Securities Snapshot
November 19, 2019

Fifth Circuit Affirms District Court’s Authority To Order Disgorgement After Kokesh v. SEC

Fifth Circuit Affirms District Court’s Authority to Order Disgorgement After Kokesh v. SEC; Second Circuit Affirms Dismissal of Shareholders’ Claims Regarding Alleged Failure to Disclose Tax Consequences of Hypothetical Actions; N.Y. Jury Finds Two Former Traders and Firm Liable for Fraud and Market Manipulation in Trading Scheme; Second Circuit Denies Whistleblower Awards; Seventh Circuit Affirms Civil Penalty Against Whistleblower.

On November 5, 2019, the Fifth Circuit affirmed a $15.5 million disgorgement order in SEC v. Team Resources, Inc. et al. Defendants had argued that the Supreme Court’s 2017 decision in Kokesh v. SEC, which held that disgorgement was a penalty subject to a five-year statute of limitations, had stripped district courts of the authority to order disgorgement as it was no longer an equitable remedy and was not expressly authorized.

The District Court disagreed and ordered $15.5 million in disgorgement based on amounts obtained by the Defendants within the five years preceding the SEC’s complaint. The Fifth Circuit affirmed, noting Kokesh had expressly stated that “[n]othing in [its] opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.” The Fifth Circuit noted that while Kokesh raised questions as to whether district courts still had such authority, such questions were not sufficient to overturn Fifth Circuit precedent.

The Supreme Court will consider the SEC’s ability to seek disgorgement later this term in Liu v. SEC, a case where the district court ordered $26.7 million in disgorgement. The issue in Liu is whether the SEC may seek disgorgement as equitable relief in light of the Kokesh holding that disgorgement is a penalty. The outcome of that case may affect future matters involving SEC disgorgement, including any appeal in Team Resources.

Second Circuit Affirms Dismissal Of Shareholders' Claims Regarding Alleged Failure to Disclose Tax Consequences Of Hypothetical Actions 

On November 6, 2019, the Second Circuit affirmed the dismissal of a securities class action brought by Eaton Corporation’s shareholders against Eaton and two of its executives in South Carolina Retirement Systems Group Trust v. Eaton Corp. Plaintiffs brought fraud claims under Section 10(b) and Rule 10b-5 based on allegedly misleading statements about the possibility that Eaton could divest its vehicle business after a recent merger with Cooper Industries plc. Plaintiffs asserted, among other things, that Eaton failed to disclose that there would be negative tax consequences from a divestiture, and instead made allegedly misleading statements that Eaton was not financially precluded from divesting that business.

The District Court dismissed the claims on the basis that there were no material misrepresentations or omissions, and the Second Circuit agreed. The Second Circuit held, for instance, that in response to a question about whether a spin-off was “precluded,” Eaton was under no obligation to discuss the potential tax consequences of a hypothetical spin-off that was not technically precluded. The Second Circuit also noted that a number of the allegations related to hypothetical actions, and where Eaton had denied that it was taking those actions, it had no obligation to discuss their potential consequences. In its ruling, the Second Circuit emphasized that allegedly misleading statements must be evaluated in context, and the entire statement must be considered in full.

N.Y. Jury Finds Two Former Traders And Firm Liable For Fraud And Market Manipulation in Trading Scheme

On November 12, 2019, in SEC v. Lek Securities Corp. et al., a Manhattan jury found that a Ukranian day-trading firm, Avalon FA Ltd., Avalon’s leader, Nathan Fayyer, and his friend, Sergey Putselnik, had engaged in fraud in violation of the Securities Act of 1933 and of the Securities Exchange Act of 1934. The SEC alleged that the defendants, through connections with foreign traders and through Putselnik’s access to a U.S.-based firm, Lek Securities, had engaged in layering and cross-market trading schemes over six years and ultimately generated $28 million in revenue from the schemes. The schemes involved coordination with foreign-based traders to submit false orders to influence market pricing, as well as the placement of real orders to influence option prices. The defense asserted that the allegations did not amount to manipulation and that traders merely placed orders that were sometimes not filled. The defendants have stated that they intend to appeal on the basis that the SEC’s theory of layering presented novel questions of law.

