At a recent panel organized by San Francisco’s Federal Bar Association, the San Francisco Regional Director of the Securities and Exchange Commission (SEC), Jina Choi, confirmed that the agency continues to focus on investor fraud in the pre-IPO private market space. Highlighting enforcement actions against the non-public Zenefits, Credit Karma, and Theranos[1], Ms. Choi reiterated the SEC’s commitment to aggressive oversight over “unicorns,” or privately-held companies valued over $1 billion. The SEC first announced its intent to step up enforcement in this space in a March 2016 speech by previous SEC Chairwoman Mary Jo White, and Ms. Choi reported that the current SEC leadership, led by current Chairman Jay Clayton, is equally committed to policing this “beat.”

The Compliance Gap has been closely tracking SEC compliance enforcement at privately-held companies, which began in earnest last fall when the SEC announced that the non-public human resources company Zenefits and its founder, Parker Conrad had agreed to pay a combined $980,000 to settle claims that the company intentionally misled the company’s Series B and C investors. The SEC alleged Conrad and the company had misled investors about the degree to which Zenefits complied with state licensing laws, resulting in a lowered valuation when the compliance failures were revealed.

In March of this year the SEC reported a first-of-its-kind settlement with Credit Karma, in which the company agreed to pay $160,000 to settle claims that it failed to provide its employees with the disclosures required by Rule 701(e) of the Securities Act.  Rule 701 requires that a company compensating its employees with stock options provide detailed financial and risk disclosures before the date of sale. The SEC alleged that Credit Karma sold approximately $13.8 million in stock options to its employees without providing the information required by Rule 701.

Just two days after announcing the Credit Karma settlement, the SEC also filed a complaint against health care company Theranos, company founder Elizabeth Holmes, and former President and Chief Operating Officer Ramesh “Sunny” Balwani. In the complaints the SEC alleged that the company, Ms. Holmes, and Mr. Balwani made false claims about the capabilities of the company’s proprietary blood-test analyzers, regulatory approval of the proprietary blood-test analyzers, and the company’s business relationships with the U.S. Department of Defense.  Theranos and Ms. Holmes agreed to settle the claims made by the SEC, but Mr. Balwani has chosen to litigate what will surely be a closely watched case.

Ms. Choi also highlighted the SEC’s new approach to devising inventive ways to punish investor fraud in the private space. For example, Ms. Choi noted that the agency required both company and individual settlement payments in the Zenefits and Theranos resolutions (Ms. Holmes agreed to pay $500,000 and Mr. Conrad agreed to pay nearly that amount).  Ms. Holmes was also required to forfeit her ownership interest in Theranos, and was permanently banned from serving as an officer or director of any publicly-traded company.  Ms. Choi indicated that these remedies were arrived at through significant consultations with allegedly defrauded investors.  This approach indicates a shift towards creative remediation schemes that reflect the wishes of alleged victims, and the perceived need for individual punishments in the privately-held company space where founders can be interchangeable with the companies they build.

[1] Farella, Braun + Martel, LLP represents an individual in connection with the Theranos investigation. This report contains only publicly available information.

SEC magnifying glassThe prosecution of Martin Shkreli, whom the BBC has called “the most hated man in America,” reveals some important lessons about the Fourth Amendment protections against search and seizure in the digital corporate context: physical access to documents on a server may trump actual ownership of records. Continue Reading The Fourth Amendment Implications of Sharing Server Space

SEC magnifying glassRamapo, New York Town Supervisor Christopher St. Lawrence heads to trial this week on federal securities fraud charges. St. Lawrence is one of two city officials charged in the case; his codefendant N. Aaron Troodler pleaded guilty earlier last month. The SDNY U.S. Attorney’s Office promoted the Troodler conviction as the first time municipal bond fraud has been successfully prosecuted under federal securities laws. The St. Lawrence trial is expected to draw lots of attention; St. Lawrence is an elected official who has spent nearly two decades at the helm of his town. Continue Reading Municipal Bond Securities Fraud Case Heads to Trial

people talking at courthouseRecent corporate guilty pleas can be expected to have serious implications for the individual executives and employees alleged to have been involved in the conduct under scrutiny. But there are other factors at play in such cases that can make even more of a difference to the eventual outcomes for individuals than whether their corporate employer pleads guilty or pursues an alternative resolution. Key among these is the extent to which a cooperative relationship can be established between company counsel and individual counsel despite accusations of individual wrongdoing.

