Monday, November 28, 2022

Cornerstone heat map indicates SEC’s most frequent FY22 enforcement target was reporting and disclosure violations

By Mark S. Nelson, J.D.

One day after the SEC issued its annual enforcement results for FY22, Cornerstone Research issued its own FY22 report on SEC enforcement actions. Cornerstone found that the most common enforcement matter involved reporting and disclosure violations. The Cornerstone report also noted that, in many categories, the current SEC enforcement results were higher than for any prior fiscal year recorded in the data repository used by Cornerstone to compile its report. The SEC's report, by contrast emphasized that the agency had brought 760 enforcement actions and recovered a record $6.4 billion in penalties and disgorgement in FY22.

“The increase in monetary settlements is consistent with the SEC’s public statements that ‘robust remedies’ are an enforcement priority,” said Sara Gilley, a coauthor of the report and a Cornerstone Research vice president. “The $1.2 billion in monetary settlements with 16 public broker-dealer subsidiaries for recordkeeping failures represents 44 percent of total monetary settlements in the fiscal year.”

Types of enforcement actions. According to Cornerstone, based on data obtained from the Securities Enforcement Empirical Database (SEED), which Cornerstone described as a collaboration between the NYU Pollack Center for Law & Business and Cornerstone, the SEC during the most recent fiscal year, the first full fiscal year under Chair Gary Gensler’s leadership, the SEC brought a total of 68 enforcement actions against public companies and/or those companies’ subsidiaries. Cornerstone’s report said this represented an increase over FY21 of 28 percent but also suggested that the increase in FY22 versus rates for the most recent three SEC chairs fell in the middle, with the Clayton-era SEC bringing fewer cases then the Gensler-era SEC and the Mary Jo White-era SEC bringing more cases than the Gensler-era SEC.

A heat map diagram included in the Cornerstone report indicated that the most common type of enforcement action involved reporting and disclosure violations (38 percent). Other frequent enforcement targets included, in declining order, broker-dealers, investment advisers and investment companies, and FCPA violations. Cornerstone said 2018 was the last time broker-dealer actions were this common and the heat map also suggested that the current level is about double the average for the period 2013 to 2021.

Enforcement actions against investment advisers and investment companies were somewhat down versus recent years, while FCPA actions continued a two-year down-trend versus the average for the period 2013 to 2021.

Venue data. Cornerstone observed that, despite court challenges to the SEC’s administrative enforcement regime, the agency still brought the bulk of its enforcement matters as administrative actions (88 percent). A Cornerstone graphic suggested that the high percentage of administrative matters was consistent with data for the period 2013 to 2022, in which only FY13 had a significantly higher percentage of civil actions (49 percent) versus administrative actions (51 percent). In all other years covered in the graphic, administrative actions ranged between 80 percent and 93 percent, spanning portions of two Democratic Administrations (6 years) and one Republican Administration (4 years).

Currently, the Supreme Court is mulling the question of whether SEC administrative action respondents can short-circuit the administrative process by bringing constitutional challenges to those proceedings in federal district courts rather than waiting to file a petition for review after an adverse agency decision.

The Supreme Court case emerged from the Fifth Circuit, as did a more recent decision vacating an SEC penalty on the grounds that the administrative proceeding: (1) violated the Seventh Amendment right to a jury trial; (2) involved an unconstitutional delegation of legislative power by Congress to the SEC because there was no intelligible principle by which the SEC would exercise the delegated power in violation of Article I of the U.S. Constitution, which vests “all” legislative power in Congress; and (3) involved statutory removal restrictions on SEC administrative law judges that violate the Take Care Clause of Article II of the U.S. Constitution. The Fifth Circuit also denied both panel rehearing and rehearing en banc in the case.

FY22 settlements. The Cornerstone report also noted several developments regarding settlements. Overall, 97 percent of settlements had a monetary component, while 82 percent of total monetary settlements involved civil penalties. In many instances, the numbers revealed by the Cornerstone report were among the highest ever recorded in the SEED repository.

Cornerstone reported that the SEC in FY22 imposed $2.8 billion in total monetary penalties as part of settlements. This total was more than FY21 and more than any other fiscal year in SEED. Much of the increase in settlement amounts can be attributed to a small number of high dollar amount settlements with broker-dealers regarding recordkeeping violations, said Cornerstone. Cornerstone said that if all settlement data is viewed together, the median settlement amount in FY22 was $9 million and the average settlement amount was $42 million. But if the several broker-dealer settlements are pulled out of the data, then the average settlement amount in FY22 falls to $30 million, a drop of about $11 million versus FY21.

Admissions of wrongdoing also were double that of any prior fiscal year. Cornerstone noted that the current SEC leadership has indicated it will seek admissions in appropriate cases. In FY22, Cornerstone said all admissions of guilt obtained in SEC proceedings involved broker-dealers matters.

Wednesday, November 23, 2022

Behnam hails smoothly functioning derivatives markets amid global turmoil

By John Filar Atwood

In a challenging year that has seen Russia’s invasion of Ukraine, significant supply chain disruptions, and global monetary and fiscal policy shifts, the U.S. derivatives markets have functioned as designed, according to CFTC Chair Rostin Behnam. In remarks at the U.S. Treasury market conference, he stated that the entire market system, including clearinghouses and clearing members, functioned well this year and derivative markets did not transmit significant stress to the broader financial system.

Behnam based his comments on recent data on the Treasury futures and commodity markets, which the agency staff has been studying carefully. He noted that highly elevated volatility does usually result in increases in observed bid-ask spreads and resting depth, which can increase transaction costs. Still, participants were able to trade in significant volumes this year and adjust their risk positions effectively, providing reliable price discovery for the global commodity trade, he stated.

Backdrop. He acknowledged that commodity and financial markets have been extremely volatile this year, with pressures coming from onset of, and extended recovery from, the pandemic and the war in Ukraine. He cautioned that with the war still going markets may shift suddenly in extreme ways. The war has led to substantial uncertainty in the global markets for energy, agriculture, and metals, he said, often leading to unanticipated movements in commodity prices because of changing market sentiment.

Adding to the stress is shifting monetary policy including the tightening by the U.S. Federal Reserve and other principal economies around the world aimed at slowing inflation, Behnam said. Price movements in commodities markets are further affected by exchange rates, with the U.S. dollar recently rising to a 20-year high against many other major currencies, putting additional upward pressure on price increases, he noted. On top of that, supply-side decisions such as OPEC’s move to decrease production by two million barrels per day have contributed to commodities price pressure and uncertainty, he added.

CFTC actions. Behnam said that amid all of the volatility, the CFTC is working to ensure that commodity markets continue to fairly and transparently serve their intended price discovery and risk management functions. The staff is carefully examining specific aspects of the markets, such as whether managed money traders have an undue impact on the direction of prices. He noted that preliminary analysis across a range of asset classes shows that managed money trading often lags price changes, and these traders are more likely to provide liquidity to other traders than take liquidity.

Position limits rule. Behnam noted that properly functioning derivatives markets need liquidity providers to better absorb price spikes. As seen with the implementation of the position limits final rule in March 2021, he said, when there is sufficient liquidity in the markets they continue to perform their price discovery functions by being an accurate reflection of supply and demand. During times of significant volatility like we are in now, he added, participants in the agribusiness and energy sectors look to U.S. markets for the risk management and price discovery.

He pointed out that the position limits rule has provided the CFTC with additional tools to ensure the proper functioning of the commodity markets by expanding federal position limits to include 16 additional agricultural, energy, and metals futures contracts of particular importance to the U.S. economy. A secondary effect is that it has strengthened the relationships between the Commission and exchanges regarding position oversight and accountability, he said.

According to Behnam, the position limits rule also supports risk management by, among other things, expanding the bona fide hedge exemptions for commercial end users but not for financial firms. The rule clarifies that commercial end users may now qualify for hedge exemptions for unfixed price transactions, he stated, which are common in the agricultural and energy industries. End users emphasized to the CFTC that these are important for effective risk management, he said.

He noted that Congress enacted the position limits regime to ensure the derivatives markets function as intended and meet both price discovery and risk management purposes. He said that the CFTC will remain vigilant in ensuring that this regime and other CFTC rules are achieving the goals that Congress mandated.

Tuesday, November 22, 2022

Commissioner Uyeda says agency should mull new Schedule 13G disclosures for asset managers

By Mark S. Nelson, J.D.

SEC Commissioner Mark T. Uyeda suggested in a narrowly-focused speech to an audience at the 2022 Cato Summit on Financial Regulation that asset managers’ efforts to assert themselves on ESG matters may not be getting adequately disclosed in their Schedules 13G, a situation Uyeda likened to that of an activist shareholder who would instead disclose their control-oriented discussions with a company on related Schedule 13D. Uyeda suggested that the Commission may need to consider requiring more disclosures about asset managers’ discussions of ESG matters with companies.

Schedule 13G and its cousin, Schedule 13D, typically arise in the context of mergers and acquisitions, such as happened earlier in the year when Elon Musk initially submitted a Schedule 13G regarding his plans to acquire Twitter instead of a Schedule 13D, where his intent to take control of the company would have been clearer. Commissioner Uyeda’s recent address, although not mentioning any specific Schedule 13G controversies, suggested a similar issue may exist for asset managers regarding their discussion of ESG matters with public companies.

