In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important SEC enforcement developments from the past month, with links to primary resources. This month we examine:
- The SEC’s continued prioritization of registration requirements in the cryptocurrency space;
- Three cases alleging financial reporting violations against public companies and their former executives, including cases continuing the SEC’s recent trends of clawing back executives’ compensation under Sarbanes-Oxley Act (“SOX”) Section 304 and of rewarding meaningful cooperation; and
- The SEC’s adoption of final rules implementing the pay-versus-performance requirement as required by Congress in the Dodd-Frank Act.
1. SEC Continued Its Increased Regulation of Crypto Asset Registration
August saw the SEC continue to focus on crypto assets—in particular, companies’ compliance with the SEC’s registration requirements—as the SEC filed charges against two more companies for conducting unregistered offerings of their crypto assets.
Bloom Protocol, LLC
In concluding that BLT are securities, the SEC continued to emphasize substance over form, making clear that companies cannot navigate around the elements of the Howey test simply by stating the tokens are not “investments” when other facts suggest otherwise. The SEC explained:
Although the terms of the token sale agreements that certain purchasers entered into with Bloom, Ltd. required purchasers to agree that they were buying BLT for their “utility” and not as an investment, the structure of the platform and the marketing demonstrate that the BLT purchasers had a reasonable expectation of profit through Bloom’s efforts to develop the token’s uses and increase its value.
The SEC also pointed to BLT investors’ after-the-fact comments about the tokens as further confirmation of their status as securities, noting “[m]any comments on social media platforms by investors that purchased in the ‘public sale’ also demonstrate that they purchased the BLT as an investment.”
In Bloom’s accepted Offer of Settlement, Bloom agreed to undertakings including registering BLT with the SEC and initiating a claims process to compensate investors, and to pay a civil money penalty of $300,000. Bloom also agreed to an additional springing penalty, up to the total amount raised of over $30.9 million if Bloom fails to comply with the SEC order. The SEC credited Bloom’s voluntary and prompt remedial actions to prepare for registration, including retaining an auditor, commencing an audit process, and hiring employees to support the audit and registration process.
The SEC alleges that from 2017 through the date of the SEC’s complaint, Dragonchain conducted a $16.5 million unregistered offering and sale of DRGN, including open market sales through social media platforms and other methods, with no available registration exemptions. The SEC further alleges that Dragonchain used DRGN to fund its operations by transferring additional DRGN to certain contractors and service providers who, in turn, sold DRGNs in the open market in unregistered transactions.
Considered in tandem with the Bloom settlement, the Dragonchain action makes clear the SEC is continuing to take action against unregistered sales of crypto assets even where they do not allege fraud or other misconduct, and is wary of promotional materials that describe “investment contracts” in ways the SEC might perceive as trying to navigate around the Howey test. Indeed, in a statement that could be read as an announcement for why the SEC chose to pursue this (and similar) cases, the SEC explained in its complaint that since Dragonchain never filed a registration statement for the offer and sale of DRGN, “it never provided investors with the material information that other issuers include in such statements when soliciting public investment. Instead, Dragonchain created an information vacuum such that it could sell DRGNS into a market that possessed only the information Dragonchain chose to share about DRGNs.” Among a sea of SEC pronouncements and settled actions, this may give another federal court an opportunity to weigh in on when tokens should be treated as investment contracts.
#CryptoRegulations #Crypto=Securities? #RegistrationRequirementCrypto
2. SEC Charges Manufacturing Company and Its Executives with Accounting and Disclosure Fraud for Pulling Forward Revenues
In contrast to the allegations against Hutchison, the SEC’s settled order with Surgalign and its former CFO finds that they violated the negligence subsections of Section 17 of the Securities Act, among other regulations. Surgalign and Jordheim agreed to cease and desist future violations and to pay civil monetary penalties—$2 million for Surgalign, and $75,000 for Jordheim.
In another signal that meaningful cooperation may impact the terms of a settlement, the SEC pointed to Surgalign’s “substantial cooperation” in determining to accept an offer of settlement for what it described in its Hutchison complaint as a rather egregious fraud. That cooperation included “disclosing information about conduct that the staff had not yet uncovered through its own investigation, conducting an internal investigation regarding this conduct, and providing the staff regular and detailed updates on the internal investigation and key documents identified through that investigation” in a way that substantially advanced the quality and efficiency of the staff’s investigation and conserved Commission resources.
