by Bruce Carton
You may feel like the Dodd-Frank Act has been with us for months already, but President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law only two weeks ago. Lawyers, bankers, auditors and compliance executives have now had several weeks to digest the final version of the 2,300-page law, and how it will affect their clients and industries.
Only a portion of the Dodd-Frank Act is directed at enforcement of securities laws by the Securities and Exchange Commission. Nevertheless, that portion contains numerous important provisions that will affect public companies, regulated entities, and professionals in the enforcement and compliance areas. Let’s take them all in turn.
Section 922 of the law provides for new, potentially game-changing whistleblower provisions. In short, anyone who alerts the SEC to a securities infraction that then leads to SEC penalties of $1 million or more can now collect 10 to 30 percent of the total penalties imposed by the agency. Yes, that whistleblower does need to provide “original information” that leads to an SEC probe. But as the penalties for some SEC cases can now be hundreds of millions of dollars, the potential for enormous financial gain to whistleblowers is very real.
For example, on July 22 the SEC settled accounting fraud charges with Dell, which agreed to pay a penalty of $100 million. Unto itself, $100 million is not an extraordinarily large amount by SEC standards. Had a whistleblower in Dell’s accounting department tipped the SEC off to the shenanigans at the company, however, that person would now be $10 million to $30 million richer under Section 922.
Section 922 also provides that any whistleblower who makes a claim may be represented by counsel, and must be represented by counsel if he or she wishes to submit the claim anonymously. Not surprisingly, this has caught the attention of the plaintiff’s bar, which believes that it may have found a lucrative new practice area. On July 23, less than 48 hours after the passage of Dodd-Frank, a law firm issued a press release announcing that it was the first firm to file a whistleblower complaint with the SEC pursuant to Dodd-Frank. That same day, another prominent plaintiffs’ law firm issued a press release announcing the “expansion of its practice to include the representation of securities fraud whistleblowers.”
Aiding and Abetting Liability
In the weeks, days and even the final hours leading up to the passage of Dodd-Frank, certain members of Congress fought, unsuccessfully, to include a provision that would have overturned the Supreme Court’s 2008 ruling in Stoneridge Investment Partners v. Scientific-Atlanta. The Stoneridge decision, together with a previous ruling in Central Bank v. First Interstate Bank, effectively blocked plaintiffs from suing “secondary actors” in private securities litigation: the bankers, auditors, law firms and others who may have aided and abetted a primary actor committing fraud, but who did not participate in the fraud itself.
The amendment that sought to overturn Stoneridge—often referred to as the Specter amendment because one if its chief proponents was Sen. Arlen Specter—would have permitted aiding and abetting exposure for those who “advise on or assist in structuring securities transactions and who have actual knowledge of securities fraud.” Even with this rigorous “actual knowledge” standard, auditors, bankers and lawyers breathed a huge sigh of relief when the amendment did not appear in Dodd-Frank, eliminating what would have been an ongoing need to litigate whether they did or did not have such knowledge.
The issue is not completely dead, however: Section 929Z requires the comptroller general of the United States to “conduct a study on the impact of authorizing a private right of action against any person who aids or abets another person in violation of the securities laws,” so stay tuned.
Dodd-Frank does, however, make it easier for the SEC to pursue cases against secondary actors for aiding and abetting. Section 929O amends Section 20(e) of the Securities Exchange Act to provide for liability for those who aid and abet violations “knowingly or recklessly.” This lessens the SEC’s burden of proof; it previously had to demonstrate that the aider or abettor “knowingly” provided substantial assistance to another person.
Funding for the SEC
At one point, SEC Chairman Mary Schapiro and her fellow commissioners seemed poised to achieve what professor Peter Henning calls the “budgetary Holy Grail” of federal agencies: the Dodd-Frank Act would allow their agency to be self-funding, removing it from the traditional appropriations process in Congress. At the 11th hour, however, a compromise between Senate and House negotiators finalizing the legislation rejected self-funding. Sen. Richard Shelby explained that “severe managerial and operational failures” like the Madoff ponzi scheme left him unwilling to remove the SEC from Congressional oversight of its funding.
Dodd-Frank did improve the SEC’s budget situation in other ways, however. First, Section 991 provides that the SEC’s budget will quickly escalate from a record-high $1.3 billion in fiscal 2011 to a massive $2.25 billion in fiscal 2015. Second, in response to the SEC’s claim that self-funding would allow it to respond quickly to unforeseen developments in the markets, Section 991 provides that certain registration fees collected by the SEC will be deposited into a new “reserve fund” not to exceed $100 million. The SEC may use the reserve fund as it deems necessary to carry out its functions, but must notify Congress of the date, amount, and purpose of the expenditures it incurs.
Nationwide Service of Process
For years, witnesses in an SEC trial could only be forced to travel 100 miles to answer a subpoena and testify in person; that often meant using videotaped depositions at trial. The Enforcement Division has long sought to expand that to nationwide “service of process,” and it finally won that battle with the Dodd-Frank Act. Now, under Section 929E, a subpoena issued to compel the attendance of a witness or the production of documents at a hearing or trial may be served at any place within the United States. This will let the SEC (as well as defense counsel) compel trial witnesses to testify in person, no matter how far the witness must travel.
This nationwide subpoena power was among the items requested by the SEC in the “Wish List” it provided to Congress in July 2009 of 42 changes it wanted to see in the federal securities laws. It is consistent with the SEC’s subpoena power in its investigations and with federal courts’ subpoena power in criminal actions.
Penalties in Administrative Proceedings
Prior to Dodd-Frank, the SEC’s authority to impose penalties in a case brought as an “administrative proceeding” (a cease-and-desist proceeding brought before an SEC administrative law judge, rather than a lawsuit brought in federal court) was restricted to regulated entities such as broker-dealers, investment advisers, and mutual funds. Administrative proceedings do have many built-in advantages for the SEC: limited discovery; no right to a jury trial; an administrative law judge employed by the agency; and “de novo” review of judges’ decisions by the same SEC commissioners who authorized the proceedings to be filed in the first place. Still, limitations on the SEC’s ability to seek penalties deterred it from bringing claims as “APs.”
Under Section 929P, the SEC may now impose a civil penalty in an administrative proceeding against any person or company. It remains to be seen whether the SEC will respond to this change in the law by increasing the number of cases it brings as APs, but that is the expected outcome. Some defendants seeing a quicker or less costly proceeding may even welcome a case filed as an AP, rather than being forced to contend with the greater discovery and procedural burdens of federal court.
There are several other significant enforcement-related provisions in Dodd-Frank. Section 929U, for instance, imposes a firm deadline of 180 days after a Wells notice has been issued for the SEC staff to file a case. Section 929P codifies the situations where the SEC has jurisdiction over actions under the’ Securities Exchange Act and the Investment Advisers Act relating to securities transactions outside the United States Together, the many provisions highlighted above will create significant challenges and opportunities for the SEC’s enforcement program. Public companies and other regulated entities should be aware that Dodd-Frank has changed the regulatory landscape dramatically.
Originally published in Compliance Week. Reprinted with permission. © 2010 Haymarket Media, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.