an obligation to create a fair market, not capitalize on insider information. Libertarian: Free Market doesn’t work with insiders trading on non-public information. Utilitarianism: Victimless crime? Insider Trading: The Law Where does insider trading liability come from? Rule 10b-5: Trading on material, non-public information is a “deceptive device” under 10(b) because a relationship of trust and confidence exists between the shareholders of the corporation and the insiders. Duty to Abstain or Disclose if the person obtains the information in a relationship of trust or confidence (fiduciary relationship). Strangers Is an eavesdropper liable for trading after overhearing a CEO tell his wife that the company might be liquidated? ○ No! Strangers have no relationship to the source of the material, non-public information – therefore no duty to disclose or abstain. Insiders: Duty to Abstain or Disclose Chiarella v. United States Employee of financial printer figured out identity of takeover targets and traded. Chiarella not guilty of insider trading because he had no duty to the shareholders with whom he traded. He had no fiduciary relationships to the target companies or their shareholders. Misappropriation: Outsider Trading US v. O’Hagan Misappropriation is a violation of §10(b). Deceived the source that entrusted O’Hagan (his client Grand Met) with non-public information. Used the information (obtained through deception) to purchase/sell securities. Pre-Existing Trading Plans A Defense to Insider Trading Good faith binding contract to trade security when unaware of inside information. Pre-existing trading strategy either explicitly specified amount, price and date; included formula for determining, or disabled the person from influencing trades. Trade accorded with pre-existing strategy. Constructive Insiders Temporary Insiders: lawyers, accountants, investment bankers - are viewed as having the same 10b-5 duties as corporate insiders. Family members are constructive insiders where there is an expectation of confidentiality. Tipper/Tippee: Dirks (Part I) Dirks was an officer of a broker-dealer specializing in analysis of insurance companies. Received information from Secrist about the assets of Equity Funding. Dirks investigated and discussed the information with a number of clients. Clients sold their holdings of Equity Funding securities. Tipper/Tippee: Dirks (Part II) Tippee does not acquire duty to disclose or abstain just by obtaining information Tippee’s duty to disclose or abstain is derivative from that of the insider’s duty. ○ Tipper must be breaching fiduciary duty AND ○ Tippee must know that the insider has breached fiduciary duty. ○ Personal benefit to the Tipper (fact specific). Tipper/Tippee: Dirks (Part III) Neither Secrist nor other Equity Funding employees personally benefited by providing information to Dirks. They did not intend to make a gift of valuable information to Dirks. Because no breach of duty to shareholders by these insiders, no derivative breach by Dirks. Dirks had no duty to abstain or disclose. Tipper/Tippee: Dirks (Part IV) There are objective facts and circumstances that often justify such an inference. For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient. Tipper/Tippee: Salman v. U.S. Salman traded on the basis of tips received from his friend Michael Kara, who received those tips from Salman’s brother-in-law and Michael’s brother, Maher Kara. Tipper (Maher Kara) did not receive pecuniary benefit for the tips. Salman v. U.S.: The Issue Can a tippee be held liable for insider trading under Section 10(b) of the Securities and Exchange Act of 1934 and the SEC’s Rule 10b-5 when the tipper did not obtain a pecuniary benefit? Salman v. U.S. – Who Won? The U.S. won: A gift of confidential information to a trading relative is sufficient to create a personal benefit in the tipper, so as to hold the tippee liable for insider trading. The tipper need not obtain money or property. Salman v. U.S. – Personal Benefit Defining a personal benefit in Dirks, the Court held that a breach can occur when an insider makes a gift of confidential information to a trading relative or friend. Maher, the tipper, provided inside information to his brother Michael. That gift of information is sufficient under Dirks. It is no different than Maher trading himself, and giving the proceeds to Michael as a gift. The tipper (Maher) benefits either way. Here it is easy to prove, because Maher tipped Michael to help him through difficult financial times. In Sum: What Government Has to Prove Regulation FD (Fair Disclosure) Intentional Disclosure: Must disclose inside information to public simultaneously with disclosure to selected analysts / investors Unintentional Disclosure: Issuer must disclose the information to the public promptly (within 24 hours) Example Memorandum Pre-Existing Trading Plans Rule 10b5-1(c) Plans: Allow insiders to trade in company stock Shadow Trading On August 17, 2021, the SEC charged a former employee of Medivation Inc., a mid-sized oncology-focused biopharmaceutical company, with insider trading based on trades he made in advance of the company's announcement that it would be acquired