Category: Articles - Page 4

Delaware Gov. John Carney has enacted a controversial law that will allow publicly traded companies incorporated in the state to grant some stockholders broad powers without a shareholder vote, ratifying the state legislature’s fast-tracked approval of the measure last month.

On July 17, Gov. Carney, a Democrat, signed Senate Bill 313 (S.B. 313), which sailed through the Delaware State Assembly in June despite concerns raised by dozens of academics, shareholder rights’ advocates, and two judges.

Critics said the state’s bar association and lawmakers too hastily drafted the law, contending that it allows side agreements whereby a company’s board of directors can cede its rights to a few powerful stockholders. The law was conceived as a response to several high[1]profile court rulings by the Delaware Court of Chancery that were perceived as anti-business, one of which is still under appeal.

The Senate passed S.B. 313, unopposed and without debate on June 13, just three weeks after it was introduced; a week later, on June 20, the House voted 34 to 7 to approve the measure. Now law, the measure amends the Delaware General Corporation Law (DGCL), which directly affects the governance of millions of companies incorporated in the First State and serves as a model nationwide.

Background

The DGCL includes important investor protection privileges, which are typically refined over time through a steady stream of decisions by the highly specialized and well-respected Delaware Court of Chancery. But recently a debate has unfolded over whether the Court has given shareholders too much say over how companies are run, rather than deferring to the business judgment of corporate directors. Delaware is home to more than half of all U.S. publicly traded corporations and more than two-thirds of the Fortune 500, and some leaders fear that any perceived bias could lead to an exodus.

DGCL Section 141(a) says the “business and affairs” of Delaware corporations “shall be managed by or under the direction of a board of directors,” as long as the directors act loyally and carefully as required by their fiduciary duty to the corporation and its stockholders. The “business judgment rule,” as it’s known, is an important element of the DGCL and has been a key to the state’s popularity among businesses— along with low startup costs, ease of incorporation, and the promise that legal disputes will be adjudicated by the Chancellors, as the seasoned and sophisticated Chancery Court judges are known.

Since 2023, several companies citing increased litigation risk have left Delaware, including TripAdvisor and Fidelity National Financial. Most famously, in June, Tesla CEO Elon Musk sought and received shareholder approval to reincorporate in Texas after Chancellor Kathaleen St. Jude McCormack rejected his 2018 pay package, originally worth $56 billion. In her January opinion, Chancellor McCormick sided with investors who said Tesla’s Board of Directors was beholden to Musk and breached its fiduciary duty by approving the mammoth pay package after sham negotiations.

Moelis

In the interest of brevity, today’s article will deal with only one of the three rulings addressed by the new law: the February 23, 2024 decision by Vice Chancellor J. Travis Laster in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. (Moelis).

Moelis & Co is a global investment bank founded by Ken Moelis, who ran the bank for years as a private entity before deciding to raise capital by taking the company public in 2014. In order to do so, he reorganized Moelis under a new holding company incorporated in Delaware with himself as CEO and Chairman of the Board.

In Moelis, Vice Chancellor Laster granted summary judgment in favor of a pension fund that objected to a stockholder agreement between Mr. Moelis and the company, reached a day before the IPO, that required the Board of Directors to get written pre-approval from Mr. Moelis over important business decisions and the composition of the board itself. As summarized by Vice Chancellor Laster: “The Pre-Approval Requirements encompass virtually everything the Board can do. Because of the Pre[1]Approval Requirements, the Board can only act if [Mr.] Moelis signs off in advance.”

Citing the standard established in Court’s landmark 1957 decision, Abercrombie v. Davies, Vice Chancellor said some of the challenged provisions facially violated Section 141(a) because they “have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters” or “tend[] to limit in a substantial way the freedom of director decisions on matters of management policy. . .”

Moreover, Vice Chancellor Laster wrote, Mr. Moelis “could have accomplished the vast majority of what he wanted” by changing the company charter or having the company issue him new preferred stock with outsized voting and director appointment rights. Instead, he created a situation where “the business and affairs of the Company are managed under the direction of [Mr.] Moelis, not the Board,” as required by Section 141(a).

Opposition to S.B. 313

Into this climate of uncertainty strode the Council of the Corporate Law Section of the Delaware State Bar Association, which quickly drew up S.B. 313 and obtained Bar Association backing. Introduced on May 23 by Delaware Senate Majority Leader Bryan Townsend, a corporate attorney with Morris James LLP, the measure allows the type of stockholder agreements invalidated in Moelis, even if their provisions are not specified in a certificate of incorporation.

The bill drew fire even before its introduction—including from Chancellor McCormick, the author of the two other opinions that prompted the creation of S.B. 313. In an April 12 letter that became public at the end of May, Chancellor McCormick wrote the Delaware State Bar Association that “there is no justification for the rushed nature of the proposal. . .” which, she said had “moved forward at a pace that forecloses meaningful deliberation and input from diverse viewpoints.” The Chancellor also took issue with the fact that the Delaware Supreme Court had not yet ruled on an appeal to the decision. “So why the rush?” she asked.

On June 7, after S.B. 313 had been introduced, a group of more than 50 law professors opposed the bill in a letter to the members of the Delaware Legislature. In the letter, posted on the Harvard Law School Forum on Corporate Governance, the professors wrote that, beyond overturning Moelis, the proposal “would allow corporate boards to unilaterally contract away their powers without any shareholder input.”

“We are professors of corporate law, and we routinely disagree over corporate law issues. Yet we are unanimous in our belief that the appropriate response to the Moelis decision is to allow the appellate process to proceed to the Delaware Supreme Court,” the letter said. “The issues at stake warrant careful judicial review, not hasty legislative action.”

