In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important SEC enforcement developments from the past month, with links to primary resources. This month we examine:
- The SEC’s continued focus on crypto;
- A no-penalty settlement in a case involving executive perks in which the SEC recognized the entity’s self-reporting and cooperation;
- Two accounting-related enforcement actions against a SPAC auditor and a nutritional supplement company;
- An SEC settlement with a registered broker-dealer and investment adviser related to the deletion of millions of emails, which were required to be preserved; and
- Charges against 13 defendants in four separate alleged insider trading schemes.
1. SEC Alleges That Coinbase Operated as an Unregistered Exchange Amidst Requests for Regulatory Clarity
On June 6, 2023, the SEC filed charges against Coinbase, Inc. (“Coinbase”), alleging violations of the registration provisions of the securities laws and contending that Coinbase operates its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency and that it failed to register the offer and sale of its crypto asset staking-as-a-service program, which the SEC claims is a security. The SEC also sued Coinbase Global Inc. for certain violations, alleging that it is a control person of Coinbase.
The SEC claims that since at least 2019, Coinbase has merged broker, exchange, and clearing agency functions but has not registered with the Commission in these capacities. The SEC alleges that Coinbase earns revenue from collecting transaction fees from investors and claims that these investors are deprived of disclosures and protections afforded by registration. The SEC further alleges that certain crypto assets that are made available for trading on Coinbase’s platforms are securities.
The SEC’s complaint also includes allegations that Coinbase conducted an unregistered securities offering through its staking-as-a-service program. According to the SEC, investors’ crypto assets are pooled and “staked” by Coinbase in exchange for rewards, which the SEC claims Coinbase distributes to investors after taking a commission. The SEC takes issue with the fact that Coinbase never filed a registration statement for its offers and sales of the staking program.
For its part, Coinbase filed an answer denying all of the charges and recently filed a letter notifying the court of its intent to file a motion for judgment on the pleadings that will argue that neither the tokens listed on the exchange nor the staking services are securities and, therefore, the SEC lacks jurisdiction to bring the case. Additionally, as discussed in our May SEC Top 5, Coinbase filed a writ of mandamus that seeks regulatory clarity for the crypto industry. In a notable development, Coinbase has achieved an incremental victory, as the Third Circuit has directed the SEC to provide a status update on Coinbase’s petition for crypto rulemaking. The SEC requested—and received—until October 11, 2023, to provide the update.
Separately, on June 5, 2023, the SEC filed a complaint against Binance Holdings Limited, which operates a leading global cryptocurrency exchange platform known as Binance.com, its founder Changpeng Zhao, Zhao’s U.S.-based exchange platform, BAM Trading Services Inc., and BAM Management US Holdings, Inc. for violations of the securities laws, including allegations of operating as an unregistered exchange, conducting unregistered offers and sales of crypto assets, and making misleading public statements. The SEC brought 13 non-scienter-based charges against the defendants under the Securities Act of 1933 and the Securities Exchange Act of 1934.
#ClarityInCrypto #RegulatoryCertainty
2. Stanley Black & Decker’s Cooperation in Perquisites Investigation Leads to No-Penalty Settlement
On June 20, 2023, the SEC settled with Stanley Black & Decker Inc. (SBD), for failing to disclose at least $1.3 million of perquisites and personal benefits provided to four executive officers and one director, but declined to impose a civil penalty in light of SBD’s self-reporting and cooperation. The undisclosed perks “predominantly related” to use of the corporate jet. That same day, a former SBD senior executive officer settled charges for allegedly causing SBD to violate proxy solicitation and books and records provisions. The SEC alleged that this senior executive officer failed to identify over $647,000 of perks and personal benefits that he received—including chauffeur services, meals, apparel, and other personal expenses—on a questionnaire that executive officers were required to complete as part of the proxy statement preparation process. Both settlements were on a neither-admit-nor-deny basis.
Notably, SBD avoided civil penalties. The SEC’s settled order notes that SBD “promptly” ensured that external counsel conducted an internal investigation under the oversight of a special committee of independent directors, self-reported a failure to disclose the perks while the internal investigation was ongoing, cooperated with the staff’s investigation, and imposed remedial measures. Division of Enforcement Director Gurbir Grewal stated that the SBD action “reaffirm[ed] the [SEC’s] commitment to . . . incentivizing self-reporting and cooperation when entities and individuals discover violations of the federal securities laws.” For his part, the senior executive who was charged paid a $75,000 civil penalty, in addition to consenting to other relief.
