When Mary Jo White was sworn in as the 31st Chair of the Securities and Exchange Commission (SEC) on April 10, 2013, she made it clear that one of her highest priorities would be to strengthen the SEC’s enforcement function in a way that is “bold and unrelenting.”1 One year into White’s tenure, the SEC has taken steps evidencing an intent to fulfill that promise. In addition, White and other senior SEC officials recently have made a number of important public announcements regarding enforcement priorities and changes since White became Chair. This advisory discusses these and related developments since we issued our six-month review of White’s tenure in October 2013.2
Efforts to Strengthen Enforcement Activity
During congressional testimony on April 29, 2014, White noted that, in fiscal year 2013, the SEC brought 686 enforcement actions and obtained US$3.4 billion in disgorgement and penalties – the largest amount ever.3 In addition, in recent speeches, White reflected on the work done by the SEC in her first year as Chair and emphasized that the SEC will continue to take steps to strengthen its enforcement activities.4 White recalled that one of her “immediate priorities” when she became Chair last year was “to look for ways to make [the SEC’s] enforcement program even more robust” – and she underscored three areas in this regard: greater coordination and collaboration with criminal authorities, obtaining the authority to recover larger civil penalties, and a “broken windows” approach to prosecuting all violations of the securities laws.
Coordination with Criminal Authorities. White noted that parallel actions by the SEC and criminal authorities are on the rise, emphasizing that the SEC’s “extensive cooperation and partnership with the criminal authorities is essential to all-encompassing enforcement of the federal securities laws.”5 As White stated, there are “no more powerful tools than a criminal conviction and the prospect – and reality – of imprisonment.”6 In discussing criminal actions, White also stated that the SEC often will charge additional defendants who are not part of the criminal case, including gatekeepers (i.e., “the attorneys, accountants, auditors, fund directors and other board members and professionals who play a critical role in the securities industry and share the responsibility with regulators to protect investors”).7
Increased Civil Penalties. White stated that “our civil penalty authority is not as strong as I would like it to be” and that “our sanctions must have teeth and we must send a strong public message about our cases.”8 In this regard, she noted her support for “legislation to increase our penalty authority, including to permit the penalty calculation to be based on total investor loss, which in many cases can be much higher than the current statutory maximums or the amount of defendants’ ill-gotten gains.”9 The leading legislative vehicle to advance this objective – The Stronger Enforcement of Civil Penalties Act of 2013 – would substantially increase the per violation cap on violations for both individuals and entities, allow for penalties equal to three times the economic gain of the violator, and provide a new calculation method that includes the amount of investor loss as part of the penalty determination.10
Even without increased civil penalty authority, the SEC has obtained significant penalties in recent cases. Indeed, within the last year, the SEC assessed several penalties in the tens (or even hundreds) of millions of dollars.11
“Broken Windows” − Prosecuting Smaller Violations. In addition to the SEC’s high profile and widely reported enforcement actions, White has directed the Enforcement Division to pursue smaller violations, following a law enforcement approach championed by former New York City Mayor Rudy Giuliani, under which “no infraction was too small to be uncovered and punished.”12 White recently elaborated on this approach: “We are trying to prevent smaller securities violations from becoming more serious ones, and trying to stop individuals who are prepared to commit minor violations from moving on to bigger ones.”13
One example of the SEC’s “broken windows” approach is a case against nearly two dozen firms, charging them with violating “an anti-manipulation rule that prohibits firms from improperly participating in public offerings of stocks soon after selling short those same stocks.” The case resulted in disgorgement of profits of as little as US$4,000 and penalties beginning at US$65,000.14
Additional Enforcement Priorities and Task Forces
White and Andrew Ceresney (Director of the Enforcement Division) have stressed certain additional enforcement priorities and made a number of organizational changes
– most notably setting up several task forces. In recent speeches, White, Ceresney, and other senior officials have provided updates on enforcement activity in these areas.
Increased Emphasis on Individual and Gatekeeper Accountability. In the first six months of White’s tenure, she and Ceresney emphasized the need to pursue responsible individuals and the importance of gatekeepers.15 More recently, Ceresney reiterated the SEC’s focus on individual accountability by stating that (i) a “core principle of any strong enforcement program is to pursue culpable individuals wherever possible,” (ii) “[c]ases against individuals have great deterrent value,” and (iii) “[i]n every case against a company, we ask ourselves whether an action against an individual is appropriate.”16 As for gatekeepers, in addition to attorneys, auditors, and directors, White has made it clear that the SEC is focused on compliance personnel. In this regard, she has (i) noted that internal compliance programs are a “critical line of defense against violations of the securities laws” and (ii) touted the importance of the SEC’s “Compliance Program Initiative” in identifying enforcement actions against registered advisers that “failed to adopt or implement an adequate compliance program” after being notified of deficiencies.17
Financial Reporting and Audit Task Force. In July 2013, the Enforcement Division announced the formation of a Financial Reporting and Audit Task Force to focus on the preparation of financial statements, issuer reporting and disclosure, and audit failures – with the goal of detecting and increasing the prosecution of violations involving false and misleading financial statements and disclosures. According to recent comments by White, the SEC “look[s] closely at the auditors in every financial reporting case,” and is also “closely focusing on senior executives for possible misconduct warranting charges” because “critical accounting issues are the responsibility of all those involved in the preparation and review of financial disclosures.”18
At the 2014 Practising Law Institute (PLI) SEC Speaks conference, David Woodcock (Chair of the Financial
Reporting and Audit Task Force) reiterated White’s message and indicated that the SEC wants to ensure that it is deterring, detecting, investigating, and prosecuting false and misleading financial statements and audit failures. Woodcock said that the Task Force’s five primary goals are to (i) understand the state of financial reporting fraud (not just why it happens, but how and where), (ii) develop a state-of-the-art methodology for identifying and investigating financial reporting fraud,
(iii) make use of best practices, detection methods, and experiences of the enforcement staff, (iv) collaborate and coordinate with regulatory and law enforcement partners, and (v) engage the public, academia, and whistleblowers.