Also in June, Vice Chancellor Laster, in a LinkedIn post he said was made outside his official capacity, called out S.B. 313 as “not the annual tweaking of the DGCL. That’s a cosmetic procedure by comparison. This is major surgery.”

Finally, on July 10, the Council of Institutional Investors asked Gov. Carney to veto the bill, saying that lawmakers’ “unprecedented action” to “overturn[] a trial court ruling that is not yet final” constituted a “legislative rush to judgment. . .”

“A hallmark of Delaware General Corporation Law is the careful and deliberate nature in which it is adopted and enforced, as well as the ways in which Delaware law balances boards’ decision-making with accountability to shareholders,” CII Jeffrey Mahoney wrote. “That reputation could be seriously impaired by a perception that influential actors can easily change the law whenever the Delaware Court of Chancery has the temerity to rule against them.”

The speed with which the measure was created, approved, and enacted appears to swing the pendulum in Delaware away from the Court of Chancery and advocates of a more deliberative approach to changes in Delaware’s board-centric corporate governance model.

Last month, the U.S. Supreme Court agreed to consider two cases from the Ninth Circuit Court of Appeals that will implicate the ability of investors to bring securities fraud claims. The most worrisome—NVIDIA Corp. v. E. Ohman J:or Fonder AB, No. 23-970—will address a fundamental question about the pleading standards for securities fraud cases under the already heightened Private Securities Litigation Reform Act of 1995 (PSLRA) standard. The other—Facebook v. Amalgamated Bank, No. 23-980—will expound upon whether publicly listed companies must disclose past known risks that do not pose ongoing or future risks. Both cases are scheduled to be heard during the upcoming 2024-2025 term.

NVIDIA: Pleading Standards for Scienter and Falsity

In NVIDIA, shareholders brought a putative class action lawsuit under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission (SEC) Rule 10b-5, alleging that NVIDIA and several of its officers intentionally misrepresented the extent to which the accelerated computing company’s gaming segment revenues were driven by selling its graphic processing units (GPU) to cryptocurrency miners rather than to gamers. Plaintiffs allege that defendants tracked mining related sales in multiple ways and had access to documents that demonstrated the high demand and use of NVIDIA GPUs among cryptocurrency miners, a conclusion plaintiffs based partly on interviews with former employees. Unlike in most securities fraud class actions, the plaintiffs were even able to allege a number of specifics relating to the documents to which defendants had access, including detailed descriptions of the contents of the documents, the names of regular internal reports, and how often the reports were distributed. The plaintiffs also relied upon an RBC Capital Markets report and independent expert analysis of public data to demonstrate that NVIDIA had generated over a billion dollars more in mining-related revenues than had previously been disclosed.

The U.S. District Court for the Northern District of California dismissed the complaint, concluding that the plaintiffs were not able to point to any specific information in NVIDIA’s internal documents to support an inference of scienter (defendants acting either recklessly or with knowledge that their own actions were wrong), which is required under the PSLRA. A divided panel of the Ninth Circuit reversed in part and remanded, disagreeing with the District Court and finding that plaintiffs adequately showed scienter based on the employee interviews, at least as to the CEO. In addition, considering an issue the District Court had not broached, the majority concluded that the expert report sufficiently supported plaintiffs’ falsity claims.

On June 17, 2024, the Supreme Court granted certiorari to hear two questions, the first relating to scienter and the second relating to falsity: (1) “Whether plaintiffs seeking to allege scienter under the PSLRA based on allegations about internal company documents must plead with particularity the contents of those documents. . .” and (2) “Whether plaintiffs can satisfy the PSLRA’s falsity requirement by relying on an expert opinion to substitute for particularized allegations of fact.”

Facebook: Disclosure of Previously Materialized Risks

In Facebook, shareholders brought a putative class action lawsuit, also under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, alleging that Facebook failed to disclose materialized business risks related to Cambridge Analytica’s access to and misuse of Facebook user data, instead describing such risks as merely hypothetical. While the District Court for the Northern District of California granted defendants’ motion to dismiss, the Ninth Circuit reversed. The divided panel held that Facebook could be held liable for securities fraud for disclosing in its filings that security breaches and improper third-party access to user data “could harm” its business, given that Facebook was aware of the Cambridge Analytica breach.

On June 10, 2024, the Supreme Court granted certiorari to consider one of the two questions from the Facebook petition: “Are risk disclosures false or misleading when they do not disclose that a risk has materialized in the past, even if that past event presents no known risk of ongoing or future business harm?”

Implications

Both the NVIDIA and Facebook cases are bound to impact the ability of investors to successfully pursue securities class action lawsuits.

The first question presented in the NVIDIA case, in particular, could serve as a serious impediment to bringing securities fraud claims. The PSLRA, as interpreted by the Supreme Court nearly two decades ago, already provides a heightened standard for pleading scienter—much higher than in any other area of law. If the Supreme Court decides NVIDIA in favor of defendant-appellants, it will make bringing securities fraud cases even more difficult by requiring plaintiffs to plead in great detail the specific contents of internal documents for the case to proceed. It is nearly inconceivable to imagine how plaintiffs can clear this hurdle, since the PSLRA imposes an automatic stay on discovery, meaning defendants are not required to produce any internal documents until after the complaint survives a motion to dismiss. This also would encourage the problematic practice of company insiders stealing company documents and turning them over to lawyers. The second NVIDIA question is important, but likely less impactful, since pleading based on expert testimony is relatively rare. And when there is expert testimony, it is not typically a “substitute for particularized allegations of fact,” but rather a tool to opine on protocol in a given industry or to analyze public data.