A person whose acquisition or beneficial ownership of a company’s stock exceeds the regulatory threshold may be eligible to use Schedule 13G if, among other things, they acquired the securities of a company in the ordinary course of business and not with the purpose nor with the effect of changing or influencing the control of the company. If a change in control is contemplated, the person acquiring a company’s securities typically would instead make disclosures on Schedule 13D. Uyeda said his anecdotal belief was that most large asset managers make disclosures on Schedule 13G because they believe they satisfy the criteria about not intending to effect a change in control of the companies whose stock they hold.

For Uyeda, the question regarding asset managers is one of whether the exercise of stewardship on ESG and other matters can morph into a question of intent to control. For example, Uyeda suggested the example of an asset manager that engages with a company on ESG matters under current SEC guidance but then votes to oust some of the company’s directors because the company’s ESG policy does not align with the asset managers’ ESG policy.

“So can an asset manager’s stewardship and engagement activities – with the implicit threat of voting against a director standing for re-election – be described as having the purpose or effect of changing or influencing control of the company? In my view, that is an open question,” said Uyeda.

Uyeda traced his concerns about the weight of asset managers’ influence to an evolution during the last 20 years in how shareholders elect directors. Specifically, Uyeda explained that in the late 1990s, many directors were elected based on a plurality vote, meaning that a single “for” vote could get a person elected director, at least in an uncontested election. But more recently, Uyeda said, uncontested director elections tend to be based on principles of majority voting in which a director would lose if he or she received more “against” votes than “for” votes. This change in how directors are elected in uncontested elections may have shifted power to asset managers, said Uyeda.

Uyeda further suggested that an asset manager’s control intent may not be determinative of whether they should be required through enforcement of existing rules or by future regulations to disclose more about the matters, such as ESG matters, that they discuss with companies.

Said Uyeda: “Even if an asset manager is determined not to have control intent–and therefore eligible to use Schedule 13G–the Commission should consider whether additional and more timely disclosure of the asset manager’s discussions with a company’s management and its voting intent should be required, either on Schedule 13G or elsewhere.”

Monday, November 21, 2022

CFPB comes full circle under Chopra

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau is an agency driven in large measure by its director. One year after being sworn in as the third director of the CFPB, Rohit Chopra’s tenure thus far signals a 180-degree turn from the business-friendly Bureau of its last director back to the Richard Cordray era of supervision and enforcement. The director of the CFPB plays a large role not only in the workings of the Bureau but in the stance of both Democrats and Republicans. The support for, and criticism of, the CFPB has flipped with each of its three directors.

The CFPB has undergone extreme change throughout its relatively short lifespan from “cop on the beat” to business-friendly agency, and back to top consumer watchdog under Chopra.

To read more about the CFPB’s full-circle pivot under Chopra, click here.

Friday, November 18, 2022

SEC Commissioner Lizarraga says considerable portions of digital asset market are likely operating illegally

By Lene Powell, J.D.

Large parts of the digital asset market may be operating outside of the federal securities laws, SEC Commissioner Jaime Lizárraga said in remarks at Brooklyn Law School. Lizárraga stressed that not every issued digital token necessarily represents a securities offering, and not every digital asset intermediary is necessarily operating as an unregistered market participant. But he agrees with SEC Chair Gary Gensler that most of the nearly 10,000 digital asset tokens in the market are likely offered as securities, and he is concerned that intermediaries that sell, trade or advise on digital assets that are securities may be operating as unregistered market participants.

“My view is that there is likely a considerable number of digital asset issuers and intermediaries illegally operating outside of the federal securities laws,” said Lizárraga.

Lizárraga said his heart goes out to retail investors who are suffering an impact from the “troubling digital asset market events of this past week,” likely referring to the collapse of the FTX crypto empire and related market effects. Erosion of value or significant losses can have a devastating impact on a working family’s or a working person’s financial security, he said.

He highlighted major risks in the digital assets market such as increasing levels of fraud, concentration of wealth and control, highly centralized intermediaries, a lack of transparency, and high volatility.

Lizárraga emphasized that the SEC has provided “an abundance of guidance” to the industry and that the SEC has an obligation to protect investors and enforce rules and regulations.

Wild growth of crypto. Lizárraga noted that the digital assets industry arose in the aftermath of the 2008 financial crisis, which exposed weaknesses in the traditional financial system, including the need to trust intermediaries, unavoidable levels of fraud, and high transaction costs.

The digital asset industry has grown phenomenally. According to Lizárraga, there are nearly ten thousand tokens and hundreds of digital asset platforms. By some estimates, one in five adult Americans has purchased digital assets. The asset class has particularly taken off in low-income and underserved communities, where an increasing number of persons are investing in digital assets. A greater share of unbanked and underbanked individuals may own digital assets than those who are fully banked.

But as to whether the digital asset market has truly developed into a viable alternative to traditional finance, Lizárraga said in his opinion, the answer is no. Nor does it offer genuine financial inclusivity and robust protections for digital asset purchasers and investors, in his view.

Significant risks. The explosive, unregulated growth of digital assets has brought risks along with it. In March, President Biden issued an executive order directing federal agencies and financial regulators to examine issues in digital asset markets. Reports have outlined several risks.
  • Increasing fraud. The U.S. Treasury Department cited one estimate of $14 billion-worth of digital asset-based crime globally in 2021—nearly double the estimate for 2020. The number of scams in 2021 rose by over 60 percent year-over-year, and the value of stolen digital assets rose by over 80 percent in 2021. Treasury noted that digital asset crimes are based on self-reporting, so it is likely these numbers don’t show a full picture.
  • Concentrated wealth and control. The top 1,000 market participants owned roughly one-sixth of Bitcoin in circulation at the end of 2020, according to one study. The same study found that the top 10,000 participants owned roughly one-third of it. When “whales” (large position holders) liquidate a position or experience losses, their counterparties can face extreme financial pressure. Further, many digital asset governance tokens are held by the top 1 percent of holders of a given token, which can lead to governance problems if voting rights holders are anonymous or not subject to robust oversight.
  • Highly centralized intermediaries. Belying the original vision of a decentralized trustless financial system as laid out in the Satoshi Nakamoto white paper, many digital asset platforms have an integrated, centralized structure, causing conflicts of interest. Platforms also commingle their own assets with customer assets, exposing customers to the risk of platform insolvency.
  • Significant lack of transparency. According to FSOC, disclosures by digital asset promoters and issuers lack uniformity and vary widely in the amount of information provided to the public, particularly for stablecoins. There is also a lack of transparency about technological vulnerabilities, which is problematic despite the many malicious cyberattacks on platforms.
  • High volatility. Lizárraga cited “recent events” and the 2022 crypto winter as evidence of how volatile the digital asset market can be. Price vacillations in digital assets are outside the norm relative to traditional markets’ routine fluctuations.
In light of recent events, we are in a watershed moment, said Lizárraga. That there is likely a considerable number of digital asset issuers and intermediaries operating illegally undermines transparency and the SEC’s ability to protect investors, he said.

“Frankly, the problems in the digital asset market are worse than those in the traditional finance system, because they occur in a largely unregulated space,” said Lizárraga.

SEC guidance. According to Lizárraga, the SEC has provided an “abundance of guidance” including the DAO Report, the SEC FinHub Framework for “Investment Contract” Analysis of Digital Assets, and multiple no-action letters issued by the staff of the Division of Corporation Finance. Decades of legal precedent on what constitutes an “investment contract” or “note” under the securities laws also provide ample guidance to the industry and the sophisticated securities law bar, he said.

“It’s not a matter of a lack of guidance but more that the existing guidance may not be what many market participants want to hear,” said Lizárraga.

Lizárraga also pushed back on the narrative that the SEC is engaged in “regulation by enforcement.” In his view, the laws are well-established, and the cases brought to date have clear applications.

“This is not regulation by enforcement, but enforcement of our securities laws as Congress intended,” said Lizárraga.

Attorney gatekeepers play an important role in advising the digital asset industry, he said. They have an obligation to be clear with their clients about the application of the securities laws to their client’s businesses—even if it is not advice their clients want to receive.

According to Lizárraga, innovative blockchain technology can exist side-by-side and be compatible with the existing federal securities law framework—but it requires a good-faith, honest and conscious choice to comply with the law and to put the interests of investors first.

“[W]hile I believe that the SEC should work with those who come to us with good faith plans and concrete timelines to meet the requirements of the federal securities laws, the SEC has an obligation to protect investors and to enforce our rules and regulations,” said Lizárraga. “Those who do violate our federal securities laws and harm investors and markets must face the consequences, pure and simple.”

Thursday, November 17, 2022

Better Markets amicus brief urges en banc appeals court to allow California federal court to hear proxy case despite forum selection clause

By Mark S. Nelson, J.D.

The full Ninth Circuit will rehear arguments in a case brought by shareholders of The Gap, Inc. alleging that the company misled investors about the company’s diversity efforts. The district court had dismissed the case on forum nonconveniens grounds based on Gap’s forum selection clause. A Ninth Circuit panel affirmed, but the full court later agreed to rehear the case and the panel opinion was vacated. Oral argument upon rehearing is expected to occur in mid-December 2022 and supplemental briefing by the parties is due November 28, 2022, with emphasis on two issues: (1) the legal impact of the fact that Gap’s forum-selection clause applies only to derivative claims, not direct claims, under the Exchange Act; and (2) the application of 8 Del. Code §115. An amicus brief submitted by Better Markets also attempts to detail a number of arguments other than 8 Del. Code §115 (Lee v. Fisher (Better Markets amicus brief), November 14, 2022).

