Tag Archive: Mary Jo White

Is the SEC Zeroing In On Directors?

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Bradley J. Bondi

The U.S. Securities and Exchange Commission (SEC) has renewed its focus on “gatekeepers,” a term SEC Chair Mary Jo White uses to describe “the attorneys, accountants, auditors, fund directors, and other board members and professionals who play a critical role in the securities industry and share the responsibility with regulators to protect investors.” Chair White views directors as the “most important” of the gatekeepers and has singled out audit committee members as playing “an extraordinarily important role in creating a culture of compliance through their oversight of financial reporting.” Under her leadership, White has put directors on notice that regulators are “pursuing those who should be serving as the neighborhood watch, but who fail to do their jobs.”

The SEC has brought several cases against directors since the beginning of White’s leadership, and more are likely to come. In September, the SEC brought securities fraud charges against Stephen Pence in connection with his role as chairman of the board of General Employment Enterprises. The SEC alleges in its complaint that Pence materially misled auditors and investors about a side business relationship that created a conflict of interest and led to misuse of company funds.

Last year, the SEC brought a controversial enforcement action against the audit committee chair for AgFeed Industries Inc. for his alleged failure to appropriately investigate and disclose accounting fraud by executives in the company’s China offices. In another case, the SEC disciplined the audit committee chair of L&L Energy for violating Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 by signing annual and quarterly reports that she knew falsely certified compliance with Sarbanes Oxley’s requirement to retain an active CFO.

According to White, some have worried that the concentration on gatekeepers “may drive away those who would otherwise serve in these roles, for fear of being second-guessed or blamed for every issue that arises.” To this she responded: first, being a director “is not for the uninitiated or the faint of heart”; second, the SEC “will not be looking to charge a gatekeeper that did her job by asking the hard questions, demanding answers, looking for red flags, and raising her hand.”  Which is to say, the heightened scrutiny of directors will remain an SEC enforcement priority.

SEC rhetoric about the boardroom and recent enforcement actions may seem disconcerting at first glance. To date, however, the enforcement actions have alleged significant wrongdoing such as intentional deception of auditors and glaring conflicts of interest. While these types of conduct are a substantial departure from normal governance, the SEC’s actions do illustrate the agency’s increased willingness to investigate the conduct of directors.

Directors can minimize their risk of scrutiny by observing the following guidance.

  • Understand the business and your role. Directors should educate themselves about the business and their evolving gatekeeper obligations at the outset of their service and throughout their tenure.
  • Evaluate channels of communication. Directors should regularly evaluate the substance and frequency of management’s communication with the board.  Direct channels of communications from key individuals, such as the general counsel, chief compliance officer, and head of internal audit, can promote timely escalation and disclosure of potential problems.
  • Assess internal controls and control functions. Effective internal controls are essential and expected. In evaluating those controls, audit committee members must have open and robust dialogue with internal and external auditors that include discussion about the controls themselves and those responsible for them.  Control functions, and the controller function itself, must remain independent from business lines.
  • Act promptly on red flags. The lesson from the SEC’s enforcement action against AgFeed directors is clear: directors must promptly investigate red flags and take decisive actions if misconduct is identified.  But identifying red flags is challenging, and performance is judged in hindsight. To minimize their own liability while protecting shareholders, directors should not hesitate to consult their own counsel when faced with a potential red flag.

Bradley J. Bondi is a partner in the litigation practice group of Cahill Gordon & Reindel LLP, and is a leader of its securities enforcement and regulatory practices.

Investors Recommend Board Oversight of Trading Plans

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New oversight responsibilities could be in store for directors. Although 10b5-1 trading plans have existed since 2000, a confluence of events—including several Wall Street Journal articles and a letter from the Council of Institutional Investors (CII) to the Securities and Exchange Commission (SEC)—has recently placed these plans in the regulatory spotlight. As noted in NACD Directors Daily this week, the SEC and federal prosecutors have opened investigations into a number of insider transactions, many centered on 10b5-1 trading plans.

Rule 10b5-1 plans were created to deter corporate insiders from trading while in possession of material, non-public information. An executive must enter such a plan when not in possession of insider information, and he or she must specify the amount, price, and date for the securities transaction, and must not be able to alter or influence the terms of the plan. However, significant loopholes still exist; for example, executives maintain the ability to cancel a plan. The SEC said that because such a cancellation does not directly result in insider trading liability because the cancellation did not occur “in connection with the purchase or sale of a security” there was no insider trading. In a November 2012 investigation, the Wall Street Journal found that 46 percent of plan terminations occurred if plans called for a stock sale prior to the company releasing good news, and thus leaving money on the table, while only 11 percent of plan terminations occurred if the plan called for a stock sale prior to the company releasing negative news.

Following the Wall Street Journal investigation, in December CII submitted a comment letter to the SEC expressing concern over potential insider trading. In this letter, CII recommends that boards be responsible for the oversight of preset trading plans, stating “making boards explicitly responsible for the oversight of Rule 10b5-1 plans will make them more responsible to long-term shareholders and more vigilant in their oversight responsibilities.” This is the sole comment letter to the SEC on the topic.

In Mary Jo White’s nomination to head the SEC, President Obama highlighted her prosecutorial experience. Many have speculated on this, including the New York Times, which noted that with her appointment, “the president showed renewed resolve to hold Wall Street accountable for wrongdoing.”

With increased public scrutiny, federal investigations, and pressure on the SEC to implement stricter rules on 10b5-1 plans, directors may wish to increase how they monitor this area.