Resolution of the Facebook question is less likely than NVIDIA to be devastating to securities cases, but a decision in favor of the appellants could still have significant repercussions. If a past event presents no risk of “ongoing or future business harm,” then it is not material—i.e. something that a reasonable investor would consider important in deciding whether to buy or sell a security—and a court likely will not sustain a securities fraud case on that basis. Moreover, the Facebook question will not impact the majority of securities fraud claims, since investors typically bring such claims only when known risks were indeed material. However, contrary to the way defendants in Facebook framed the question to the Court, the known risk at issue was in fact material to investors and to Facebook—indeed, Facebook agreed to pay $5.1 billion in civil penalties to settle charges by the Federal Trade Commission and the SEC over the scandal.

Regardless of the cases’ outcomes, the fact that the Justices will hear two securities fraud cases next term is a testament to the Supreme Court’s increasingly active role in this space. In recognition of the cases’ potential impact, Cohen Milstein is helping to spearhead amicus efforts supporting plaintiffs in both NVIDIA and Facebook. We encourage investors to follow these cases closely and support those efforts.

Judge’s ruling opens door for crypto, blockchain, digital asset insiders and others with inside information about fraud and misconduct to blow the whistle.

On August 7, 2024, the U.S. Securities and Exchange Commission (SEC) secured a ruling in a groundbreaking case, SEC v. Ripple Labs Inc., et al., that certain cryptocurrency and digital asset token transactions must be registered with the SEC. Failure to register such transactions under Sections 5(a) and 5(c) of the Securities Act of 1933 will result in enforcement actions and penalties.

Specifically, the court ordered that Ripple Labs Inc., (Ripple) a privately held company and one of the world’s largest enterprise blockchain solutions for global financial institutions, businesses, and governments, pay a $125 million civil penalty for its failure to register institutional sales of its XRP token in 1,278 transactions in violation of the federal securities laws. The court also permanently enjoined Ripple from ongoing sales of XRP without registering them as securities, lest it continue to violate the federal securities laws. Simultaneously, the court denied the SEC’s request for an additional $876 million disgorgement.

While both sides are claiming victory, the court’s decision, nevertheless, sets a precedent for how cryptocurrency and blockchain developers can legally raise funds from institutional investors moving forward. This decision is also a call to action for potential whistleblowers.

A Call to Action for Whistleblowers

Originally filed in 2020, the SEC alleged that Ripple made more than $1 billion in unregistered sales of its XRP token. In July 2023, the court issued a 34-page summary judgment ruling, finding the XRP token was a security when it was sold directly to institutional investors but not when it was sold on public exchanges in blind transactions.

Going forward, cryptocurrency and blockchain developers looking to raise funds from institutional investors must register their transaction under Sections 5(a) and 5(c) of the Securities Act of 1933 (Securities Act).

The judge’s ruling opens the door for would-be whistleblowers in the crypto, blockchain, and digital asset markets to come forward and blow the whistle based on their knowledge of possible federal securities law violations, in addition to coming forward to report illegal sales of securities, like the unregistered transactions here – Ripple’s XRP offerings to institutional investors.

With this long-awaited ruling, whistleblowers, now more than ever, can play a pivotal role in holding crypto, blockchain, and digital asset companies to account to ensure greater market confidence.

What are Sections 5(a) and 5(c) of the Securities Act of 1933?

The Securities Act serves to ensure that companies register securities with the SEC, disclose material information about those securities to the public, and do not engage in fraud. Section 5 requires companies (issuers) to file a registration statement with the SEC when publicly offering securities.

Section 5 (a) and (c) center on the SEC’s review and approval of the registration statement, while regulating the issuers’ activities, including communications, during this review.

Case Background

In 2020, the SEC alleged that Ripple raised more than $1.3 billion in 2013 by selling XRP in an unregistered security offering to investors.

Ripple, which touts American Express, BBVA, and BMO among its clients, argued that XRP should not be treated as a security. Ripple maintained that XRP does not meet the criteria set out by the Howey Test, a standard used to determine whether a financial instrument is classified as a security.

One of the first of its kind, the lawsuit sent shockwaves through the cryptocurrency sector when blockchain projects had been operating with little regulatory oversight.

As a result, the August 7 ruling sets a precedent going forward for the industry. While the SEC will have authority over sales to institutions, crypto exchanges can allow cryptocurrency trades to “programmatic buyers,” i.e., algorithmic trades to the public, with the understanding that cryptocurrency transactions on exchanges are not securities transactions.

What if I witness misconduct or suspect fraud?

If you observe possible misconduct or fraud violation of the Sections 5(a) and 5(c) of the Securities Act of 1933, it is critical that you inform the SEC.

The SEC will often pay monetary awards to whistleblowers who voluntarily provide the agency with original information about violations of the federal securities laws.

How do I report this misconduct or fraud to the SEC?

If you suspect misconduct or fraud, contact a lawyer, such as a member of Cohen Milstein’s Whistleblower practice, who can counsel you on the Whistleblower process and help you complete and submit the SEC’s tip, complaint, and referral form (Form TCR).

Such consultations are confidential and free-of-charge.

What type of information is needed to report fraud or misconduct to the SEC?

In addition to your personal observations and a completed Form TCR, the SEC requires supporting information that is original and not in the public sphere.

What if I’m not a company insider?

You do not need to be a company “insider” (like an employee) to witness or report possible fraud or misconduct. Other market participants or victims of fraud or misconduct who observe these actions committed by others may also qualify as whistleblowers.

