Court Rules that Law Firm’s Oral Summaries to SEC of Interview Notes and Memoranda Constitutes Waiver of Work Product Protection

We previously reported that on October 31, 2017, two former executives from General Cable Corporation (“GCC”) moved to compel Morgan Lewis & Bockius LLP (“Morgan Lewis”) to produce interview memoranda and notes created during an internal investigation of GCC that were subsequently provided to the SEC and an independent auditor. In S.E.C. v. Herrera, et al., No. 17-20301, 2017 WL 6041750 (S.D. Fla. Dec. 5, 2017), the issue before the court was whether Morgan Lewis “waived work product protection when it voluntarily gave the SEC oral summaries of the work product notes and memoranda its attorneys prepared about interviews of its client’s executives and employees.” On December 5, 2017, Magistrate Judge Jonathan Goodman issued a ruling ordering Morgan Lewis to produce the notes and memoranda for the interviews the firm discussed with the SEC.

As a matter of background, GCC retained the law firm to conduct an internal investigation after the company announced that it had identified accounting errors related to inventory at its operations in Brazil. As part of its internal investigation, Morgan Lewis interviewed more than three dozen witnesses, many of which were conducted in Brazil, and prepared notes and memoranda of those interviews. According to the motion papers, Morgan Lewis “regularly communicated with the SEC, voluntarily produced documents, and routinely made Brazil-based witnesses available for interviews with the SEC.” Specifically, Morgan Lewis attorneys “met with SEC staff and provided oral downloads of 12 witness interviews.” Subsequently, a Cease and Desist Order against GCC was entered and shortly thereafter, the SEC filed suit against the defendants alleging that they actively concealing material inventory accounting errors in violation of various securities laws.

In their motion to compel, the defendants sought all of the law firm’s interview notes and memoranda on the basis that Morgan Lewis waived work product protection by providing oral downloads of some interviews to the SEC and by providing work product, both orally and in writing, to Deloitte, GCC’s independent auditor. For its part, Morgan Lewis argued that “the oral conveyance of information derived from interviews does not waive the work product protection as to the underlying attorney notes and memoranda[,]” and if a waiver had occurred, it did not extend beyond the specific disclosures made. As for the disclosures made to Deloitte, Morgan Lewis argued that the oral conveyance or actual provision of work product to a company’s auditors does not waive the work product protection.

As an initial matter, Judge Goodman noted that “[i]n the context of work product, the question is not, as in the case of the attorney-client privilege, whether confidential communications are disclosed, but to whom the disclosure is made – because the protection is designed to protect an attorney’s mental processes from discovery by adverse parties.” This protection is waived when otherwise protected materials are “‘disclosed in a manner which is either inconsistent with maintaining secrecy against opponents or substantially increases the opportunity for a potential adversary to obtain the protected information.’” Judge Goodman “easily conclude[d]” that the SEC was an adversary of Morgan Lewis’ client, GCC, since the SEC was investigating GCC and eventually imposed a $6.5 million civil penalty against the company. Judge Goodman dismissed Morgan Lewis’ argument that the oral conveyance, as opposed to the actual production, of the notes and memoranda did not constitute a waiver, finding the oral downloads to be the “functional equivalent” of the actual notes and summaries. Judge Goodman did agree that the waiver did not extend beyond the notes and memoranda of the 12 interviews the law firm provided oral summaries of to the SEC. Judge Goodman noted that the compelling the disclosure of attorney work product is disfavored and the defendants failed to demonstrate substantial need to overcome this high hurdle. In addition, Judge Goodman denied the defendants’ request for documents produced to Deloitte holding that the disclosure of work product to Deloitte did not constitute a waiver because Deloitte is not an adversary to GCC.

