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SEC’s Division of Enforcement Issues Annual Report SEC’s Division of Enforcement Issues Annual Report

SEC’s Division of Enforcement Issues Annual Report

On November 6, the U.S. Securities and Exchange Commission’s (“SEC”) Division of Enforcement (“Division”) released its 2019 Annual Report (“Report”).[1] Despite facing what the Report calls “significant headwinds,” the SEC stepped up its enforcement activity for fiscal year 2019, including obtaining a sizeable increase in the amount of money recovered. This increase in enforcement activity is noteworthy considering the impact of a 35-day long government shutdown, as well as two recent Supreme Court decisions—Kokesh v. SEC[2] and Lucia v. SEC[3]—which have affected the SEC’s ability to seek disgorgement and have required new hearings in some of its prior administrative proceedings, respectively. The results are somewhat less impressive, however, in light of the SEC’s Shareholder Class Initiative, which itself accounts for 95 standalone actions. Nonetheless, with the SEC’s two-year long hiring freeze lifted in April 2019 and a number of Division positions now filled, we can expect that enforcement efforts will remain active in the year ahead.

With regard to enforcement priorities, Division co-directors Stephanie Avakian and Steven Peikin continued to emphasize some of the same key themes from last year, including protecting retail investors and holding individuals accountable. Notably, this year’s co-directors’ message also focused on “matured and expanded” enforcement activities in the digital asset space, including the SEC’s first charges for the unlawful promotion of an Initial Coin Offering, as well as several settlements and litigation against issuers of digital assets for failure to adhere to registration requirements. The co-directors also highlighted several areas of continued focus, including coordination with law enforcement, accelerating the pace of investigations, messaging credit for cooperation, and streamlining and accelerating the evaluation of whistleblower award claims.
The Report highlighted the five key principles, which were first introduced in 2017: (1) focus on the retail investor; (2) focus on individual accountability; (3) keep pace with technological change; (4) impose remedies that most effectively further enforcement goals; and (5) constantly assess the allocation of the Division’s resources. In addition to these key principles, the Report noted the Division focused its resources on two key priority areas in 2019: retail investor protection and combating cyber threats. In view of those key principles and priority areas, we have highlighted our key takeaways from this year’s Report.

Increased Enforcement Activity, Especially Monetary Relief

The Division brought 862 enforcement actions in fiscal year 2019—up from 821 actions last year. This is despite last year’s shutdown of the federal government, which lasted 35 days and resulted in nearly a complete cessation of all SEC activities. As the Report acknowledges, the increased activity is due, in part, to the self-reporting nature and accelerated resolution process of the Share Class Initiative, which is discussed further below. When accounting for the 95 actions brought under this initiative, the number of standalone cases brought by the SEC is actually lower than in fiscal years 2015 through 2018.

Also notable is the 10% increase—$404 million—from last year in the amount of money recovered by the SEC through enforcement actions. Of this total, nearly $3.25 billion was obtained through disgorgement of ill-gotten gains, and $1.1 billion was in the form of penalties imposed. This increase is even more significant than it initially appears, as last year’s monetary relief figure was heavily skewed by one settlement—Petrobras—a Foreign Corrupt Practices Act case for which the SEC obtained $933 million in disgorgement and $853 million in penalties. 

Finally, the amount of money returned to harmed investors increased dramatically—from $794 million in 2018 to nearly $1.2 billion in 2019. This is also partially attributable to the Shareholder Class Initiative, since most of the money recovered through that initiative went directly to harmed investors.

Protecting Retail Investors Remains a Top Priority

Protecting retail investors remains a top enforcement priority for the Division, which devoted significant resources to this effort in 2019. Essential to this focus is the SEC’s securing of 95 settlements—79 settlements in March 2019 and another 16 in September 2019—as a result of its Share Class Selection Disclosure Initiative.[4] Under this program, first announced in February 2018, the Division agreed to recommend standardized settlement terms for investment advisory firms that self-reported failures to disclose conflicts of interest associated with the selection of fee-paying mutual fund share classes when a lower- or no-cost share class of the same mutual fund was available. In 2019, these 95 investment advisory firms that voluntarily self-reported to the Division were ordered to return a total over $135 million to affected mutual fund investors, the majority of whom are retail investors. 

Focus on Investment Advisory and Investment Company Issues

As a result of the Share Class Selection Disclosure Initiative, the majority of the SEC’s standalone cases in 2019 concerned investment advisory and investment company issues, which, as expected, represents a notable change from last year. In 2018, 22% of the SEC’s actions involved investment advisors and investment companies; in 2019, that number jumped to 36%. 

