Top 5 SEC Developments (September 2023)

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:

• A string of settled charges for alleged violations of the Whistleblower Protection Rule;
• Charges against an electronic trading firm and its broker-dealer subsidiary for allegedly making false and misleading disclosures regarding protecting customer trading data and preventing trader access to material non-public information (“MNPI”);
• Settled charges against a registered investment adviser for alleged misstatements regarding the integration of environmental, social, and governance (“ESG”) factors into its investment process;
• Two revenue recognition enforcement actions against public companies and certain senior executives for accounting fraud and misleading disclosure violations; and
• Enforcement sweeps focused on alleged violations of the Marketing Rule and failures by both corporate insiders and the public companies where they worked to timely report holdings and transactions of public company stock.

1. SEC Enforces Violations of Whistleblower Protection Rule Based on Employment Agreement Language

During September, the SEC announced settled charges against three separate entities—including one private company—for violations of Securities Exchange Act of 1934 Rule 21F-17 (the “Whistleblower Protection Rule”). This rule prohibits any actions taken to impede an individual from communicating with the SEC about a potential securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. The SEC charged Monolith Resources, LLC, an energy and technology company; CBRE, Inc., a real estate services and investment firm; and D. E. Shaw & Co., L.P., a registered investment adviser (collectively, the “Charged Entities”). In each of these instances, the SEC found that the Charged Entities had allegedly disincentivized, discouraged, and/or impeded whistleblowers from contacting the SEC about potential violations of the federal securities laws.

The settlements highlight the SEC’s continued enforcement of whistleblower rule violations and shine a light on employee separation agreement considerations. In each settled action, the SEC found that the Charged Entities had been requiring departing employees to sign agreements with language that the SEC alleged violated the Whistleblower Protection Rule.

Monolith Resources: The SEC alleged that between 2020 and early 2023, Monolith, a private company, used separation agreements that required certain departing employees to waive their rights to monetary whistleblower awards. Although the agreements didn’t limit an employee’s right to file a complaint or charge, it stated that employees had no “right to recover money damages or other . . . relief awarded” by the government agency. The SEC stated that it considered Monolith’s remedial actions, which included revising the agreements and contacting employees who had signed prior versions, in determining to accept Monolith’s settlement offer of a $225,000 civil penalty and a cease-and-desist order.

CBRE: The SEC alleged that between 2011 and 2015, CBRE furnished departing employees with a separation agreement that contained a representation that the employee had not filed a complaint against CBRE with any federal agency, among other authorities. Although CBRE amended this agreement in 2015 to carve out complaints to the SEC, the SEC alleged that this change was “prospective in application” and did not remedy the language used originally. CBRE consented to a $375,000 civil penalty and a cease-and-desist order.

D. E. Shaw: D. E. Shaw consented to a $10 million civil penalty and a censure, among other relief, in connection with allegations that, from at least 2011 through 2023, it conditioned the receipt of deferred compensation for approximately 400 of its departing employees on signing agreements affirming that they had not filed complaints against D. E. Shaw with any government agencies or officials. Further, the SEC alleged that from at least 2011 through 2019, D. E. Shaw required new employees to sign agreements, as a condition of employment, prohibiting them from disclosing confidential information outside the company without D. E. Shaw’s authorization, with no exception for whistleblowers.

These settlements serve as a stern reminder that the SEC continues to police employment agreement language and will seek hefty civil penalties for provisions that could be read to impede whistleblowing. For earlier actions focused on the Whistleblower Protection Rule, read our Client Alerts from June 2022 and February 2023.

#WhisteblowerProtection #EmploymentAgreementCompliance

2. SEC Charges Global Market Maker for False and Misleading Disclosures Regarding Efforts to Protect Customer Trading Data and Prevent Access to MNPI

On September 12, 2023, the SEC filed charges in the Southern District of New York against public company Virtu Financial Inc., one of the country’s largest electronic trading firms, and its broker-dealer subsidiary, Virtu Americas LLC (collectively, “Virtu”), for making allegedly false and misleading statements about how it safeguarded confidential customer trading data and for failing to establish, maintain, and enforce policies and procedures reasonably designed to prevent the misuse of MNPI. As of the date of the SEC’s complaint, the SEC claimed that Virtu processed about 25% of market orders placed by U.S. retail investors and that its proprietary traders “had nearly unfettered access” to MNPI about its institutional customers’ trades. Notably, the SEC did not allege that anyone at Virtu accessed or used customer identifying information or MNPI in an inappropriate manner.  

