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From Securities Regulation Daily, January 23, 2018

Securities Regulation Institute gives the lowdown on need-to-know cases

By Lene Powell, J.D.

A panel of the Northwestern University Pritzker School of Law Securities Regulation Institute gave an info-packed update on important litigation developments from the past year, including a clarification on insider trading, a new limit on the ability of the SEC to seek disgorgement in enforcement actions, and a lack of resolution on conflicting disclosure requirements.

The panel was moderated by David Lynn, a partner at Jenner & Block and former chief counsel of the SEC Division of Corporate Finance. Panelists included Robert Buckholz, a partner at Sullivan & Cromwell; Lisa Fairfax, a professor at George Washington University Law School; and Monica Loseman, a partner at Gibson, Dunn & Crutcher.

Salman: clarity on insider trading. The Supreme Court decision in Salman v. United Statesclarified the scope of criminal insider trading liability for tippees.

In Salman, the court unanimously held that a tippee can be liable for trading on material non-public information (MNPI) received from an insider relative or friend—even if the tipper did not receive a direct financial benefit. As Lynn explained, tippees essentially inherit the duties of insiders from whom they receive MNPI, and have the same potential liability as insiders.

The decision resolved a circuit split arising from United States v. Newman, in which the Second Circuit had held that, in order for a tippee to face liability for insider trading, the tipper must also receive something of a pecuniary or similarly valuable nature in exchange for providing MNPI to family or friends. The Salman ruling was subsequently reinforced in the U.S. v. Martoma in the Second Circuit.

Although Salman and Martoma clarified the scope of tippee liability in some ways, they left open some important questions, including:

  • What types of relationships meet the “relative or friend” test? 
  • If a tippee does not meet the “relative or friend” test, what type of non-pecuniary personal benefit” is sufficient to face insider trading liability?
  • What constitutes sufficient proof of knowledge of a “personal benefit” with respect to remote tippees?

New limit on disgorgement after Kokesh. In Kokesh v. SEC, the Supreme Court unanimously held that disgorgement in SEC enforcement actions is subject to a 5-year statute of limitations.

The SEC did not always have the power to seek disgorgement, Loseman explained. Originally, the SEC’s only statutory remedy in enforcement actions had been an injunction against future violations. The SEC began asking federal courts to order disgorgement in the 1970s, and federal courts began to grant it. Then, in the 1990s, SEC also began to obtain civil monetary penalties.

In Kokesh, the court held that disgorgement as applied in SEC enforcement proceedings operates as a “penalty” under 28 U.S.C. §2462. It based this on several reasons. First, in SEC enforcement actions, disgorgement is a remedy for wrongs committed against the United States, rather than an aggrieved individual. Second, the SEC explicitly requests disgorgement for punitive and deterrent purposes. Finally, disgorgement is not compensatory because not all funds disgorged go to the putative victims. Because the court found disgorgement to be a penalty, it is subject to the 5-year statute of limitations in §2462, which applies to any government action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture.

The main implication of Kokesh is that the SEC will have to bring cases more quickly if it is seeking disgorgement. This is a big deal, because disgorgement is a very big stick for the SEC. Over the last couple of years, the SEC has recovered around $4 billion per year in total. In FY 2017, the SEC reported disgorgement of $2.95 billion, versus $832 million in civil monetary penalties. And beyond trimming the SEC’s sails, there are possible implications for other agency enforcement actions, including CFTC enforcement actions.

Loseman also noted a new lurking uncertainty about the SEC’s ability to seek disgorgement at all, at least in the way the SEC currently seeks it. The SEC typically seeks disgorgement of gross gains rather than net. But the court in Kokesh pointed out that common law calls for the subtraction of costs incurred in producing the revenues subject to disgorgement. In a footnote, the court reserved opinion on whether courts actually have authority to order disgorgement in SEC enforcement proceedings and whether courts have applied disgorgement principles properly. This could foreshadow future challenges to the authority of courts to order disgorgement in SEC enforcement actions. And potentially, challenges could even broaden out to other remedies, like practice bars, said Loseman.

Leidos: what duty to disclose? The Supreme Court granted cert to hear a case involving conflicting duties to disclose under Item 303 of Regulation S-K and Rule 10b-5, but the case was withdrawn from the docket before decision, leaving lingering questions.

In Leidos, Inc. v. Indiana Public Retirement System, the Second Circuit held that a failure to make a required disclosure of “known trends and uncertainties” under Item 303 of Regulation S-K was an omission that would give rise to a Section 10(b) claim, if the registrant had “actual knowledge” of the relevant trend or uncertainty and the other elements of the claim were met, including materiality. 

