In its 2019 Annual Report, the Division reviews its key initiatives from 2018 (Share Class Selection Disclosure Initiative, Retail Strategy Task Force, and Cyber Unit), and highlights enforcement actions involving public companies and financial institutions (including commercial banks, investment firms, and insurance companies). As in 2018, the Division reiterates the critical role of financial intermediaries and other “gatekeepers” (such as accountants, auditors, and attorneys) in regulating financial institutions, and similarly renews its emphasis on the importance of holding individual wrongdoers accountable. Looking forward, the Division emphasizes that it plans to continue to: (1) coordinate and investigate in parallel with criminal authorities; (2) accelerate the pace of its investigations; (3) provide greater transparency regarding cooperation credit; and (4) streamline and accelerate its evaluation of whistleblower claims.
A Record-Setting Year
In spite of the 35-day shutdown of the federal government from December 22, 2018 through January 25, 2019 and the lowest level of staff and contractors in recent years, the Division had a record-setting year. The Division’s quantitative metrics were up nearly across the board for FY 2019 as compared to FY 2018—from 821 to 862 enforcement actions, from 490 to 526 standalone actions, from US$3.9 billion to US$4.3 billion in disgorgement and CMPs, from 550 to 595 market participants barred or suspended, and from nearly US$800 million to nearly US$1.2 billion distributed to harmed investors. The Division attributes the measurable increase in activity in part to the self-reporting nature of the Initiative, which is discussed below in further detail.
Notably, the number of standalone enforcement actions charging investment advisers and/or investment companies nearly doubled, from 108 (22% of all actions) in FY 2018 to 191 (36% of all actions) in FY 2019. These numbers demonstrate the Division’s continued focus on the asset management industry. The steep increase in the number of enforcement actions involving the asset management industry were offset by a decrease in enforcement actions across all other categories, except (a) issuer reporting / audit & accounting actions and (b) Foreign Corrupt Practices Act (FCPA) actions.
While the recent lift on the Division’s hiring freeze and the growth of the Division’s self-reporting and whistleblower initiatives indicate that the overall uptick in activity will likely continue, the Division notes that its ability to act efficiently and effectively has been adversely impacted by the Supreme Court’s recent decisions in Lucia v. SEC (holding that the appointment of SEC Administrative Law Judges violated the Appointments Clause of the U.S. Constitution) and Kokesh v. SEC (holding that the SEC’s claims for disgorgement are subject to a five-year statute of limitations, and further noting that whether disgorgement constitutes “equitable relief” remains an open issue). In addition to monitoring the continuing effects of those decisions, Dechert is keeping an eye on Liu v. SEC,2 in which the Supreme Court will determine whether the SEC “may seek and obtain disgorgement from a court as ‘equitable relief’ for a securities law violation.” Should the Court rule in petitioners’ favor in Liu v. SEC, the SEC’s ability to seek disgorgement as a form of equitable relief in addition to CMPs would be reined in, absent legislative action.
Initiatives and Areas of Focus in 2019
In FY 2019, 95 investment advisory firms voluntarily self-reported to the Division pursuant to the Initiative, which was launched in February 2018 and led by the Division’s Asset Management Unit. The Initiative, in short, was a voluntary program that allowed investment advisors to self-report failures to disclose conflicts of interest related to their compensation from 12b-1 fees. Under the Initiative, the Division recommended a settlement with standardized terms that included: (1) a cease-and-desist proceeding for violations of Sections 206(2) and 207 of the Advisers Act; (2) the payment of disgorgement and prejudgment interest; and (3) an acknowledgment that the adviser had or would provide specified undertakings related to the misconduct. In exchange for self-disclosure, the Division recommended that the Commission not impose any civil penalties.
As a result of the Initiative, over US$135 million in disgorgement was returned to mutual fund investors in FY 2019. It is worth noting the significance of the Initiative to the Division’s overall numbers—without the actions arising from the Initiative, the number of enforcement actions might have been the lowest seen in recent years. Also of note, on October 18, 2019, on the heels of announcing that 16 investment advisers self-reported pursuant to the Initiative, the SEC’s Division of Investment Management issued a set of responses to “frequently asked questions” concerning advisers’ fiduciary duties as well as Form ADV and other disclosure obligations with respect to financial conflicts of interest arising from certain compensation arrangements. Although the period for self-reporting under the Initiative has ended, the SEC continues to bring cases in this area, which will likely continue to be an area of focus for the Division.