8 Del. Code §115 not addressed. As previously reported, the Ninth Circuit panel’s May 2022 opinion affirmed the district court’s dismissal of the plaintiff’s Exchange Act Section 14(a) derivative suit because of Gap’s forum selection clause requiring the suit to be brought in Delaware state court. The panel noted that the plaintiff had conceded that the forum selection clause was valid and, thus, the only issue before the panel was the enforceability of the forum selection clause.

U.S. Supreme Court precedent, said the panel, required transfer of the case absent extraordinary circumstances, which the justices left undefined, but which the Ninth Circuit has understood to mean: (1) the forum selection clause was obtained by fraud or overreaching; (2) enforcement is against strong policy of the forum in which the suit was filed; or (3) the plaintiff would be deprived of a day in court.

The policy prong of the Ninth Circuit’s formulation was the only enforceability issue addressed in the May 2022 panel opinion. The plaintiff had argued that a strong policy against the forum selection clause in the forum, a federal district court in California, was implied by the Exchange Act’s anti-waiver provision, the Exchange Act’s provision making federal courts the exclusive forum for Exchange Act claims, Delaware state caselaw, and federal courts’ general obligation to hear cases over which they have jurisdiction.

The panel rejected all of the plaintiff’s arguments but noted with respect to federal courts’ more generalized obligations to hear cases over which they have jurisdiction that the plaintiff had not identified 8 Del. Code §115 and, thus, waived any argument based on that provision of Delaware law. Upon rehearing en banc, the plaintiff and Gap must explicitly address the application of 8 Del. Code §115 in their supplemental briefing.

The Seventh Circuit, in Seafarers Pension Plan v. Bradway, held that a forum selection clause identical to Gap’s was invalid under 8 Del. Code §115. The Seventh Circuit majority concluded that Delaware law resolved the case in favor of the plaintiff.

The complaint in Seafarers focused on the reelection of directors who had allegedly tolerated poor oversight of the design and construction of 737 Max airliners. The court recited that 8 Del. Code §115 allows forum selection clauses to limit claims about internal corporate affairs (such as derivative claims) to be brought exclusively “in any or all of the courts in this State.” But the majority noted that Boeing’s forum selection clause was contrary to the Exchange Act’s jurisdiction provision and federal courts in Delaware are courts “in” Delaware.

The Seventh Circuit then, among other things, looked at the legislative history of 8 Del. Code §115 and reasoned thus: “By eliminating federal jurisdiction over the Seafarers Plan’s exclusively federal derivative claims, Boeing’s forum bylaw forecloses suit in a federal court based on federal jurisdiction. That’s exactly what Section 115 was ‘not intended to authorize’” (footnote omitted).

The opening briefs (plaintiff Lee; Gap) submitted by the parties in the Ninth Circuit panel proceeding did not mention Seafarers, but the plaintiff’s reply brief did finally make the argument that Seafarers should apply to invalidate Gap’s forum selection clause, a theory the panel said was waived. The full Ninth Circuit has asked the parties to supplementally brief this issue. Lastly, although Better Markets’ amicus brief in the en banc proceeding mentioned Seafarers, it did so without also addressing 8 Del. Code §115, but it did address many of the other arguments made by the plaintiff and Gap, albeit while arguing in support of the plaintiff.

Exclusivity not waivable. A key point made by Better Market’s amicus brief is that the Exchange Act’s exclusivity provision is not waivable. According to Better Markets, the Ninth Circuit’s now vacated opinion would shunt an exclusively federal claim to a state court where it must be dismissed for lack of jurisdiction. Here, Better Markets disputed Gap’s assertion that the forum selection clause remains valid because the state court is not being asked to adjudicate the federal claim, just to dismiss it. Rather, Better Markets said the forum selection clause is invalid because the only forum the clause allows (Delaware state court) cannot adjudicate the claim.

Better Markets also questioned the Ninth Circuit panel’s use of the Supreme Court’s opinion in McMahon, which examined the Federal Arbitration Act and the Exchange Act and concluded that an agreement to arbitrate could supplant the Exchange Act’s exclusivity provision. Better Markets argued that the Ninth Circuit panel misunderstood McMahon to mean that the Exchange Act’s exclusivity provision is more generally waivable.

Better Markets also sought to note flaws in other arguments made by Gap. For one, Gap had argued that it was still subject to the substantive requirements of Exchange Act Section 14(a); Better Markets said the argument missed the point that a waiver violation can occur if a plaintiff is barred from enforcing those substantive requirements. With respect to Gap’s assertion that the plaintiff could still bring a direct claim, Better Markets observed that direct and derivative claims seek to address different harms and seek to obtain different remedies. In the instant case, the plaintiff alleged that Gap was harmed by its own discriminatory practices and would likely incur remediation costs.

Better Markets also noted the rising trend of companies amending their certificates of incorporation or bylaws to adopt forum selection clauses. According to Better Markets, which searched the SEC’s EDGAR database for specific forum selection clause language, within the last 10 years 167 companies have adopted a forum selection clause addressing derivative claims, including derivative claims brought under Exchange Act Section 14(a).

The case is No. 21-15923.

Wednesday, November 16, 2022

Cert denied for petition seeking review of remote tippee liability

By Elena Eyber, J.D.

The Supreme Court denied certiorari for a petition asking it to review the judgment of the Seventh Circuit regarding remote tippee liability. The petitioner who was convicted of conspiring to commit insider trading as a remote tippee of an insider petitioned the Court to resolve two questions when determining tippee liability under Dirks and Salman: (1) what level of knowledge a remote tippee must have of the personal benefit to the insider to have participated in the insider’s breach, especially where, as in this case, the insider received money in exchange for disclosure, but also claimed he intended to benefit a friend; and (2) how to determine the scope of a conspiracy when a remote tippee is far removed from the insider and does not participate in, or have knowledge of, the conspiracy’s profit sharing agreement (Weller v. U.S., November 14, 2022).

Insider trading. Weller was convicted of conspiring to commit insider trading as a remote tippee of insider Shane Fleming, a vice president of Life Time Fitness, Inc. In his capacity as vice president, Fleming learned that the company was likely to be acquired by private equity firms, and that the price of LTF’s stock would increase to at least $65 per share. Fleming had a fiduciary duty to LTF to maintain the confidentiality of this material nonpublic information and not to disclose it to others. Fleming disclosed the information to his friend and business partner, Bret Beshey, knowing that Beshey would use the information to purchase and sell securities. Beshey agreed to pay Fleming a share of the profits that he earned as a result. Beshey then provided the information to Chasity Clark, his girlfriend, and Peter Kourtis, his friend and business partner. Kourtis provided the information to Weller, who is a remote tippee, multiple levels removed from the insider. Weller ultimately purchased out-of-the-money call options, earning more than $550,000. Weller did not pay Kourtis a share of his profits, but he did give Kourtis $20,000 of marijuana.

Seventh Circuit decision. On appeal to the Seventh Circuit, Weller argued that his case should not have proceeded to trial because the indictment failed to allege an essential element of the offense that Weller knew that the insider received a personal benefit in exchange of the disclosure of material nonpublic information in breach of his fiduciary duty. Further, he argued that the evidence was insufficient to establish that he knew of the personal benefit, and thus, was insufficient to prove he had the requisite knowledge to join the conspiracy. Weller argued that the allegation and evidence that Weller had knowledge that a friendship existed between Fleming and Beshey was insufficient to allege or prove his knowledge that Fleming had disclosed the information to his friend as a gift, thereby personally benefitting himself, in breach of his fiduciary duty. Thus, without knowing that Fleming had sold the information for money, it was not illegal for Weller to trade on that information. Further, he argued he could not have knowingly joined in the single conspiracy alleged in the indictment where his connection to the other members was so attenuated, as the Second Circuit held in Geibel.

The Seventh Circuit affirmed the decision of the district court, upholding the denial of Weller’s motion to dismiss because the indictment alleged that Beshey was Fleming’s friend, and that Fleming violated a duty to this employer. The Court held that given Salman and Dirks, these allegations were sufficient to allege that Fleming received a personal benefit. The Seventh Circuit found that the evidence was sufficient, despite Weller’s lack of knowledge beyond the existence of a friendship, because there is no requirement to prove that a monetary benefit was received by the insider. The Seventh Circuit found that while the insider would be entitled to acquittal had he been charged with conspiring with Weller, the same was not true of Weller where he was charged with conspiring with the insider. The Seventh Circuit explained that even if Weller had only participated in a narrower conspiracy, he had not been prejudiced because no matter what else one makes of the evidence, Weller and Kourtis conspired to misuse material nonpublic information.

Personal benefit and knowledge requirements. Weller argued that the personal benefit and knowledge elements for insider trading liability merit this Court’s review, and that this Court should reexamine the limits of the personal benefit test for insider trading liability and its connection to the requisite knowledge that a remote tippee must have to knowingly conspire. Weller argued that these elements have been broadened by the lower courts so significantly since they were established in Dirks that they no longer serve the limiting purpose for which they were intended, and instead now function as a general duty on all market participants, in stark contrast to this Court’s prior rulings.

Weller argued that the Seventh Circuit’s opinion further weakens the personal benefit requirement by allowing for dual and contradictory motivations when the Seventh Circuit held that alleging and proving that a friendship exists between the insider and tippee is sufficient on its own to demonstrate that the insider received a personal benefit, even where the insider received money from the same tippee in exchange for disclosure. In addition to broadening the personal benefit test, Weller argued that the Seventh Circuit’s opinion conflicts with this Court’s precedent in Dirks and Salman by requiring mere knowledge that a friendship existed between the insider and the first tippee to prove Weller’s knowledge that the insider breached his fiduciary duty by disclosing in exchange for a personal benefit.