As Buckholz explained, there is a circuit split on this issue because earlier Third and Ninth Circuit opinions held that the “known trends and uncertainties” requirement does not establish an independent duty to disclose. Significantly, the Third Circuit opinion was authored by now-Justice Alito.

The Supreme Court granted cert to hear Leidos, but the case was withdrawn from the docket due to a potential settlement. However, Buckholz noted, the fact that the Supreme Court did grant cert implies that the issue will likely be back for review at the Supreme Court in the future. Therefore, it’s worth getting familiar with the case.

Buckholz observed that the SEC has given very detailed guidance on the Item 303 “known trends and uncertainties” requirement. Specifically, the guidance says that if management cannot determine that an uncertainty is not reasonably likely to occur, then the issuer must disclose, unless it determines that that a material effect is unlikely to occur. 

This creates a strong bias in favor of disclosing, said Buckholz. In fact, he added, the SEC has specifically acknowledged that this approach is not governed by the Basic v. Levinsonapproach to materiality. It’s meant to dredge up an expansive body of information. But there is tension with 10b-5, which only requires registrants to disclose “material” information.

As a practical matter, Buckholz said the tension between the two thresholds frankly doesn’t make that much difference to him in deciding what to disclose, from the perspective of a transactional lawyer. If the registrant has actual knowledge of a bad thing coming down the pike, it’s very hard to see how non-disclosure wouldn’t be an omission of a fact needed to render some statement in the disclosure document not misleading. If someone identifies a known trend, it’s instinctive to look for where to fit that in. Isn’t it at least a risk factor, asked Buckholz, and if so, how could you advise a registrant not to disclose it? 

But, added Buckholz, things are different in the litigation context than the transactional context. He has heard that wariness about possible litigation can lead to defensive drafting and information overload. If the Supreme Court takes up this issue again, this could lead to better clarity in this area.

Other significant cases. Other cases of note include:

  • Constitutionality of SEC administrative proceedings: The Supreme Court granted cert in Lucia v. SEC: to hear whether SEC administrative law judges ALJs are “employees” who are not subject to the Appointments Clause. This is important because if ALJs are instead found to be “inferior officers”, then they have been appointed unconstitutionally, possibly throwing SEC administrative proceedings into question. In November 2017, the Department of Justice submitted a brief taking the position that SEC ALJs are “inferior officers” for purposes of the Appointments Clause, and the SEC issued an order ratifying the agency’s prior appointment of ALJs. The SEC directed ALJs to reconsider the record of cases still before them and has remanded cases still pending before the Commission in which ALJs had made initial decisions.
  • Opinion liability. Two cases applied Omnicare to claims predicated on Section 10(b) and Rule 10b-5. Omnicare held that a statement of opinion is not actionable under Section 11 of the Securities Act simply because the stated opinion ultimately proves incorrect. Rather, an opinion may give rise to liability if it was not sincerely held or contained embedded statements of untrue facts. The two cases are Tongue v. Sanofi in the Second Circuit and City of Dearborn Heights v. Align Technology in the Ninth Circuit.
  • Whistleblower protections. The Supreme Court heard oral argument in Digital Realty Trust v. Somers in November 2017 on whether the Dodd-Frank provision protecting whistleblowers from retaliation protects persons who report violations only internally, rather than to the SEC. There is some tension between the Dodd-Frank provision, the SEC’s implementing rule and an interpretation, and a whistleblower provision in Sarbanes-Oxley. At oral argument, some Justices stated that Section 922 is clear in requiring report to the SEC, and also expressed skepticism about according deference to the SEC’s interpretation under Chevron when the SEC did not include that interpretation in its original rule.
  • Equitable tolling: In CalPERS v. ANZ Securities, the Supreme Court held that equitable tolling under American Pipe is not applicable to the 3-year statute of repose with respect to claims brought under Section 11 of the Securities Act. As a result, unnamed members of a putative class must take action before the 3-year statute of repose to preserve their right to later bring individual claims.
  • State court jurisdiction: The Supreme Court heard oral argument in November 2017 in Cyan v. Inc. Beaver County Employees Retirement Fund, which addresses whether state courts have subject matter jurisdiction over class action claims arising under the Securities Act. District courts are divided over whether the Securities Litigation Uniform Standards Act of 1998 grants exclusive jurisdiction over Securities Act class actions to federal courts. At oral argument, some Justices referred to the drafting of this SLUSA provision as “gibberish.” 

The Securities Regulation Institute is an annual event providing securities attorneys with legal updates and practical advice from regulators, judges, and prominent practitioners. For more information, visit

Keep up in the year to come with Wolters Kluwer Securities Regulation Daily and follow the WK Securities team on Twitter at @WK_Securities.

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