The United States Securities & Exchange Commission (the SEC or the Commission) held its annual SEC Speaks conference in Washington, DC on February 20 and 21, 2015, recapping the prior year and emphasizing SEC priorities for the coming year.
Chairman Mary Jo White addressed the Division of Enforcement's focus on bringing innovative, high-impact cases, and its continued push to obtain more settlement admissions in order to achieve heightened accountability from both entities and individuals. In 2014, the Division of Enforcement brought an unprecedented 755 cases and obtained $4.1 billion dollars in monetary relief; another agency record. Chairman White highlighted a number of first-of-their-kind cases brought in 2014, including: cases against high-frequency trading firms; the Commission’s first action based on the failure to have adequate risk controls before providing market access to customers; the first action applying whistleblower anti-retaliation authority; the first action against a private equity firm relating to its allocation of fees and expenses; the first emergency action to halt a fraudulent muni-bond offering; and the first action against a broker-dealer based on failure to have policies and procedures guarding against the misuse of material non-public information. Chairman White stated that the Commission issued its largest whistleblower award to date—over $30 million—and noted that 2014 saw a 40% increase in financial reporting cases brought by the Commission. She advised that Division of Enforcement is focused on cases involving "violations where market participants fail to provide a level playing field in the securities markets." Chairman White also noted that the Division of Enforcement remains committed to bringing actions involving financial reporting and auditing fraud, as well as cases against gatekeepers, including auditors, transfer agents and attorneys.
Division of Enforcement: Harnessing Technology to Reach "Unprecedented Year" in Enforcement
Speakers from the Division of Enforcement, including Andrew Ceresney, Director of the Division of Enforcement, focused on the Commission’s use of technology to file 755 actions last year—the most ever filed in the history of the SEC—and obtained orders for over $4 billion in monetary sanctions—nearly 20% more than the Commission’s previous record amount.
Stephanie Avakian, Deputy Director of Enforcement, discussed the creation of a fraud task force and its ability to leverage technology to identify suspicious trading activity and patterns. As a result, the Commission charged 580 defendants with insider trading over the past five years. Last year, the Division asserted substantially more actions surrounding financial fraud and issuer disclosures. Ms. Avakian said that this year the Division will continue to file impactful actions, with a focus on revenue recognition, expense valuation, faulty asset impairment conclusions, insufficient related-party disclosures and insufficient internal controls. The Division will also emphasize the role of auditors as the gatekeepers to proper financial reports.
Additionally, the SEC noted that the recent Flannery and Hopkins decision by the full Commission is the most complete and detailed analysis of Section 17a of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Exchange Act Rule 10b-5 in recent history. Specifically, the majority decision by the Commission ruled that Section 17a and Section 10(b) and Rule 10b-5 are “mutually supportive” of one another, meaning that certain conduct can violate both sections. The opinion also discusses the objective inquiry required for a determination of materiality, with a focus on whether a given statement would be important to a reasonable investor.
Matthew Solomon, Chief Litigation Counsel, spoke about recent litigation developments and the Commission's current trial docket. He noted that the Commission’s litigation program employs 130 litigators, who achieved strong trial results and a number of admission settlements last year. Mr. Solomon stated that, for 2014, the Commission had 30 trials nationwide, the most in the last 10 years, with five times more jury trials than in 2013. The SEC won about 80% of its trials and, most recently, ten of its last twelve trials. Mr. Solomon noted the SEC’s disagreement with the Second Circuit’s decision in United States v. Newman, which vacated the convictions against two insider trading defendants and dismissed the indictments against them with prejudice. Mr. Solomon stated that the Commission’s aggressive approach to enforcement may result in some losses at trial, but that the SEC will remain steadfast in its approach to insider trading cases.
Julie Riewe, Co-Chief of the Asset Management Unit, highlighted the Unit’s growth in each of the twelve SEC offices across the country and total of 75 professionals nationwide. Ms. Riewe said that, over the past year, the Unit focused on misconduct by registered investment companies, private funds, advisors and accountants. In January, the Unit charged an investment advisor for compensation received when advising clients to invest in certain funds. Over the next year, the Unit will focus on valuation, performance advertising, governance and conflict of interest matters, including issues where advisors fail to either fully resolve a conflict or disclose the same.