An example of the SEC’s renewed focus on accounting and auditing cases came in September 2013, when it announced charges against three auditors as part of an initiative called “Operation Broken Gate.”19 Based on recent comments, we can expect that enforcement activity in this area likely will continue to be a focus of the SEC.
Microcap Fraud Task Force. In July 2013, the Enforcement Division announced the formation of a Microcap Fraud Task Force to focus on fraud in connection with the issuing, marketing, and trading of low-priced stocks issued by small companies. White recently highlighted microcap fraud as an “area where effective law enforcement requires both extensive cooperation with the criminal authorities and pursuit of many standalone cases.”20 She explained that, while microcap fraud cases “typically originate with a trading analysis that shows patterns of trading suggestive of illegal activity,” the SEC’s enforcement staff then needs to “identify the promotional statements feeding the trading activity, investigate whether and how those statements may be actionable, identify the promoters and other participants orchestrating the scheme, and follow the stock and money.” White also stated that “these cases are uniquely conducive to criminal methods, where cooperators and undercover agents can interact with the wrongdoers and collect very powerful evidence.”
At PLI’s 2014 SEC Speaks conference, Elisha Frank and Michael Paley (Co-Chairs of the Microcap Fraud Task Force) indicated that the SEC is approaching fraud in this area in a more targeted and concentrated manner, including through the use of better technology and cooperation. Frank said that the task force is focusing on gatekeepers (including attorneys, auditors, and transfer agents) as well as repeat players (including stock promoters and foreign financial entities that are helping individuals conceal their identities when selling microcap shares). Paley added that, in addition to targeting the people behind the fraud, the task force is bringing many trading suspensions and proactively stopping market manipulation before retail investors are harmed.
Market Integrity and High-Frequency Trading. White recently noted that technology has created a “fundamental shift” in markets and the SEC has “tried to send a strong enforcement message to the exchanges and alternative trading systems that play critical roles in securities market transactions that they must operate fairly, within the rules and with a close eye on their responsibilities to safeguard their technology.”21 In this regard, during a congressional hearing on April 1, 2014, White testified that the SEC has “intensified our comprehensive review of market structure issues, including high-frequency and off-exchange trading practices.”22 The SEC’s focus on technology also has led to actions against (i) NASDAQ for inadequate testing of its systems during the Facebook IPO, (ii) a dark pool for failing to protect confidential trading information, and (iii) the New York Stock Exchange for compliance failures that provided certain customers with a head start on trading information.23
FCPA Enforcement. At PLI’s 2014 SEC Speaks conference, Kara Brockmeyer (Chief of the Enforcement Division’s Foreign Corrupt Practices Act Unit) described the SEC’s continued commitment to enforcing the FCPA. She noted that the SEC already had brought as many cases so far in fiscal year 2014 as it brought in all of fiscal year 2013. This includes a settlement with Alcoa in January 2014 that resulted in disgorgement of US$175 million (US$14 million of which was satisfied by Alcoa’s forfeiture in a parallel criminal matter).24 Brockmeyer said that the SEC continues to see many cases involving travel and entertainment expenses and use of third party intermediaries. In addition, she advised companies to pay heed to due diligence of third party intermediaries and to ensure that internal audit departments conduct testing for adequate FCPA controls (similar to the testing done for SOX certification purposes). Brockmeyer also observed that the SEC has seen an increase in international cooperation as more countries increase their efforts to enforce bribery laws.
