In several weeks, the U.S. Securities and Exchange Commission will release its annual enforcement results, and speculation about the trajectory of the SEC’s Division of Enforcement will resume in full force. The results will reflect enforcement activity from the first full fiscal year of Jay Clayton’s tenure as SEC chairman. In the 16 months since Clayton’s swearing in, there have been repeated questions about how vigorously the Division of Enforcement is policing the U.S. capital markets. Naturally, following Mary Jo White’s “bold and unrelenting” enforcement agenda, many expected a decline in enforcement activity under Clayton. There has, in fact, been a dip in the number of SEC enforcement actions during Clayton’s tenure, but the decline has not been as precipitous as many anticipated. And the decline in enforcement activity does not tell the whole story of the current enforcement program. There have been marked changes in priorities and tone and subtle shifts in the mix of cases coming out of the commission. As we await details of the SEC’s 2018 enforcement results, we might pause for a moment to take stock of the enforcement program. It is instructive to assess the volume of cases, changes in tone, priorities and resources, and the subtle reclustering of enforcement actions, all of which offer insight into where the enforcement cases have gone and where we might expect them to crop up.
Flagging Enforcement Figures
There are conflicting reports on the magnitude of the decline in SEC enforcement actions by the commission. Analysts apply different criteria in compiling and parsing SEC enforcement statistics, which sometimes leads to disparate conclusions. The weight of authority agrees, however, that there has in fact been a decline in the number — and pace — of enforcement actions since Clayton became chairman. The decline is borne out in the SEC’s own enforcement statistics. In fiscal year 2015, the SEC brought 807 enforcement actions and obtained disgorgement and penalties totaling approximately $4.2 billion. In 2016, the SEC improved on those numbers, bringing 868 actions (a record high) and obtaining disgorgement and penalties totaling more than $4 billion. In 2017, by contrast, the SEC brought 754 enforcement actions — the lowest figure since 2013 (686) — and obtained judgments and orders totaling $3.8 billion. The decline appears to have carried into 2018. Anecdotally, many members of the securities enforcement defense bar report a slowing of enforcement activity, and there have been other indications that the downturn continues. For example, in May 2018, Cornerstone Researchreported that SEC enforcement actions against public companies “continued their downward trend through the first half of the 2018 fiscal year.” Indeed, Cornerstone found that the first half of fiscal year 2018 featured the lowest number of actions against public companies since the first half of fiscal year 2013. While enforcement actions against public companies comprise only a segment of the securities enforcement program, in past years the number has been a useful predictor of the overall trajectory of the enforcement program. It should be expected, then, that the SEC’s 2018 enforcement results will reveal another drop in the number of actions. The question is: How far will the number fall? Changes in Tone, Priorities and Resources There have been notable changes in tone, priorities and resources at the commission that are changing the direction of the SEC enforcement program and likely contributing to the flagging figures. The chairman sets the enforcement tone for the commission and the Division of Enforcement. Clayton has repeatedly stressed the importance of the enforcement program and praised its staff — particularly under staunch questioning by members of Congress who are known enforcement hawks — but enforcement is not his top priority. Clayton is more focused on encouraging initial public offerings and easing regulatory burdens on capital formation. Changes in the makeup of the commission itself also influence the vigor of the enforcement program. Commission membership has been in flux for most of Clayton’s tenure. Robert Jackson and Hester Peirce joined the commission in January 2018, and Elad Roisman was sworn in earlier this month. The commission will incorporate another new member after Kara Stein steps down in December, unless she is reappointed. Commissioners who identify enforcement as one of the pillars of their regulatory agenda have an opportunity to influence the direction of the program. But none of the new commissioners has emerged as an outspoken advocate for an aggressive enforcement program. On the contrary, Peirce has a record of voting against enforcement actions and has been openly skeptical about overly zealous enforcement. “Enforcement is not an end goal for the commission,” she said in May. It is a “last resort” in promoting the commission’s mandate. The continuing evolution of Clayton’s commission may mean changes in the direction or tone of the enforcement program. Within the Division of Enforcement itself, there have been changes that impact the direction of the program. Last summer, the commission welcomed new co-directors of enforcement, Stephanie Avakian and Steve Peikin, who have set a tone and priorities for the division that centers on protecting retail investors and combating cyber-related misconduct. To that end, the SEC created within the division a Retail Strategy Task Force and a dedicated Cyber Unit. The creation of these dedicated units and the corresponding resource reallocation are emblematic of shifts in the SEC’s enforcement priorities that have trickle-down effects on the types of cases — and regulated entities — on which the staff is focused. In addition to changes in the tone at the top, there has been a markedly high level of attrition throughout the ranks of the division. In the last 18 months, the Division of Enforcement “has hired only five new staffers despite losing more than three dozen … the most in any Securities and Exchange Commission group.” From a resources standpoint, the departures create a resource strain that prevents the division from operating at optimal capacity. And the staffing issue is unlikely to be remedied soon as SEC budget requests would replace less than half of the lost headcount. “The tragedy of these reductions in staff,” Jackson has said, “is that it means fewer