Stephanie Avakian and Steven Peikin, the new Co-Directors of the U.S. SEC Enforcement Division (“Division”), released a report on November 15, 2017, summarizing the Division’s enforcement activity for the fiscal year ending September 30, 2017 (“the Annual Report”).1 The SEC Co-Directors stated that “[w]hile we necessarily police a broad landscape and have numerous areas of focus, at a high level, our decision making is guided by five core principles.”
The Annual Report identified these core principles as:
- Focusing on the Main Street investor.
- Focusing on individual accountability.
- Keeping pace with technological change.
- Imposing sanctions that most effectively further enforcement goals.
- Constantly assessing the allocation of resources.
After discussing these principles, the Annual Report described the Division’s recent initiatives and offered a broad summary of the SEC’s enforcement trends over the past year.
Five Core Enforcement Principles
The Division has, in the past several months, gone to great lengths to emphasize its commitment to protecting retail investors. In their first core principle, the Co-Directors reiterated the importance of safeguards for these investors. Explaining that retail investors are the most common participants in the market and noting the heightened vulnerability they face, the Annual Report specified that rooting out accounting fraud, sales of inappropriate products and use of unsuitable trading strategies, pump-and-dump frauds and Ponzi schemes will remain focal points.
The Annual Report stated that the Division will also continue to pursue misconduct by financial institutions and intermediaries. The SEC has recently brought cases against financial firms for overcharging customers in advisory fees, failing to warn investors adequately about risk of complex products, and guiding investors toward higher-fee mutual funds when there were lower-cost options. The Annual Report makes clear that the Division’s has two goals—“protecting Main Street and policing Wall Street”—and that the SEC’s oversight of Wall Street will be “viewed through a lens focused on retail investors.”
The Co-Directors’ second core principle is pursuing misconduct by individuals. While the Annual Report mentioned continuing to pursue enforcement actions against institutions, it highlighted the importance of bringing cases against individuals. Since SEC Chairman Jay Clayton took office in May 2017, individuals have been charged in over 80 percent of standalone enforcement actions. Current leadership at the SEC believes that, “[t]he vigorous pursuit of individual wrongdoers must be the key feature of any effective enforcement program.”
The Division’s third principle is keeping pace with technological change. The Co-Directors noted that the proliferation of technology has given wrongdoers new ways of manipulating markets. The Division has stated that it is working to keep up with potential cyber-related misconduct such as account hacking, expansion of the “dark web,” and the illicit use of cryptocurrency. The Division has formed a new Cyber Unit to centralize enforcement efforts against technology-based misconduct. This Unit will work with the Department of Justice and other law enforcement agencies going forward.
The Division’s fourth principle is the imposition of sanctions that most effectively further enforcement goals. This principle may be viewed as the traditional core of the SEC’s enforcement efforts. The Co-Directors stressed that they will continue to pursue disgorgement, penalties, and asset freezes. The Division has also stated that it will assess each case independently to determine whether more tailored relief such as specific undertakings, admissions of wrongdoing or monitoring efforts are appropriate. The Co-Directors stated that they do not believe in a statistics-driven approach, although the Annual Report cites a plethora of statistics to illustrate the Division’s effectiveness. While this declaration is encouraging, industry professionals should take a wait-and-see approach before concluding that the era of statistics-driven enforcement is truly over.
The Division’s final stated core principle is to constantly assess the allocation of its resources. This principle focuses on using the Division’s limited manpower most effectively. The Annual Report noted that the SEC received more than 16,000 tips and over 20,000 reports of suspicious activity in the last year despite having under 1,200 employees to investigate them. The Division stated that it will be focused on addressing the most significant risks to markets in establishing its enforcement priorities.
Division’s New Initiatives
The Division’s two major new enforcement initiatives under the helm of Chairman Clayton are the establishment of the Cyber Unit and of the Retail Strategy Task Force. The Division has stated that these initiatives dovetail with the five core principles outlined above, as the initiatives address the emerging technological threats to markets and the strong focus on retail investors.
The Cyber Unit, as described above, is the first new specialized unit created since the advent of specialized groups within the Division in 2010, and was created to address the growing level of technology-driven misconduct in the securities markets. While the Cyber Unit’s mandate is still somewhat uncertain, it will initially focus on market manipulation schemes involving false information spread through technology, hacking to obtain nonpublic information, misuse of distributed ledger technology and initial coin offerings, misconduct committed on the “dark web,” intrusions into retail brokerage accounts, and cyber threats to critical market infrastructure.