On December 12, 2017, Morgan Lewis filed a motion for clarification or reconsideration of Judge Goodman’s Order. In its motion, the firm represents that the attorney notes taken during a meeting with the SEC “reflect the substance of the oral communications conveyed to the SEC by Morgan Lewis concerning the twelve interviews at issue.” Morgan Lewis requests, to avoid “manifest injustice,” that the Court review these notes in camera and then modify its Order “to provide that, instead of the interview notes and memos for the twelve interviews at issue,” only the attorney notes and a portion of an interview memo read to the SEC be produced to the Defendants. This motion is still pending and we will report back when there are further developments.

When sharing information obtained over the course of an internal investigation with a government agency, one should consider the implications such conduct has on privilege and waiver. The decision above serves as a reminder that even oral disclosures of work product to an adversary can constitute a waiver.

SEC Awards More Than $4.1 Million to Whistleblower Despite a Finding that Whistleblower Unreasonably Delayed Reporting Misconduct

The SEC announced earlier today that it has awarded more than $4.1 million to a former company employee who “alerted the agency to a widespread, multi-year securities law violation and continued to provide important information and assistance throughout the SEC’s investigation.” Press Rel. No. 2017-222. To determine an appropriate award amount, the SEC considers a number of criteria that are outlined in the Rule 21F-6 of the Exchange Act, including (1) the significance of the information provided to the Commission, (2) the assistance provided in the Commission action, (3) law enforcement interest in deterring violations by granting awards, (4) participation in internal compliance systems, (5) culpability, (6) unreasonable reporting delay, and (7) interference with internal compliance and reporting systems. 17 C.F.R. § 240.21F-6.

In its Order, the Commission found that the whistleblower’s positive contributions were “somewhat offset” by the whistleblower’s “unreasonable delay in reporting the misconduct,” which is one of the criteria used to evaluate the award amount. However, the Commission noted that it did not weigh the whistleblower’s delay in reporting as heavily as it might have otherwise due to several mitigating factors. First, the Commission noted that a large part of the whistleblower’s reporting delay “occurred prior to the establishment of the whistleblower award program in July 2010,” and the Commission has generally not penalized whistleblowers as heavily due to the absence of the benefits provided by the program, such as monetary awards, anonymity, and heightened confidentially protections. Second, the Commission noted that the whistleblower “was a foreign national working outside the United States,” and therefore, it was unclear whether the whistleblower anti-retaliation provision of the Exchange Act would apply to the whistleblower.

When balancing the whistleblower’s contribution with the unreasonable delay in initially reporting the misconduct, along with the totality of the circumstances, the Commission found that the award determination was justified.

According to the press release, the agency has “now awarded more than $179 million to 50 whistleblowers since issuing its first award in 2012.” The awards come from an investor protection fund that was established by Congress and financed through monetary sanctions that are paid by violators of securities laws.

Ex-Executives Move to Compel Law Firm to Produce Notes from Internal Investigation

On October 31, 2017, two former executives from General Cable Corporation (“GCC”) filed a motion to compel Morgan Lewis & Bockius LLP (“Morgan Lewis”) to produce interview memoranda and notes created during an internal investigation of GCC that were subsequently provided to the SEC and an independent auditor. In S.E.C. v. Herrera, et al., No. 17-20301 (S.D. Fla. filed Jan. 24, 2017), the government alleged that Mathias Francisco Sandoval Herrera (“Herrera”) and Maria D. Cidre (“Cidre”), acting as CEO and CFO of the Latin American operations of GCC, violated various securities laws when they “actively concealed from GCC executive management material inventory accounting errors at the company’s subsidiary in Brazil, including the overstatement of inventory by tens of millions of dollars and allegations of a massive theft by GCC Brazil employees.”