Daniel Hawke, Chief of the Market Abuse Unit, said that the Unit focused the past year on complex insider trading and market structure enforcement programs, with a high priority on national security and broker-dealer exchanges. Mr. Hawke noted that these matters are difficult to investigate, but his Unit will continue to use the technology available to assert claims against high-frequency trading firms and gatekeepers that allow manipulative trading practices. Mr. Hawke said that, for the upcoming year, the unit will focus on latency market manipulation, layering and actions under the market access rule, Rule 15c3-5.
David Glockner, Regional Director of the Chicago Regional Office, emphasized the "tremendous success" of the whistleblower program, noting that the total amount paid to whistleblowers last year was more than the last three years combined. Last year, the Commission made a $30 million payment to a nonresident whistleblower. Mr. Glockner also said that the Commission is always looking for signs of potential retaliation against whistleblowers. He stated that this year, the Commission will continue its use of data analytics while focusing in cybersecurity issues across a number of divisions, including processes to ensure the adequacy of cybersecurity controls and disclosures.
Antonia Chion, Associate Director of the Division of Enforcement, discussed the Broker Dealer Task Force, formed approximately 18 months ago, calling it an "incubator of ideas," comprised of senior officers from all across the country, with representatives from most of the specialized units. Ms. Chion indicated that the Broker Dealer Task Force is currently focusing on the retail space, with a particular emphasis on churning and excessive trading as well as AML compliance. With respect to churning, the Task Force is focusing on two key metrics: (i) the turnover ratio and (ii) the cost-equity ratios. Through the help of more innovative data collection technologies and analytics, the Task Force has identified numerous broker dealers with statistics indicative of churning. The Broker Dealer Task Force is using these analytics to bring enforcement cases faster. With respect to AML compliance, Ms. Chion indicated that the Broker Dealer Task Force is leveraging data and analytical reviews performed by the Bank Secrecy Act (the BSA) Review group, responsible for reviewing Suspicious Activity Reports (SARS), to help the Task Force identify possible AML compliance issues. The BSA group conducts extensive analysis on non-filing and late filing metrics. Ms. Chion indicated that the Broker Dealer Task Force used these metrics to identify a number of firms that required additional investigation. Ms. Chion further explained why the Task Force has such a great focus on SARS reporting, indicating that a SAR can be an early alert of possible misconduct and that a timely SAR allows the SEC to better carry out its mission to protect investors.
David R. Woodcock, Regional Director of the Fort Worth Regional Office and Chair of the Financial Reporting and Audit Task Force, emphasized that financial fraud and issuer disclosure and audit matters continue to be a priority of the division, and they have seen about a 40% increase in cases in this space over the last year. Mr. Woodcock highlighted a number of significant actions, including: SEC v. CVS Caremark Corp., which resulted in a $20 million penalty relating to misleading disclosures; Diamond Foods which resulted in a $5 million penalty relating to underreporting of expenses in order to inflate income; In the Matter of Saba Software, Inc., which resulted in a $1.75 million penalty relating improper revenue recognition practices stemming from erroneous time reporting practices to hit financial targets. Mr. Woodcock also noted that the Task Force brought its first homegrown case, which involves internal controls and will be a litigated administrative proceeding against a public issuer.
Margaret S. McGuire, Senior Counsel to the Director and Vice-Chair of the Financial Reporting and Audit Task Force, indicated that the Task Force has seen a marked decrease in number of restatements and revisions, but have also seen that many auditors and companies are much more in tune to the risks of financial fraud, which is a very good thing for the markets and for investors. Ms. McGuire also highlighted two of the Task Force’s initiatives: (i) issuer monitoring and review and (ii) ICFR. With respect to issuer monitoring and review, Ms. McGuire stated that the Task Force undertook to really identify problematic issues earlier in the review process, using internal and external data and tools to review and monitor issuers so they can spot potential areas of investigative interest earlier in the process. Currently, there are over 200 issuers that are of interest to Task Force’s work, which span industries, financial statement metrics and accounting issues. With respect to ICFR, Ms. McGuire stressed that the importance of a robust controls environment cannot be overstated. The Task Force is looking closely at instances where issuers have filed multiple revisions because a pattern of multiple revisions can indicate a lax control environment. Ms. McGuire closed her remarks by stating that this type of early detection is key to their work going forward.