Further, Weller argued that the petition should be granted because this case provides a vehicle to strengthen the personal benefit and knowledge requirements to convict a remote tippee of conspiring to commit insider trading. Weller argued that while this Court previously held that a friendship may justify an inference that the insider personally benefited from disclosing as a gift, the Seventh Circuit now held that the existence of a friendship establishes both the personal benefit to the insider and the knowledge of the remote tippee, even where a personal benefit was pecuniary. The Court should reject this rule, which expands liability to anyone who knowingly trades on insider information.

Conflict with the Second Circuit’s opinion in Geibel. Lastly, Weller argued that the Court should grant the petition because the Seventh Circuit’s ruling in this case conflicts with the Second Circuit’s ruling in Geibel. Specifically, while the Second Circuit held that a remote tippee may seek acquittal where the remote tippee participated in only a narrower conspiracy and was prejudiced by the variance, the Seventh Circuit now held that such grounds for acquittal are limited to the insider accused of conspiring with a remote tippee.

The petition is No. 22-0330.

Tuesday, November 15, 2022

Payment-for-order-flow disclosure deficiencies outlined in staff risk alert

By John Filar Atwood

In its most recent review of Regulation NMS Rule 606 disclosure practices, the staff of the SEC’s Division of Examinations found deficiencies in how broker-dealers are reporting on their payment-for-order-flow (PFOF) arrangements. The staff has outlined its findings in a new risk alert, which it hopes will serve as incentive for brokers to reevaluate the accuracy and specificity of their Rule 606 reports.

Rule 606 requires broker-dealers to disclose in a public report how they handle customers’ orders, including the routing of non-directed orders from its customers that are for national market system shares and submitted on a held basis or for a national market system security that is an option contract with a market value less than $50,000. In particular, the reports should contain the material aspects of a broker’s PFOF arrangements and disclosures on how the firm routes non-directed orders for execution.

The staff noted that PFOF may present a conflict of interest because the PFOF receiving firm may be incentivized to route order flow to maximize PFOF revenue, including only routing orders to venues that agree to pay a certain level of PFOF, which may come at the expense of customers’ order execution quality. Rule 606 reports are intended to allow broker-dealer customers to better evaluate their firm’s routing services and how well they manage potential conflicts of interest.

PFOF disclosure. The staff found that some broker-dealers did not disclose the material aspects of their relationship with their routing broker or execution venues, which included omitting a description of any PFOF arrangement and any profit-sharing relationship that may influence a firm’s routing decision.

Specifically, the staff observed that some broker-dealers, with respect to PFOF arrangements with non-exchange venues, did not disclose the specific per share PFOF rebate applicable to different sizes and order types under each PFOF arrangement. Instead, the firms included general information that the firm received PFOF, average per share rebates, and use of the language “may receive” when the firm in fact received PFOF. Broker-dealers also relied on references to the remuneration in the tables contained within the Rule 606 report and stated generally that the firm received the same rebate from all market makers, the staff found.

The staff also observed instances where broker-dealers did not disclose that they had arrangements with or provided attestations to venues to route retail orders. Deficiencies included firms that did not disclose that they represented to their routing or executing brokers that they would provide exclusively retail order flow to the routing broker in order to receive PFOF under arrangements with their routing brokers, according to the staff.

Further, some firms did not disclose that they had a rebate arrangement and a rebate split with their venues. The staff identified instances where firms did not disclose the details of PFOF revenue split arrangements with their clearing firm or routing broker, which is required even if the firm chooses the approach of adopting by reference the routing brokers’ reports.

Price improvement/execution quality. The staff stated that while firms had discussions with their execution venues regarding an increase or decrease in PFOF for a corresponding decrease or increase in price improvement (PI) and thereby lower or higher execution quality (EQ), the firms did not disclose the PFOF and PI/EQ trade-off in their Rule 606 reports.

In addition, the staff advised that broker-dealers that refuse to route orders to execution venues unless those venues agree to pay a level of PFOF specified by the firm must disclose when the PFOF negotiated by the firms reduces the PI and EQ opportunities for the firms’ customers. The staff emphasized that this disclosure is required regardless of any specific conversation with execution venues surrounding a trade-off between PFOF and PI or EQ.

The staff further stated that Rule 606’s requirement that a firm describe the material aspects of its relationship with the executing venue along with a description of the terms of any PFOF arrangements, imposes a duty to disclose that trade-off. Accordingly, failure to disclose such a trade-off in a firm’s Rule 606 reports could be interpreted by a firm’s customers as a representation that the level of PFOF required by a firm as a condition for routing customer orders to an execution venue does not affect the customers’ PI or EQ opportunities, the staff said.

Another deficiency identified by the staff was when a broker-dealer added new venues to its Rule 606 report without including corresponding material aspects disclosures for the newly added venues despite the venues having PFOF arrangements with the firm.

The staff also outlined instances where broker-dealers did not disclose the material aspects of their PFOF arrangements with exchange venues. These included firms either not disclosing the material terms of the PFOF arrangements with exchanges, or including hyperlinks to exchanges’ fee schedules which did not describe the firms’ incentive for routing to particular exchanges along with the quantifiable terms. The staff noted that as part of a firm’s material aspects discussion, firms should describe the specific rebate tier applicable to the firm.

Non-PFOF deficiencies. The staff also discussed deficiencies it observed outside of the PFOF disclosure requirements. In some cases, firms routed all orders to a clearing firm without either creating a Rule 606 report or incorporating by reference the clearing firm’s Rule 606 report. In addition, some broker-dealers improperly identified routing firms rather than the venues to which they routed orders for execution, including identifying a routing-only broker-dealer as a venue but omitting the names of the actual venues to which the routing-only broker-dealer relayed orders for execution.

The staff said that it also found that some firms inaccurately classifying order percentages among the four order type categories—market orders, marketable limit orders, non-marketable limit orders, and other orders—including use of conflicting methods for classifying order percentages and aggregate amounts of net rebates received in terms of the four order types. Some firms disclosed inaccurate amounts of net aggregate rebates received for each of the four order types, while others used incorrect dates for determining inclusion of a stock in the S&P 500 index, the staff said.

A final general observation in the risk alert is that broker-dealers did not have adequate written supervisory procedures to ensure the accuracy of the Rule 606(a) reports or the accuracy of the material aspects disclosures. In addition, some firms did not sufficiently review the data quality underlying the reports, which led to inconsistent disclosures in the reports, the staff stated.

Monday, November 14, 2022

Real estate firm failed to verify that investors were accredited

By Anne Sherry, J.D.

The SEC filed settled charges against a California-based real estate company for conducting an unregistered offering for a fund it manages. According to the SEC’s order, PIC Renegade Properties, LLC, raised over $54 million from about 140 investors in the offering. Although it invoked a registration exemption, it did not qualify because it failed to take reasonable steps to verify all the investors were accredited (In the Matter of PIC Renegade Properties, LLC, Release No. 33-11132, November 9, 2022).

The respondent established the real estate investment fund in June 2015. That month, it filed a Form D Notice of Exempt Offering of Securities stating that the fund was relying on the registration exemption of Regulation D Rule 506(c). That rule permits an issuer to conduct a general solicitation if all purchasers are accredited investors and reasonable steps are taken to verify as much.

The fund raised over $54 million between July 2015 and 2019 from about 140 investors, but in at least 25 cases the respondent failed to obtain financial information or documents to verify individual investors’ income or net worth or entity investors’ assets. In some other cases, the respondent accepted funds from investors even though documents indicated the investors did not meet accreditation thresholds.

The firm also failed to adopt written policies and procedures, controls, or other compliance measures relating to accreditation verification and failed to comply with the fund’s own requirements for verification.

As a result of these deficiencies, the respondent sold securities to at least four unaccredited investors. An individual whose household net worth was $800,000 invested $115,000 of her retirement funds, while a nonprofit organization with only $200,000 in assets was able to put $109,000 in the fund. In another case, the firm received an accountant’s letter purportedly verifying that an irrevocable trust established for the care of an elderly grantor was accredited as a natural person with over $1 million in net worth. This letter was irrelevant because the trust (which in fact had only $600,000 in assets) was an entity, not a natural person.

For violating Securities Act Section 5(a), the respondent agreed to cease and desist from future violations and to pay a penalty of $400,000.

This is Release No. 33-11132.

Friday, November 11, 2022

What will be the regulatory fallout of the busted Binance-FTX rescue?

By Mark S. Nelson, J.D.

In the hours after Binance decided to back out of a plan to rescue FTX, FTX’s CEO and founder, Sam Bankman-Fried, appeared to take much of the blame for FTX’s recent troubles, stating in a sometimes profanity-laden tweet that “I'm sorry. That's the biggest thing. I … up, and should have done better.” Bankman-Fried also said the financial woes at FTX concerned FTX International and partly blamed “poor internal labeling of bank-related accounts” for errors regarding user margin.

Wednesday, crypto markets were focused on whether Binance, the largest crypto platform by volume, would acquire competitor FTX. By afternoon, that deal had fallen through leaving confusion about whether FTX could be saved by another firm or might have to take other steps to avoid collapse. While no obvious solution has materialized, the regulatory response to FTX’s fall may be about to begin.

Already, multiple bills introduced in the 117th Congress would largely place authority to regulate crypto markets with the CFTC. The several bills vary in their details, but most would give the CFTC explicit authority over crypto spot markets. Critics of the bills, however, have raised concerns that some of the bills may not do enough to prevent the CFTC from using any new authorities to take a closer look at other non-crypto markets. The most prominent of these bills do not explicitly purport to alter SEC authorities, but there are equally strong calls to preserve SEC authority as there are to ease SEC rules regarding tokens. A legislative solution for crypto markets may have to await the next Congress.