Does the SEC offer a whistleblower award for reporting fraud or misconduct?

Yes. If your information leads to a successful SEC enforcement action resulting in more than $1 million in monetary sanctions, you will receive an award ranging from 10-30% of any amount collected.

Where do I find more about reporting fraud and becoming a whistleblower?

The SEC’s Office of the Whistleblower provides comprehensive guidelines on the reporting fraud and the whistleblower process.

You can also contact a member of Cohen Milstein’s Whistleblower practice for a confidential and free-of-charge consultation.

About the Author

Christina McGlosson, special counsel in Cohen Milstein’s Whistleblower practice, focuses exclusively on Dodd-Frank Whistleblower representation. She is the former acting director of the Whistleblower Office in the Division of Enforcement at the U.S. Commodity Futures Trading Commission. She was also a senior attorney in the SEC’s Division of Enforcement, where she assisted in drafting the SEC rules to implement the whistleblower provisions of Dodd-Frank.

Christina represents whistleblowers in the presentation and prosecution of fraud claims before the SEC, CFTC, FinCen, as part of the U.S. Treasury, the Department of Justice, and other government agencies.

Christina McGlosson, Special Counsel: Dodd-Frank Whistleblower Practice

Cohen Milstein Sellers & Toll PLLC

1100 New York Avenue, NW

Washington, DC 20005

E: cmcglosson@cohenmilstein.com

T. 202-988-3970

Advertising Material. This content is informational in nature and should not be read or interpreted as legal advice. Should you need legal advice, please contact a lawyer.

On June 17, 2024, the U.S. Commodity Futures Trading Commission’s Division of Enforcement (CFTC) issued an order in an Enforcement action that simultaneously settled charges against Trafigura Trading LLC for several CFTC violations, including, significantly, not disclosing whistleblower carveout language in its employee agreements in violation of Regulation 165.19(b).

By not including this carveout language, which allows for voluntary communications about confidential matters between current and former employees and law enforcement and regulatory agencies, Trafigura impeded potential whistleblowers and other witnesses from coming forward about the company’s alleged illegal conduct.

Why is this Important?

This is the first time that the CFTC has charged a business entity for its failure to include whistleblower carveout language in its employment agreements, putting the market on notice that the CFTC is not only committed to protecting potential whistleblowers but it will not tolerate entities that impede or retaliate against potential whistleblowers and their communications with law enforcement and/or regulatory agencies.

What is Regulation 165.19(b)?

An integral part of the CFTC Commodity Exchange Act’s whistleblower provisions, Regulation 165.19(b) states: “No person may take any action to impede an individual from communicating directly with the Commission’s staff about a possible violation of the Commodity Exchange Act (CEA), including by enforcing, or threatening to enforce, a confidentiality agreement or predispute arbitration agreement with respect to such communications.”

Enacted in 2017, Regulation 165.19(b) helped strengthen the anti-retaliation protections of the CFTC’s whistleblower program, which was created in 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) Furthermore, this amendment gives the CFTC greater authority to bring actions against employers who interfered and/or retaliated in such communications.

Background on Trafigura Trading LLC

Trafigura is one of the world’s largest commodities traders, trading over 263 million metric tons of oil and oil products in fiscal year 2023. It is also a major participant in oil derivatives markets and other swaps markets. Registered in Singapore with trading operations in Houston, Texas, the CFTC claims that Trafigura obtained and traded on material, nonpublic information about a Mexican trading entity between 2014 and 2019. The CFTC further alleges that in February 2017, Trafigura manipulated the U.S. Gulf Coast high-sulfur fuel oil price assessment, a fuel benchmark published by S&P Global Platts, benefitting Trafigura’s futures and swaps positions, including derivatives traded on U.S. Commodity Futures Exchanges, including the New York Mercantile Exchange and the ICE Futures U.S. Inc. in violation of the CEA.

Trafigura’s Employment Agreements

According to a June 17, 2024 CFTC press release, between 2017 and 2020, Trafigura required its employees to sign employment agreements and requested that former employees sign separation agreements containing non-disclosure provisions prohibiting them from disclosing company information, with no exception for law enforcement agencies or regulators, such as the CFTC.

Because these employment agreements did not include language allowing employees and former employees to communicate with regulatory authorities about confidential company information, including company dealings that may be illegal, this not only violated Regulation 165.19(b), but led to confusion among certain current and former Trafigura employees and therefore impeded their direct and voluntary whistleblower communications with the CFTC.

Securities & Exchange Commission’s Rule 21F-17(a)

The CFTC’s public stand against an entity for allegedly failing to include whistleblower carveout language in employee contracts follows an example set by the Securities & Exchange Commission (SEC). As recently as February 2023, the SEC charged Activision Blizzard Inc. with similar whistleblower disclosure violations, resulting in an enforcement action and a $35 million whistleblower fine.

Similar to the CEA’s Regulation 165.19(b), the SEC’s Securities Exchange Act of 1934, Rule 21F-17(a) provides that, “No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement.”

Whistleblower Protection & Confidentially

The CFTC Whistleblower Program and SEC Whistleblower Program are both committed to protecting the identity of whistleblowers and prohibiting retaliatory behavior. The integrity and success of these programs relies on the courage and trust of witnesses to come forward voluntarily and free of intimidation to report misconduct or fraud.

What if I witness misconduct or suspect fraud?

If you observe possible misconduct or fraud in violation of the CEA, it is critical that you inform the CFTC. The CFTC will often pay monetary awards to whistleblowers who voluntarily report violations of the CEA that leads to a successful enforcement action, as well as privacy, confidentiality, and anti-retaliation protections for whistleblowers.