Elisha L. Frank, Assistant Regional Director of the Miami Regional Office and Co-Chair of the Microcap Fraud Task Force, discussed the focus of the Task Force, which was announced in July 2013 and went operational on October 1, 2014. The Microcap Fraud Task Force consists of 19 front-line staff attorneys located in eight offices across country and several non-lawyer fraud investigators. Ms. Frank indicated that the Task Force is focused on developing and cultivating a more coordinated approach to looking at microcap fraud, using continued development and data analytics to be more effective and efficient in investigations and to bring matters more quickly. She emphasized that the Task Force is very focused on using trading suspensions, which allow the Commission to halt apparent pump and dump schemes before their completion. Last year, there were 36 trading suspensions in 18 matters filed in federal court or instituted as administrative proceedings.
Michael D. Paley, Assistant Regional Director of the New York Regional Office and Co-Chair of the Microcap Fraud Task Force, highlighted some of the impactful cases that demonstrate the Division's focus on gatekeepers, including: a settled action against two eTrade subsidiaries that failed to engage in a reasonable inquiry as to the facts surrounding the stock sales; a settled action against Oppeneheimer relating to the unregistered sales of penny stocks while ignoring red flags and failing to conduct a searching inquiry as to whether the stocks were exempted under the registration provisions of the federal securities laws; a case against a transfer agent in a typical pump and dump scheme involving Heathrow Natural Foods, where the transfer agent completely failed to supervise its employees with respect to Heathrow’s unregistered issuance of shares; and most recently, a case against five financial institutions involved in facilitating the liquidation of penny stocks making these pump and dump schemes possible.
Michael J. Osnato, Chief of the Complex Financial Instruments Unit, emphasized that the Unit’s purpose is to ensure that the Enforcement Division is on the cutting edge of complex financial instruments. Mr. Osnato stressed the Unit’s simple mandate—to identify and investigate potential misconduct arising from creation, sale, usage and valuation of complex financial instruments. Mr. Osnato also discussed how the Unit carries out this mandate through smart and efficient case generation by putting in place a dedicated infrastructure that identifies these types of cases, including a dedicated strategy officer who is tasked with building their pipeline. Mr. Osnato stated that the Unit also conducts more wide-ranging holistic reviews of asset classes in order to better understand the markets and products. He also discussed the general philosophy the Unit brings to its investigations. The cases the Unit prosecutes generally involve complex and sophisticated business entities as well as smart and well-counseled individuals. As such, Mr. Osnato stressed that it is incumbent on the Unit to find ways to streamline their investigations through the aggressive use of cooperation and resolution tools such as reverse proffers. Mr. Osnato closed by providing some insight into where the Unit is headed, including maintaining a significant focus on complex products and the way they interact with public disclosures, looking at data analytics to improve their pipeline and an increased and focusing on credit rating agencies as a whole.
Kara N. Brockmeyer, Chief of the FCPA Unit, stressed that the Unit had an extremely busy year in FY 2014, in which they brought seven cases totaling $381 million in disgorgement and that the Unit has already filed as many cases this year through February. Ms. Brockmeyer indicated that the FCPA Unit has sued individuals, as well as agencies, and that the Unit continues to focus on the perennial hot spots—China, Russia and Africa—but also saw an increasing number of cases involving bribery schemes in the Middle East, Southeast Asia and Europe. Going forward, the Unit is going to focus on small- and medium-sized companies going into international markets for first time. Ms. Brockmeyer indicated that the Unit has tried to give meaningful credit for cooperation, stressing that cooperation helps the Unit perform more efficient and effective investigations, and the Unit has imposed very reduced penalty amounts as a result of significant cooperation (typically 10% of disgorgement amount). Ms. Brockmeyer also discussed the types of cooperation the Unit is seeing, including real-time reporting of investigative findings; bringing foreign employees to the United States or other jurisdictions where they can be interviewed; advising the SEC of terminations prior to letting employees go; and she encouraged companies to think creatively about how they get the documents and information the SEC needs to conduct efficient and effective investigations and inquiries. Ms. Brockmeyer indicated that the Unit has seen an uptick in self-reporting, which is a good sign that means companies are catching things while they are small. She also stated that the Unit is seeing increasing levels of international cooperation and an increasing number of cases where they are working in tandem with foreign regulators and foreign prosecutors.
LeeAnn G. Gaunt, Chief of the Municipal Securities and Public Pensions Unit, emphasized that, though this Unit is small, the individuals within the Unit are "very expert and very efficient." Ms. Gaunt then discussed a number of enforcement "firsts" from 2014, including the very first emergency action ever brought to enjoin a fraudulent offering by a municipality involving the city of Harvey, Illinois and charging a municipal official as a “control person” under Section 20(a) of the Exchange Act. The Unit also sued the State of Kansas for failing to disclose unfunded pension liabilities. In addition, Ms. Gaunt discussed the MCDC initiative, a voluntary self-reporting program, where the Division offered standardized settlement terms for underwriters and issuers reporting violations. Ms. Gaunt indicated that the Unit had a tremendous response, and they believe a number of enforcement actions will come out of this program.
