View original on Law360: https://www.law360.com/articles/1220808
The U.S. Securities and Exchange Commission’s Division of Enforcement had a banner year in 2019 — but don’t mention it.
According to its annual report, the enforcement division brought 862 enforcement actions in fiscal year 2019 — its second highest tally ever — and obtained judgments and orders totaling more than $4.3 billion in disgorgement and penalties, the most in the division’s history.[1]
“By any measure, we believe the Division had a very successful year,” said Division of Enforcement Co-Directors Stephanie Avakian and Steven Peikin.[2] 
Still, the co-directors would prefer that observers focus not on the numbers, but on “qualitative factors such as the nature, quality, and diversity of the SEC’s enforcement actions and the impact of those actions on the behavior of market participants and the overall integrity of our markets.”[3]
This sentiment follows a string of speeches and public statements in which the co-directors “emphatic[ally] … reject the premise” that analyses of SEC enforcement statistics “can adequately measure the success or impact of an enforcement program.”[4] Commissioner Hester Peirce, too, has cautioned that “the number of enforcement cases initiated or settled in any particular twelve-month period doesn’t matter.”[5]
And just two days before the annual report was published, in a speech that is broadly critical of a so-called broken windows approach to enforcement, Peirce reiterated her skepticism “of armchair analyses of our enforcement program that draw grand conclusions merely by counting cases and tallying penalties.”[6]
While statistics alone may not “provide a full and meaningful picture of the quality, nature, and effectiveness” of the program, the numbers do help develop the narrative around the Enforcement Division’s priorities and trajectory.
And FY 2019 was, by any measure, a strong year for the Enforcement Division. In addition to the volume of cases and amount of monetary sanctions, the division weathered a historic government shutdown, adapted its practices to adverse rulings from the U.S. Supreme Court, brought first-of-their-kind cases involving initial coin offerings, and settled a swath of cases that further the division’s goal of protecting retail investors.
So, what does the Enforcement Division’s annual report tell us about the priorities and trajectory of the enforcement program? A few observations:
- The case mix indicates that the Enforcement Division is holding fast to its focus on protecting Main Street investors;
- The staff is using self-reporting initiatives and sweeps to good effect; and
- The record-setting amount of penalties and disgorgement hints at several interesting trends in the enforcement program that are worth exploring, including the real impact of the Supreme Court's 2017 decision in Kokesh v. SEC and emerging settlement trends.
Focusing on Main Street Investors
During their tenure, Avakian and Peikin have consistently ranked an enforcement focus on protecting Main Street investors at the top of the division’s priority list. And under their direction, the division has dedicated considerable resources to protecting Main Street investors. The Retail Strategy Task Force and Share Class Selection Disclosure Initiative count among the division’s significant investment in programs designed to identify and address conduct that harms retail investors.[7]
The mix of cases the SEC brought in FY 2019 indicates that the division is holding fast to its focus on protecting Main Street investors. According to the annual report, investor harm most frequently occurs “in the interactions between investment professionals and retail investors.” The division’s caseload overwhelmingly clustered in this space.[8]
Practitioners who subscribe to SEC press releases will by now be accustomed to headlines touting actions that put a stop to schemes targeting retail investors. From improper fees, to microcap pump-and-dump schemes, to affinity frauds and Ponzi schemes, FY 2019 featured a broad swath of actions against individuals and financial services firms that allegedly defrauded Main Street investors.
In total, the division brought 191 stand-alone cases against investment advisers or investment companies last year — a record number of cases against investment advisers, and far and away the largest bucket of cases in FY 2019.
The division also brought 38 stand-alone cases against broker-dealers. Together, cases against investment advisers and broker-dealers accounted for 43% of the division’s entire caseload.
Actions against investment advisory firms and broker-dealers predominantly exist in the spaces where investment professionals intersect with retail investors. In keeping with the division’s focus on protecting Main Street investors, those cases are now a key part of the SEC enforcement program, and we should expect them to lead the agenda in the coming years.[9]
Self-Reporting and Sweeps Drive Enforcement
In February 2018, the Enforcement Division commenced its Share Class Selection Disclosure, or SCSD, Initiative, which encouraged firms to self-report disclosure violations relating to fees charged in connection with mutual fund investments. Firms that elected to self-report were offered more favorable settlement terms in related enforcement actions.[10]
The self-reporting initiative was a massive success. In 2019, the division settled 95 actions under the initiative, and ordered firms to pay more than $135 million in disgorgement and interest.[11]
The staff has indicated that there are more SCSD cases in the pipeline. Also in FY 2019, the SEC charged 12 financial institutions in its ongoing investigation into improper handling of prereleased American depositary receipts, or ADRs. The line of cases has yielded monetary settlements totaling more than $350 million.[12] The staff has indicated that this enforcement sweep is ongoing.
The SCSD self-reporting initiative and ADR prerelease practices sweep were programmatically significant for the SEC in FY 2019, accounting for more than 12% of all enforcement actions and 12% of the penalties and disgorgement ordered.
More importantly, perhaps, the self-reporting initiative and sweep allowed the division to further its primary objective of protecting Main Street investors and overcome resource, or headcount, constraints resulting from a years-long hiring freeze that was only lifted a few months ago.