by Pfizer Inc. The trades were not, however, in Medivation shares, but in shares of Incyte Corporation, a comparable mid-cap oncology-focused biopharmaceutical company, that had traded similarly to Medivation after a previous announcement of a merger in their sector. Class 12 – Anti-Money Laundering / U.S. Foreign Corrupt Practices Act Bank Secrecy Act / AML Programs (Part I) Bank Secrecy Act Authorizes the Secretary of the Treasury to issue regulations requiring financial institutions (including broker-dealers) to keep records and file reports on financial transactions that may be useful in investigating and prosecuting money laundering and other financial crimes. The Financial Crimes Enforcement Network (FinCEN), a bureau within the Treasury, has regulatory responsibilities for administering the BSA. Rule 17a-8 under the Securities Exchange Act of 1934 (Exchange Act) requires  broker-dealers to comply with the reporting, recordkeeping, and record retention rules adopted under the BSA. Bank Secrecy Act / AML Programs (Part II) 2001 U.S. Patriot Act Amended and strengthened the BSA. It imposed a number of AML obligations directly on broker-dealers, including: ○ AML compliance programs ○ Customer identification programs ○ Obtaining beneficial ownership information and customer due diligence ○ Monitoring, detecting, and filing reports of suspicious activity; ○ Due diligence on foreign correspondent accounts, including prohibitions on transactions with foreign shell banks ○ Due diligence on private banking accounts ○ Mandatory information-sharing (in response to requests by federal law enforcement) ○ Compliance with “special measures” imposed by the Secretary of the Treasury to address particular AML concerns. Bank Secrecy Act / AML Programs (Part III) Suspicious Activity Reports (SARs) A broker-dealer is required to file a suspicious activity report if: (i) a transaction is conducted or attempted to be conducted by, at, or through a broker-dealer; (ii) the transaction involves or aggregates funds or other assets of at least $5,000; and (iii) the broker-dealer knows, suspects, or has reason to suspect that the transaction: a) Involves funds derived from illegal activity or is intended or conducted to hide or disguise funds or assets derived from illegal activity as part of a plan to violate or evade any federal law or regulation; b) Is designed to evade any requirements set forth in regulations implementing the BSA; c) Has no business purpose or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or d) Involves use of the broker-dealer to facilitate criminal activity. C.L. King & Associates and Miller CLK fined $292,000 and CCO fined $20,000 and suspended in all principal capacities for 3 months for failing to establish an appropriately designed AML system. Firm liquidated almost 12 million shares of penny stocks for 2 customers, one of which was a Liechtenstein–based bank, generating $19.26 million in proceeds. SEC v. Alpine Securities The SEC's complaint alleges that Alpine Securities Corporation routinely and systematically failed to file SARs for stock transactions that it flagged as suspicious. When it did file SARs, Alpine Securities allegedly frequently omitted the very information that formed the bases for Alpine knowing, suspecting, or having reason to suspect that a transaction was suspicious. As noted in the complaint, guidance for preparing SARs from the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN) clearly states that "explaining why the transaction is suspicious is critical." The SEC's complaint charges Alpine Securities with thousands of violations of Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-8. TD has been placed under multiple consent orders, requiring significant remediation and corrective actions on its AML program The Bank received the largest Bank Secrecy Act (BSA)-related penalty imposed on a financial institution to date, paying a combined fine of approximately $3 billion USD, while admitting to criminal violations The compliance program was found deficient in monitoring and reporting potentially suspicious transactions. Violations included: ○ Failing to maintain a comprehensive AML program that would meet BSA standards, ○ Failing to file timely Suspicious Activity Reports (SARs), and ○ Allowing a substantial backlog of alerts or unmonitored transactions. TD Bank failed to allocate sufficient resources to maintain a robust AML program, leaving approximately $18.3 trillion of transaction activity inadequately monitored between 2018 and 2024. Specific deficiencies included a lack of automated transaction monitoring for certain activities and inadequate controls for traditionally "lower risk" peer-to-peer, checks, and Automated Clearing House (ACH) transactions. Consent orders impose operational constraints and oversight measures on TD Bank, including an asset cap and stringent approval processes for new bank products, services, markets, and stores in the U.S. According to the Consent Order, TD Bank had long-term, pervasive, and systemic deficiencies in its U.S. AML policies, procedures, and controls but failed to take appropriate remedial action according to language in