Home » Quarterly Investigations and Enforcement Webinar Recap – SEC and CFTC Enforcement
Quarterly Investigations and Enforcement Webinar Recap – SEC and CFTC Enforcement
By Chris Conte, Stacie Hartman & Alexandrea Rahill on May 28, 2021
Posted in Enforcement Policy Developments, Securities Violations and Accounting Fraud
Steptoe's recent quarterly Investigations & Enforcement webinar, held on May 12, included a discussion on Securities Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) enforcement trends. In this blog post we summarize the SEC and CFTC enforcement trends, including developments related to insider trading, Regulation FD, climate and ESG, whistleblowers and other trends. For those who missed the webinar, click here to access the recording.
Equities Markets
We continue to watch for indications as to how federal prosecutors and regulators will react to the significant price volatility in equities markets over the last year, particularly in connection with companies that had unique exposure to the COVID crisis.
We are also keeping a close eye on the Blaszczak case. In January, the Supreme Court remanded the case to the Second Circuit for further briefing in light of the Supreme Court's decision in Kelly v. United States (Bridgegate). The government has conceded that the information at issue in Blaszczak is not property under Kelly, and has requested that the property fraud and conversion counts be reversed. As a result, two key issues are before the Second Circuit:
In late April, the Second Circuit appointed counsel to argue that Kelly does not invalidate the Second Circuit's original holding that the information at issue in Blaszczak constitutes property.
An amicus brief has questioned whether it is still the law in the Second Circuit that insider trading cases under Title 18 do not require proof that the tipper received a personal benefit.
Argument on these two important issues, among others, is slated for June 6, 2021.
Finally, we are watching to see whether the Biden administration will reinvigorate efforts to craft a uniform definition of insider trading.
Insider trading in the derivatives markets has been addressed differently than in equities markets. Unlike equity markets, derivatives markets rely on those who have privileged information to trade on it, including farmers, banks, miners, gas suppliers, and even intermediaries. This trading is viewed as enhancing price discovery for all market participants. These differences were recognized by the CFTC in promulgating Rule 180.1, which serves as the basis for its misappropriation cases. Prior to the enactment of the Dodd-Frank Act, the CFTC's only insider trading authority was against its own personnel and those of the exchanges and Self-Regulatory Organizations (SROs) it oversaw. Now, with Rule 180.1, the Commission focuses on the misappropriation theory of insider trading.
Since forming the Insider Trading and Information Protection Task Force in 2019, the CFTC has pursued cases where employees traded on information of their employer, which are the more obvious cases. More recently, the CFTC has pursued cases under the tipper-tippee theory of liability used in securities insider trading cases. In September, the CFTC brought an action against natural gas trader Marcus Schultz for misappropriating information from his employer, then pre-arranging trades based on that information with another trader, John James. DOJ has brought actions as well, to which both Schultz and James pleaded guilty. James, as a non-employee, had no duty of confidentiality but knew that the information had been misappropriated. These are the first insider trading cases brought by DOJ under the Commodity Exchange Act (CEA) and Rule 180.1.
In December 2020, the CFTC announced a settlement with Vitol Inc., an energy and commodities trading firm in Houston, Texas, for alleged violations of the CEA based on bribes to foreign government officials. The order's non-adjudicated findings stated that Vitol made corrupt payments to employees and agents of Brazilian state-owned entities in exchange for confidential information, including specific trading and price information at the heart of competitive bidding process for fuel contracts with Petrobras. For additional discussion of this case, see the section on Foreign Corruption below. These developments make it clear that the CFTC will continue to pursue and likely broaden the scope of the misappropriation cases it brings.