How do I report misconduct or fraud to the CFTC?

If you suspect misconduct or fraud, contact an attorney, such as a member of Cohen Milstein’s Whistleblower practice, who can counsel you on the Whistleblower process and help you complete and submit the CFTC’s tip, complaint, and referral form (Form TCR).

Such consultations are confidential and free of charge.

What information is needed to report fraud or misconduct to the CFTC?

In addition to your personal observations and a completed Form TCR, the CFTC requires supporting information that is original and not in the public sphere.

What if I’m not a company insider?

You do not need to be a company “insider” (like an employee or trader) to witness or report possible fraud or misconduct. Other market participants or victims of fraud or misconduct who observe these actions committed by others may also qualify as whistleblowers.

Does the CFTC offer a whistleblower award for reporting fraud or misconduct?

Yes. If your information leads to a successful CFTC enforcement action resulting in more than $1 million in monetary sanctions, you will receive an award ranging from 10-30% of any monetary sanctions collected.

Where do I find more information about reporting fraud and becoming a whistleblower?

The CFTC’s Whistleblower Office provides comprehensive guidelines on reporting fraud and the whistleblower process.

You can also contact a member of Cohen Milstein’s Whistleblower practice for a confidential and free-of-charge consultation.

About the Author

Christina McGlosson, Special Counsel: Dodd-Frank Whistleblower Practice
Cohen Milstein Sellers & Toll PLLC
1100 New York Avenue, NW
Washington, DC 20005

E: cmcglosson@cohenmilstein.com
T. 202-988-3970

Advertising Material. This content is informational in nature and should not be read or interpreted as legal advice. Should you need legal advice, please contact a lawyer.

OpEd by Joseph Sellers, founder and co-chair of Cohen Milstein’s Civil Rights & Employment practice.

The broad and flexible interpretations of the word “sex” have surely surpassed the expectations of the bill’s authors, and even more so its detractors who added the word itself.

When opponents to Title VII of the Civil Rights Act of 1964, which turns 60 this month, added the word “sex” to the list of protected characteristics, they hoped it would tank the bill. These detractors were certain that this landmark legislation, which would boldly expand the rights and workplace protections of Americans on the basis of race, color, religion and national origin, would surely be doomed if this new and little-discussed form of protection was added. To their chagrin, the bill passed – and in the six decades since, that one word has proven to have a tremendous, positive impact particularly on the lives of women and members of the LGBTQ+ community in unexpected ways.

In 1964, there was virtually no legislative history of what the word “sex” was intended to mean. In fact, it had been added to the Civil Rights Act as an amendment so hastily that there was no serious discussion of how the word should be interpreted. That legacy has permitted the courts, including some members of the Supreme Court who subscribed toa textualist approach to the law, to interpret the word in ways that the legislators who added this protection may not have intended.

. . .

Again, in one of its most significant civil rights decisions of the 21st century, the Supreme Court interpreted the protection against discrimination on the basis of sex in a manner that may not have been envisioned by the Congress that enacted Title VII in 1964. In Bostock v. Clayton County, the Court ruled that Title VII prohibits employment discrimination based on sexual orientation or gender identity. Writing for the majority, Justice Neil Gorsuch explained simply and unequivocally: “An employer who fires an individual for being homosexual or transgender fires that person for traits or actions it would not have questioned in members of a different sex. Sex plays a necessary and undisguisable role in the decision, exactly what Title VII forbids.”

This is the legacy created by the last-minute addition of the protection against discrimination on the basis of sex to Title VII of the Civil Rights Act of 1964. There is little doubt that the proponents of adding “sex” as a protection provided by Title VII did not envision, and likely would not have approved, of the interpretation of this protection provided in the decades that followed its enactment. But, as Justice Scalia explained in Oncale v. Sundowner, “statutory prohibitions often go beyond the principal evil to cover reasonably comparable evils, and it is ultimately the provisions of our laws rather than the principal concerns of our legislators by which we are governed.” That singular principle has given rise to protections, likely unforeseen in 1964, to the rights of all Americans across gender identities, gender expressions and sexual orientations to be free from discrimination in the workplace. These broad and flexible interpretations of the word “sex” have surely surpassed the expectations of the bill’s authors, and even more so its detractors who added the word itself.

But today, the continued evolution of the protections against discrimination because of sex, as well as the broad range of other workplace protections, are at risk. The scope and nature of these protections have evolved through the repeated, and sometimes varied and even conflicting, interpretations of these statutory protections accorded the various courts in our judiciary. The path to each of these landmark rulings began at trial courts that applied the law as they interpreted it. These debates about the interpretation of the protection against discrimination because of sex took place in public rulings issued by courts when each considered these issues before they eventually led to the Supreme Court’s landmark rulings. Had the adjudication of these vitally important issues about how to interpret this widely lauded protection occurred in private, rather than public, rulings, the evolution of the interpretation of protections against discrimination because of sex as well as other workplace protections may have been stunted or stymied altogether.

We caught up with Christina McGlosson for a discussion about current SEC/CFTC Enforcement Division priorities, the types of information whistleblowers can provide to help these enforcement divisions open investigations and combat fraud, and more.

Christina recently joined our Whistleblower practice as our expert in the Dodd Frank whistleblower provisions. She previously served as the former acting director of the Whistleblower Office in the Division of Enforcement at the U.S. Commodity Futures Trading Commission. She was also a senior attorney in the SEC’s Division of Enforcement for over a decade.

What do you see as current SEC/CFTC areas of enforcement interest?