the regulatory orders and court documents. Regulatory Orders The Bank has consented to orders with multiple agencies: Office of the Comptroller of the Currency (OCC), Federal Reserve Board, and Financial Crimes Enforcement Network (FinCEN). Including plea agreements with the Department of Justice, TD pleaded guilty to conspiring to fail to maintain an anti-money laundering (AML) program that complies with the BSA, fail to file accurate Currency Transaction Reports (CTRs), and launder money. Press Releases and Headlines “TD Bank created an environment that allowed financial crime to flourish. By making its services convenient for criminals, it became one” – U.S. Attorney General Merrick Garland Media "TD Bank hit with record $3 billion fine over drug cartel money laundering" - CNN "TD Bank Shares Fall After $3 Billion Money Laundering Settlement" - Forbes "A huge bank pleaded guilty to conspiring to launder money, so why weren't top executives charged?" - LA Times Regulators "TD Bank allowed its AML program to languish, making TD Bank a target for illicit actors—including its own employees..." - FinCEN "The bank’s blatant risk management failures attracted illicit actors and are egregious and unacceptable," - OCC "TD Bank prioritized growth and convenience over following its legal obligations," - DOJ TD Bank Securities Class Action The TD Bank class action lawsuit alleges that defendants throughout the Class Period made false and/or misleading statements and/or failed to disclose material adverse facts concerning the true state of TD Bank’s anti-money laundering (“AML”) program; pertinently, TD Bank concealed or otherwise minimized the significance of the failures of TD Bank’s AML program and made no indication that the imposition of an asset cap or other punitive or compliance measures would be imposed that would undermine TD Bank’s continued growth for the foreseeable future. Foreign Corrupt Practices Act The Foreign Corrupt Practices Act (FCPA) addresses the problem of international corruption in two ways: (1) the anti-bribery provisions prohibit individuals and businesses from bribing foreign government officials in order to obtain or retain business; and, (2) the accounting provisions impose certain recordkeeping and internal control requirements on issuers and prohibit individuals and companies from knowingly falsifying an issuer’s books and/or records or circumventing or failing to implement an issuer’s system of internal controls. Violations of the FCPA can lead to civil and criminal penalties, including fines, disgorgement of profits, and/or imprisonment. FCPA Anti-Bribery Provisions Jurisdiction Issuers under the Exchange Act of 1934 Domestic Concerns: Citizens, national, or resident of the U.S. Territorial Jurisdiction: Foreign nationals / entities within the territory of the U.S. Business Purpose Test The FCPA applies to payments intended to induce or influence a foreign official to use his or her position "in order to assist…in obtaining or retaining business for or with, or directing business to, any person." This requirement is known as the "business purpose test" and is broadly interpreted. Examples Winning a contract Influencing the procurement process Circumventing the rules for importation of products Evading taxes or penalties Influencing the adjudication of lawsuits or enforcement actions Obtaining exceptions to regulations Avoiding contract termination Bribes to Customs Officials Improper Travel and Entertainment FCPA Bribery Safe Harbor Facilitating / Expediting Payments To further routine government action involving non-discretionary acts: ○ Visa processing fees ○ Supplying utilities ○ Police protection Focus on purpose of the payment FCPA Bribery Affirmative Defenses Local Law Defense: Payments in question legal under written local law (rarely used) Reasonable/ Bona Fide Expenditure: Travel/lodging expenses to a foreign official where expenses are directly related to the promotion, demonstration, or explanation of a company’s products or services, or related to the execution/performance of a contract. FCPA Accounting Provisions (Part I) In addition to the anti-bribery provisions, the FCPA contains accounting provisions applicable to public companies. The FCPA’s accounting provisions operate in tandem with the anti-bribery provisions and prohibit off-the-books accounting. The accounting provisions are designed to “strengthen the accuracy of the corporate books and records and the reliability of the audit process which constitute the foundations of our system of corporate disclosure.” FCPA Accounting Provisions (Part II) Books and Records Provision Internal Controls Provision Bribes have been mischaracterized as: ○ Commissions or Royalties ○ Consulting Fees ○ Sales and Marketing Expenses ○ Scientific Incentives or Studies ○ Travel and Entertainment Expenses ○ Supplier / Vendor Payments ○ "Customs Intervention" Payments SEC v. Coburn and Schwartz Gordon J. Coburn – Former President Steven Schwartz – Former Chief Legal Officer Chennai, Tami; Nadu, India Campus FCPA Violations? Civil Penalty + Disgorgement → $25MM Department of Justice → Criminal Charges Exam 17 December 2024 6:00pm – 8:00pm