The leaders of the Securities and Exchange Commission (“SEC” or “Commission”) addressed the public on February 19-20 at the annual SEC Speaks conference in Washington, D.C. The presentations covered an array of topics, but common themes included the Commission’s ongoing effort to carry out the rulemaking agenda set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act, its increasing focus on cyber issues including its use of new technology to surveil and root out harmful practices in the modern and increasingly-complex market, and its continued focus on the conduct of gatekeepers. From a litigation and enforcement perspective, key takeaways from the conference include the following:
SEC Chair Mary Jo White began her remarks by touting the “unprecedented number of enforcement cases” brought by the Commission in 2015, which produced “an all-time high for orders directing the payment of penalties and disgorgement”—a trend that she stressed would continue in 2016. Addressing the agenda for 2016, Chair White explained that the Commission will focus on issues relating to cybersecurity, market structure requirements, dark pools and other alternative trading systems, insider trading, disclosure deficiencies, and sales and marketing practices with respect to complex instruments and retail investors. Chair White said that, among other things, the Commission will “actively continue” its review of disclosure effectiveness, continue to bring enforcement actions relating to missing or inadequate internal corporate controls, and continue to focus on financial reporting. Chair White noted that she will continue lobbying her fellow Commissioners for support for “a uniform fiduciary duty for investment advisers and broker-dealers,” underscoring her commitment to the Commission’s renewed focus on gatekeepers, which was a major theme of this year’s conference. Chair White concluded her remarks by noting that “risk-taking is essential” to the process by which “capital markets fuel not only macroeconomic growth, but also critical innovations,” and that while “regulators should not seek to eliminate [risk taking] altogether,” they must “safeguard the investment and capital raising process from unacceptable risks that can dilute, distort, or disable the fair playing field that is integral to robust free financial markets.”
Deputy Director of Enforcement, Stephanie Avakian, noted that insider trading cases “continue to be a priority” for the Commission in 2016. She discussed the Second Circuit’s decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014)—in which the court held that prosecutors in tipper/tippee insider trading cases must show that the tipper received a “personal benefit” of a pecuniary or quid pro quo nature in exchange for the tip—and the circuit split that was recently created by the Ninth Circuit’s decision in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015), in which the court held a tipper’s gift of confidential information to a trading relative, even though not for pecuniary gain, was sufficient to establish a “personal benefit.” Avakian described it as “important” that the Supreme Court has granted certiorari review of Salman in light of this circuit split, and the Commission is likely to file an amicus brief presenting its views. She also surveyed the landscape of district court decisions post-Newman, including the United States District Court’s decision in SEC v. Payton, 97 F. Supp. 2d 558 (S.D.N.Y. 2015), in which the court held that the SEC’s lighter civil burden for insider trading cases was satisfied in tippee cases by a showing of recklessness. Avakian also discussed the Commission’s 2016 enforcement interests in issues related to cybersecurity. She noted that the Commission’s focus falls in three areas: (1) cases where there has been a failure to safeguard customers’ information (citing the Commission’s administrative proceeding against R.T. Jones Capital Equities Management, Admin. Proc. No. 3-16827, in which R.T. Jones agreed to a cease and desist order as well as censure and a $75,000 penalty arising from the Commission’s charges that the firm violated Regulation S-P by “entirely” failing to have policies in place in advance of a data breach where sensitive client information that was stored on a third party web server was hacked); (2) cases where material confidential information has been stolen for the purpose of illegal trading or market manipulation (citing a “wide scale hacking case” brought by the Commission in August 2015 against over thirty defendants whose hacking scheme generated over $100 million in illegal profits based on the use of stolen material, non-public information); and (3) cyber disclosure failures. Avakian noted that, while the Commission has brought cases in the first two categories, it has yet to bring a case charging cyber disclosure failures. She also emphasized the Commission’s view that a firm that has been the victim of a cyber-attack is just that—“a victim”—and encouraged companies to self-report rather than stay silent for fear of being investigated by the SEC or other governmental agencies. Avakian explained that the Commission understands and appreciates that “it may be difficult to assess the impact and extent of [an] intrusion,” and that “decisions about whether, when and what to disclose can be very difficult.” She further noted that “whether a company self-reported to law enforcement is a significant factor” and explained that the SEC “will give substantial credit for having reported.” Askari Foy, Associate Director of the Technology Controls Program in the Office of Compliance Inspections and Examinations, echoed these comments, noting that the Division’s main priority in 2016 will be to ensure that firms have written cyber security policies and procedures in place. He emphasized, however, that the Commission is not a “gotcha regulator” in this space and that its focus is on whether firms show a demonstrated commitment to developing an effective information security program, including by addressing data governance issues “at the highest level,” not just leaving such matters solely to the IT department.
