Securities Regulation

Liu v. SEC: The Supreme Court Limits the SEC’s Disgorgement Power and Sets the Stage for Future Legal Battles

By Neil T. Smith, David Peet, R. Nicholas Perkins, K&L Gates

On June 22, 2020, in a much-anticipated decision, the Supreme Court held that the Securities and Exchange Commission (“SEC” or “the Commission”) can continue its longstanding practice of seeking disgorgement as an equitable remedy in judicial proceedings under Section 21(d) of the Securities Exchange Act of 1934.

In Liu, the Court held that a disgorgement award that (1) does not exceed a wrongdoer’s net profits, and (2) is awarded for victims constitutes an equitable remedy within the scope of the SEC’s statutory authority. In so holding, the Court made clear that legitimate business expenses must be accounted for in determining how much the SEC can seek in disgorgement. Though the Court indicated its skepticism toward the SEC’s longstanding practice of sending disgorged funds to the Treasury, it did not specifically address whether disgorged funds must be returned to victims of the misconduct being prosecuted, leaving that determination to the lower courts. The Court also left unanswered whether the SEC is authorized to impose joint and several liability on violators. Following Kokesh and other recent decisions, this is the Supreme Court’s latest decision to rein in the SEC’s enforcement authority.

While Liu stopped short of eliminating the power of the SEC to seek disgorgement for securities law violations, it provided companies facing SEC enforcement scrutiny with the necessary tools for challenging and circumscribing the amount sought by the Commission. While this decision provides some clarity on the parameters of the SEC’s authority, it leaves open many questions that will be resolved in future settlement negotiations and court battles.

For further information, see our June 24, 2020 publication on the decision.

Ninth Circuit Affirms Dismissal in Stock-Drop Lawsuit, Citing Shareholder’s “Implausible” Scienter Theory

By Joseph De Simone, Glenn K. Vanzura & Kevin C. Kelly, Mayer Brown

On June 10, 2020, the US Court of Appeals for the Ninth Circuit affirmed the dismissal of a putative securities fraud class action against Endologix, Inc., a medical device company, on the grounds that the shareholder’s core theory of liability had “no basis in logic or common experience.” In that case, Nguyen v. Endologix, Inc., the plaintiff alleged that Endologix and certain of its executives misled investors about whether the Food and Drug Administration would approve the company’s new aneurysm sealing product, Nellix. The Ninth Circuit held that the shareholder’s complaint, for all its “girth,” lacked “a critical ingredient under the Private Securities Litigation Reform Act: allegations that state with particularity facts giving rise to a strong inference” that the defendant acted with scienter—namely, that the defendants made false or misleading statements either intentionally or with deliberate recklessness.

For a further discussion of the Ninth Circuit’s holding and the implications, see our June 22, 2020 Legal Update.

SEC Staff, Chief Accountant, Provide Additional Guidance Related to COVID-19

By Brian V. Breheny, Andrew J. Bray, Hagen J. Ganem, Josh Lagrange, Ryan J. Adams, Jeongu Gim, Blake M. Grady, Caroline S. Kim and Justin A. Kisner, Skadden, Arps, Slate, Meagher & Flom LLP

On June 23, 2020, the Division of Corporation Finance (the Division) of the SEC issued CF Disclosure Guidance: Topic No. 9A (Guidance) on disclosures focusing on the impact of COVID-19 on operations, liquidity, and capital resources. In addition, SEC Chief Accountant Sagar Teotia issued a statement (Statement) on the same day regarding significant accounting, auditing, and financial reporting issues recently addressed by the Office of the Chief Accountant (OCA) in connection with the COVID-19 pandemic.

The Guidance supplements the Division’s earlier views, which focused on disclosing the evolving impact of COVID-19, as well as reporting earnings and financial results, issued in CF Disclosure Guidance: Topic No. 9 on March 25, 2020. Echoing Topic No. 9, the Guidance encourages companies to provide disclosure that allows investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change. The Guidance also emphasizes that companies should provide clear and complete disclosure regarding how they are managing short- and long-term liquidity and funding risks given the current economic environment, especially if such efforts present new risks or uncertainties.

The statement from the SEC chief accountant describes significant accounting, auditing, and financial reporting issues on which OCA has engaged with stakeholders since its April 3, 2020, “Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19.”

Among other things, the Statement provides key reminders emphasizing the importance of high-quality financial reporting; at the same time, it recognizes that many companies continue to work through accounting and financial reporting issues related to operational and other challenges resulting from COVID-19.

For further information, see our June 29, 2020 publication on the guidance.