#DoesCooperationWork? #IndependentInternalInvestigationsMatter
3. SEC Brings Separate Accounting-Related Enforcement Actions Against SPAC Auditor and MusclePharm Executives
On June 21, 2023, the SEC settled an enforcement action against Marcum LLP, a national accounting firm, alleging “systemic quality control failures and violations of audit standards” in connection with audit work done for hundreds of special purpose acquisition companies (SPACs). The SEC alleged that Marcum’s SPAC work “vaulted” the firm to the position of fifth‑largest public company auditing firm, as measured by number of clients, and that this growth strained Marcum’s public company practice. According to the SEC, Marcum’s own inspections revealed audit deficiencies but that the firm failed to remediate them, and Marcum lacked adequate staff for the SPAC work the firm took on, among other deficiencies. For example, the SEC alleged that Marcum did not properly archive audit documentation for six or more months following the date of the report or other issuance, and audit documents were frequently maintained only within engagement team members’ email communications. Despite this, the SEC claimed that Marcum implemented a six-month auto delete policy on all emails for its SPAC practice in March 2021. As another example, the SEC also claimed that Marcum lacked sufficient policies, procedures, and monitoring related to work paper signoffs and that missing signoffs ranged from 10 to 50%. The SEC also claims that Marcum lacked sufficient policies, procedures, and monitoring for the assembly and retention of audit documentation, email retention, and documentation related to departed personnel.
SEC Chair Gary Gensler continued the SEC’s auditors-are-gatekeepers theme, noting that “Marcum neglected its essential gatekeeper function in service to its own growth. Marcum took on more than 600 new SPAC clients for a nearly six-fold increase in just one year, churning out audits at an unsustainable pace causing widespread quality control and audit standard violations that put its clients and the investing public at risk.” Without admitting or denying the SEC’s allegations, Marcum consented to an order finding that it engaged in improper professional conduct within the meaning of SEC Rule of Practice 102(e), violated audit standards across many engagements, and violated Regulation S-X Rule 2-02(b)(1), and agreed to pay a $10 million civil penalty, among other relief. The enforcement action against Marcum follows the SEC’s heightened scrutiny of the SPAC boom.
In a separate accounting-related enforcement action, on June 27, 2023, the SEC filed a settled complaint against three former executives and a litigated action against the former CEO, of nutritional supplement company MusclePharm Corp. The settled complaint alleges, among other violations, that the three former executives—formerly MusclePharm’s Executive Vice President of Sales and Operations, Vice President of Sales, and contract Chief Financial Officer—aided and abetted the company’s reporting, books and records, and internal controls violations. The SEC alleged that the former VP of Sales and Operations and the contract CFO violated the antifraud provisions of the securities laws and that the VP of Sales knowingly circumvented internal controls. In sum, the SEC alleged that the three executives reported inflated revenues by prematurely booking sales for unshipped orders that remained under MusclePharm’s control, and certain revenue was overstated by misclassifying customer credits as advertising expenses rather than reductions to revenue. The SEC contended that these actions artificially inflated the company’s publicly reported quarterly revenues by up to 25% and gross profits by up to 49%. The three executives settled with the SEC on a neither-admit-nor-deny basis and agreed to monetary relief, although one of them is litigating the civil penalty amount.
In the litigated action, the SEC contends that the former CEO committed securities fraud and aided and abetted MusclePharm’s securities fraud, reporting, books and records, and internal controls violations. According to the SEC, the former CEO misled investors about the company’s default with institutional noteholders and falsely certified that he had evaluated its internal controls. The SEC seeks injunctive relief, civil penalties, and clawback of bonuses, incentives, and equity-based compensation under SOX Section 304(a).
#ScrutinyforSPACs #FinancialCompliance
4. SEC Reaches $4 Million Settlement with a Large Investment Bank’s Wholly Owned Subsidiary for Lost Emails
On June 22, 2023, the SEC imposed a civil monetary penalty on a broker-dealer and investment advisor that is a wholly owned subsidiary of a major investment bank (the “Registrant”) as part of a $4 million settlement addressing allegations that the Registrant deleted approximately 47 million emails in about 8,700 email mailboxes, many of which the SEC alleged were business records that were required to be retained for three years under Exchange Act Section 17(a) and Rule 17a-4(b)(4).