In an appearance on today’s CNBC’s “Squawk Box” with Andrew Ross Sorkin and Becky Quick, SEC Chair Gary Gensler addressed issues surrounding tokens more generally and, while not directly speaking to any possible SEC action regarding FTX, he tangentially noted the requirements for disclosures concerning mergers.

With respect to tokens, Gensler said the key issue is the small number of lending platforms and exchanges that take customers’ money and then borrow and trade against customers. Gensler said it can take time to build enforcement cases against these entities, but he suggested that the SEC would continue to pursue a tripartite path of investor education, registration of intermediaries, and enforcement. Gensler also noted that crypto markets are highly interconnected.

With respect to Binance and FTX, and others who might seek to bail out FTX, Gensler declined to speak about any SEC action, although he observed that even in the case of a letter of intent regarding a merger, there must be full, fair, and truthful disclosure.

Representative Tom Emmer (R-Minn) added his voice to the confusion that surrounds the next steps for FTX. In a somewhat cryptic tweet, and without offering further evidence, Rep. Emmer stated: “Interesting. @GaryGensler runs to the media while reports to my office allege he was helping SBF and FTX work on legal loopholes to obtain a regulatory monopoly. We’re looking into this.”

During Gensler’s “Squawk Box” appearance, Sorkin had asked about a March 29, 2022 entry in Gensler's calendar indicating a meeting Gensler had with Bankman-Fried. Sorkin asked, “Do you feel like you were hoodwinked?” Gensler replied: “I think we’ve been clear in these meetings and you can look at my calendar’s public, many meetings with folks in this industry, it’s very clear in these meetings, same message to the public, same message to them that non-compliance is not going to work, the public is going to be hurt, but also we’re going to continue on these dual paths and if we need to going to be the cop on the beat, going into court, putting the facts and the law in front of judges.”

Although it is unclear if Rep. Emmer was referring to the meeting noted by Sorkin, the lawmaker has been an outspoken proponent of enacting legislation to clarify rules for blockchain ventures. Representative Emmer has, over several Congresses, authored at least three blockchain bills: (1) the Blockchain Regulatory Certainty Act (H.R. 5045) (safe harbor from licensing requirements for certain non-digital-currency-controlling blockchain developers and service providers); (2) the Safe Harbor for Taxpayers with Forked Assets Act (H.R. 3273) (excluding from gross income the receipt of any forked convertible virtual currency); and (3) the Securities Clarity Act (H.R. 4451) (purporting to distinguish an investment contract from an asset sold pursuant to an investment contract for purposes of Howey analysis).

With respect to the last bill, the Howey analysis referred to is that required under a Supreme Court precedent that provides that an investment contract is a security if it involves an investment of money, in a common enterprise, with a reasonable expectation that others will use their managerial skills to generate profits. Howey has been a workhorse of SEC enforcement in the blockchain space. Gensler and his predecessors have remained steadfast in telling the public that most blockchain tokens are securities under Howey.

Thursday, November 10, 2022

If you don’t think the S and G of ESG matter, just ask Uber, experts say

By John Filar Atwood

While the SEC’s climate proposals have grabbed headlines in 2022, social and governance rules are coming and will demand just as much attention from companies, according to panelists at Practising Law Institute’s securities regulation conference. Proposals surrounding human capital management and corporate board diversity are on the SEC’s rulemaking agenda, so could be just around the corner.

The panelists acknowledged that unlike climate measures, social and governance issues can feel amorphous and be hard to quantify. That does not mean they can be overlooked, said Marian Macindoe, head of ESG stewardship at Parnassus Investments, who was at Uber when the company was brought to its knees by S&G issues.

Macindoe, who was head of ESG at Uber at the time, noted that in 2017 Uber controlled 80 percent of the ridesharing market when it fell victim to a sexual harassment incident and claims of mistreating its employees. The final straw, she said, was how it was seen as undercutting a taxi strike that was in response to the former Administration’s foreign travel ban.

Public perception of Uber plummeted, and it lost 100,000 subscribers almost overnight, Macindoe said. Five years later, Uber is still trying to climb out of that reputational hole, she noted.

Forthcoming proposals. WilmerHale’s Meredith Cross said that she advises her clients that social and governance issues matter but acknowledged that they are hard to pin down. She believes the SEC is taking its time in drafting the rules because different issues are important to different companies and it is hard to encompass the varying priorities within rule proposals.

Gibson Dunn partner Thomas Kim added that the SEC needs to draft its proposals carefully because its first S&G rule, the pay ratio disclosure requirement, was not that successful. Kim said the disclosure was supposed to highlight pay inequality, but all it did was point out that businesses have different kinds of work. It is not a revelation that McDonald’s, which employs workers at lower pay scales, will have a higher pay ratio than Goldman Sachs which hires white collar employees, he noted. Pay ratio is not a useful metric, he said.

Kim said the difficulty in quantifying social and governance issues was underscored by recent SEC comment letters to filers. Many companies now voluntarily prepare and file an ESG report, he noted, and the SEC has asked companies why they did not include S&G issues contained in the report in their 10-Ks. The answer in every instance was “because it is not material,” he said. Social and governance issues do not have a financial component, he continued, so they are measured by what a “reasonable investor” would find material.

Materiality. Emily Zahler, vice president at Tapestry Inc., said that materiality is where her team begins to address ESG issues. The company does a materiality assessment every few weeks by engaging with its shareholders and asking what issues matter most to them. The company then considers what actions it can take to impact those issues, she stated.

Asked what S&G issues generally surface in those discussions, Zahler said that diversity, equity, and inclusion (DEI) is at the top. DEI is so important that Tapestry works it into its compensation program, she noted. After that, shareholders generally bring up issues surrounding ethics and compliance, she said.

Other important social issues can be gleaned from the last proxy season, which D.F. King’s Zally Ahmadi characterized as “the year of the social proposal.” She said that the top social proposals this year were:
  • Political spending and lobbying;
  • Labor issues and discrimination;
  • Equal employment opportunity issues and workforce diversity;
  • Racial equity audits;
  • Human rights risk assessments; and
  • Anti-ESG proposals.
The last entry on the list is deceptive, she noted, because those proposals were submitted mostly by the same proponent. Moreover, they asked for civil rights audits and were worded as if they were concerned about diversity but in the supporting statement it was clear that they wanted non-diverse workforces. All of the anti-ESG proposals received extremely low levels of support from shareholders this season, she said.

Wednesday, November 09, 2022

In a win for the SEC, court finds LBRY tokens are securities

By Rodney F. Tonkovic, J.D.

In a ruling that may have significant ripple effects, a district court concluded that LBRY, Inc.'s digital token was offered as a security. The Commission charged LBRY, a digital content provider using blockchain, with conducting an unregistered offering of digital asset securities called LBC. Both parties moved for summary judgment and the court found in favor of the SEC, concluding that the record showed that LBC was promoted as an investment that would grow through the company's efforts. No reasonable trier of fact would reject the SEC's contention that LBC was offered as a security, the court said (SEC v. LBRY, Inc., November 7, 2022, Barbadoro, P.).

LBRY, Inc. used blockchain technology to allow users to share digital content, such as videos or images, without a centralized host. The company bills itself as "the first decentralized, open-source, fully encrypted content distribution service built using the same blockchain technology that underlies Bitcoin." LBRY uses a native digital token called LBRY Credits (LBC) to compensate miners, but LBC can also be spent to publish or purchase content or create channels within the LBRY Network. When LBC launched in June 2016, LBRY reserved 400 million LBC for itself.

In March 2021, the SEC charged LBY with failing to register a securities offering. According to the complaint, starting in 2016, LBRY offered and sold over 13 million LBC to investors, purportedly to fund its business and build its network. The Commission argued that LBC were offered and sold as investment contracts and, therefore, securities because the money raised was pooled in a way that the fortunes of LBC holders were intertwined with those of other holders, including LBRY itself. And, LBC holders expected a return on their investments based on LBRY's entrepreneurial or managerial efforts. The SEC seeks injunctive relief, disgorgement of money obtained through the offerings, and civil penalties.

The parties filed cross-motions for summary judgment: the SEC argued that LBRY sold unregistered securities, while LBRY contended that LBC is not a security and also that it had no notice that its offerings are subject to the securities laws. The court concluded that LBC is an investment contract and that LBC had received fair notice.

Is LBC a security? The court found that LBRY's offerings of LBC established that it was offering it as a security. First, the court noted that the SEC identified multiple statements leading potential investors to reasonably expect that LBC would grow in value—LBRY's overall messaging was about LBC's growth potential. LBRY, the court said, was "acutely aware of LBC’s potential value as an investment. And it made sure potential investors were too." In the First Circuit, such "economic inducement" is evidence of Howey's "expectation of profits;" this was the only part of the Howey test in dispute.

Even if LBRY never spoke to LBC's growth potential, the court continued, any reasonable investor familiar with its business model would have understood that LBC was expected to grow through LBRY's efforts. From the start, LBRY's profitability turned on its ability to grow LBC through increasing usage of the LBRY Network. Moreover, the fact that LBRY retained hundreds of millions of LBC for itself signaled that it was motivated to improve the value of its blockchain, the court said.