GCC, a global manufacturer of copper, aluminum, and fiber optic wire and cable products, announced in October 2012 that “it had identified accounting errors relating to inventory at its Brazil operations, that its previously issued financial statements for 2009-2011, audited by [Deloitte & Touche LLP], should not be relied upon, and that it intended to issue a restatement of financials.” Following this announcement, GCC retained Morgan Lewis to conduct an internal investigation, which consisted of interviewing more than three dozen witnesses, many of which were conducted in Brazil, preparing notes and memoranda of those interviews, and preparing memoranda related to other aspects of the investigation. “After retaining Morgan Lewis, GCC reported the accounting errors to the SEC, which launched its own investigation . . . . [that] led to a Cease and Desist Order against GCC in December 2016, which required the payment of a civil monetary penalty in the amount of $6,500,000.”

In their motion to compel, the defendants state that during the internal investigation, Morgan Lewis “regularly communicated with the SEC, voluntarily produced documents, and routinely made Brazil-based witnesses available for interviews with the SEC.” The defendants allege that Morgan Lewis shared work product with the SEC both orally and in writing, and with this work product, the SEC had a “decided advantage” in the litigation by being able to “focus its investigation and decide which of the nearly 40 witnesses – many of whom where GCC employees in Brazil – to interview and from whom to elicit sworn statements during the investigation.” Additionally, during Morgan Lewis’ internal investigation, “Deloitte independently formed a forensic team to assess the sufficiency of the Morgan Lewis investigation.” Deloitte served as GCC’s independent auditor and issued unqualified opinions on GCC’s financial statements during the relevant time period. The defendants state that Deloitte had reason to believe that it would be charged by the SEC in connection with its audits of GCC and that Morgan Lewis “regularly shared its work product” with Deloitte, both orally and in writing.

In light of these disclosures, the defendants served Morgan Lewis with a subpoena seeking, among other items, notes and memoranda from Morgan Lewis’ witness interviews. In response, Morgan Lewis “declined to produce any documents on the basis of privilege, including the attorney-client privilege, the work-product doctrine, and the certified public accountant-client privilege.” While the defendants do not dispute that the interview memoranda were prepared by Morgan Lewis in anticipation of litigation, they argue that Morgan Lewis waived privilege when it provided written interview notes and memoranda to the SEC, an adversarial investigative agency, as well as oral downloads of each. As for documents and information shared orally with Deloitte, the defendants concede that the majority of courts have held that independent or outside auditors typically share a common interest with the corporation for purposes of the work-product doctrine and waiver analysis, but argue that in the present case, Deloitte does not share a common interest with GCC due to the fact that Deloitte was potentially a target of the SEC. Specifically, defendants argue that “Deloitte was a potential adversary to GCC because Deloitte was motivated to claim that GCC personnel had misled Deloitte regarding accounting practices at GCC[,]” and “Deloitte was a potential conduit of information to the SEC in an effort to avoid or minimize its own liability.”

In opposition, Morgan Lewis makes three primary arguments as to why it should not be compelled to produce its interview memoranda and notes: (1) courts strong disfavor ordering the production of such materials; (2) defendants failed to demonstrate that Morgan Lewis waived the work product protection; and (3) defendants failed to demonstrate a substantial need for these materials. As an initial matter, Morgan Lewis notes that the materials sought are neither transcripts nor witness statements, but rather are attorney summaries of relevant information derived from witness interviews. Morgan Lewis relies on the Supreme Court’s Upjohn decision to argue that “‘[f]orcing an attorney to disclose notes and memoranda of witness’ oral statements is particularly disfavored because it tends to reveal the attorney’s mental processes[,]” and absent a showing of waiver, defendants must show a substantial need for the materials to prepare a defense.

As for defendants’ waiver argument, Morgan Lewis argues that the PowerPoint presentation prepared for the SEC is not work product, but a collection of facts and therefore the issue of waiver is inapplicable in that instance. In addition, Morgan Lewis contends that “the oral conveyance of information derived from interviews does not waive the work product protection as to the underlying attorney notes and memoranda[,]” and if a waiver has occurred, the waiver does not extend beyond the specific disclosures made. As for the disclosures made to Deloitte, Morgan Lewis argues that the oral conveyance or actual provision of work product to a company’s auditors does not waive the work product protection.