Joseph Brenner, Chief Counsel in the Division of Enforcement, discussed the Commission’s continued focus on bringing enforcement actions against gatekeepers such as attorneys, auditors, directors, and underwriters, all of whom he called “the first line of defense against misconduct.” He noted that cases involving “affirmative misconduct” by a gatekeeper are rare, and that this category of enforcement actions more commonly turns on the nature of the gatekeeper’s functions or representations, in particular where the gatekeeper has fallen short of professional standards. Brenner discussed the Commission’s enforcement actions against: BDO USA, LLP, Admin. Proc. No. 3-16800, and Grant Thornton, LLP, Admin. Proc. No. 3-16976, for failure to comply with audit standards; its actions against broker-dealers such as Oppenheimer & Co. Inc., Admin. Proc. No. 3-16361, for violation of their duty to file suspicious activity reports (“SARs”); and its action against a current and former unit of E*Trade Financial Corporation, Admin. Proc. No. 3-16192, for failure to conduct a reasonable inquiry to determine if certain transactions were part of an unlawful distribution. Margaret McGuire, Chief of the Financial Reporting and Audit Group, stressed that the Commission will continue to look at auditors’ conduct in financial reporting fraud cases as well. Brenner also noted that the Commission is bringing an increased number of cases against attorneys who have provided securities law advice despite not having the requisite minimum level of competence in the field or taking reasonable steps to become educated in the particular area of law at issue. He emphasized that the Commission is “not looking to second guess good faith efforts” of gatekeepers, and that the cases the Commission has brought are those in which the gatekeeper “didn’t come close” to meeting its professional obligations. Brenner also discussed enforcement actions against rating agencies for acting contrary to their published methodologies, and noted that such cases generally turn on the reason for the gatekeeper’s failure to live up to its representations. Finally, he noted that the majority of enforcement actions against gatekeepers have been against individuals, and that the Commission frequently secures remedies in settlements beyond the typical injunctions, penalties and/or disgorgement. These additional remedies include forward-looking remedies such as limitations on individuals’ supervisory functions, suspensions of licenses, prohibitions on the taking on of new clients in the affected business area, prohibitions on continuing activities in the affected area, and structural changes within a firm designed to achieve compliance.
Matthew Solomon, Chief Litigation Counsel in the Division of Enforcement, touted the Division’s “heavy litigation docket” in 2015—including 27 trials, fourteen summary judgment wins and many admission settlements. He indicated this active docket will continue in 2016. Citing the Division’s undefeated record in federal court cases and (only) two losses in administrative proceedings in 2015, Solomon dismissed recent criticism from the defense bar that the Commission has a “home court advantage” in administrative proceedings. He also pointed to the Commission’s recent proposed amendments to the Rules of Practice for administrative proceedings and its recently-published explanation of its forum selection process in contested actions. He noted that administrative proceedings “play a crucial role in our enforcement program and will continue to [ ] in the years to come,��� notwithstanding recent challenges to such proceedings by the defense bar on constitutional grounds, among which include challenges to the appointment of Administrative Law Judges as improper under Article 2 of the Constitution because they are not appointed by the Commission as a whole (some of those challenges are pending in federal court, while others have been dismissed on jurisdictional grounds). Solomon also discussed the Division’s “aggressive” protection of the Commission’s “processes,” highlighting that the Division brought a number of contempt actions and subpoena enforcement actions in 2015 and will continue to do so against those who seek to evade compliance with these procedural processes. He warned would-be obstructionists that the Division will provide criminal referrals where appropriate, and cautioned that “[i]f you lie in SEC testimony, [you] do so at your own peril.”