The SEC and CFTC are focused on combating fraud in the global markets due, among other concerns, to the rise of technology and artificial intelligence. Their priorities include:

At both agencies, digital assets and crypto exchanges.
At the CFTC, unregistered entities, such as unregistered commodity pool operators and futures commission merchants, as well as unregistered exchanges.
For the SEC and CFTC, off-channel communications, like messaging about company business using WhatsApp, Telegram, and other apps to circumvent company servers, or transferring company client calls to personal cell phones.
Although financial fraud has always been a staple of the SEC’s Enforcement Division, Financial fraud has re-emerged as a priority.
At both agencies, market manipulation, including pump-and-dump schemes, wash trading, and at the CFTC, spoofing.
AI whitewashing is a top priority for the SEC, which is monitoring companies for falsely adding the words “artificial intelligence” to future business, for example, in order to improve imminent earnings reports, and increase share prices.

Who are whistleblowers?

Whistleblowers play a critical role in stopping fraud and misconduct and ensuring the integrity of financial markets.

They are often professionals in banks, those who work at broker-dealers, hedge funds, investment advisors, investment companies, other financial services companies, both public and private companies, on trading floors, or in compliance, among other places.

What types of information can whistleblowers provide that is helpful to enforcement agencies?

The SEC and CFTC are interested in whistleblower tips involving fraud or misconduct that violates the federal securities laws or the commodity exchange act, respectively.

The ideal whistleblower is someone with direct knowledge of the fraud and who has supporting evidence, such as documents, emails, text messages, or participated directly in conversations.

Can whistleblowers be outsiders?

Absolutely. Any individual who became aware of an entity’s fraud or misconduct through documents received or conversations with those at the entity who engaged in the fraud or misconduct can be a whistleblower.

What is the best way to present a whistleblower’s information to a government agency?

Accurately describing the fraud or misconduct on a whistleblower tip, complaint, or referral (TCR) form is critical to inspiring review and the opening of an investigation by the SEC or CFTC’s Enforcement Division.

Even the most brilliant individual who has witnessed fraud or has documentary evidence of fraud in his or her possession may not know the provisions under, say, the Commodity Exchange Act or the federal securities laws, to properly draft and submit a whistleblower TCR to the SEC or CFTC.

Hiring an attorney with Dodd-Frank and federal securities law expertise is an efficient and effective way to assess whether your claim rises to the level of an enforcement agency review, let alone an investigation.

If you want to file a TCR anonymously, you must hire an attorney to represent you.

Your attorney will also help you organize and index your documentary evidence and prepare your whistleblower TCR in the most compelling way, which is more likely to result in an enforcement investigation and subsequent monetary award for the whistleblower.

The decision to blow the whistle on fraud can feel risky. Can whistleblowers maintain anonymity?

Yes. But if you do, you are required by law to retain an attorney to represent you. A whistleblower’s strongest possibility to obtain a monetary award for helping an enforcement division is to hire an attorney with significant Dodd-Frank expertise to represent you.

In addition to helping prepare your TCR, your attorney will appear on your behalf at SEC and CFTC Enforcement Division meetings to discuss your TCR. To remain anonymous, the whistleblower will present him or herself at Enforcement Division meetings only through voice technology.

Whistleblower confidentiality and identity protection are critical to the success of the SEC and CFTC whistleblower programs.

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Christina McGlosson served as the senior counsel to the director of the SEC’s Division of Enforcement, assisting in the restructuring of the division on the heels of the Madoff fraud, which included structuring the Office of the Whistleblower and drafting the rules to implement the Dodd Frank Whistleblower Provisions.

With the 2024 general election only eight months away, now is a good time for ethics and compliance counsel of public pension funds to refresh their understanding of the Securities and Exchange Commission’s (“SEC”) Rule 206-4(5) under the Investment Advisers Act of 1940. It’s also a good time to remain vigilant about this so-called “Pay-to-Play Rule” and its implications.

Enacted in 2010, the SEC’s Pay-to-Play Rule limits investment advisors from making political contributions to certain state and local government officials and candidates who possess the authority to influence the selection of an investment manager for public pension funds. It should be noted that the Pay-to-Play Rule does not extend to federal officials and candidates. There is an exception to this rule when a certain state or local official is running for federal office. For example, if the Governor of California decides to run for the President of the United States, they would be limited from receiving political contributions from investment advisors because the governor has appointment authority over the California Public Employees’ Retirement System. In fact, this scenario played out in the 2012 presidential election. According to Washington Post columnist Dan Balz, Republican presidential nominee Mitt Romney eliminated Governor Chris Christie of New Jersey from his vice-presidential short list because Governor Christie would be prohibited from raising money from financial institutions under the Pay-to-Play Rule (Romney also asked Christie to resign as governor, but he refused to do so).

The Pay-to-Play Rule does not extend to every investment advisor. Specifically, the rule applies to political contributions by “covered associates,” who may be defined in two ways: (1) general partners, managing members, or executive officers of an investment advisor; and (2) employees who solicit a government entity such as a public pension fund for the advisor, directly or indirectly. The application of the rule may be tricky because it requires determining what investment advisor directly or indirectly supervises a covered associate. On its face, independent contractors may appear outside of the rule; however, an investment advisor may also indirectly supervise them, thus falling under the rule.

The Pay-to-Play Rule also puts in place a two-year “cooling off” period during which an advisor is prohibited from receiving compensation from a public pension fund for two years after an advisor or “covered associate” makes a political contribution. Again, there is an exception: the rule allows an advisor or “covered associate” to make de minimis contributions: (1) $350 per election cycle for candidates running for offices that the advisor can vote for; and (2) $150 for other candidates.