Finally, Morgan Lewis states that defendants have failed to show a substantial need for the sought after materials. Morgan Lewis argues that a speculation that the passage of time has causes witness memories to fade does not rise to a level that overcomes the work product protection. In any event, defendants are in possession of the 400,000-plus documents that General Cable produced to the SEC, which can be used to refresh the recollections of the witnesses.

We will monitor the pending motion and report on further developments.

Split Second Circuit Affirms Insider Trading Conviction While Rejecting Newman’s “Meaningfully Close Personal Relationship” Requirement

On August 23, 2017, the United States Court of Appeals for the Second Circuit affirmed an insider trading conviction against a portfolio manager, and in doing so, held that the “meaningfully close personal relationship” requirement set forth in the Second Circuit’s landmark decision, United States v. Newman, to infer personal benefit “is no longer good law.”


Matthew Martoma (“Martoma”) managed an investment portfolio at S.A.C. Capital Advisors, LLC (“SAC”) that focused on pharmaceutical and healthcare companies. His “conviction[] stem[s] from an insider trading scheme involving securities of two pharmaceutical companies, Elan Corporation, plc (“Elan”) and Wyeth, that were jointly developing an experimental drug called bapineuzumab to treat Alzheimer’s disease.” During the development of bapineuzumab, Martoma arranged for consultation visits paid by SAC with two doctors who were working on the clinical trial. One doctor was the chair of the safety monitoring committee for the clinical trial and provided Martoma with “confidential updates on the drug’s safety that he received during meetings on the safety monitoring committee.” The other doctor, a principal investigator on the clinical trial, provided Martoma with “information about the clinical trial, including information about his patients’ responses to the drug and the total number of participants in the study.”

In July 2008, one of these two doctors was selected to present the results of “Phase II” of the clinical trial at the International Conference on Alzheimer’s Disease, but prior to the conference, the doctor identified “‘two major weaknesses in the data that called into question the efficacy of the drug as compared to the placebo.” Martoma spoke with this doctor on two occasions, including an in-person meeting where the doctor shared with Martoma “the efficacy results and discussed the data with him in detail.” Martoma subsequently spoke with the owner of SAC and prior to the public announcement of the efficacy results, “SAC began to reduce its position in Elan and Wyeth securities by entering into short-sale and options trades that would be profitable if Elan’s and Wyeth’s stock fell.” When the final results from the clinical trial were publicly presented approximately a week later, Elan’s and Wyeth’s share prices declined and the “trades that Martoma and [SAC’s owner] made in advance of the announcement resulted in approximately $80.3 million in gains and $194.6 million in averted losses for SAC.”

The Appeal

In February 2014, following a four-week jury trial, Martoma was convicted of one count of conspiracy to commit securities fraud in violation of 18 U.S.C. § 371 and two counts of securities fraud in connection with an insider trading scheme. Martoma appealed his conviction primarily on two grounds—“that the evidence presented at trial was insufficient to support his conviction and that the district court did not properly instruct the jury in light of the Second Circuit’s decision in United States v. Newman, issued after Martoma was convicted.” Specifically, Martoma argued that there was no “meaningfully close personal relationship” as set forth in Newman between him and the doctor, and that the doctor did not receive any “‘objective, consequential . . . gain of a pecuniary or similarly valuable nature’ in exchange for providing Martoma with confidential information.” Martoma also argued that the jury instructions were inadequate because they “did not inform the jury about the limitations on ‘personal benefit’” as set forth in Newman.

The majority summarily rejected Martoma’s sufficiency of evidence argument finding that Martoma was a “frequent and lucrative client” of the doctor who was paid $1,000 for approximately 43 consulting sessions where the doctor regularly disclosed confidential information. Relying on Newman, the court noted that “‘the tipper’s gain need not be immediately pecuniary,’ and . . . that ‘enter[ing] into a relationship of quid pro quo with [a tippee], and therefore hav[ing] the opportunity to . . . yield future pecuniary gain,’ constituted a personal benefit giving rise to insider trading liability.” The court held that even though the doctor was not paid for the two consultations on the efficacy results, under the pecuniary quid pro quo theory, a “rational trier of fact could have found the essential elements of the crime [of insider trading] beyond a reasonable doubt.”

