Securities Enforcement Roundup – August 2024

In this issue of our monthly Securities Enforcement Roundup, we highlight top securities enforcement developments and cases from August 2024.

In August 2024:

• The SEC announced its latest round of “off-channel communications” settlements, with over 20 broker-dealers, investment advisers, and dually registered firms agreeing to pay several hundred millions in combined civil penalties to settle recordkeeping violations;
• A district court issued the remedies order in SEC v. Ripple, imposing a $125 million civil penalty and injunctive relief, but denying the SEC’s request for $867 million in disgorgement and $200 million in prejudgment interest;
• A Greek Orthodox priest and hedge fund founder sued the SEC in federal court claiming that the SEC was unconstitutionally trying to ban the hedge fund founder from the securities industry through an SEC administrative proceeding;
• An investment adviser agreed to pay a $95,000 civil penalty for violating the “pay-to-play” rule of the Investment Advisers Act of 1940; and
• An ex-SPAC agreed to a $1.2 million “springing penalty” to resolve charges related to financial reporting, accounting, and controls failures.

SEC ANNOUNCES ANOTHER ROUND OF SETTLEMENTS REGARDING ‘OFF-CHANNEL COMMUNICATIONS’

The US Securities and Exchange Commission (SEC) announced its latest round of enforcement actions related to “off-channel communications.” The SEC brought charges against over 20 broker-dealers, investment advisers, and dually registered broker-dealers and investment advisers for failing to maintain and preserve business-related electronic communications (e.g., text messages sent and received on employee personal devices). To settle the charges, the firms agreed to pay nearly a combined $400 million in civil penalties, which adds to the billions in fines that the SEC and the Commodity Futures Trading Commission have already imposed upon registrants for similar recordkeeping violations since 2021.

The firms acknowledged that their conduct regarding off-channel communications violated the recordkeeping provisions of the federal securities laws, including Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) thereunder and/or Section 204 of the Advisers Act and Rule 204-2(a)(7) thereunder. As part of the settlements, all but one firm was required to retain an independent compliance consultant to conduct a “comprehensive compliance review” of firm policies and procedures related to electronic communications. 

According to the SEC’s press release announcing the settlements, three of the firms self-reported their violations and, as a result, paid “significantly lower civil penalties than they would have otherwise.” The self-reporting firms paid civil penalties in the amounts of $5.5 million, $4.5 million, and $1.6 million, and were each required to engage compliance consultants. In announcing the settlements, SEC Enforcement Director Gurbir Grewal also noted that the SEC “remain[s] committed to ensuring compliance with the books and records requirements of the federal securities laws,” suggesting that the SEC’s off-channel investigations will continue.

SDNY Issues Remedies Order in Ripple Case

On August 7, 2024, Judge Analisa Torres of the US District Court for the Southern District of New York issued a long-awaited remedies order in SEC v. Ripple Labs, Inc. The court’s order granted the SEC’s request for injunctive relief and imposed a $125 million civil penalty on Ripple Labs, Inc., but denied the SEC’s request for $867 million in disgorgement and $200 million in prejudgment interest.[1]

In July 2023, the court issued a highly anticipated ruling granting in part and denying in part the parties’ cross motions for summary judgment, finding that certain of the at-issue token sales constituted “investment contracts” (i.e., sales to institutional buyers) and were therefore subject to the registration requirements under the Securities Act of 1933 (the Securities Act), while other sales were not.[2] The SEC dismissed the charges against Ripple’s executives, obliviating the need for trial and teeing up a final judgment and remedies order to be imposed by the court.

In its remedies order, the court imposed significantly lighter monetary sanctions than the SEC requested.[3] Notably, the court applied the Second Circuit’s opinion in SEC v. Govil and rejected the SEC’s claim for $867 million in disgorgement, finding that the SEC offered only “speculative evidence” that the institutional buyers at issue did not receive the “return on the investment contemplated” and failed to show the requisite “pecuniary harm” to support disgorgement.[4] The $125 million civil penalty was also significantly lower than the $876 million requested by the SEC.[5] 

In assessing the civil penalty, the court utilized a transaction-by-transaction approach (excluding programmatic sales and other distributions) and multiplied the number of unregistered transactions by the statutory amount for first-tier penalties. The court, however, also permanently enjoined Ripple from violating Section 5 of the Securities Act by selling a security in the absence of an exemption or an effective registration statement and rejected Ripple’s request to waive the “bad actor disqualification,” which prevents Ripple from using the SEC’s Regulation D exemption for future securities offerings for five years.[6] The parties have until October 7, 2024 to file a notice of appeal.