Structured Finance

Federal Housing Agencies and GSEs Announce Updates to COVID-19 Relief Measures for Mortgage Loan Borrowers

By Krista Cooley, Kerri Webb & Daniel Pearson, Mayer Brown

In recent weeks, the U.S. federal housing agencies and government-sponsored enterprises (GSEs) that insure, guarantee, or purchase “federally backed mortgage loans” covered by Section 4022 of the CARES Act (Act) have continued their intense pace of issuing temporary measures and updates to such measures, intended to implement the Act’s provisions applicable to such loans. These actions aim to provide assistance to mortgage loan borrowers facing financial hardship in connection with the COVID-19 outbreak during and after the forbearance period set forth in the Act. The agencies and GSEs also have issued several announcements regarding flexibility for servicers and originators of “federally backed mortgage loans” to address certain of the unintended consequences of the broad forbearance relief authorized by the Act.

Our Legal Update summarizes some of the significant guidance related to the Act’s broad mortgage forbearance provisions and certain of the unintended consequences. Specifically, we provide details regarding: (1) updates to the federal housing agencies’ and GSEs’ foreclosure and eviction moratoria; (2) updates to the GSEs’ COVID-19 Payment Deferral option; (3) announcements by the U.S. Department of Housing and Urban Development’s (HUD) Federal Housing Administration (FHA) and the GSEs regarding their insurance endorsement or purchase of mortgage loans that go into forbearance post-closing and prior to endorsement or purchase, subject to certain important conditions; and (4) the GSEs’ announcement that certain borrowers in forbearance are temporarily eligible for refinancing and new home purchases.

Securities Regulation

U.S. Department of Labor Proposes New Investment Duties

By Rani Doyle, EY*

The U.S. Department of Labor announced, on June 23, 2020, a proposed rule that would update and clarify the Department of Labor’s investment duties regulation. The announcement stated that the proposal would make five core additions to current regulation:

  • New regulatory text to codify the Department’s longstanding position that ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
  • An express regulatory provision stating that compliance with the exclusive-purpose (i.e., loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to non-pecuniary goals.
  • A new provision that requires fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA.
  • The proposal acknowledges that ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. The proposal adds new regulatory text on required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among truly economically “indistinguishable” investments.
  • A new provision on selecting designated investment alternatives for 401(k)-type plans. The proposal reiterates the Department’s view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of an investment alternative to be offered to plan participants and beneficiaries in an individual account plan (commonly referred to as a 401(k)-type plan). The proposal describes the requirements for selecting investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.

A Conversation with SEC Chairman Jay Clayton: Long-Term Investing, Sustainability and the Role of Disclosures

By Laura D. Richman, Mayer Brown

On June 23, 2020, SEC Chairman Jay Clayton discussed his perspectives on long-term investing, sustainability and the role of disclosures during a webinar hosted by FCLTGlobal, a non-profit organization that develops research and tools that encourage long-term investing and business decision-making, with Mark Wiseman, the newly announced chair of AIMCo.

While environmental, social and governance (ESG) matters are grouped by some into a single category, Chairman Clayton reiterated his view that “E,” “S” and “G” matters are different and lumping them together into one score diminishes their usefulness. Chairman Clayton recognizes companies may have significant E or S or G issues that are various in nature. He believes it is important to understand how management looks at these issues and encourages dialogue between companies and investors on these topics.

According to Chairman Clayton, efforts to combine metrics that include subjectivity, especially when preferences are added in, create imprecision. He sees this as a substantial limitation in using a single point ESG ratings score. Chairman Clayton is an advocate of principles-based disclosure that is flexible enough to apply to many different types of situations, including those encompassed within the ESG concept. According to Chairman Clayton, materiality for disclosure purposes should be built around what is material to a reasonable investor, which could include qualitative, quantitative, financial, or non-financial metrics.

The SEC’s principles-based disclosure framework allows the SEC to issue targeted guidance as circumstances warrant. Chairman Clayton noted that the SEC has already provided guidance in the environmental area and indicated that at some point in the future that guidance may be updated. He stated that social matters raise different concerns and pointed to SEC guidance addressing disclosure of self-identified diversity characteristics that a board or nominating committee has considered in determining whether to recommend a person for board membership as an example of an SEC response to social disclosure.

Chairman Clayton observed that to the extent disclosure is forward-looking, as often the case with respect to environmental matters, it is more difficult to audit. However, this does not mean that such disclosures receive a “free pass.” According to Chairman Clayton, such disclosures must be based on good faith estimates, consistent with how management looks at the issues. Chairman Clayton stated that he is open to dialogue in the area of sustainability to encourage use of the forward-looking safe harbors to get more information to investors.

With respect to balancing liquidity and long-term investing, Chairman Clayton observed that liquidity is important even to long-term investors and that long-term investors are important to the economy. He believes that managing a company for quarterly guidance does not provide a healthy perspective for the long term. However, even if changes are made in the area of quarterly guidance, Chairman Clayton recognizes that investors will be thirsting for current information and sees a continuing need for some monthly or quarterly check-in from the company.

*Material included in this Month-In-Brief publication is for general informational purposes only and does not represent the advice of Ernst & Young LLP, K&L Gates LLP, Mayer Brown or any of its professionals as to any client or particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome.


Rani Doyle

Rani Doyle

Managing Editor, Securities Law


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