Read more in our article posted on Law360: Individual Defense in the Shadow of Corporate Guilty Pleas.

whistleblower

In a company with a robust compliance culture, potential whistleblowers can express their concerns without fear of retribution. By contrast, the penalty for a culture that silences whistleblowers just got steeper.  Companies caught punishing those who raise red flags, especially when they turn out to be lawyers, could be forced to confront documents otherwise inadmissible against the company due to attorney-client privilege.  Continue Reading Revenge of the Whistle-blower: Possible Consequences of Compliance Failures

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On December 6, 2016, after nearly twenty years of silence on insider trading, the U.S. Supreme Court unanimously affirmed the Ninth Circuit in holding that prosecutors need not show that a tipster received a pecuniary or other tangible benefit for providing inside information where the insider and trader are close friends or relatives. Salman v. United States, U.S. Supreme Court Case No. 15-628.

Salman was convicted for trading on information received from his friend, Michael Kara, who had in turn received the information from his brother and Salman’s brother-in-law, Maher Kara, a former Citigroup investment banker. Although Salman was not the insider, he was convicted based on so-called “tippee liability,” where the insider discloses nonpublic information to an outsider (a “tippee”) who then trades on the basis of the information, as established by the Supreme Court in its landmark Dirks decision. Dirks v. S.E.C., 463 U.S. 646 (1983).  Under Dirks, a tippee can be liable for insider trading provided the insider received a “personal benefit” from tipping the information, which benefit may be inferred where the tipper receives something of value in exchange for the tip or “makes a gift of confidential information to a trading relative or friend.”

Continue Reading Insider Trading Conviction in First Insider Trading Case in Nearly Two Decades Affirmed by Supreme Court

The announcement that San Francisco private company Hampton Creek faces an SEC inquiry related to their alleged “buyback” program of vegan mayo comes as no shock. See reporting on Bloomberg. As soon as the facts were initially reported it seemed only a matter of time until the regulators, who have been looking for a poster child (or rather, a whole class of poster children) of private company enforcement in the Bay Area, swooped in. Continue Reading Developments in SEC Private Company Enforcement: Sophisticated VC’s in the Role of Victim

We noted with interest the latest moves by some Bay Area tech giants to permit their employees to sell restricted stock to help them realize the stock value as part of their compensation: See New York Times reporting here. It should come as no surprise that private company employees in our tech economy rely on their potential restricted stock value as an important part of their compensation package, and also their decision whether to work for, or stay working for, one of the “hot” pre-IPO companies (which are legion in Northern California). What may surprise private companies is that this kind of restricted stock sale by employees creates a very easy “in” for the SEC to bring a case should any hidden compliance failures or fraud later be revealed. Continue Reading Private Company Employee Stock Sales Highlight Hidden Dangers of Compliance Failures

Every day corporate entities and individuals in some parts of the world provide payments to foreign officials in exchange for business favors. While it may be a common feature of business in these places, this kind of activity is illegal under the Foreign Corrupt Practices Act (FCPA), which criminalizes various acts of bribery and related accounting fraud. The consequences for failing to comply with the FCPA are severe, and ensuring compliance can be especially difficult for start-up or relatively young companies growing rapidly and expanding into foreign markets before they can institute robust compliance systems. Continue Reading Minding the Compliance Gap in an Evolving FCPA Landscape

When the Volkswagen emissions scandal hit the press last year, we wondered which agency would manage the subsequent investigations. We are still waiting on the car company’s plan to remedy the emissions testing software and waiting to see if criminal charges will be filed—and if so, who specifically will be in the DOJ’s criminal crosshairs (DOJ filed a mammoth civil suit in January). The DOJ isn’t the only agency stepping up enforcement in the emissions space, however. This past week the SEC got in the emissions game on the security side, charging Navistar International with misleading investors in connection with their truck engine emissions. Continue Reading SEC Spotlight Hits Emissions Issues