The U.S. Securities and Exchange Commission (“SEC”) has announced charges against several investment advisers for failing to comply with SEC regulations regarding reporting as well as deficient filings. In particular, the SEC noted violation of the Investment Advisers Act for the failure of the advisers to perform impromptu exams of client custodial assets annually by an independent public accountant or an annual audit of client investment financial statements prepared by an independent public accounting firm. In addition, advisers must distribute audited financial statements to investors by fiscal year end. Failure to advise of receipt of audited financials and amend financials to reflect same was another problem cited. One investment adviser was charged not only for failing to obtain unannounced reviews of client assets over which it had custody but also for failing to implement written policies and procedures in order to prevent such violations.
The advisers charged by the SEC were found to have performed the audits improperly, failed to provide investors with timely audited financials, or failed to provide amended financial statements as necessary. As a result, the advisers were investigated, censured, sanctioned, required to cease and desist from the violations, and required to pay hefty civil monetary penalties.
The SEC is increasing its focus on enforcement. As the agency ramps up to flag issues that merit examination or investigation, advisers must be cautious to comply with the rules or suffer the consequences.
Recently, the U.S. Securities and Exchange Commission (“SEC”) adopted the Congress-mandated “pay versus performance” rule in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The rule requires companies to clearly set out the relationship between executive compensation paid as of September 22, 2022, and the financial performance of the company. It further mandates disclosure of five years of data in proxy and information statements in which executive compensation information is required to be included for fiscal years ending on or after December 16, 2022, impacting the 2023 proxy season.
There are some notable exceptions to these reporting requirements, such as emerging growth companies ("EGCs"), foreign private issuers ("FPIs"), and registered investments, but smaller reporting companies ("SRCs") that have ceased to be EGCs are required to comply. The new rules also do not demand the new disclosure be included in Annual Reports on Form 10-K and registration statements. Additionally, the new disclosure will not be deemed to be incorporated by reference into any existing filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the registrant does so intentionally.
These new rules represent the most sweeping change to executive compensation rules since 2006, when the current Compensation Discussion & Analysis and accompanying tables were established. The rules build upon the SEC's recent approach towards more rigid and expansive rulemaking and impose significant new disclosure requirements on domestic public companies. Among other items, the new rules create a completely new method for calculating executive compensation and require companies to re-tabulate new fair values for their equity awards. Further, the new rules create brand new prerequisites for disclosure of company performance targets by requiring: (1) a list of at three to seven financial performance measures that, in the company's assessment, represent the “most important” measures used to ascertain executive compensation, and (2) “clear descriptions” (either “graphically, narratively, or a combination of the two”) of the relationship between the compensation actually paid and specific financial performance measures, including total return to shareholders and net income.
Affected companies would do well to get a head-start on what promises to be an onerous and data-heavy reporting and filing process. Although the full effect of this process and the impact on investor voting is yet unknown, what is known is that the new disclosures are not deemed incorporated by reference into any Securities Act or Exchange Act filing. They are still subject to “proxy fraud” liability under Rule 14a-9 and other provisions of the federal securities laws that are liability based, as are all other proxy-specific disclosures.
The federal securities laws cover a wide range of topics and often lack clear-cut rules. The scope of scheme liability is a prime example, and the framework for analyzing it lies in the crossroads between “misstatement subsections” and “scheme subsections” provisions of the Securities Act of 1933 (“’33 Act”).
The case at hand arose when the U.S. Securities and Exchange Commission (“SEC”) accused a mining company, as well as its former CEO and CFO, of misstating value impairments related to the purchase of a coal mine. The district court dismissed the SEC’s claims, but only a few days later, the U.S. Supreme Court ruled in Lorenzo v. SEC that disseminating a false statement could be a basis for liability under scheme subsections of the ’33 Act. In light of the Court’s decision, the SEC asked the district court to reconsider its order favoring the mining company; however, the judge denied the request and explained that scheme liability requires something more than just statements or omissions—a dissemination allegation, for example.
The SEC appealed, and the Second Circuit agreed with the district court’s narrow reading of Lorenzo. According to the Second Circuit, “misstatements and omissions can form part of a scheme liability claim, but an actionable scheme liability claim also requires something beyond misstatements and omissions.” The court rejected the SEC’s argument that Lorenzo expanded the scope of scheme liability to make misstatements and omissions alone sufficient to state a scheme liability claim. The court explained that the SEC’s argument undermined the primary liability’s limitation to the maker of the statement and the heightened pleadings requirement of the Private Securities Litigation Reform Act.
This case suggests that in order to prevail in a similar action, a plaintiff must point to individuals who possess the requisite authority over making the allegedly misleading statements. More litigation may follow to clarify what qualifies as sufficiently beyond mere misstatements and omissions.
For insurance purposes, this case indicates that the once dormant scheme liability defense is slowly making its way back. It is therefore crucial that entities making statements upon which the public relies, especially banks, obtain efficient scheme liability coverage.
For insurance purposes, it is important to note that ESG-compliant companies have begun to face increased D&O risks.
Director/Officer | Role | Company |
---|---|---|
Richard Lee Ramirez | President, CEO | JMJ Capital Group |
Michael Ross Kane | CEO | The Hydrogen Technology Corporation |
Brent David Willis | CEO | NewAge, Inc. |
Amount | Director/Officer | Role | Company |
---|---|---|---|
$ 294,889.86 | Mark Goldberg | CEO | In Ovations Holdings, Inc. |
$ 41,868.00 | Tyler Ostern | CEO | Moonwalkers Trading Limited |