Hedge Fund Founder Sues SEC Over ‘Follow-on’ Administrative Proceedings

On August 21, 2024, a Greek Orthodox priest and hedge fund founder filed a complaint for declaratory and injunctive relief against the SEC in the US District Court for the District of Columbia. The complaint asks the court to declare an SEC “follow-on” administrative proceeding—in which the SEC is asking to bar or suspend the hedge fund founder from the securities industry—as unconstitutional and enjoin the SEC from continuing it.[7]

In November 2021, a jury cleared the hedge fund founder of several claims brought by the SEC but found that he did make false or misleading statements about other companies in reports forwarded to his investors and, as a result, was ordered to pay a $160,000 civil penalty.[8] The founder’s complaint argues that the SEC’s administrative case (seeking to suspend or bar him from the industry) is a “caricature of structural adjudicative bias that would violate his right to due process under the Fifth Amendment” in part because administrative law judges are “hand-picked” by the SEC and heavily favor the SEC in such proceedings.[9] The SEC has not yet filed a response and no hearing has been set in this matter.

The recent US Supreme Court decision SEC v. Jarkesy may be a factor in how the District Court of Columbia decides the case. In Jarkesy, the Court held that the Seventh Amendment of the US Constitution entitles a defendant to a jury trial when the SEC seeks civil penalties for securities fraud, and the “SEC may not seek such penalties through its own ‘in-house’ administrative enforcement proceedings, which lack juries.”[10]

SEC PROVIDES REFRESHER ON PAY-TO-PLAY VIOLATIONS

On August 19, 2024, the SEC announced settled charges against a registered investment adviser for violating the “pay-to-play” rule of the Investment Advisers Act of 1940.[11] Among other things, the pay-to-play rule prohibits certain investment advisers from receiving compensation for managing a government entity’s investments for two years after they or any “covered associates” make a political contribution to state or local candidates or officials, who are in a position to influence the selection of certain investment advisers.[12] Importantly, contributions made by new hires before joining an investment adviser are still considered for purposes of triggering the two-year lookback period under the pay-to-play rule.

According to the SEC, the investment adviser began managing the investments of the Michigan Public Employees’ Retirement fund in a closed-end pool in 2017. On July 1, 2020, the adviser hired a new employee, who had made a $7,150 campaign contribution to a government official in Michigan in December 2019. After being hired, the employee obtained a full refund of the contribution. The SEC alleged that, during the course of the individual’s employment at the investment adviser between September 2020 and May 2021, the employee solicited investments for the adviser from government entities and triggered the “lookback” provision under the “pay-to-play” rule.[13]  

Relying on the two-year lookback provision, the SEC imposed a $95,000 civil penalty, censured the firm, and ordered the investment adviser to cease and desist from committing or causing further violations of the pay-to-play rule.[14] In dissent, Commissioner Hester Peirce warned that the SEC’s “sweeping” application of the pay-to-play rule “effectively chill[s] a person’s right to engage in political activity” and “captures conduct that lacks any reasonable probability of unduly influencing actual investment decisions.”[15] Particularly in an election year, this settlement underscores the necessity for investment advisers to ensure compliance with the SEC’s pay-to-play rule.

FORMER SPAC AGREES TO $1.2 MILLION ‘SPRINGING PENALTY’

On August 29, 2024, a former special-purpose acquisition company (SPAC) specializing in global oil and gas services agreed to pay a $400,000 civil penalty related to financial reporting, accounting and controls failures, and a “springing penalty” of $1.2 million should the company fail to fully remediate certain material weaknesses and ineffective disclosure controls and procedures within the next year.[16]  

In March 2022, the former SPAC publicly disclosed that its financial statements for 2018 through 2020 should no longer be relied upon. An internal audit determined that “the accounting errors were caused by pervasive, systemic deficiencies in the company’s systems, processes, controls, and resources, including supply chain, finance, and accounting” and were likely attributable to the firm’s “rapid business growth, high rates of employee turnover, and management pressure to meet internal performance expectations.”[17]  

In March 2023, the company started implementing a formal remediation plan, including restructuring its financial reporting and developing proper monitoring controls.[18] In December 2023, it filed a multiyear restatement.[19] While the SEC acknowledges that the restatement corrected the accounting errors and the company has made “significant progress in its remediation plan,” that process is “not complete, and the company’s material weaknesses have not been fully remediated.”[20] As a result, the ex-SPAC agreed to fully remediate such weaknesses in the coming year or else pay a large $1.2 million civil penalty.

The SEC has utilized so-called springing penalties in prior settlements and Director Grewal has recently highlighted them as a way to encourage self-reporting among companies that are not able to pay big penalties and fully remediate right away.[21] This most recent settlement suggests the SEC will continue to use springing penalties going forward.