investigations, fewer actions, and, ultimately, fewer dollars returned to investors.” On top of the programmatic changes and resource constraints taking shape within the commission, there have been developments in the courts that could hamper the staff’s ability to pursue enforcement actions. In the last 18 months, there has been an unusual amount of new case law relating to securities enforcement, headlined by three recent U.S. Supreme Court cases. In Kokesh v. SEC, the Supreme Court held that disgorgement is a “penalty” subject to a five-year statute of limitations, increasing pressure on the enforcement staff to timely detect misconduct and institute investigations or enforcement actions. In Digital Realty Trust v. Somers, the Supreme Court held that whistleblowers must report to the SEC to qualify for certain whistleblower protections provided in the Dodd-Frank Wall Street Reform and Consumer Protection Act, which could stem the flow of valuable whistleblower complaints to the SEC’s Office of the Whistleblower and, ultimately, the Division of Enforcement. And in Lucia v. SEC, the Supreme Court held that administrative law judges are “inferior officers” who must be appointed by the president or the “head” of a department, which creates administrative headaches for the commission and, in the near term, a backlog of hundreds of cases that may need to be reheard. There have also been several lower court cases that impact the enforcement landscape, including changes in insider trading jurisprudence that are playing out in the Martoma litigation. Taken together, the current enforcement environment is characterized by a less aggressive enforcement tone at the top, shifting enforcement priorities and programs, challenging resource constraints, and restrictive new case law. A natural result of these developments is fewer enforcement actions. Where Have the Enforcement Cases Gone? Still, the decline in the number of SEC enforcement actions has not been as precipitous as some predicted. In fact, even if we assume the fiscal year 2018 enforcement results will reflect a modest downturn in the number of new actions, any number in the 700s will still rank among the five to six busiest enforcement years of all time — markedly higher than pre-financial crisis enforcement, and on par with the early years of Mary Jo White’s tenure at the commission. On some level, then, enforcement cases haven’t really gone anywhere. This may simply be a period of modest decline. Enforcement activity tends to be somewhat cyclical and is marked by periodic level-setting. The division may be facing challenges — resource constraints and an increasingly difficult legal landscape — but the staff continues to vigorously work to identify and root out securities laws violations. There may be a perception that an outsized number of cases are gone because enforcement actions are simply starting to cluster in slightly different areas. In reviewing SEC enforcement press releases from fiscal year 2018 — which provide an illuminating, if imperfect, proxy for the issues that are of programmatic significance to the division — a few noteworthy trends emerge. First, the commission is backing up its rhetoric around protecting retail investors. So far in 2018, nearly 50 percent of the enforcement press releases have mentioned harm to investors. (Roughly 15 percent mention “retail investors” specifically.) These cases comprise a broad spectrum of misconduct, including classic pump-and-dump and Ponzi schemes, technology-driven securities fraud, and sophisticated accounting schemes. If we were to imagine “investor protection” actions as a distinct category of SEC enforcement statistics, it would be the largest category by a fair margin. The commission and the enforcement division have been clear that protecting retail investors will continue to be programmatically important, so we should expect to see further expansion in this category. Second, the focus on investor protection is causing enforcement actions to cluster around certain categories of cases and defendants. Broadly speaking, the dispersion of enforcement actions in fiscal year 2018 seems to be roughly in line with historical averages. (For example, historically, securities offering cases comprise roughly 14 percent of SEC enforcement actions. In fiscal year 2018, those cases again appear to encompass around 14 percent of the SEC’s enforcement actions.) There is, however, a subtle reclustering in certain areas. Of the greatest statistical significance, there seems to be a resurgence of cases against investment advisers, broker-dealers and their associated persons. SEC actions involving these entities and individuals had been in a period of modest decline. (Although the Financial Industry Regulatory Authority has been managing a busy docket of actions against registered firms and representatives.) Broadly, the investment adviser and broker-dealer cases capture familiar categories of misconduct that harms retail investors, such as the misappropriation or misuse of customer funds, suitability and churning cases, failures to supervise, cases relating to investment advisory and brokerage fees, and (recently) the sale of cryptocurrencies. This trend is a direct result of the enforcement division’s focus on protecting retail investors and should be expected to continue. Finally, the enforcement focus on investment advisers and broker-dealers seems to be shining a light on small- and middle-market firms. There are certainly still occasional enforcement actions against large Wall Street firms, but they seem to comprise an increasingly smaller percentage of SEC enforcement actions. Instead, we are seeing cases against smaller investment advisers and brokerages — firms that are more likely to touch retail investors. Conclusion In terms of sheer numbers, the enforcement division is undoubtedly in a period of retrenchment. But if we look beyond the numbers, we see that the commission is still bringing a historically high volume of enforcement actions. They just happen to be clustering (or reclustering, perhaps) in slightly different areas, with a particular focus on firms that touch retail investors. For financial services firms that cater to retail investors, these trends should sound a warning. Fewer cases does not mean the commission is pursuing its enforcement role with less vigor — but it may be refocusing resources in your space.