Chief of the Complex Financial Instruments Unit (“CFI”), Michael Osnato, discussed the CFI’s mandate of identifying and investigating violations in connection with the sale, valuation and marketing of complex securities. He noted the CFI’s increased focus on rooting out large scale practices that cause harm before it is too late. In particular, Osnato noted that the CFI is conducting targeted sweeps of industries where there is the potential for systemic harm, such as the subprime auto loan market. He also discussed the CFI’s use of software called ABS Tracker, which looks at trade data for complex over the counter debt instruments and identifies common forms of misconduct in the asset-backed securities market. Osnato identified the following three 2016 areas of priority for the CFI Unit: (1) complex products, in which the CFI will focus not just on the dealer community, but also on the secondary market; (2) complex market practices, in which the CFI will focus heavily on sophisticated market actors that seek to exploit opacity and gaps in market regulation (for example, banks engaging in arbitrage to manipulate their capital requirements under international banking regulations); and (3) retail products, in which the CFI will prioritize and deploy corporate negligence theories against issuers of structured products who violate Section 17(a)(2) of the Securities Act.
Co-chief of the Market Abuse Unit, Robert Cohen, discussed the Market Abuse Unit’s focus on cases against operators of dark pools and other alternative trading systems, spoofing, cyber fraud, and data analysis designed to detect insider trading. He noted that common violations with respect to dark pools are that firms do not operate as described, insofar as they give material information to some subscribers but not others and/or do not protect confidential information of their trading customers. Cohen noted that the Commission has brought seven cases against stock exchanges, as well as a series of cases against alternative trading systems in this area. He also discussed the Commission’s settlements of administrative proceedings against Barclays Capital Inc., Admin. Proc. No. 3-17077, and Credit Suisse Securities (USA) LLC, Admin. Proc. No. 3-17078, in which the Commission alleged, among other things, that the firms, at times, failed to adequately disclose certain information regarding monitoring of order flows in their dark pools. Cohen also noted that spoofing—or manipulative conduct in which traders send non-bona fide orders that cause movement in a security, and then place orders on the other side of the market to make a profit—is a “very important area” and one on which the Enforcement Division is “very” focused. Finally, he pointed out that high frequency trading (“HFT”) continues to be “a very important subject” for the Market Abuse Unit, which is paying “close attention to HFT firms.”
Sharon Binger, Regional Director of the Commission’s Philadelphia Office, discussed the Commission’s whistleblower and cooperation programs. She noted that whistleblower tips have increased 30% since 2012, with more than 4,000 tips in 2015, including tips from 61 countries outside the U.S. In addition, in 2015, the SEC paid a total of $37 million in rewards to whistleblowers. She indicated that the most common tips concern financial disclosure issues and offering frauds, and emphasized that the Commission will continue to leverage the “high quality information” provided by whistleblowers. Binger also discussed the Commission’s 2015 administrative proceeding against KBR, Inc., Admin. Proc. No. 3-16466, under Rule 21F-17 for requiring its employees to sign confidentiality statements in connection with internal investigation interviews, which contained overly restrictive language requiring company approval before any employee could discuss any company matter with law enforcement. KBR was ordered to amend its confidentiality statement to make clear that employees did not need to seek prior authorization in order to report matters directly to the Commission and other federal law enforcement agencies. Binger said that agreements may not, “in word or effect, stop employees from reporting to the SEC,” although she noted that the Commission is “not applying any hard and fast rules” to employee waiver agreements. Binger stated that the Commission had signed 103 cooperation agreements, six non-prosecution agreements and nine deferred prosecution agreements since the beginning of its cooperation program in 2010, and noted that these agreements provide flexibility to the Commission and allow for the possible reductions of suspensions or bars. Binger emphasized that there are tangible benefits to cooperation, including the Commission’s explicit reference to the cooperation in litigation or press releases, as well as the possible decision not to charge, which Binger said underscored “the importance of self-reporting early.” If the Commission is left to discover a problem itself, Binger said that “it will raise many questions” about why the firm did not self-report.