Interestingly, although self-reporting initiatives and sweeps have long been useful tools in the division’s enforcement toolbox,[13] Peikin indicated last month at the Securities Enforcement Forum in Washington, D.C., that he does not expect the division to launch anything else like the SCSD self-reporting initiative in the near future.
How to Think About Disgorgement and Penalties
The SEC achieved impressive results this year “despite facing significant headwinds,” which included a compressed statute of limitations for cases in which the commission sought disgorgement, resource constraints, a 35-day government shutdown, and a SEC Chairman Jay Clayton-era enforcement philosophy that would militate toward smaller fines.
How could the SEC possibly reach record-level monetary sanctions in those circumstances? Two possible explanations: (1) the enduring impact of Kokesh is overstated; and (2) settlement demands are inching up across the board.
The impact of Kokesh is overstated.
The co-directors of enforcement frequently lament the adverse impact of Kokesh, in which the Supreme Court held that SEC claims for disgorgement are subject to a five-year statute of limitations. According to the annual report, “the Kokesh ruling has caused the Commission to forgo approximately $1.1 billion dollars in disgorgement in filed cases.”
While that figure is eye-catching, the enduring impact of Kokesh may be overstated. The case seems to have disproportionately impacted matters that were in the pipeline around the time Kokesh was decided in 2017.
Over the last year, reports of the amount of disgorgement left on the table have crept up only incrementally. And comparing the division’s 2018 and 2019 annual reports, it appears the SEC was forced to forgo only $200 million in FY 2019 as a result of Kokesh. Note that in an era of outsized enforcement penalties, it is not uncommon for the total amount of disgorgement and penalties to float up or down $200 million in a given fiscal year.
The impact of Kokesh is likely diminishing for three reasons. First, the division pointed out in the annual report that it is reallocating resources to cases that “hold the most promise for returning funds to investors.” The implication is that the staff is less likely to expend investigative resources on long-running, or older, frauds — thereby sidestepping potential Kokesh issues — favoring instead matters involving more recent misconduct.
Second, the division is focusing on accelerating the pace of its investigations. According to the annual report, in FY 2019, investigations took, on average, 24 months from case opening to filing an action — a marked improvement over recent years. Financial fraud and disclosure cases averaged 37 months, dragging this figure down. Accelerating the pace of investigations alleviates some of the time burden imposed by Kokesh.
Finally, as many predicted after Kokesh was decided, the staff appears to be demanding tolling agreements more often, and earlier, in investigations. This is becoming an expectation for practitioners in the securities enforcement defense bar. While accelerating the pace of investigations diminishes time pressure, stopping the clock through tolling agreements completely relieves the pressure.
Together, these trends appear to be mitigating the effects of Kokesh and draw into question its enduring impact. It should be noted that two developments relating to Kokesh may impact the enforcement program in the coming year(s). First, a legislative fix for Kokesh is taking shape. A bill is being circulated that would extend the statute of limitations applicable to claims for disgorgement to 10 years.[14]
Second, the Supreme Court recently agreed to hear a case that will decide whether the SEC may seek disgorgement at all in litigated matters.[15] Depending on the outcome, either development could meaningfully impact the trajectory of the enforcement program.
Settlement demands are inching up.
During their tenure, Avakian and Peikin have spoken on several occasions about their objective to seek only remedies that most effectively further the commission’s enforcement goals, including smaller fines or non-monetary relief in appropriate cases.[16] Indeed, this objective has counted among the division’s five core principles for the past several years.
The desire to better tailor relief and remedies to the division’s enforcement goals has developed largely around fears that outsized enforcement penalties may be harmful to investors — a result that is anathema to the SEC’s investor protection mandate — and a view that penalties have unreasonably increased in recent years without discernably improving the effectiveness of the enforcement program.
Nevertheless, in FY 2019 the division obtained judgments and orders for the highest amount of disgorgement and penalties ever (during an 11-month fiscal year in which the staff’s efforts were purportedly hampered by Kokesh), which would seem to undercut the notion that the division is rethinking its approach to remedies and relief.
The seeming incongruity between the principle of imposing only remedies that further enforcement goals and the simultaneous pursuit of penalties that led to a record-setting year may be resolved as follows: Even if the division is considering tailored or alternate remedies in some matters, settlement demands are inching up across the board. The numbers appear to support this conjecture.
There have undoubtedly been years where a handful of large settlements meaningfully inflated the total amount of disgorgement and penalties ordered, but that was not the case in FY 2019. Indeed, according to the annual report, in FY 2019, the top 5% largest cases accounted for 70% of the total monetary sanctions ordered — a pretty average figure.
By comparison, in FY 2018, the top 5% accounted for 77% of the total.
Moreover, according to the annual report, in FY 2019 the median disgorgement ordered, penalties ordered and total money ordered per action all met or set record highs. Indeed, the median total money ordered in FY 2019 was 52% higher than FY 2018 and 11% higher than the second highest figure reported.
Thus, it appears that a wave of smaller cases against smaller and middle-market firms cost incrementally more to settle, driving up the total amount of disgorgement and remedies. We may see fewer eye-popping headlines, but expectations around the cost of settling an SEC enforcement matter seem to be creeping up.
Reflecting on a Banner Year
Qualitatively and quantitatively, FY 2019 was a banner year for the SEC’s Division of Enforcement, which is, in fact, worth mentioning. Factors both within and without the division will shape the enforcement narrative in 2020, but there is every reason to believe the program will continue apace.