The SEC alleged that Virtu purported to use “information barriers” to wall off its order execution service for large institutional clients from its proprietary trading desk, through which the broker-dealer subsidiary traded for its own benefit. According to the SEC, between approximately January 2018 and April 2019, Virtu failed to safeguard a database that contained post-trade information generated from customer orders, including customer identifying information and other MNPI. The SEC alleges the database was accessible to virtually everyone at the broker-dealer subsidiary and its affiliates through widely known and frequently shared generic usernames and passwords. During this period, Virtu allegedly misled customers and investors about these inadequate safeguards, communicating to customers that its policies and procedures adequately protected client information and that only certain employees could access customers’ post-trade data, when in fact Virtu’s proprietary traders had access.

The SEC charged Virtu with violating Sections 17(a)(2) and (3) of the Securities Act and Section 15(g) of the Exchange Act and seeks injunctive relief, disgorgement and prejudgment interest, and civil penalties.

According to a press release issued by Virtu, “[i]n a routine SEC exam in 2019, Virtu voluntarily disclosed to SEC staff that for a limited period during 2018 and early 2019, certain post-trade data in its back-office database was hypothetically accessible to a broader group of employees than intended.”

#SensitiveCustomerInformation #SafeguardScrutiny #HonestyInDisclosures

3. SEC Reaches $19 Million Settlement with a Large Registered Investment Adviser for Environmental, Social, and Governance (ESG) Investment Process Misstatements

On September 25, 2023, the SEC announced settled charges with Deutsche Bank AG subsidiary, DWS Investment Management Americas Inc. (“DIMA”), a registered investment adviser. The SEC alleged that DIMA violated the Investment Advisers Act of 1940 by making materially misleading statements about its integration of ESG factors into its investment process.

According to the SEC, DIMA marketed itself as a leader in ESG that adhered to policies for integrating ESG considerations into its investment advice. A senior DIMA leader claimed in 2019 that DIMA had a proprietary “ESG Engine” that was the “centerpiece” of its commitment to integrate ESG into its investment process. According to the SEC, however, from approximately August 2018 until late 2021, DIMA failed to implement certain provisions of its global ESG policy when advising on ESG integrated products. The SEC found that, although DIMA marketed its ESG integration process by having the ESG Integration Policy available on its website, DIMA lacked the processes that were necessary to consistently monitor or demonstrate its implementation of this policy. The SEC also alleged that DIMA identified gaps in implantation, but failed to remove the policy from its website.

The SEC found that DIMA violated Section 206(2) of the Advisers Act, which can be based on a finding of negligence, as well as Section 206(4) and Rules 206(4)-7 and 206(4)-8. DIMA agreed to a cease-and-desist order, censure, and a monetary penalty of $19 million to settle the SEC’s charges. In reaching the settlement, the SEC said it considered both remedial acts undertaken and cooperation efforts by DIMA. In tandem with this settlement, the SEC also announced settled charges with DIMA for separate anti-money laundering related violations. DIMA agreed to a cease-and-desist order and $6 million penalty in the anti-money laundering settlement.

#ESGFactors #ImplementESG

4. SEC Brings Actions Against Individuals and an Issuer for Accounting and Disclosure Fraud

The SEC brought two notable accounting cases in September. On September 28, 2023, the SEC announced a litigated enforcement action against former CFO Edward O’Donnell and Chief Commercial Officer Victor Bozzo of Pareteum Corp., a now defunct New York-based telecommunications company, and settled charges against Pareteum’s former controller, Stanley Stefanski. On September 29, 2023, the SEC announced settled charges against Newell Brands Inc. (“Newell”), a Georgia-based consumer products company, and its former CEO, Michael Polk.

In the first case, the SEC alleged that from at least 2018 through mid-2019, O’Donnell, Bozzo, and Stefanski engaged in a scheme to improperly recognize revenue for customers’ non-binding purchase orders for SIM card services despite knowing that customers had not committed to paying for the services unless they could sell the services to downstream customers. The SEC also alleged that because of this misconduct, Pareteum improperly recognized revenue for the purchase orders before the SIM cards were shipped to customers. According to the SEC, this alleged scheme artificially inflated Pareteum’s revenue numbers by $12 million in 2018 and by $27 million in the first and second quarters of 2019.