3. SEC Charges Eagle Bancorp and Former CEO with Failing to Disclose Related Party Loans
Eagle’s loans received public attention in December 2017, when a short-seller report accused Eagle of failing to properly disclose related party loans. Eagle responded to the short-seller report by falsely claiming that the loans in the short-seller report were not related party loans in statements to the investing public.
The SEC charged Eagle with violating anti-fraud, proxy, reporting, books and records, and internal accounting controls provisions of the federal securities law, and Paul with violating anti-fraud and proxy provisions of the federal securities law and making false certifications. Eagle agreed to cease and desist from future violations and to pay disgorgement of $2.6 million, prejudgment interest of $750,493, and a civil penalty of $10 million, and Paul agreed to a permanent injunction, a two-year officer and director bar, and to pay disgorgement of $109,000, prejudgment interest of $22,216, and a penalty of $300,000. In a parallel action, on August 16, 2022, the Federal Reserve Board announced settled enforcement actions against EagleBank and Paul.
Eagle was not the first, and certainly will not be the last, company that faced investor scrutiny following a short-seller report questioning the company’s disclosures. The case should serve as a reminder to companies to have an effective process in place to respond to questions—legitimate and otherwise—to avoid compounding potential errors by standing by false or misleading statements in prior disclosures. The SEC’s description of the company’s actions when confronted with the short-seller’s allegations likely provide insight into how the parties arrived at a $10 million company penalty in a negligence-based action. The SEC explained:
After the release of the short seller report, numerous Eagle investors inquired of Eagle and Paul about the nature and amount of these loans to Paul’s family trusts, and whether they were or should be disclosed as related party loans. Despite being aware of these inquiries, and instead of undertaking a thorough and independent investigation of the short report’s allegations, Eagle relied on Paul’s false assertions about the facts necessary for an accurate analysis of whether the loans to Paul’s family trusts were related party transactions that should have been disclosed.
4. SEC Charges Infrastructure Company and Its Former Executive with Financial Reporting Fraud
The Company agreed to pay $12 million to settle SEC charges, a number that may have been influenced by the Company’s cooperation with the SEC and remediation efforts. As set forth in the SEC’s complaint against the Company, the Company self-reported potential revenue recognition issues to the SEC and initiated an internal investigation “[w]ithin weeks” of receiving internal complaints concerning the accuracy of certain project forecasts, and subsequently restated its financial statements from 2017 through 2019 and disclosed the overstatement of its revenues in 2017 and 2018. The complaint further described the Company’s remediation efforts, which the SEC noted in its litigation release along with the Company’s selfreporting, explaining it “credits [the Company] with self-reporting to the Commission and undertaking remediation by, among other things, redesigning its internal accounting controls and policies and procedures to increase the transparency and accuracy of expected costs for construction projects.”
In separate administrative proceedings, the former CEO and CFOs of the Company, who were not charged with misconduct, agreed to return bonuses and compensation back to the Company pursuant to SOX Section 304, which “requires executives to reimburse certain compensation when an issuer is required to restate its financials as a result of misconduct.”
5. SEC Adopts Pay-Versus-Performance Disclosure Requirements
Item 402(v) will require that companies provide a new table disclosing specified executive compensation and financial performance measures for the company’s five most recently completed fiscal years. This table will include, for the principal executive officer (“PEO”), and, as an average, for the other named executive officers (“NEOs”), the Summary Compensation Table measure of total compensation and a measure reflecting “executive compensation actually paid,” as specified by the rule.
The financial performance measures to be included in the table are: (i) cumulative total shareholder return (“TSR”) and TSR of the company’s peer group, (ii) net income, and (iii) a company-selected measure specific to that particular company, in each case, over the company’s five most recently completed fiscal years. Furthermore, the company shall include a separate list of its top three to seven financial performance measures used to link executive compensation actually paid to the company’s NEOs during the most recently completed fiscal year to company performance.
In addition, Item 402(v) requires a clear description of the relationships between each of the financial performance measures included in the table and the executive compensation actually paid to its PEO and, on average, to its other NEOs. Companies will be required to also include a description of the relationship between the company’s TSR and its peer group TSR.
Olivia Stitz, an associate in our New York office, and Chenjia Zhu, a law clerk in our New York office, contributed to the writing of this alert.
 The Howey Test is a four-prong test created by the Supreme Court for determining whether certain transactions should be treated as investment contracts, which are listed as securities under the Securities Act of 1933 and Securities Exchange Act of 1934. Under the Howey test, a transaction is an investment contract if (i) it is an investment of money; (ii) the investment is in a common enterprise; (iii) there is an expectation of profits from such investment; and (iv) any profit comes from the efforts of a promoter or third party.