Here again, the rule can be tricky to apply because the rule extends to an individual who is not a covered associate at the time of the contribution but then becomes a covered associate during the two-year time period. For example, in 2022, the SEC fined the Asset Management Group of Bank of Hawaii where a similar set of facts occurred. According to the SEC’s administrative proceedings, in July 2018, an officer of the Bank of Hawaii, as a noncovered associate, made a $1,000 contribution to the then[1]governor of Hawaii. Three months later, the officer became an indirect supervisor of the bank’s Asset Group, which provided investment advisory services. This change in role converted the officer from a non-covered associate to a covered associate. The SEC determined that the Asset Group of Bank of Hawaii violated the Pay-to-Play Rule because the now covered associate or former bank officer made a political contribution to the governor of Hawaii during the “cooling off” period. The governor of Hawaii possesses the authority to influence the investment advisory services for the University of Hawaii, a client of the investment manager. As a result, the SEC prohibited the investment management firm from receiving advisory fees from the University of Hawaii.

Therefore, ethics and compliance counsel of public pension funds should take three steps going into the election season. First, ethics counsel should proactively communicate with investment managers about the Pay-to-Play Rule, encouraging such managers to identify “covered associates,” adopt preclearance policies, and carry out period compliance checks about campaign contributions to certain state and local officials. Second, ethics counsel should identify a list of local and state elected officials or candidates that possess authority to appoint or influence their pension fund. Finally, ethics counsel should consider reviewing and updating placement agent forms, including disclosures of political contributions under the Pay-to-Play Rule. A “placement agent” may be defined as an internal or external employee to an investment advisor that does marketing on behalf of the investment manager. In some instances, this may not apply since certain states and pension funds have banned the use of placement agents. Taking these proactive steps will provide public pension funds with assurances that there are no compliance concerns.

In our inaugural installment of Securities Litigation 101, we discussed the ins and outs of shareholder derivative actions—lawsuits in which shareholders act on behalf the company to sue its directors for fiduciary breaches that caused harm to the company. Today, we will explore a powerful tool that shareholders can use to determine whether to file a derivative lawsuit: a books and records demand.

These procedures, often referred to as Section 220 demands for the section of the Delaware General Corporation Law (DGCL) that gives shareholders the right to inspect records of Delaware corporations, are also available outside the First State. By seeking internal board materials, shareholders can determine whether a company’s board of directors acted properly from a fiduciary standpoint or, conversely, can lay the groundwork for potential derivative litigation.

Submitting a books and records demand is straightforward and follows relatively the same process under each state’s corporate laws. If the shareholder has a “proper purpose”—defined as one “reasonably related to such person’s interest as a stockholder”—counsel prepares a letter explaining the concerns and basis for the document requests. A proper purpose for making a demand may include valuing the shareholder’s interest in the corporation or investigating possible wrongdoing, such as breaches of fiduciary duty by directors or officers that could include corporate waste, self-dealing, failure to oversee the business, allowing the business to engage in illegal activity, or insider trading. Along with the letter, the shareholder provides proof of their ownership of the stock during the relevant period and a power of attorney authorizing counsel to make the demand on their behalf.

Once a shareholder clears these hurdles, they are typically able to obtain access to board documents (such as board meeting agendas, minutes, and presentations), policies and procedures, and annual directors’ and officers’ questionnaires. The scope of the board materials to be produced is defined by the evolving caselaw in the particular state where the company is incorporated.

Annual directors’ and officers’ questionnaires are particularly helpful in identifying any intertwined relationships between the executives running the company and the directors charged with its oversight. Certain interdependencies may mean board members lack independence, thus making it “futile” to demand that the board bring claims against the company in a derivative action and allowing the shareholder to sue the board on the company’s behalf to protect the company from further harm—and in turn, protect the shareholder’s interest in the company. Derivative litigation does not return money directly to shareholders but rather may seek a monetary remedy for the company itself and/or seek to force companies to address inadequacies in corporate governance oversight, workplace policies, or other shortcomings that can harm shareholder value over the long term.

If the corporation does not comply with the books and records demand, the shareholder may enforce their right to make the demand by filing an action asking the court to compel the company to comply with the demand. These cases, typically summary proceedings, are litigated at an unusually fast pace, with litigators asking for a bench trial as soon as two to three months after filing a complaint. More like an evidentiary hearing than a full-blown trial, books-and-records trials normally last one day or less, with no opening or closing statements.

Cohen Milstein has significant experience issuing books and records demands on behalf of its institutional investor clients to uncover evidence of wrongdoing or mismanagement that would otherwise go unseen. By taking this preliminary step, shareholders can better assess how best to act as responsible stewards of the companies they own before bringing litigation.

The SEC has strengthened Customer Data Protection to address the expanded use of technology and risks by financial institutions.

On May 16, 2024, the U.S. Securities and Exchange Commission (SEC) announced the adoption of amendments to Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Customer Information (the “Amendments”), which govern the treatment of nonpublic personal information about consumers by certain financial institutions.

The Amendments require broker-dealers (including funding portals), investment companies, registered investment advisers, and transfer agents to:

Incident response: Develop, implement, and maintain written policies and procedures for an incident response program that is reasonably designed to detect, respond to, and recover from unauthorized access to or use of customer information.

Customer notification: Provide affected customers timely notification about sensitive customer information that was or is reasonably likely to have been accessed or used without authorization.
- Notices must be issued no later than 30 days after becoming aware of the unauthorized access to or use of customer information.
- Notices must include details about the incident, the breached data, and how affected individuals can respond to the breach to protect themselves.