The crux of the decision lies in Martoma’s challenge to the adequacy of the lower court’s jury instruction. To complicate matters, during the pendency of the appeal, both the Second Circuit and the Supreme Court issued decisions that weighed heavily into the court’s analysis. First, in United States v. Newman, which we previously reported on here, the Second Circuit held, in relevant part, that a trier of fact could not infer that a tipper personally benefitted from disclosing information as a gift unless that gift was made to someone with whom the tipper had a “meaningfully close personal relationship.” This requirement was derived from an example the Supreme Court provided in Dirks v. S.E.C., 463 U.S. 646 (1983), where an insider is deemed to have personally benefited when disclosing inside information as “a gift . . . to a trading relative or friend.” Subsequently, in Salman v. United States, which we previously reported on here, the Supreme Court found as obvious that an insider personally benefits from trading on inside information and then giving the proceeds as a gift to his brother, and an insider “‘effectively achieve[s] the same result by disclosing the information to [the tippee], and allowing him to trade on it,’ because ‘giving a gift of [inside] information is the same thing as trading by the tipper followed by a gift of the proceeds.’”

Acknowledging that the discussion of gifts in both Dirks and Salman were “largely confine[d]” within the context of gifts to trading relatives and friends, and that the Supreme Court in Salman did not explicitly hold that gifts to anyone, including non-relatives and non-friends, can give rise to the personal benefit necessary to establish insider trading liability, the Second Circuit determined that “the straightforward logic of the gift-giving analysis in Dirks, strongly reaffirmed in Salman, is that a corporate insider personally benefits whenever he ‘disclos[es] inside information as a gift . . . with the expectation that [the recipient] would trade’ on the basis of such information or otherwise exploit it for his pecuniary gain.” Against this backdrop, the Second Circuit held that:

[A]n insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed “with the expectation that [the recipient] would trade on it,” and the “disclosure resemble[s] trading by the insider followed by a gift of the profits to the recipient,” whether or not there was a “meaningfully close personal relationship” between the tipper and tippee.

In other words, the Second Circuit “reject[ed], in light of Salman, the categorical rule that an insider can never personally benefit from disclosing inside information as a gift without a ‘meaningfully close personal relationship.’” Coupled with the fact that it had already determined the evidence was sufficient to support Martoma’s conviction, the Second Circuit determined that the jury instruction pertaining to personal benefit was not obviously erroneous, and even if it were, such an error did not impair Martoma’s rights.

The Dissent

Of note in an already notable decision is the scathing dissent, which is lengthier than the majority opinion, authored by Judge Pooler. Judge Pooler opined that by expanding the recipient of a gift from a “trading relative or friend” as set forth in Dirks to any person, the “majority strips the long-standing personal benefit rule of its limiting power.” Judge Pooler expressed particular disagreement with the majority’s application of Salman to overturn Newman’s “meaningfully close personal relationship” requirement because the Supreme Court explicitly overturned the second holding in Newman that had required a showing of a monetary or other gain in conjunction with a gift of information to a trading relative or friend, but left untouched the first holding that there must be a “meaningfully close personal relationship” to infer a personal benefit from a gift. She states:

In the past, we have held that an insider receives a personal benefit from bestowing a “gift” of information in only one narrow situation. That is when the insider gives information to family or friends—persons highly unlikely to use it for commercially legitimate reasons. Today’s opinion goes far beyond that limitation, which was set by the Supreme Court in Dirks, received elaboration in this Court’s opinion in Newman, and was left undisturbed by the Supreme Court in Salman. In rejecting those precedents, the majority opinion significantly diminishes the limiting power of the personal benefit rule, and radically alters insider-trading law for the worse.