LBRY responded that some purchasers acquired LBC for consumptive, rather than speculative uses. The court rejected this argument, stating that nothing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract. In sum, the evidence showed that LBC was promoted as an investment that would grow over time through the company's development of the LBRY Network—the economic realities established that LBRY was offering LBC as a security.

Fair notice. LBRY argued further that it did not receive fair notice that its offerings were subject to the securities laws. In support of this argument, the company posited that the SEC has only attempted to enforce the registration requirement against an issuer of digital tokens in the ICO context. But, LBRY failed to point out any SEC statement or reading of Howey suggesting that only ICO's are subject to the registration requirement. The SEC based its claim on venerable Supreme Court precedent, the court said, and "LBRY is in no position to claim that it did not receive fair notice that its conduct was unlawful."

Ripple effects. While this case is from a district court in the First Circuit, the ruling may have some impact on other pending litigation concerning digital asset securities. In 2020, the Commission hit Ripple Labs with an enforcement action alleging that the crypto giant raised over $1.3 billion through unregistered sales of a digital asset called XRP. Like LBRY, Ripple maintains that XRP was not sold as an investment. Unlike the LBRY case, the Ripple action hinges on whether XRP was promoted as an investment in a common enterprise. When last before the Southern District of New York, the court granted summary judgment in favor of the SEC, finding that the allegations plausibly showed that the individual defendants viewed XRP as an investment and promoted it as an investment in a common enterprise. Unlike LBRY, the court allowed Ripple's fair notice defense.

The case is No. 21-cv-260.

Tuesday, November 08, 2022

Chamber reiterates objections to SEC climate proposal

By Anne Sherry, J.D.

In supplemental comments on the SEC’s proposed climate-related disclosures, the U.S. Chamber of Commerce reiterated and expanded upon its earlier objections that the rule would greatly burden companies and auditors. The Chamber observes that even the institutional investors that would purportedly benefit from the rules oppose them as proposed. And the Supreme Court’s recent reliance on the major questions doctrine for statutory interpretation suggests that the SEC may lack the authority to issue rules that, according to the Chamber, “reorder the market.” According to the group, the proposal’s flaws result from the SEC moving too quickly on a huge volume of rules, depriving an already shorthanded staff of the time needed to develop properly tailored proposals.

Climate proposal. The proposed amendments to Regulations S-K and S-X would, if adopted, require public companies to formally incorporate climate risk disclosures in their annual and periodic reports. Under the proposed regulation, companies would have to provide information about Scope 1 and Scope 2 emissions and provide a related attestation report from an independent service provider if the company is an accelerated or large accelerated filer.

The proposal also would include Scope 3 disclosures to the extent they are material or if a company has such an emissions target. Smaller reporting companies would be exempt from this requirement, and the Scope 3 provisions would afford companies a longer phase-in time, provide for a safe harbor, and not require attestation.

Chamber concerns. In its supplemental comment letter, the Chamber said that the proposed rules fail to strike the right balance of informing and protecting investors without imposing too great a cost on disclosing entities or the economy as a whole. The group raises three main issues with the amendments.

First, the Chamber writes that participants throughout the financial industry believe that significant aspects of the proposal would be costly and unworkable. Even the large institutional investors cited throughout the proposal believe the SEC has gone too far in requiring detailed, prescriptive disclosures that do not reflect the emerging state of climate data. For example, proposed Article 14 of Reg S-X would require companies to calculate the impacts of climate risks on every line item on their financial statements and disclose any impacts that aggregated to 1 percent or more of a line item. Multiple large investors said this line-by-line reporting requirement would impose an enormous operational burden on companies without producing meaningful or comparable data to inform investment decisions. Similarly, given the emerging development of Scope 3 methodologies, the Scope 3 disclosure requirement would impose enormous costs with little benefit to investors.

Second, the letter asserts that the SEC’s cost-benefit analysis is significantly flawed. The Commission estimated initial compliance costs of $640,000 and annual ongoing costs of $530,000, but one large reporting company said its implementation costs would exceed $100 million and it would spend $10 to $25 million per year thereafter. In another example, the SEC estimated annual internal costs of $150,000, which would likely not cover the salary and benefits for even one new full-time employee. The SEC also failed to consider some costs, like the “multi-billion-dollar” impact on the broader economy and the opportunity costs of reallocating budgets and priorities. On the benefits side, the Chamber argues that the evidence shows many investors do not find disclosures on greenhouse gas emissions to be material.

Finally, the Chamber cited the Supreme Court’s decision in West Virginia v. EPA, significantly the Court’s emphasis on the major questions doctrine, a canon of statutory interpretation that instructs that Congress does delegate consequential powers to agencies unless that delegation is clear. The SEC may have “some latitude” in requiring that material information be disclosed, but it does not have the delegated authority to “reorder the market,” the Chamber writes. Congress also did not delegate to the Commission the authority to regulate emissions that contribute to climate change. Furthermore, the letter states that the proposed rules violate the First Amendment by compelling speech on issues that are controversial and subject to reasonable debate.

Monday, November 07, 2022

PLI panelists grapple with controversial climate disclosure proposals

By John Filar Atwood

Panelists at Practising Law Institute’s securities regulation conference did not mince words about the SEC’s climate disclosure proposals, calling the current iteration of them “outrageously hard,” “messy,” and “not moored to reality at this point.” The experts did not call into question the SEC’s attempt to draft regulations in this area, but strongly believe that the proposals should be modified before being implemented.

The panelists’ remarks are not unlike what the SEC is seeing in the more than 4,000 unique comment letters on the proposals, which express significant support but also include a substantial number of recommended changes. WilmerHale’s Meredith Cross referenced some letters where the commenters essentially said, “start over, it’s too hard.”

Cross believes that the proposals as they stand will be very expensive to implement. She is worried that even with the pushback from many stakeholders, the requirements could just get bigger and harder.

Kier Gumbs of Broadridge Financial said that he hopes the International Sustainability Standards Board will finish its effort to develop climate standards, and that the SEC will incorporate them into its rules. He acknowledged that the SEC probably will not take that path, but he believes stakeholders should strongly encourage the global harmonization of standards.

Cross said that everyone needs to accept that the SEC is not just going to adopt someone else’s climate disclosure requirements. “They didn’t do it with IFRS, and it will not happen here,” she said. The Commission does not want to give over its rulemaking to some other organization, she noted, nor is it allowed to. However, the SEC can bring in concepts from around the world, she added, so suggested that a possible way forward is through requiring an ESG report that could be provided outside of other required filings, and then used as a passport around the world.

Ernst & Young’s Mark Kronforst agreed that global standard-setting efforts are so different that it is hard to see how they all will ultimately connect. He noted that the European Union seems to favor a double materiality standard, and the SEC has called for a scenario analysis in climate disclosures. For U.S. companies, he said, it is difficult right now to predict what the requirements will be.

Gumbs noted that there is some commonality globally such as the greenhouse gas emissions standard and a widespread reliance on the Task Force on Climate-Related Financial Disclosures (TCFD) framework. Even before any climate disclosure rules are adopted, companies should be applying the TCFD framework to their ESG efforts, he advised.

Lona Nallengara, a partner at Shearman & Sterling, touched on the climate disclosure proposals in a separate panel suggesting that they are not workable in their current form. However, practically speaking a lot of what is in the proposals such as Scope 1 and Scope 2 information is going to have to be disclosed anyhow, he stated. A large company that is consumer facing will need to have a robust ESG platform, he continued. The company’s stakeholders—either customers, employees, or shareholders—are eventually going to ask for it, he said.

Diving into some of the specifics surrounding the proposals, Charles Schwab’s Karen Garnett noted that there have been about 15,000 total comments on them so far. She said that there has been considerable concern around the timing of the rules because if they are adopted this year some companies will have to put processes in place by January 2023 to begin gathering the information that will be required to be reported in 2024. In her view, however, it is very unlikely that the rules will be adopted this year.

Kronforst said that there has been a lot of pushback on the Regulation S-X piece of the proposals. In that section, the SEC proposed, among other things, to require certain climate-related financial statement metrics and related disclosure to be included in a note to a registrant’s audited financial statements. A metric would need to be disclosed if the absolute value of all climate-related impacts or expenditures with respect to a corresponding financial statement line item represents at least 1 percent of the line item.

Kronforst hopes that the 1 percent threshold will be raised or converted to a materiality standard. As it is written, the requirement “would be an extremely heavy lift,” he said. Based on the comment letters, he said it feels like the percentage might change. Companies are holding back on preparing for this right now to see if it gets adjusted in the final rule, he added.

Panelists agreed that it is unclear what even will qualify as a climate expense under the proposed rules. Kronforst said it will be a challenge if a company does something for multiple reasons, such as both to save money and because it is good for the environment. Should a company split up those expenses in its financial statements, he asked. He expressed his hope that there will be clarifications on this and other matters in the adopting release.

Friday, November 04, 2022

COO should have known to disclose beneficial ownership

By Anne Sherry, J.D.

An executive was on notice, objectively if not subjectively, that his power to direct voting of shares owned by other entities amounted to beneficial ownership. While the defendant disclosed beneficially owning more than 30 percent of his company, he failed to disclose additional shares that he controlled through relationships and agreements with other companies. The district court in Maryland rejected the executive’s argument that the SEC did not give fair notice before bringing the civil action (SEC v. Miller, November 1, 2022, Boardman, D.).

The defendant is the former COO of Abakan, Inc., a publicly traded manufacturing company. In 2013 he disclosed beneficially owning 22 million shares in Abakan, more than 30 percent of its outstanding common stock. However, the SEC took action for his failure to disclose that he beneficially owned additional shares through relationships and agreements with three Uruguayan entities and individuals affiliated with those entities. These relationships allowed the defendant to direct that shares be sold and the proceeds sent to himself or entities he controlled.

