On October 8 and 9, the U.S. Securities and Exchange Commission (“SEC” or “Commission”) presented its annual program, The SEC Speaks in 2020. The Commission touted its virtual enforcement results, particularly in Chairman Clayton’s opening remarks and during the Division of Enforcement panel. Chairman Clayton stated that the Commission brought more than 700 actions in fiscal year 2020, and noted that significant percentage of those were brought after March 15. He further reported that the Commission obtained more than $4 billion in financial remedies, which was an increase from the prior year. The SEC made clear that the COVID-19 pandemic has not slowed their enforcement efforts and since March, the SEC has brought more than three dozen trading suspensions, more than 400 enforcement actions of which six are COVID-related fraud actions, and more than 640 new investigations and inquiries of which 150 are COVID-related.
1. An increase in particular categories of cases since COVID-19.
The uptick of investigations and inquiries are reportedly in insider trading and market manipulation matters; disclosure issues, particularly with regard to impairments, valuations, and material weaknesses; and the failure to comply with redemption requests. The SEC suggested that companies ensure that corporate insiders know the requirements related to material nonpublic information, as well as the disclosure controls and processes, to include the proper dissemination of material nonpublic information.
2. All aspects of investigations and enforcement actions are going forward.
The SEC reports that in the majority of cases, witnesses have provided virtual testimony and it is an “outlier” situation for a witness to refuse remote testimony. Depending on the record, the SEC may continue with the Wells process and commence an enforcement action without testimony. The SEC believes that courts are not sympathetic to defendants declining to participate in remote depositions.
3. Many fiscal year 2020 cases involve the Securities Act of 1933 Section 5, investment advisors, and insider trading.
Of the cases discussed, the SEC referred to the SEC v. Telegram case as a “seminal decision,” in which the Court granted the SEC’s preliminary injunction to prevent the distribution of digital assets, finding that the digital assets were securities.
4. The SEC’s in-house data analytics and risk-based tools are identifying more types of cases.
Previously, the SEC used these tools to detect insider trading schemes and retail frauds at broker-dealers or investment advisors. Now these tools are able to identify potential fraud by issuers and disclosure violations. The data analytics tools have successfully been used in the SEC’s Earnings Per Share (“EPS”) Initiative, which focuses on earnings management practices including the identification of anomalous data points and identifies issuers that report metrics that are contrary to historical industry results. The staff highlighted problematic practices that have been identified, such as improper accounting adjustments at quarter-end to change actual EPS as compared to estimates and improper valuations, among others. These tools are also identifying potential disclosure violations concerning executive compensation and proxy requirements.
5. Cooperation credit is alive and well.
The staff emphasized the importance of cooperation and noted actions in which there were no penalties assessed because the company voluntarily self-reported and quickly remediated the bad conduct. Cooperation credit is especially beneficial to the staff in matters that are resource-intensive and where the cooperation is provided before the staff has spent much time on the investigation.
6. The SEC is focused on specific key areas.
The staff noted that the SEC is still focused on non-GAAP metrics and key indicators in financial reporting. The SEC is also closely monitoring COVID-related disclosures, specifically, financial reporting that may require disclosure, judgment and estimates (such as those related to impairments, debt modification and/or going concern disclosures), and whether current financial conditions show underlying issues that should have been disclosed earlier. The staff is also focusing on misconduct related to the interaction of investment professionals with retail investors, and compliance with the former suitability rule, and current Regulation Best Interest. The SEC also has initiatives aimed at protecting teachers and the military. The staff noted continued concerns about potential ongoing Ponzi schemes and affinity frauds.
7. The recent changes to the Whistleblower rules are expected to bolster the program.
In fiscal year 2020, the SEC reports that it issued 39 awards of approximately $175 million and noted that this represents almost one-third of all money ever awarded, and more than one-third of all whistleblower awards ever awarded under the program. These matters resulted in more than $760 million in financial remedies. The staff believes that the recently adopted amendments to the whistleblower awards rules increase transparency and strengthen and bolster program. The SEC advised that companies must take whistleblower complaints seriously and stated that 85% of employees or former employees who reported alleged violations to the SEC also reported internally to the company, but they did not believe the company was taking adequate action.
While COVID-19 may have slowed down many aspects of the economy the SEC contends that it has not slowed enforcement efforts. The SEC’s enforcement staff reports that it is continuing to operate at full-speed even though most are working remotely. Companies would be wise to exercise added caution when making disclosures related to COVID-19 and its impact, as the staff has made clear it will be paying close attention.