Since Regulation S-P’s adoption in 2000, technological advancements require critical updates to help protect the privacy of customers’ financial data. The Amendments are designed to modernize and enhance the protection of consumer financial information in the event of a data breach.

What if I witness misconduct or suspect fraud?

If you observe financial institutions not reporting a data breach, or failing to have written policies and procedures for safeguarding customer nonpublic information, it is critical that you inform the SEC.

The SEC will often pay monetary awards to whistleblowers who voluntarily provide the SEC with original information about violations of the federal securities laws.

How do I report this misconduct or fraud to the SEC?

Such consultations are confidential and free-of-charge.

What type of information is needed to report fraud, non-compliance, or misconduct to the SEC?

In addition to your personal observations and a completed Form TCR, the SEC requires supporting information that is original and not in the public sphere.

What if I’m not a company insider?

Does the SEC offer a whistleblower award for reporting fraud or misconduct?

Yes. If your information leads to a successful SEC enforcement action resulting in more than $1 million in monetary sanctions, you will receive an award ranging from 10-30% of any amount collected.

Where do I find more about reporting fraud and becoming a whistleblower?

The SEC’s Office of the Whistleblower provides comprehensive guidelines on reporting fraud and the whistleblower process.

You can also contact a member of our Whistleblower practice for a confidential and free-of-charge consultation.

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About the Author

Christina McGlosson is Special Counsel in our Whistleblower practice, where she focuses exclusively on Dodd-Frank Whistleblower representation. She is the former acting director of the Whistleblower Office in the Division of Enforcement at the U.S. Commodity Futures Trading Commission (CFTC). She was also a senior attorney in the SEC’s Division of Enforcement for over a decade. Christina represents whistleblowers in the presentation and prosecution of fraud claims before the SEC, CFTC, FinCen, as part of the U.S. Treasury, and other government agencies.

Cohen Milstein Sellers & Toll PLLC

1100 New York Avenue, NW

Washington, DC 20005

E: cmcglosson@cohenmilstein.com

T. 202-408-3635

Advertising Material. This content is informational in nature and should not be read or interpreted as legal advice. Should you need legal advice, please contact a lawyer.

The SEC’s Recent Risk Alert Highlights the Potential for Fraud

On April 18, 2024, the U.S. Securities and Exchange Commission (SEC) issued a Risk Alert summarizing the staff’s preliminary observations involving compliance by registered investment advisers with Rule 206(4)-1 of the Investment Advisers Act of 1940, as amended (the Marketing Rule).

The Risk Alert addresses the “general prohibition” provisions of the Marketing Rule in addition to the requirements relating to (1) adopting and implementing policies and procedures; (2) maintaining books and records; and (3) completing Form ADV questions regarding advertisements, specifically those including actual performance and hypothetical performance.

SEC staff observed and provided specific details regarding compliance deficiencies they have discovered in the following areas:

Untrue and unsubstantiated statements of material fact regarding the investment adviser’s business;
Misleading inferences or omission of material facts relating to conflicts, endorsements, performance claims, third party ratings, testimonials, and performance information;
Fair and balanced treatment of material risks or limitations;
References to specific investment advice that were not presented in a fair and balanced manner;
Inclusion or exclusion of performance results or time periods in manners that were not fair and balanced; and
Advertisements that were otherwise materially misleading because of font size, visibility of disclosures, etc. particularly on websites and in videos.

The Risk Alert emphasizes the SEC’s focus on advertisements and Marketing Rule compliance and highlights the need for registered investment advisers to “reflect upon their own practices, policies, and procedures and to implement any appropriate modifications to their training, supervisory, oversight, and compliance programs.”

What if I witness misconduct or suspect fraud?

If you observe investment adviser misconduct in violation of the Marketing Rule or any other federal securities law, it is critical that you inform the SEC.

The SEC will often pay monetary awards to whistleblowers who voluntarily provide the agency with original information about violations of the federal securities laws.

How do I report this misconduct or fraud to the SEC?

Such consultations are confidential and free-of-charge.

What type of information is needed to report fraud or misconduct to the SEC?

In addition to your personal observations and a completed Form TCR, the SEC requires supporting information that is original and not in the public sphere.

What if I’m not a company insider?

Does the SEC offer a whistleblower award for reporting fraud or misconduct?

Yes. If your information leads to a successful SEC enforcement action resulting in more than $1 million in monetary sanctions, you will receive an award ranging from 10-30% of any amount collected.

Where do I find more about reporting fraud and becoming a whistleblower?

The SEC’s Office of the Whistleblower provides comprehensive guidelines on the reporting fraud and the whistleblower process.

You can also contact a member of Cohen Milstein’s Whistleblower practice for a confidential and free-of-charge consultation.

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About the Author

Christina McGlosson is special counsel in Cohen Milstein’s Whistleblower practice, where she focuses exclusively on Dodd-Frank Whistleblower representation. She is the former acting director of the Whistleblower Office in the Division of Enforcement at the U.S. Commodity Futures Trading Commission (CFTC). She was also a senior attorney in the SEC Division of Enforcement.

Christina represents whistleblowers in the presentation and prosecution of fraud claims before the SEC, CFTC, FinCen, as part of the U.S. Treasury, and other government agencies.

Christina McGlosson, Special Counsel: Dodd-Frank Whistleblower Practice

Cohen Milstein Sellers & Toll PLLC

1100 New York Avenue, NW

Washington, DC 20005

E: cmcglosson@cohenmilstein.com

T. 202-408-3635