This ruling unwinds the landmark Newman decision, which limited the circumstances that a gift of information could be inferred as receipt of a personal benefit, but how long the ruling will remain in effect is unclear. It is possible that the Second Circuit will review the case en banc, or that the Supreme Court will grant certiorari should Martoma seek it, particularly in light of the fact that Newman’s “meaningfully close personal relationship” requirement was not an issue in front of the Supreme Court in Salman since the case involved two brothers. For the time being, however, the decision allows prosecutors to go forward with insider trading cases that may have been previously foreclosed under Newman’s “meaningfully close personal relationship” requirement.

11th Circuit Nixes CPA’s Claim That SEC Sanctions Preclude Criminal Prosecution

On February 3, 2017, the United States Court of Appeals for the Eleventh Circuit rejected an accountant’s argument that the imposition of both criminal charges and SEC sanctions on the basis of the same alleged conduct violated the Fifth Amendment’s Double Jeopardy Clause. This appellate court ruling illustrates that defendants in SEC investigations and enforcement proceedings must be mindful that the imposition of civil penalties, disgorgement, and permanent bars do not preclude the prospect of criminal prosecution.

Thomas D. Melvin (“Melvin”), a certified public accountant, agreed in April 2013 to pay the SEC a civil penalty of $108,930 and disgorgement of $68,826 to settle alleged violations of Sections 10(b) and 14(e) of the Securities and Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. According to the SEC, Melvin purportedly had disclosed confidential insider information that he received from a client that pertained to the pending sale of a publicly traded company. A Rule 102(e) administrative proceeding in September 2015 also permanently barred Melvin from practicing before the SEC as an accountant. Exchange Act. Rel. No. 75844.

The Department of Justice instituted a parallel criminal proceeding against Melvin that involved the same alleged wrongful activity. Melvin moved to dismiss the eventual indictment on the ground that the collective sanctions the SEC had levied upon him constitutionally precluded a criminal prosecution under the Double Jeopardy Clause. After a federal district court denied his motion to dismiss, Melvin pleaded guilty to six counts of securities fraud pursuant to a written plea agreement. He then appealed the district court’s denial of his motion to dismiss.

In United States v. Melvin, No. 16-12061 (11th Cir. Feb. 3, 2017), the Eleventh Circuit conducted two inquiries to determine whether the imposition of the civil penalty, disgorgement and professional debarment against Melvin were so punitive that they rose to the level of a criminal penalty. For the initial inquiry, the court found that Congress intended the sanctions imposed by the SEC to be a form of civil punishment because monetary penalties are expressly labeled as “civil penalties” and the legislative branch empowered the SEC to prohibit an individual from appearing or practicing before it.

As to the second inquiry, the circuit court examined seven “useful guideposts” articulated by the United States Supreme Court in Hudson v. United States, 118 S. Ct. 488, 493 (1997). These guideposts included whether:

  1. “the sanction involves an affirmative disability or restraint”;
  2. “it has historically been regarded as a punishment”;
  3. “it comes into play only on a finding of scienter”;
  4. “its operation will promote the traditional aims of punishment—retribution and deterrence”;
  5. “the behavior to which it applies is already a crime”;
  6. “an alternative purpose to which it may rationally be connected is assignable for it”; and
  7. “it appears excessive in relation to the alternative purpose assigned.”

Applying these guideposts, the Eleventh Circuit believed that the sanctions at issue “constitute no affirmative disability or restraint approaching imprisonment” and observed that “neither money penalties nor debarment have historically been viewed as punishment.” It also noted that “penalties for security fraud serve other important nonpunitive goals, such as encouraging investor confidence, increasing the efficiency of financial markets, and promoting the stability of the securities industry.” As such, the appellate court concluded that Melvin’s criminal prosecution did not constitute a violation of the Double Jeopardy Clause.