Securities offerings (21%) and issuer reporting/accounting and auditing (17%) represent the next highest proportion of enforcement actions. Other actions comprised a relatively small proportion of the Division’s enforcement actions: broker-dealers (7%), insider trading (6%), market manipulation (6%), Foreign Corrupt Practices Act (3%), and public finance (3%).

Importance of Whistleblowers

The Report once again touted the success of its whistleblower program, noting the SEC received a record number of whistleblowers complaints in 2019. According to the Report, the SEC’s whistleblower program has led to more than $2 billion in financial remedies since its inception in 2011. The Report also acknowledged that the SEC has been working to streamline and substantially accelerate the evaluation of claims for whistleblower awards in the next year.

Continued Focus on Individuals

The SEC continued its focus on individual accountability, which the Report called its “most effective method of achieving deterrence.” In 2019, 69% of the SEC’s standalone actions involved charges against one or more individuals,[5] which is in line with the results of the last several years. The individuals charged include those at the top of the corporate hierarchy, such as CEOs, CFOs, and COOs, as well as gatekeepers, such as accountants, auditors, and attorneys.

SEC’s Evolving Approach to Digital Assets and Cyber-Related Misconduct

Two years ago, the Division established the Cyber Unit to combat cyber-related threats by focusing on violations involving distributed ledger technology, cyber intrusions, and hacking to obtain material, nonpublic information.[6] The Report highlights the efforts of the Cyber Unit, which contributed to the investigation and filing of several significant cases in these areas. In particular, the Division settled three actions charging Initial Coin Offering issuers with violations of the registration requirements. In addition, the SEC brought a number of digital asset-related enforcement actions under the anti-touting, broker-dealer registration, and exchange registration provisions of the securities laws. The Report further indicated, in the context of digital assets, that the SEC continues to pursue issuers suspected of fraudulent conduct, suggesting we can expect one or more enforcement actions that address fraudulent conduct in the digital asset space. 

In addition to Initial Coin Offerings and digital assets, the Report described its focus on cybersecurity threats to public companies and regulated entities, highlighting actions finding violations of Regulation Systems Compliance and Integrity (Reg SCI). The Report also made special mention of its investigations into “business email compromises,” which ultimately led the SEC to issue a report to issuers warning that cyber-related threats of spoofed and manipulated electronic communications should be considered when devising and maintaining a system of internal accounting controls.[7]
Finally, the Report brought attention to its use of technology to investigate unlawful trading. It specifically noted that, in 2019, the SEC brought significant trading-related cases that may not have been possible without its ability to analyze voluminous amounts of data. In particular, the SEC acknowledged that one case, which was filed against nine defendants who allegedly hacked into the SEC’s EDGAR system and extracted nonpublic information for use in illegal trading, would likely not have been possible to bring just a few years ago due to the geographical dispersal and technological sophistication of the perpetrators. As the SEC embraces more sophisticated use of technology, we anticipate that its ability to investigate wrongdoing will likewise become more sophisticated.
A Mixed Bag—Both Challenges and Opportunities for the SEC

The SEC also continues to discuss the impact of Kokesh v. SEC, a 2017 Supreme Court decision holding that the SEC’s claims for disgorgement are subject to a five-year statute of limitations, that it reports has caused the agency to forgo at least $1.1 billion in disgorgement. We will be watching the disgorgement issue closely, as the Supreme Court recently granted certiorari in Liu v. SEC, a case that challenges the SEC’s long-held position that it has authority to seek disgorgement for securities laws violations as a form of equitable relief. A ruling against the SEC could have a significant impact on the SEC’s enforcements efforts. The Report makes no mention of this case. 

It is possible that the uptick in enforcement activity will continue next year in light of the lifting of the hiring freeze. On April 1, 2019, the more than two-year long agency-wide hiring freeze was lifted, and the Division was allocated 22 new slots, which the Report says enabled the Division to begin to rebuild staffing levels that were lost during the hiring freeze. Fifteen new staff joined the Division in 2019. 

For more information, please contact Tim Belevetz, Meredith Wood or another member of our White Collar Defense & Investigations team.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
[2] 137 S. Ct. 1635 (2017).
[3] 138 S. Ct. 2044 (2018).
[5] The Report notes that this figure excludes the actions brought under the Share Class Initiative, which applied only to entities.
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