While the Initiative has come to a close, the Division’s Retail Strategy Task Force (RSTF) is in full swing, as one of the Division's five “core principles” is to protect retail, or “Main Street,” investors. In addition to its focus on retail investor advocacy and outreach, the Division has invested in the development of “data-driven, analytical strategies” to assist with the identification of trading and investment practices that may harm retail investors—strategies which continue to lead to investigations and charges by the SEC. As a result, it is likely that the Division will continue to bring actions involving fees/expenses and conflicts of interest.
Another ongoing “key priority area” of the Division is cyber-related misconduct, which is spearheaded by its Cyber Unit (established in September 2017). In FY 2019, the Division “established a framework for future resolutions” of actions relating to initial coin offerings (ICOs) by requiring: (1) establishment of a claims process for harmed ICO investors; (2) registration of tokens with the SEC under Section 12(g) of the Exchange Act; and (3) digital asset issuer compliance with standard issuer reporting requirements. Also in 2019, the SEC filed its first charges for unlawful promotions of ICOs and brought actions against the founder of a digital asset trading platform, against an “ICO Incubator,” and against issuers of digital assets for failure to register as a national securities exchange, as a broker-dealer, and as an issuer of securities, respectively. The Division further notes a continued effort to pursue cases in this area, as was confirmed on November 15, 2019 when the SEC announced final judgment in the Middleton matter, noting that the defendant and his company agreed to pay nearly US$9.5 million by consent as a result of the SEC’s charges.
The Division’s Annual Report also makes clear the continuing importance of individual accountability. In the Division’s words, a “central pillar” of its program, and the SEC’s “most effective method of achieving deterrence,” is the tenant that individual wrongdoers—not just the company— should be held accountable. In 2019, individuals were charged in 69% of the SEC’s standalone actions (excluding actions arising from the Initiative, which applied only to entities), which is on par with 2018’s 70%. Notably, the Division emphasized that the individuals named range from so-called members of the “C-Suite” (such as CEOs, CFOs, and CCOs) to lower-level employees and “gatekeepers” (such as accountants, auditors, and attorneys).
Looking Ahead to 2020
The Division emphasized four areas of focus that it intends to maintain going forward. First, the Division noted that, because civil sanctions are, at times, inadequate to deter certain bad actors (namely “recidivists, microcap fraudsters, Ponzi schemers, and others who act with a high degree of scienter”), it will continue to coordinate and investigate in parallel with criminal authorities. Significantly, in more than 400 investigations, the Division shared its investigative materials with other regulators and law enforcement offices.
Second, in FY 2019, on average it took 24 months for the Division to file an enforcement action after opening the case, and that average increases to 37 months in financial fraud and issuer disclosure cases. Going forward, the Division expects to accelerate the pace of its investigations, pointing to the recent Nissan matter (filed within 10 months of the case opening) and PPG matter (filed within 17 months of the case opening) as evidence of a quicker pace to come.
Third, the Division aims to provide greater transparency as to how cooperation is considered and weighed by the SEC. One example highlighted by the Division is the PPG matter referenced above, in which the SEC imposed no penalties, taking into account PPG’s “prompt self-reporting,” its “extensive cooperation,” and its “implementation of remedial measures immediately upon learning of the improper conduct.” Additionally, the Division pointed to Comscore’s “prompt remedial acts and cooperation,” though that matter did result in a US$5 million penalty for the company, with an additional US$700,000 penalty paid by its CEO. Although in these matters the Respondents were credited for their promptness and cooperation with the SEC, the rubric for such credit remains uncertain.
Finally, the Division is actively working to streamline and accelerate the whistleblower claim evaluation process. Since its inception, the whistleblower program has led to “high-quality SEC enforcement actions” that have resulted in financial remedies of over US$2 billion. In exchange for their tips, the SEC has awarded 66 whistleblowers nearly US$400 million. In addition, on November 15, 2019, the SEC announced that it would award over US$260,000 to three individuals for alerting the SEC “to a well-concealed fraud targeting retail investors." Having received a record number of whistleblower claims in 2019, streamlining the process will be one of the Division’s main areas of focus in 2020.
Fiscal Year 2019 was a record-setting year for the Division. This trend will likely continue under the leadership of Ms. Avakian and Mr. Peikin as they enter their third year as Co-Directors of the Division. We also expect to see a continuation of the Division’s active enforcement across the asset management industry, which remains the largest sub-category of enforcement cases overall. Given the success of the Initiative, there likely will be more efforts undertaken by the Division to encourage self-reporting and streamline the Division’s investigatory work.