Regulation FD
In March, the SEC brought a litigated case against AT&T and three Investor Relations executives for repeated violations of Regulation Fair Disclosure (Reg FD). Reg RD is a Commission rule, aimed at leveling the playing field, that requires issuers that disclose material information to do so broadly to the investing public instead of making selective disclosures to securities analysts, among others. The Complaint alleges that:
AT&T learned at the end of a quarter that a steeper-than-expected decline in its smartphone sales would cause its revenue for the quarter to fall short of analysts' consensus estimates;
IR executives then selectively disclosed this internal sales data, information AT&T generally considered material to investors, in private, one-on-one calls to 20 securities analyst firms;
Calls were made to induce the analysts to reduce first quarter revenue estimates in order for AT&T to avoid falling short of consensus revenue estimates for the third consecutive quarter;
The analysts substantially reduced their revenue forecasts, leading to the overall consensus revenue estimate falling; and
As are result, AT&T beat consensus analyst revenue estimates.
The SEC has not brought many Reg FD cases, but those that have been brought have been settled. AT&T and the IR executives are litigating the case, which is rare. In March 2021, AT&T issued a statement in response to the charges. According to the statement:
No analyst testified material nonpublic information was conveyed in the calls;
The information discussed concerned the publicly reported industry phase-out of subsidies for new smartphone purchases and the impact of this phase-out on AT&T's smartphone revenue had been previously disclosed;
Investors understood AT&T's core business was not selling devices and smartphone sales were immaterial to the company's earnings; and
The market didn't react to AT&T's results when disclosed which confirms there was no disclosure of material nonpublic information.
The AT&T litigation is ongoing, but there are a few early takeaways that issuers can take from this enforcement action:
Efforts to influence analysts' estimates, and communications at the very end of a quarter, will draw SEC suspicion.
The subjective views of the analysts that the information was not material may be of limited import, as materiality is judged based on an objective standard.
Disclosing a general trend in revenue is distinct from disclosing information that confirms actual revenue results against the general trend.
There is increasing investor demand for investment products that incorporate Climate and Environment, Social, and Governance (ESG) factors. The SEC is focused on company disclosures about these factors and fund manager investing based on these factors. Environmental factors for disclosure and investing purposes could relate to (1) what is the company's impact on the environment (e.g., its energy use or pollution output); or (2) how "climate change" creates risks and opportunities for the company and its industry. Social factors could relate to issues impacting diversity and inclusion, human rights, and the health and safety of employees or customers. Governance factors could relate to (1) how the company is run (e.g., the degree of transparency in reporting, ethics and compliance programs, and shareholder rights); or (2) the composition and role of the board of directors.
In February, the SEC's Division of Corporation Finance announced climate-related reviews. The Division is examining the extent to which public companies are addressing the Commission's 2010 disclosure guidance for when climate change-related risks and opportunities are required to be made in a company's disclosures. The Division is also speaking with public companies to understand how they are managing climate-related risks.
In March, the SEC's Division of Enforcement announced the formation of a Climate and ESG Task Force, which will develop initiatives to identify ESG-related misconduct. The Task Force will leverage data analytics tools to identify potential disclosure violations, such as
inconsistent disclosures by a company across its own disclosures or atypical disclosures across companies and industries. The Task Force is initially focusing on reviewing public company disclosures for material gaps or misstatements regarding climate risks, and reviewing investment adviser and fund disclosures on ESG investing. The task force will be led by Kelly L. Gibson, the Acting Deputy Director of Enforcement. According to statements made by Gibson, enforcement will be based solely on existing rules, guidance, and "long-standing principles of materiality and disclosure." In statements, Gibson made note of the Fiat Chrysler case, in which the company disclosed in public statements that internal audit had confirmed vehicles complied with environmental regulations concerning emissions. The SEC charged the company with making misleading statements because it did not sufficiently disclose the internal audit review was not a comprehensive review of compliance with emissions regulations. The Fiat Chrysler case suggests that public companies can expect the SEC to examine filings and public statements regarding Climate and ESG, including sustainability reports and responses to questionnaires, to determine (1) whether the company has made Climate and ESG related statements that materially differ across statements; and (2) whether a company's public statements are supported, and not contradicted by, information the company has not disclosed.
In April, the Office of Compliance, Inspections and Examinations (OCIE) issued a Risk Alert relating to its review of ESG investing and highlighting observations of exams of investment professionals offering ESG products and services. OCIE observed instances of (1) potentially misleading statements regarding ESG investing processes, and (2) misrepresentations regarding the adherence to global ESG investing frameworks. OCIE will continue to examine firms to evaluate whether they are accurately disclosing their ESG investing approaches, and have adopted and implemented policies, procedures, and practices that are consistent with their ESG-related disclosures.