Chief of the Foreign Corrupt Practices Act (“FCPA”) Unit, Karen Brockmeyer, touted the $215 million in disgorgement obtained by the Commission in 2015, and anticipates a “very busy year” for the FCPA in 2016, with some significant cases in the pipeline over the next 3-6 months. Brockmeyer announced a renewed focus on the pharmaceutical industry “with several cases in the pipeline,” as the pharma industry is “having a difficult time addressing the risks.” She also anticipates more FCPA cases in the financial sector, including with respect to hiring issues. Brockmeyer anticipates that we can expect to see Commission-only FCPA cases rather than parallel DOJ cases, particularly for non-bribery conduct or smaller/less egregious conduct. She touted as a major success the Commission’s first financial services case against The Bank of New York Mellon Corporation (“BONY”), Admin. Proc. No. 3-16762, in which the company paid $14.8 million to settle charges stemming from alleged internships that the company provided to unqualified family members of foreign government officials. Brockmeyer noted that the BONY case demonstrates that the Commission will be looking for employment and other types of benefits, not just monetary benefits, in its FCPA enforcement efforts. On the monetary benefits side, Brockmeyer discussed the Commission’s case against the chief executive officer (“CEO”) of South American-based LAN Airlines S.A. (“LAN”), Admin. Proc. No. 3-17100. In that case, the Commission charged the CEO for bribery of union officials under the FCPA’s books and records and accounting provisions on the grounds that he authorized improper payments to a third party consultant, who may have passed some money on to union officials who were embroiled in a dispute between the airline and its employees in Argentina. The CEO agreed to pay a $75,000 penalty and attend anti-corruption training, among other things. Notably, no government officials were involved in the LAN case. Based on Brockmeyer’s comments, it appears that the Commission will be pursuing similar cases in the future.
Antonia Chion, Associate Director and Co-head of the Broker-Dealer Task Force, discussed the Anti-Money Laundering Initiative, which got off the ground in 2015, and the Task Force’s new initiative on retail investments. Chion noted that the Task Force has performed data analysis of broker-dealer SAR filings in 2013, which showed instances where broker-dealers filed no SARs, or late and incomplete SARs, leading to “dozens” of referrals across the country to the Division of Enforcement for further investigation. Chion encouraged firms to review their policies for filing SARs in 2016, which she said requires a “high level of commitment from industry professionals.”
Co-chief of the Asset Management Unit, Marshall Sprung, discussed the Asset Management Unit’s priority on private fund governance and conflicts of interest for 2016. He said that private equity firms are being scrutinized where fund managers are not appropriately allocating fees to investors or are otherwise failing to disclose conflicts of interest. Sprung expects enforcement actions in 2016 concerning preferential trade allocation and misallocations of fees and expenses, including travel and entertainment fees, by private fund managers. On the retail account side, Sprung expects enforcement actions in the areas of conflicted fee arrangements and advertising- and performance-related client communications, including situations where advisors tout hypothetical and inflated performance figures of their sub-advisors without conducting adequate investigation into the accuracy of those numbers. Sprung also cautioned that his unit would be monitoring gatekeepers as well, describing them as “the proverbial neighborhood watch” that will continue to be held accountable.
Finally, Andrew Calamari, Regional Director of the Commission’s New York Office, discussed the Commission’s new initiative to combat “churning,” whereby advisors recommend excessive trading to their clients in order to generate higher advisor fees. Calamari described this as a “perennial problem,” which led the Commission to develop a new process by which it can analyze turnover and cost-equity ratios. He noted that turnover of six or more times per year and/or a cost-equity ratio of 20% or more is indicative of churning. Calamari discussed the results of the churning initiative analysis, which showed numerous accounts engaging in excessive trading, leading to the Commission’s issuance of Section 21(a) orders to many firms and clearing houses requiring them to make statements under oath explaining such trading.