From these updates, the SEC's Division of Enforcement will continue to take an aggressive approach to its enforcement actions, with a focus on technological advancements to further support each of its units.
Key Commissioner's Remarks
Hon. Daniel M. Gallagher
Commissioner Daniel M. Gallagher's remarks focused on appropriately addressing conflicts of interest in the financial industry. Commissioner Gallagher expressed his concerns regarding an extension of the fiduciary duty currently imposed on registered investment advisors to broker-dealers and others who provide investment advice to investors. He discussed the U.S. Department of Labor’s current re-proposal of a plan to label as fiduciaries those who advise investor accounts protected by the Employee Retirement Income Security Act, due to concerns regarding conflicts of interest. Commissioner Gallagher expressed his belief that this proposal is ill-advised and ignores decades of securities industry rules that directly address such issues. Commissioner Gallagher recommended that the industry follow the Commission’s approach of mitigating conflicts of interest through adequate disclosure, rather than completely banning such conflicts, in order to provide a broader range of options for investors. Commissioner Gallagher stated that "investors benefit from choice," and cautioned that extending the fiduciary label would leave investors with both fewer choices and higher prices. If the fiduciary standard were to be uniformly adopted by the industry, Commissioner Gallagher believes that many products would disappear and the highest burden of the change would be borne by low and middle income investors.
Hon. Kara M. Stein
Commissioner Kara M. Stein discussed the evolution of technology in the securities industry and its impact on effective oversight and regulation. She addressed ways for the industry to reimagine disclosure and data in order to keep pace with a data-centered, digitalized market, such as layered disclosures, in order to make large amounts of data more easily accessible and usable to investors. Commissioner Stein noted how technological advances have led to the creation of increasingly complex financial products, and questioned whether investors would be better served by simpler products that provide the same benefits. Finally, Commissioner Stein stated that the Commission’s long-standing promotion of a "culture of compliance" in registered entities, effective use of the anti-fraud provisions of the federal securities laws, and other Commission tools such as automatic disqualification (bad actor) provisions, each continue to be vitally important to effectively regulate the continually changing digital marketplace. Commissioner Stein pressed for the Commission to re-examine its practice of granting waivers from automatic disqualifications for entities and individuals facing enforcement actions that would otherwise be banned from taking part in activities such as private placements. She referred to arguments against denying waivers a "red herring" that defies common sense, and noted that automatic disqualification provisions play important roles in preventing recidivism and deterrence.
Hon. Luis A. Aguilar
Commissioner Luis Aguilar focused his remarks on Commission goals for 2015. Chief among these goals for Commissioner Aguilar is the necessity for the Commission to complete the rulemaking mandates pursuant to the Dodd-Frank Act and the JOBS Act. Commissioner Aguilar noted that, as of January 2015, the Commission had finalized 56 of the approximate 95 mandated rulemakings, and stressed urgency (especially in the derivatives markets), commenting further that the current pace suggests another five years before completion. In addition to rule-making goals, Commissioner Aguilar also suggested enhanced use of one of the Commission's "most potent" enforcement tools: permanent industry and officer/director bars. Commissioner Aguilar concluded his remarks by lamenting the current state of diversity within the Commission, though he hoped the Commission’s recently formed diversity council (which he now chairs) would achieve progress.
Hon. Michael S. Piwowar
Commissioner Michael Piwowar provided recommendations for how the SEC can become a more fair, orderly and efficient agency. With respect to fairness, he noted that the SEC should provide sufficient information and guidance to market participants so that said participants can better understand how they will be impacted by the SEC’s rulemaking and decisions. For example, Commissioner Piwowar suggested that, in order to "ensure that all are treated fairly and equally," the Commission should "set out and implement guidelines" for determining which cases will be brought in administrative proceedings and which in federal district courts. In order to make the SEC more orderly, Commissioner Piwowar stated that the SEC needs policies to prioritize rule-making, investigations and examinations, and that the Commission should strive to exercise its investigative discretion to complement its policy initiatives. Finally, Commissioner Piwowar said that the SEC should utilize investor testing, pursue pilot programs, and collaborate with academics and experts with greater frequency in order to increase efficiency at the SEC.