The SEC charged the CFO and Chief Commercial Officer with violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, among other charges levied against the CFO. The SEC’s complaint seeks injunctive relief, disgorgement and prejudgment interest, civil penalties, and officer and director bars. The U.S. Attorney’s Office for the Southern District of New York simultaneously announced criminal charges against the CFO and Chief Commercial Officer and that Pareteum’s Controller pled guilty on September 28, 2023. In its order bringing settled charges against the Controller, the SEC considered the Controller’s cooperation. In the criminal case, the Controller also pled guilty to conspiracy, securities fraud, making false SEC filings, improperly influencing the conduct of audits, and perjury. The SEC previously announced settled charges against Pareteum for its fraudulent disclosures on September 2, 2021.

In the second case, involving Newell and its CEO, according to the SEC’s settlement, from the third quarter of 2016 through the second quarter of 2017, Newell allegedly took actions that increased the company’s publicly disclosed core sales growth in ways that were “out of step” with Newell’s actual but undisclosed sales trends, allowing the company to announce “strong” or “solid” results in quarters it internally described as disappointing due to shortfalls in sales. As alleged, the CEO approved plans for Newell to pull forward sales from future quarters, use accrual reductions, and reclassify consideration payable to customers. The SEC alleged that Newell engaged in accounting practices that were inconsistent with GAAP, while overriding its internal accounting controls. The SEC charged both Newell and its former CEO with violations of Securities Act Sections 17(a)(2) and 17(a)(3), which can be based on a finding of negligence, among other accounting-related charges.  The SEC cited Newell’s remediation and cooperation—including by disclosing information about conduct that the SEC had not yet uncovered through its own investigation, conducting an internal investigation, and identifying key documents—and the company and its former CEO ultimately agreed to pay a civil penalty of $12.5 million and $110,000, respectively, among other relief.

#GAAPRules #DontRecognizeRevenueTooEarly

5. SEC Announces Enforcement Sweeps Against Investment Advisers for Marketing Rule Violations and Public Companies and Their Insiders for Failing to Timely Report Stock Transactions and Holdings

The SEC used two sweeps to charge groups of respondents for violations of an investment adviser marketing rule and SEC rules requiring public companies and their insiders to timely report information about stock transactions and holdings, respectively. On September 11, 2023, the SEC announced settled charges against nine registered investment advisers (the “Charged Firms”) for failing to comply with amendments to Advisers Act Rule 206(4)-1 (the “Amended Marketing Rule”), which prohibits registered investment advisers from including any hypothetical performance in their advertisements unless they adopted required policies and procedures first. These charges come less than one month after the SEC brought its first charges for violations of its Amended Marketing Rule.

The SEC alleged that the Charged Firms advertised hypothetical performance on their websites without adopting or implementing policies and procedures required under the Amended Marketing Rule. These advertisements of hypothetical performance included: performance derived from model portfolios, performance that was back-tested by the application of a strategy to data from prior time periods when the strategy was not actually in use, and targeted or projected performance returns with respect to any portfolio. The SEC also alleged that two of the investment advisers charged failed to maintain required copies of their ads.

Without admitting or denying the SEC’s findings, all of the Charged Firms agreed to be censured, to cease and desist from future Marketing Rule violations, and pay civil penalties ranging from $50,000 to $175,000. The SEC’s investigation of potential Marketing Rule violations is ongoing.

For further details and recommendations on compliance with the Marketing Rule, read our Client Alert.

Separately, on September 27, 2023, the SEC announced settled charges against six officers, directors, and major shareholders of public companies for failing to timely report holdings and transactions in company stock and also against five publicly traded companies for contributing to filing failures or failing to report such filing delinquencies. This sweep stems from an SEC enforcement initiative focused on Form 4 and Schedules 13D and 13G reports that company insiders are required to file regarding their holdings of company stock.

According to the SEC, the untimely filings associated with these charges were delayed by weeks, months, or even years in some instances. Altogether, the SEC alleges that the insiders and companies charged deprived investors of timely information about over $90 million in transactions.

The charged individuals and public companies agreed to cease and desist from violating the respective charged provisions of the Securities Exchange Act and pay civil penalties ranging from $66,000 to $200,000. The SEC’s investigation of potential beneficial ownership violations of Schedules 13D and 13G is ongoing.

#HypotheticalNoNos #BeOnTime