The Retail Strategy Task Force, the second major Division initiative, reaffirms the current SEC leadership’s commitment to safeguarding the interests of retail investors. The mission of the Task Force is to implement innovative strategies to root out misconduct by
investment professionals in their dealings with retail investors. In other words, the Division is likely to focus on “impact” cases rather than narrow incidences of misconduct, in order to amplify the effect of its limited resources. The Task Force will focus on incidents of widespread misconduct such as the charging of inadequately disclosed fees, and recommending and trading in wholly unsuitable strategies and products.
Enforcement Over the Past Year
The Annual Report provides quantitative information about enforcement actions over the past fiscal year. In total, the SEC brought 754 enforcement actions, down from 868 in fiscal year 2016. The reduction is largely attributable to the smaller number of cases brought as part of the Continuing Disclosure Cooperation Initiative, a self-reporting program focused on municipal bond offering documents. That initiative ended in fiscal year 2016.
Total monetary judgments in fiscal year 2017 were US$3.789 billion, including US$832 million in penalties and almost US$3 billion in disgorgement. The monetary judgments were driven mostly by a small number of cases. The five percent of cases that involved the biggest monetary recoveries accounted for 62 percent of penalties and 69 percent of ordered disgorgement.
The 2017 enforcement data may not reflect the priorities of the new leadership because the investigations detailed in the Annual Report were ongoing for years prior to Chairman Clayton’s confirmation. The transition process at the SEC is continuing and clearer trends will emerge in the coming months as new personnel at the Commission take actions consistent with their stated regulatory priorities.
Looking Ahead to 2018
Several recent changes in the legal landscape of SEC enforcement will have a major effect on the Division’s work going forward. On June 5, 2017, the U.S. Supreme Court in Kokesh v. Securities and Exchange Commission2 held that disgorgement in the securities context is a “penalty” under 28 U.S.C. § 2462 and therefore subject to a five-year statute of limitations. As a result of the Court’s decision, the SEC must commence disgorgement actions within five years of the date a claim accrues.
The Kokesh decision will shape the Commission’s investigations going forward and has financial implications for current and prospective defendants. The SEC will no longer be able to pursue ill-gotten gains obtained more than five years before it commences a disgorgement action. This may encourage the SEC to prioritize cases with large prospective disgorgement awards and to request tolling agreements earlier in the investigatory process.
Another pending Supreme Court case that will substantially shape the Commission’s investigations is Somers v. Digital Realty Trust, Inc.3 The issue presented in Somers is whether a whistleblower can invoke the anti-retaliation protections of the Dodd-Frank Act after making an internal report to corporate management but not reporting directly to the SEC, as was held by the Ninth Circuit. If the Court affirms the Ninth Circuit ruling, whistleblowers will continue to catalyze white collar enforcement across the country. If, on the other hand, the Supreme Court moves toward a narrower definition like the Fifth Circuit’s,4 it could interrupt these trends and reduce the role that whistleblowers play in future SEC actions.
In addition to this changing legal landscape, the SEC is adjusting to a new Presidential Administration and new leadership. The Division’s Co-Directors, the SEC Chairman, and much of the senior leadership at the SEC took office during fiscal year 2017. Because of this change in leadership, it is unclear whether 2017’s enforcement trends will continue in 2018. Commissioner Michael Piwowar, for example, discussing the prior leadership’s policy of “broken windows,” characterized that policy as a “misguided effort” that “did not meaningfully improve investor protection.”5 Commissioner Piwowar made clear that “those days have passed.”
Co-Director Peikin has also signaled an end to the broken windows policy. At the Securities Enforcement Forum in Washington, D.C. on October 26, 2017, Peikin said the Division would be more selective in the investigations it opens, deemphasizing industry-wide sweeps and technical violations, and pursuing fewer admissions of wrongdoing during settlement negotiations. Instead, regulators will pursue cases with the goal of sending a broader message to the industry of violations that the Commission takes most seriously.
In addition, Chairman Clayton has stated that SEC action should take account of the cost of compliance, and that vaguely worded mandates often lead to subpar regulatory outcomes.6 These points may signal that the Chairman is moving the SEC away from using enforcement actions to articulate new compliance standards. The SEC’s recent Annual Report, however, is notable in that it did not appear to sound an opening salvo in a fundamental retrenchment of SEC enforcement. Rather, the Co-Directors reaffirmed a strong commitment to SEC enforcement going forward, including against individuals, and announced the realignment of the Division’s priorities to reflect those of the new Chairman.