This ruling is the most recent cautionary reminder that, even in this era of headline-grabbing civil penalties that far exceed those the SEC sought and obtained just a few years ago, defendants should never lose sight that the resolution of SEC charges does not preclude the prospect of a parallel criminal proceeding. Indeed, any time the SEC’s prosecutorial theory is potentially fraud-based, defendants and their counsel must remain extremely cautious to the possible involvement of criminal authorities and develop their legal strategies accordingly.

The SEC’s Form 1662 underscores this point. This form, which is provided to all persons requested to supply information voluntarily to the SEC or directed to do so via subpoena, states:

It is the policy of the Commission … that the disposition of any such matter may not, expressly or impliedly, extend to any criminal charges that have been, or may be, brought against any such person or any recommendation with respect thereto. Accordingly, any person involved in an enforcement matter before the Commission who consents, or agrees to consent, to any judgment or order does so solely for the purpose of resolving the claims against him in that investigative, civil, or administrative matter and not for the purpose of resolving any criminal charges that have been, or might be, brought against him.

The disposition of an SEC proceeding also does not prevent the SEC from sharing any information it has accumulated with criminal authorities. Instead, as Form 1662 warns, the SEC “often makes its files available to other governmental agencies, particularly United States Attorneys and state prosecutors” and there is “a likelihood” that the SEC will provide this information confidentially to these agencies “where appropriate.”

SEC Announces Record Number of Enforcement Actions Filed in FY 2016

On October 11, 2016, the SEC announced its enforcement results for fiscal year 2016, which ended on September 30th. Press Release No. 2016-212. In total, the SEC continued its trend of increased enforcement activity by filing 868 enforcement actions, a new single-year high, which included “a record 548 standalone or independent enforcement actions” and “judgments and orders totaling more than $4 billion in disgorgement and penalties.” In comparison, the SEC filed 807 enforcement actions (507 standalone or independent actions) in fiscal year 2015, and 755 enforcement actions (413 standalone or independent actions) in fiscal year 2014. Touting its recent successes, SEC Chair Mary Jo White announced in the press release that “[o]ver the last 3 years, we have changed the way we do business on the enforcement front by using new data analytics to uncover fraud, enhancing our ability to litigate tough cases, and expanding the playbook bringing novel and significant actions to better protect investors and our markets.”

This past fiscal year marked new highs for the SEC in the number of cases involving investment advisers or investment companies, as well as enforcement actions related to the Foreign Corrupt Practices Act. Other significant actions the SEC highlighted involved “combating financial fraud and enhancing issuer disclosure,” holding “attorneys, accountants and other gatekeepers accountable for failure to comply with professional standards,” “enhancing fairness among market participants,” “rooting out insider trading schemes,” “fighting market manipulation and microcap fraud,” “halting international and affinity-based investment frauds,” “policing the public finance markets,” and “cracking down on misconduct involving complex financial instruments.”

Under the whistleblower program, the SEC this past year awarded a record $57 million to 13 whistleblowers, brought the first standalone action for retaliation against a whistleblower, and charged multiple companies for Rule 21F-17 violations, which prohibits any action impeding an individual from communicating directly with Commission staff about possible securities laws violations.

In addition, the SEC announced victories in five federal jury or bench trials this year, including its first ever victory “against a municipality and one of its officers for violations of the federal securities laws.”

Private Equity Fund Advisers Agree to Settle Charges of Improperly Disclosing Acceleration of Monitoring Fees and Improperly Supervising Expense Reimbursement Practices

In a recent action, the SEC demonstrated its continuing focus on private equity fund advisers’ fees. On August 23, 2016, Apollo Management V, LP, Apollo Management VI, LP, Apollo Management VII, LP, and Apollo Commodities Management, LP (collectively, “Apollo”), agreed to settle charges brought by the SEC for “misleading fund investors about fees and a loan agreement and failing to supervise a senior partner who charged personal expenses to the funds” in violation of Sections 206 and 203 of the Advisers Act. Press Release No. 2016-165.