The COO moved for summary judgment on the SEC’s claims. As a factual matter, he disputed that he beneficially owned the securities. As a legal matter, he argued that the SEC deprived him of due process by failing to warn him ahead of filing suit that his conduct amounted to beneficial ownership. The court denied summary judgment.

According to the defendant, the rule that defines beneficial ownership does not provide adequate notice of the conduct it reaches, and the SEC opted in his case to rely on the “totality of the circumstances” to prove the defendant was a beneficial owner, a standard too vague and imprecise to be permissible under the Constitution. But the court said that a rule does not have to clear a very high bar: it must give fair warning of the proscribed conduct and a reasonably clear standard of culpability, but it does not need to use mathematical precision.

Here, the SEC rule defining beneficial ownership refers to “voting power” and “investment power,” but does not itself identify or explain conduct that would constitute “power.” Turning to dictionary definitions, the court found that they comported with the commonly understood use of the word to mean “ability,” which was more than sufficient clarity to provide fair notice and a standard of culpability.

Furthermore, even if the defendant did not subjectively understand his conduct amounted to beneficial ownership, a person of ordinary intelligence, especially with experience in the securities industry, would have understood that the reporting rule reaches the ability to direct the disposition of shares. Previous cases consistent with this understanding also put the defendant on notice of the rule’s meaning. The defendant also provided no authority for his assertion that the SEC departed from its previous stance of evaluating beneficial ownership by “objective indicia of ownership” rather than, in his case, a “totality of the circumstances.”

Finally, the court denied summary judgment on the defendant’s factual defenses, which the SEC countered with opposing evidence. Because there was a genuine dispute of material fact, summary judgment was not appropriate.

The case is No. 19-cv-02810.

Thursday, November 03, 2022

Commission set to revamp open-end funds once again

By Mark S. Nelson, J.D.

The SEC voted 3-2 to propose rules for open-end investment companies that, if adopted, would bring changes to how these funds calculate NAV, including the use of swing pricing. A Fact Sheet accompanying the proposing release indicated that the Commission was motivated by lessons learned following the market downturn that accompanied the onset of the COVID-19 pandemic. As a result, the proposed amendments would require funds to classify assets by assuming potentially stressed market conditions in order to not overestimate their degree of liquidity. The proposal also would require swing pricing in order to allocate costs to investors who are responsible for fund inflows and outflows rather than diluting fund shareholders generally. Swing pricing would be further paired with a required “hard close” (Open-End Fund Liquidity Risk Management Programs and Swing Pricing; Form N-PORT Reporting, Release No. 33-11130, November 2, 2022).

“[G]ummy bears” and fund rules. SEC Chair Gary Gensler suggested that the classification part of the proposal would keep funds honest about which of their assets are truly liquid, analogizing the problem to his inability to classify gummy bears as fruit. Gensler also more generally stated the financial and economic case for the proposal thus: “A defining feature of open-end funds is the ability for shareholders to redeem their shares daily, in both normal times and times of stress. Open-end funds, though, have an underlying structural liquidity mismatch. This is because they invest in securities across a range of liquidities, including securities that are costlier or take more time to sell.”

Commissioner Hester Peirce voted against issuing the proposal and questioned its timing given that the Commission already has many open proposals. She also suggested that investors could use ETFs to combat dilution and that open-end funds might compete on offering anti-dilution tools. “The Commission’s flaw is hubris—thinking we can redesign open-end funds to eliminate their purported flaws has only revealed our own,” said Peirce.

Commissioner Mark Uyeda likewise voted against issuance of the proposal, citing the proposed amendments as a way to hasten investors’ move out of open-end mutual funds and into ETFs and distinguishing the use of swing pricing in Europe as being unique to that region’s markets.

According to Commissioner Caroline Crenshaw, who supported the proposal, public comments should focus on several questions, including the rule’s potential unintended consequences, any operational challenges regarding implementation of the hard close, and whether alternatives to swing pricing such as liquidity fees or estimated fund flow information would be sufficient.

Commissioner Jaime Lizárraga, who also voted to issue the proposal, said the proposal emphasizes fund redemptions in time of stress. “The market instability and stressed conditions at the onset of the COVID-19 pandemic tested liquidity risk management programs and revealed weaknesses that warrant our attention,” said Lizárraga.

Swing pricing. The proposal would require open-end funds to mitigate the dilution of shares by using swing pricing to set funds’ net asset value (NAV). The swing pricing requirement would apply to most funds but would not apply to money market funds or ETFs.

Under the proposal, Investment Company Act Rule 22c-1 would be amended to provide that a fund’s board must set the time to calculate the fund’s NAV and to further provide that a fund could not do transactions at other than the current NAV. The amended rule also would require a fund to establish and implement swing pricing policies and procedures.

Among the several procedures to be required, a fund would have to adjust its NAV by a swing factor if either of two conditions occurs:
  • The fund has net redemptions; or
  • The fund has net purchases exceeding its inflow swing threshold.
According to the definition section of the proposed amended rule, “swing factor” would mean the percent of NAV by which the fund adjusts its NAV per share. “Inflow swing threshold” would mean net purchases of two percent of a fund’s net assets (or a smaller amount determined by the fund’s swing pricing administrator).

A fund’s swing pricing administrator would have to review investor flow information and make certain determinations, which could be based on reasonable, high confidence estimates. “Investor flow information” would be defined to mean daily purchase and redemption activity (e.g., individual, aggregated, or netted eligible orders, but not in kind purchases or redemptions).

The proposal also would impose a “hard close” requirement under which an investor's order to purchase or redeem fund shares is eligible for a particular day’s price only if the order is received before the fund calculates it NAV (often 4 p.m. eastern time). The Fact Sheet explained that this requirement would “operationalize” the swing pricing requirement by facilitating better flow information.

Liquidity risk management. As proposed, amended Investment Company Act Rule 22e-4(b) would retain the general requirement that each fund and in-kind ETF adopt and implement a written liquidity risk management program that is reasonably designed to assess and manage its liquidity risk. The amendment, however, would delete existing text and notes regarding monthly reporting on Form N-PORT and classification methodology.

Under the amended rule, classification would be determined by: (1) measuring the number of days in which the investment is reasonably expected to be convertible to U.S. dollars without significantly changing the market value of the investment (a fund would include the day on which the liquidity classification is made in the measurement); and (2) assuming the sale of 10 percent of the fund’s net assets by reducing each investment by 10 percent.

With respect to the highly liquid investment minimum, the general requirement would be re-phrased as an explicit command as compared to the existing rule text, which speaks of funds that do not primarily hold assets that are highly liquid investments. Thus, the amended rule would require that a fund determine and maintain a highly liquid investment minimum that is equal to or higher than 10 percent of the fund’s net assets.

In the case of illiquid investments, the amended rule would retain the general requirement that no fund or in-kind ETF may acquire any illiquid investment if, immediately after the acquisition, the fund or in-kind ETF would have invested more than 15 percent of its net assets in illiquid investments that are assets. However, the amended rule would address the situation where a fund has posted margin or collateral in connection with a derivatives transaction that is classified as an illiquid investment. Thus, if applicable, a fund also would include as illiquid investments that are assets the value of margin or collateral posted in connection with the derivatives transaction that the fund would receive if it exited the transaction. In other respects, the rule would not change regarding a fund or in-kind ETF that holds more than 15 percent of its net assets in illiquid investments that are assets.

Reporting requirements. As explained by the SEC’s Fact Sheet, the proposal would require funds to file each month’s report within 30 days after month-end, such that the report would become public 60 days after month-end. The change would apply to all registrants that report on Form N-PORT, including open-end funds other than MMFs, registered closed-end funds, and ETFs organized as unit investment trusts.

The release is No. 33-11130.

Wednesday, November 02, 2022

CFTC rulemaking petition seeks clarity on DAOs

By Mark S. Nelson, J.D.

Haun Ventures announced that it plans to submit a rulemaking petition to the CFTC in which it urges the agency to issue rules or guidance clarifying the status of decentralized autonomous organizations (DAOs) and the status of persons who participate in such entities. One of the few prior times that a federal agency issued guidance on DAOs was in 2017 when the SEC issued its DAO Report, ostensibly providing guidance for all types of digital asset securities or, as the SEC currently calls them, crypto asset securities. Haun Ventures’ rulemaking petition cites the CFTC’s recent Ooki DAO/bZeroX enforcement action as the primary reason for seeking regulatory clarity.

Ooki DAO/bZeroX. Ooki DAO was the resulting entity created after bZeroX transferred its bZx protocol to bZx DAO, a decentralized entity that was then renamed Ooki DAO. According to the CFTC’s federal court complaint filed against Ooki DAO and a settled administrative order against bZeroX, the bZx protocol enabled margined and leverage retail commodity trading based on the difference between two virtual currencies.

The CFTC’s complaint and administrative order alleged similar facts based on violations of the CEA and a related regulation. The CFTC first charged that Ooki DAO/bZeroX engaged in unlawful off-exchange leverage and margined retail commodity trading, including activities that could only be lawfully undertaken by a registered designated contract market (DCM). The CFTC also charged that Ooki DAO/bZeroX unlawfully engaged in the activities of a registered futures commission merchant (FCM). Lastly, the CFTC charged that Ooki DAO/bZeroX failed to have procedures in place regarding anti-money laundering and know-your-customer requirements. bZeroX and two individuals settled the administrative charges brought against them for $250,000. bZeroX and the individuals agreed to cease and desist from the offending activities, while agreeing to the settlement without admitting or denying the CFTC’s charges.