The CFTC has also been active in this area, with a focus on Environmental factors, which are especially pertinent given the CFTC's regulation of derivatives energy markets. The agency is appropriately focused first on regulation before enforcement. The CFTC has been an early leader on climate risk issues, recently creating a Climate Risk Unit to focus on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy. The CFTC will work with industry-led and market-driven processes to ensure new products and markets fairly facilitate hedging, price discovery, market transparency, and capital allocation.
Other CFTC Enforcement Issues
The CFTC's Division of Enforcement (DOE) has continued to pursue spoofing and disruptive trading. The enforcement actions have involved large penalties, including a nearly $1 billion fine against a global financial institution.
The digital assets industry remains a new frontier, but the CFTC is leaning into enforcement, including against entities not regulated by the CFTC. For example, DOE recently brought an enforcement action against digital asset trading platform Coinbase for false and inaccurate reporting and wash trading by a former employee. As Commissioner Stump noted in a concurring statement, the CFTC does not regulate non-derivative exchanges such as Coinbase, but the CFTC relies on its anti-fraud jurisdiction over spot markets affecting derivatives regulated by the CFTC.
When the CFTC formed the Corruption Task Force two years ago, there were questions as to how the CFTC would wade into foreign corruption, given its lack of authority under the Foreign Corrupt Practices Act (FCPA). Knowing that task forces are typically announced only when an enforcement action is underway, it shouldn't be a surprise that the Commission has brought a case—the first is against Vitol Inc. Vitol agreed to pay a $16 million penalty to the CFTC alone and disgorgement totaling $135 million, including to DOJ and Brazilian authorities. The CFTC's findings include that Vitol:
Bribed and paid kickbacks to employees and agents of certain state-owned entities (SOEs) in Brazil, Ecuador, and Mexico to obtain preferential treatment and access to trades with SOEs to the detriment of both entities and other market participants
Attempted to manipulate two S&P Global Platts physical oil benchmarks, which would have distorted futures, swaps, and other derivatives and physical trades that price in reference to those benchmarks. If successful, such conduct would have been to the detriment of market participants who held opposing positions—including Vitol's counterparties—or those who rely on the benchmarks as a price reference for U.S. physical or derivative trades.
Misappropriated confidential information (see Insider Trading, above).
The DOJ brought a parallel action against Vitol, resulting in significant fines and a deferred prosecution agreement (DPA). The Vitol case is notable for its ties to the U.S. market, such as U.S. benchmarks and trades on U.S. exchanges. The CFTC's extraterritorial jurisdiction is more limited than the SEC's, and we would expect that the CFTC's foray into foreign corruption should likewise be limited.
The SEC's Whistleblower Office recently announced a new record for total dollar payouts in any fiscal year—$250 million—surpassing last year's record in less than five months. In April, the SEC announced that it had awarded its second-largest ever whistleblower award, paying more than $50 million to two tipsters whose information led to "tens of millions of dollars" returned to harmed investor.
In February, the SEC announced its first whistleblower award, which totaled $9.2 million, based on an NPA or DPA agreement with the DOJ. The whistleblower had previously received an award from the SEC in an SEC action based on the same information. And in March, the SEC awarded $5 million to joint whistleblowers whose tip alerted the staff to misconduct occurring abroad.
The CFTC's whistleblower program has also seen record payouts. The numbers are necessarily a smaller fraction of the SEC's program given the comparative size of the agencies and their programs, but the CFTC is widely considered to punch above its weight, and this area is no different. The CFTC has granted whistleblower awards associated with enforcement actions that have resulted in sanctions totaling over $1 billion compared to the SEC's sanctions of $3.9 billion—an amount that is over 25%, notwithstanding the fact that the CFTC is 15% the size of the SEC in terms of budget and personnel. The comparisons are typically even more stark at the end of the fiscal year, when there is always a final push for year-end numbers.