According to Brockmeyer, in the coming year, the SEC plans to bring more FCPA cases as administrative proceedings, rather than as civil actions in federal district court. She further advised that cooperation credit will continue to be important, noting the SEC recently entered into its first-ever non-prosecution agreement (NPA) in an FCPA case (which involved Ralph Lauren). Brockmeyer noted that Ralph Lauren’s cooperation was evident in its (i) self-reporting of suspected bribery within two weeks of identifying violations,
(ii) discovery of violations due to its rollout of enhanced FCPA training, (iii) facilitating the SEC’s investigation by, among other things, providing English language translations of foreign documents and bringing foreign witnesses to the United States, and (iv) engaging in extensive remediation, including conducting a worldwide review to determine whether there were problems in other locations.25
Private Funds Unit. The SEC recently announced the formation of a unit within the Office of Compliance Inspections and Examinations that will focus on private equity and hedge funds.26 At a recent conference, Igor Rozenblit (co-head of the unit) indicated that initial areas of interest will be asset valuation, fee structures and related disclosures, and communications with limited partners.27
The increased focus on private equity and hedge funds is due in large part to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which required a large number of investment advisers to private equity and hedge funds to register with the SEC. In January 2014, the SEC reported the results of its first round of inspections of 250 of the newly registered advisers, which highlighted issues involving disclosures to limited partners, shifting fees and expenses, and misleading performance and valuation metrics.28 In her April 1, 2014 congressional testimony, White noted that “[t]here is an immediate and pressing need for significant additional resources to permit the SEC to increase its examination coverage of registered investment advisers so as to better protect investors and our markets.”29
Other Enforcement Initiatives
Admissions of Wrongdoing. One of the first steps White took as SEC Chair was to change the longstanding policy of permitting essentially all defendants to settle cases without admitting or denying liability or admitting of facts that establish their liability.30 According to White, admissions “provide a greater degree of public accountability,” “boost
investors’ confidence in our enforcement program and our markets,” and “serve as a strong deterrent to all who are tempted to follow in the defendants’ footsteps.”31
White recently remarked that the SEC “now consider[s] requiring admissions in cases where the violation of our securities laws includes particularly egregious conduct, where large numbers of investors were harmed, where the markets or investors were placed at significant risk, where the conduct obstructs our investigation, where an admission can send a particularly important message to the markets or where the wrongdoer poses a particular future threat to investors or the markets.”32
At PLI’s Enforcement 2014: Perspectives from Government Agencies conference, Ceresney discussed additional details regarding the policy, including that (i) a decision to seek an admission is not a negotiation point during settlement discussions because, at that point, the enforcement staff already will have decided that an admission advances programmatic goals and is willing to litigate if necessary, and
(ii) in an effort to ensure a centralized approach, Ceresney is the “clearinghouse” to decide whether to seek an admission in any particular case.
White also has recognized that, while the initial policy change consisted of “broad parameters” under which admissions would be required, there are now “a number of cases with admissions that illuminate those categories.”33 In this regard, the SEC has required admissions in seven cases since the policy change. One recent case is instructive. On January 29, 2014, the SEC announced a settlement with Scottrade in which it alleged that the firm failed to provide the agency with complete and accurate information about trades done by the firm and its customers over a six-year period. Scottrade agreed to pay a US$2.5 million penalty and admitted the facts underlying the SEC charges, which an SEC regional office director characterized as “egregious.”34 White recently stated that her “expectation is that there will be more such cases in 2014 as the new protocol continues to evolve and be applied.”35
With a greater emphasis on admissions, some defendants may conclude that a settlement requiring an admission poses at least as great a threat as the risk of trial. In fact, White has acknowledged that she expects the policy “could well lead to more trials by parties refusing to admit their wrongdoing,” but that “[m]ore trials should mean greater public accountability and more instances of a full factual record of wrongdoing that should foster better development of the law.”36 Accordingly, as the SEC’s admission protocol evolves, we might expect to see more trials.37
Cooperation. During White’s tenure, the Enforcement Division has continued to emphasize the importance of cooperation and is utilizing more of the tools available to it under its previously-announced “Cooperation Program.”38 For example, as discussed above, the SEC entered into its first NPA in an FCPA case. Similarly, the SEC recently entered into its first NPA and its first deferred prosecution agreement with individuals, where the individuals assisted in SEC investigations involving insider trading and stolen investor assets, respectively.39
Whistleblower Tips. According to the SEC’s 2013 Annual Report to Congress on the Dodd-Frank Whistleblower Program, there were 3,238 whistleblower tips to the SEC during the 2013 fiscal year, bringing the total number of tips since the establishment of the program in August 2011 to 6,573.40 The most common complaint categories reported by whistleblowers were Corporate Disclosures and Financials (17.2 percent), Offering Fraud (17.1 percent), and Manipulation (16.2 percent). During fiscal year 2013, the SEC paid four whistleblower bounty awards, totaling over US$14 million.
White has stressed the importance of the Whistleblower Program. For example, on October 9, 2013, she noted the program’s role in generating enforcement leads that may not have been uncovered using the SEC’s other enforcement tools, and she stated that it has incentivized companies “to report misconduct before a whistleblower comes to [the SEC] first” and to “beef up their internal compliance function.”41
The impact of the SEC’s enforcement priorities is beginning to take hold in the cases being charged, reflecting a convincing tone that the SEC’s leadership is reinforcing through strong public statements. Market participants of all types, whether entities or individuals, should take notice of these enforcement priorities. Particular attention should be paid to the effectiveness of existing compliance and training programs and whether upgrades should be made before problems arise, as well as how to react when faced with a problem, the possibility of an SEC investigation, or an investigation itself. These decisions are likely to be increasingly important in determining how matters are ultimately resolved as the SEC’s new initiatives continue to unfold.