CFTC Commissioner Summer K. Mersinger dissented from the CFTC’s enforcement action against Ooki DAO. Her central thesis was the following: “While I do not condone individuals or entities blatantly violating the CEA or our rules, we cannot arbitrarily decide who is accountable for those violations based on an unsupported legal theory amounting to regulation by enforcement while federal and state policy is developing.”

Specifically, Mersinger objected to the CFTC’s use of state law principles primarily used in private transactions to define those who vote DAO tokens to be members of an unincorporated association who are then personally liable for the actions of the DAO. Mersinger posited that this approach may chill technological development. According to Mersinger, the CFTC instead could have held the two individual respondents liable under a theory of aiding and abetting.

Haun Venture’s rulemaking petition is based largely on Mersinger’s dissent, albeit with some more details of how Haun Venture would like to see commodities law develop with respect to DAOs.

“Shockwaves” in web3 community. Haun Ventures, a $1.5 billion venture capital firm with portfolio projects emphasizing web3 and DAOs, conceded its interest in having the CFTC adopt a regulation that would benefit itself and similar investors in DAOs. Haun Ventures’ main concern regarding the Ooki DAO matter is that, in its view, too many people who hold or vote DAO tokens could be held personally liable for the actions of a DAO under the CFTC’s current approach to blockchain enforcement. Haun Ventures’ rulemaking petition noted that DAOs are a key piece of web3 development and the CFTC’s approach had sent “shockwaves” through the web3 community and could chill participation in DAOs.

According to Haun Ventures, the CFTC should engage in rulemaking to amend an existing regulation and to adopt a new rule specific to the DAO setting. For example, existing rules should be amended to include a definition of “DAO.” Second, the CFTC should add a rule aimed at limiting the circumstances in which individuals could be held personally liable for the actions of a DAO.

To achieve the second goal, Haun Ventures suggested a rule that would penalize willful conduct that causes a DAO to take unlawful actions, or which involves aiding and abetting such actions, or which involves acting in concert with others to cause a DAO to violate the law. A key theme connecting most, but not all, of the examples the rulemaking petition would have written into CFTC regulations would especially favor passive investors or passive holders of DAO tokens. In other words, DAO participants who do not vote their tokens or who vote their tokens on actions unrelated to a DAO’s unlawful actions would not be held personally liable.

Tuesday, November 01, 2022

U.K. regulator proposes measures to cut down on greenwashing

By John Filar Atwood

The U.K.’s Financial Conduct Authority (FCA) has released a package of measures aimed at curbing greenwashing, the practice of companies using exaggerated, misleading, or unsubstantiated sustainability-related claims about their products. Among other things, the FCA proposes to require investment product sustainability labels and restrictions on how terms like “ESG,”, “green,” or “sustainable” are used.

The FCA said that the proposals are consistent with its overall ESG strategy, and are designed to ensure that investors can trust that products have the sustainability characteristics they claim to have. The FCA hopes to finalize the rules and to have some of the basic anti-greenwashing requirements go into effect by July 1, 2023. However, the labeling, naming and marketing, and initial disclosure requirements would not go into effect until at least June 30, 2024.

Focus of proposals. The proposals cover the following main areas:
  • Sustainable investment labels to help consumers navigate the investment product landscape and enhance consumer trust.
  • Consumer-facing disclosures to help consumers understand the key sustainability-related features of a product.
  • Detailed disclosures on pre-contractual disclosures covering the sustainability-related features of investment products.
  • A new sustainability product report that discloses ongoing sustainability-related performance information including key sustainability-related performance indicators and metrics, and a sustainability entity report that covers how firms are managing sustainability-related risks and opportunities.
  • Naming and marketing rules that will restrict the use of certain sustainability-related terms in product names and marketing materials unless the product uses a sustainable investment label.
  • Requirements for distributors to ensure that product-level information, including the labels, is made available to consumers.
  • A general anti-greenwashing rule that applies to all regulated firms which reiterates existing rules to clarify that sustainability-related claims must be clear, fair, and not misleading.
The proposals will focus solely on funds and portfolio management based in the U.K., but the FCA recognizes that overseas funds also form part of its market. Accordingly, the regulator intends to follow with a separate consultation on how the current package of proposals may be applied to overseas funds.

Labels. The proposals include the following three broad sustainable investment labels: sustainable focus; sustainable improvers; and sustainable impact. This is how the FCA defines each label:
  • Sustainable Focus: Products with an objective to maintain a high standard of sustainability in the profile of assets by investing to 1) meet a credible standard of environmental and/or social sustainability, or 2) align with a specified environmental and/ or social sustainability theme.
  • Sustainable Improvers: Products with an objective to deliver measurable improvements in the sustainability profile of assets over time. These products are invested in assets that, while not currently environmentally or socially sustainable, are selected for their potential to become more environmentally and/or socially sustainable over time, including in response to the stewardship influence of the firm.
  • Sustainable Impact: Products with an explicit objective to achieve a positive, measurable contribution to sustainable outcomes. These are invested in assets that provide solutions to environmental or social problems, often in underserved markets or to address observed market failures.
The FCA noted that the proposals build on existing requirements and expectations for firms that were outlined in a July 2021 list of guiding principles for the design, delivery and disclosure of ESG funds. In addition, the regulator intends to build on the proposed requirements in line with the development of international sustainability-related reporting standards by the International Sustainability Standards Board.

Monday, October 31, 2022

Legal tech experts compare general enterprise and legal industry solutions

By Matthew Garza, J.D.

The recently-held 5th Annual Legal/Reg Tech Workshop hosted by Doon Insights took place at a turbulent time for markets, but despite, or maybe because of that, progress in legal and reg tech continues to push ahead. Tech penetration rates in the legal industry are still much lower than other comparable fields, which means there is a lot of upsides for gains, as evidenced by the heightened pace of financings and M&A in the sector, according to Doon. With that background Doon gathered a panel of legal tech experts to discuss a big question facing law firms and in-house legal departments—do we invest in enterprise-wide platforms that integrate data management across the organization, or go with more bespoke solutions built for lawyers?

Peter Krakaur of Ernst & Young explained that he faces the challenge of measuring and connecting data from EY’s various global businesses, and asked a baseline question for the panel—do lawyers really need specialty legal technology products to do their jobs effectively?

Shelby Austin, a former law firm partner who runs legal tech firm Arteria AI, said that the adoption of legal technology by law firms has been an evolution, but early efforts, like organizing legal discovery documentation using general database principles, often failed. Now firms face even bigger challenges because of the explosion of data, meaning bigger dollars are needed to build bigger systems.

Wolters Kluwer’s Ken Crutchfield, who started in the nascent field of legal tech as a teenager in the 1980s with Lexis Nexis, said he has watched unique technology needs grow out of legal, tax, and accounting departments who were low priority tech spends within businesses. Off-the-shelf products didn’t fit their needs so they were forced to go looking for more bespoke solutions. “There are a lot of things going in spreadsheets that makes people shudder,” he said. That drives demand for tailored solutions within range of department budgets, who are struggling to find what they needed in all-of-enterprise platforms.

Julian Tsisin, Director of Legal Technology and Data at Meta, talked about the challenge of getting the needs of the legal department served by the central IT infrastructure of a company. “My goal is to make the legal department as efficient as possible,” but IT is focused on enterprise security, performance, and costs, with the importance of a single department’s efficiency way down the list. A task like automating a decision-making tree is a challenge for a central IT department that sees a narrow company benefit, challenges with data protection, and specialized support costs.

Mr. Tsisin said enterprise tools have gotten much better and more flexible than five years ago, but Meta takes a hybrid approach that also takes advantage of legal-specific tools that can offer its legal team exactly what it needs. A central IT platform can’t, for example, provide contract analytics, which Meta needs to better understand what is inside its huge portfolio of contracts.

Data in the modern legal business. Given the explosion of data and how its management is transforming business, firms and corporate counsel understand the need to go digital, said Mr. Krakaur, but face the reality that not all tech solutions fit. Law firms have different needs than corporations, and for practical reasons. For instance, they may handle contract lifecycle management for clients but they do not own the contracts, which are assets of the client. The lawyers are only one part of the management of that contract, and they are not in control of company systems to build them out for legal needs, he said.

Shelby Austin said niche data solutions might not have the sophisticated features and security enterprises require, and in fact the separate needs of the legal department and tax and accounting departments points to the need for an integrated solution. For a large company the value of the contract to the enterprise may be more important than saving time for the legal department to efficiently manage the contract, she said. The legal department, she said, needs to fit its strategy within the rest of the enterprise.

Ken Crutchfield addressed the “data silos” that develop within companies, saying that they could create compliance problems for the business by not being integrated with other departments’ needs. But in heavily regulated industries it might be impossible to find enterprise-wide solutions that account for specific legal compliance needs. How do you bridge that gap?

Julian Tsisin of Meta said the data can be connected, but there are real legal issues around confidentiality and privilege, with privilege being a uniquely legal issue. “I am not aware of any solution that, out of the box, will solve that,” he said. He noted that in the past his position lived in the central engineering department of the company, but now he sits in the legal department, which allows him to be more forceful in advocating for the department’s unique needs. And he expects he will continue to do just that, “assuming we still need specific legal solutions.” At some point he expects that enterprise solutions may develop sufficiently to solve for every department’s need, he said, but in the meantime, a hybrid approach will be necessary.