According to the SEC Order, Apollo advises a number of private equity funds that own multiple portfolio companies. Like most private equity fund advisers, Apollo charges annual management fees and certain other fees to the limited partners in its private equity funds and charges monitoring fees to certain portfolio companies under separate monitoring agreements. Release No. 4493. Investors benefit from the monitoring fees in that a certain percentage of the monitoring fees are used to offset a portion of the annual management fees. The SEC found that the monitoring agreements allowed Apollo, upon the triggering of certain events, to terminate the agreement and accelerate the remaining years of the monitoring fees to be collected in a present value lump sum termination payment. Triggering events included the private sale or IPO of a portfolio company. The SEC found that the accelerated fees created a conflict of interest for the adviser and noted that while the accelerated monitoring fees reduced annual management fees paid by the funds, the accelerated payments reduced the portfolio companies’ value prior to their sale or IPO, thereby “reducing the amounts available for distribution to the” the funds’ investors. The SEC found that Apollo did not disclose to the limited partners “its practice of accelerating monitoring fees until after Apollo had taken accelerated fees.” Id.

In addition, the SEC found that in June 2008, the general partner of one of Apollo’s funds entered into a loan agreement between the fund and four parallel funds in which the parallel funds loaned an amount to fund equaling the carried interest due to the fund from the recapitalization of two portfolio companies owned by the parallel funds. Until the loan was extinguished, taxes owed by the general partner on the carried interest were deferred and the general partner was required to pay accrued interest to the parallel funds. While the parallel funds’ financial statements disclosed the interest, Apollo’s failure to disclose that the accrued interest would be allocated solely to the account of the general partner was determined to be materially misleading.

The SEC further found that a former Apollo senior partner, on two occasions, improperly charged personal expenses to Apollo-advised funds and the funds’ portfolio companies, and in some instances, fabricated information to conceal his conduct. Upon discovery of the partner’s conduct, Apollo orally reprimanded the partner but did not take any other remedial or disciplinary steps.

Finally, according to the SEC, Apollo also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act arising from the undisclosed receipt of accelerated monitoring fees and failed to implement its policies and procedure concerning employees’ reimbursement of expenses.

Without admitting or denying the SEC’s findings, Apollo agreed to pay $40,254,552, consisting of a disgorgement of $37,527,000 and prejudgment interest of $2,727,552. In addition, the SEC assessed a $12.5 million civil penalty,  stating that the penalty is not higher due to Apollo’s cooperation during the investigation and related enforcement action. The SEC reserved the right to increase the penalty should it be discovered that Apollo knowingly provided false or misleading information or materials to the staff during the course of its investigation.

Registered Investment Advisor Agrees to Settle Charges of Failing to Clearly Disclose Transaction Costs Beyond “Wrap Fees” to Investors

On July 14, 2016, RiverFront Investment Group, LLC (“RiverFront”) agreed to settle charges brought by the SEC for failing to “properly prepare clients for additional transaction costs beyond the ‘wrap fees’ they pay to cover the cost of several services bundles together.” Press Release No. 2016-143. According to the SEC, participants in wrap fee programs usually pay an annual fee “which is intended to cover the cost of several services ‘wrapped’ together, such as custody, trade execution, portfolio management, and back office services.” Release No. 4453. The SEC found that under these wrap programs, a sponsoring firm will offer clients a selection of third-party managers, referred to as subadvisors, to have discretion over the clients’ investment decisions. When subadvisors execute trades on behalf of clients through a sponsor-designated broker-dealer, the transaction costs associated with the trades are included in the wrap fee. On the other hand, if a subadvisor sends a trade to a non-designated broker-dealer, a practice known as “trading away,” clients incur additional transaction costs beyond the wrap fee. Continue reading “Registered Investment Advisor Agrees to Settle Charges of Failing to Clearly Disclose Transaction Costs Beyond “Wrap Fees” to Investors”

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