The SEC previously reached a settlement with Lek Securities, and its CEO Samuel Lek, for their role in allowing Avalon and Putselnik access to U.S. markets. Under that settlement, Mr. Lek paid a fine of $420,000 and his firm paid over $1.5 million in disgorgement and civil penalties.

Second Circuit Denies Whistleblower Awards

On November 8, 2019, the Second Circuit denied whistleblower awards for three individuals in Kilgour, et al. v. SEC. Between 2010 and 2014, the individuals disclosed information to the SEC that they thought would be helpful to the SEC’s investigation into alleged misstatements in the financial statements of Deutsche Bank AG. In 2015, the SEC reached a $55 million settlement with Deutsche Bank that resolved an SEC enforcement action. After that settlement, the individuals filed applications with the SEC seeking whistleblower awards. Although the SEC awarded $16 million to other whistleblowers, it denied the individuals’ applications.

The individuals asked the Second Circuit to set aside the SEC's denial of their applications and instruct the SEC to issue whistleblower awards to them based on the value of the information that they provided to the SEC. Among other arguments, the Second Circuit considered whether the SEC should be equitably estopped from claiming that it did not rely on one of the individuals’ submissions and instead should be directed to issue an award because, even though his submissions did not contribute to the success of the SEC’s enforcement action, the information in those submissions did.

The Second Circuit rejected the argument. Giving Chevron deference to the SEC’s interpretation of the Dodd-Frank Act, the Second Circuit concluded that it was reasonable to require a whistleblower’s submission to contribute significantly to the SEC’s successful action in order for the whistleblower to receive an award. The Second Circuit explained: “The SECʹs interpretation. . . strikes a sensible balance between care and timeliness, one that is more consistent with the whistleblower program’s purpose: A whistleblower might still be rewarded for being the first to bring incriminating information to the SECʹs attention, but only if that information is contained in a credible, and ultimately useful submission.”

Seventh Circuit Affirms Civil Penalty Against Whistleblower

On November 8, 2019, the Seventh Circuit affirmed a civil penalty for insider trading in SEC. v. Williky. The case arose from an allegedly fraudulent scheme involving Imperial Petroleum, Inc. in which Imperial allegedly purchased finished biodiesel and resold it while claiming government incentives and tax credits for companies producing biodiesel from raw feedstock. Imperial allegedly hired Williky in 2009 to inflate artificially the price of Imperial’s stock through a series of “wash and match trades” and “scalping” emails. As part of Imperial, Williky allegedly acquired millions of shares of Imperial stock (but did not report his ownership when it exceeded five percent, as was required).  By July 2011, Williky allegedly knew that Imperial had misrepresented the source of its biodiesel to investors. By November 2011, Williky allegedly knew the complete extent of Imperial’s fraud. While in possession of that confidential information, Williky allegedly sold all of his shares by February 2012, avoiding a loss of $798,217.

As he sold his shares, Williky contacted federal authorities in the hope of becoming a whistleblower. In March 2015, the SEC charged Williky with violating federal securities laws through market manipulation and insider trading. As part of the lawsuit, the SEC sought to impose a civil penalty for Williky’s insider trading. Williky entered into a bifurcated settlement with the SEC, conceding his involvement in the allegedly fraudulent scheme and agreeing that the District Court would determine the financial remedies to be assessed based on the facts of the SEC’s complaint. The District Court entered a judgment of $1,596,434, equal to two times Williky’s avoided losses.

On appeal, Williky argued that the judgment ignored his cooperation as a whistleblower and was consequently an abuse of discretion. The Seventh Circuit disagreed. First, the Seventh Circuit observed that “the civil penalty’s main design is to deter insider trading, not to encourage whistleblowing and cooperation after the fact. . . . Given all of the facts and circumstances, the district court properly determined that a civil penalty was necessary to serve as an effective deterrent.” Second, the Seventh Circuit held that the District Court properly weighed the value of Williky’s cooperation, which was “limited” because (among other things) Imperial already was under investigation. Third, the Seventh Circuit found that “Williky has been notably uncooperative throughout the course of litigation” with the SEC, as a result of which “the SEC has undoubtedly spent significant resources in litigating the matter.” In sum, the Seventh Circuit concluded: “Allowing Williky to flagrantly commit insider trading and then settle to avoid civil penalties would create a pervers[e] incentive that undermines the purpose of the statute.”