According to the SEC, in 2012, the Registrant engaged a vendor to manage its electronic documents. That vendor periodically represented to the Registrant, and to FINRA, that its media storage complied with Rule 17a-4(b), including the 36-month retention period for all emails. In 2016, the Registrant undertook a project to delete documents that were no longer required to be retained. In 2019, a team working on that project discovered that the vendor had failed to properly apply the default 36-month retention setting to emails with a necessary domain, which resulted in the deletion of those emails from January 1 to April 23, 2018. The emails were not recoverable. The Registrant reported the deletion event to the SEC.
The Registrant did not admit or deny wrongdoing but consented to a cease-and-desist order, a censure, and a civil penalty. The SEC’s order noted that the Registrant implemented its own 36‑month retention coding procedures, updated its procedures to prohibit deletion tasks to be run on electronic documents still subject to retention requirements, and required that any employee seeking to run a deletion task first obtain senior-level information officer approval.
#RecordKeepingError #DataLossPrevention
5. SEC Brings Insider Trading Charges Against 13 Defendants in Four Alleged Insider Trading Schemes
On June 29, 2023, the SEC filed four insider trading enforcement actions in the U.S. District Court for the Southern District of New York (“SDNY”). The SDNY United States Attorney’s Office announced parallel criminal charges in each of these matters.
First, the SEC charged three individuals, Bruce Garelick, Michael Shvartsman, and Gerald Shvartsman, and Michael Shvartsman’s firm, Rocket One Capital LLC (“Rocket One”), with insider trading in connection with SPAC Digital World Acquisition Corporation’s (“DWAC”) October 2021 announcement that it would acquire Trump Media & Technology Group Corp. (“TMTG”). According to the SEC, while serving as a member of DWAC board of directors and an employee of Rocket One, Garelick tipped his boss, Michael Shvartsman, who then shared the tips with his brother, Gerald Shvartsman. The Shvartsman bothers then purchased DWAC shares on the open market and sold their positions when DWAC announced that it merged with TMTG for profits of almost $23 million. The SDNY United States Attorney’s Office criminally charged Garelick and the Shvartsmans.
Second, the SEC charged two individuals for insider trading in connection with call options in Pfizer, Inc. (“Pfizer”). According to the SEC, Amit Dagar, a Pfizer employee at the time, tipped his close friend and business partner, Atul Bhiwapurkar, that Pfizer’s COVID-19 antiviral treatment, Paxlovid, was successful before Pfizer’s November 5, 2021, public announcement of the same. The SEC alleged that on November 4, 2021, Dagar learned MNPI about the success of the trial and, around four hours later, bought short-term, out-of-the-money Pfizer call options, including options that expired the next day. Dagar tipped Bhiwapurkar that same day, and Bhiwapurkar bought similar call options. The complaint alleges that the two individuals realized one-day investment returns of 791%. The SDNY United States Attorney’s Office criminally charged Dagar and Bhiwapurkar.
Third, the SEC charged five individuals, including a Massachusetts police chief in connection with alleged insider trading before the announcement of a tender offer by Alexion Pharmaceuticals, Inc. to acquire Portola Pharmaceuticals, Inc. in May 2020. According to the SEC, Joseph Dupont, an Alexion executive, tipped his close friend Shawn Cronin, a police chief. Cronin then tipped two friends—Jarrett Mendoza and Stanley Kaplan—and Kaplan tipped his friend Paul Feldman. The SEC alleges that Kaplan and Feldman tipped family and friends, who also traded. Cronin, Mendoza, Kaplan, and Feldman all profited, and other traders who received alleged MNPI from Kaplan or Feldman profited to the tune of $1.7 million. The SDNY United States Attorney’s Office criminally charged all five individuals.
Fourth, the SEC charged registered representative Jordan Meadow and Stanley Teixiera, the CCO of an international company, with trading on the basis of MNPI that Teixeira got from his girlfriend’s laptop while she was working at home during the COVID-19 pandemic. Teixeira’s girlfriend was an executive assistant at a major investment bank. According to the SEC, Teixiera misappropriated information about upcoming public company mergers and acquisitions from his girlfriend’s laptop and then bought call options and tipped others, including Meadow. Teixiera and Meadow both made allegedly illegal profits and Meadow recommended trades on the basis of MNPI to his brokerage customers, resulting in millions in profits for the customers and hundreds of thousands of dollars in commissions for Meadow. The SDNY United States Attorney’s Office criminally charged Teixiera and Meadow.
#RemoteWorkMNPI #CallOptionsScrutiny
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