The SEC’s Enforcement Division had a busy 2019, bringing 862 enforcement actions and obtaining more than $4.3 billion in disgorgement and penalties during its fiscal year. The co-directors said their division’s results were “impressive,” in that they “combatted wrongdoing by holding individuals, issuers, financial institutions, and other entities accountable, and by stripping wrongdoers of their ill-gotten gains,” but also acknowledged some of the procedural challenges the Commission faced as the result of recent court decisions.[1] This year, we expect a similar level of enforcement activity to continue, while the SEC’s tactics will continue to evolve. Our SEC enforcement defense team is watching the following areas in particular in 2020.
Continued focus on investment advisers and issues affecting retail investors
In 2019, there was a 36% increase in the number of enforcement actions against investment advisers.[2] Approximately half of these actions were voluntary self-disclosures through the Share Class Selection Disclosure Initiative, a one-time initiative that is winding up, which suggests that the sharp increase is probably a spike rather than the beginning of a trend. Regardless, investment advisers will likely remain one of the most-common targets of enforcement actions as the SEC continues to prioritize protecting “Main Street” investors. Enforcement Division Co-director Stephanie Avakian recently said that the SEC is actively looking for circumstances where an adviser has a financial conflict due to incentives that could affect investment recommendations to clients. Accordingly, the adequacy of disclosures concerning fees, expenses, and conflicts of interest will be on the SEC’s radar this year.[3]
SEC staff have also suggested that the Commission would consider developing another similar self-disclosure initiative, similar to the Share Class Initiative, to leverage their efforts and resources most effectively.[4] The priorities of the SEC’s Retail Strategy Task Force, which uses data analytics to identify potential wrongdoing to be investigated, could provide some insights into possible areas of focus for the next initiative.
In 2019, the SEC launched its Teachers’ Initiative and Military Service Members’ Initiative in an effort to educate teachers, veterans, and active duty military personnel about investments, as well as fees and expenses. The SEC’s investment of resources in this area suggests that fraud and disclosure violations in retirement programs that are specific to educators and service members could be an area to watch in 2020.
It’s all about cyber and privacy these days
As we kick off 2020, cybersecurity and privacy issues remain at the forefront of our national discourse. The Division of Enforcement’s Cyber Unit was established in September 2017 and focuses on violations involving digital assets, initial coin offerings, and cryptocurrencies; cybersecurity controls at regulated entities; issuer disclosures of cybersecurity incidents and risks; trading on the basis of hacked nonpublic information; and cyber-related manipulations, such as brokerage account takeovers and market manipulations using electronic and social media platforms.[5] The SEC named a new chief of the unit in December, Kristina Littman, and—not surprisingly, given the importance of cybersecurity and data privacy in today’s environment—we expect the unit to be very active in a number of areas in 2020.
It is, of course, not a surprise that the financial markets and financial transactions are a prime target for hackers and other bad actors, and the SEC is focused on combating fraud in this new frontier. The Cyber Unit is also investigating many areas that are more-nuanced. For example, public companies should be prepared for SEC scrutiny into the adequacy and timeliness of their disclosures regarding cybersecurity incidents. With the passage of a U.S. federal privacy law such as Europe’s GDPR looking unlikely in the near future, the SEC is relying on existing laws to take action against companies that fail to maintain comprehensive policies and procedures related to cybersecurity risks and incidents, or that fail to make accurately and timely disclosures of material events related to cybersecurity.[6] The SEC has stated recently that analysis of whether regulated entities are monitoring, managing, and addressing cybersecurity risks appropriately will be a focus of its examination program. The SEC has also warned against selective and misleading disclosures about cybersecurity incidents, and public companies can expect to receive pushback on vague disclosures about incidents, policies, and procedures. The CCPA’s private right of action will add another layer of complexity to companies’ analyses of their disclosure obligations.
We also expect that the SEC will continue to take action against allegedly misleading disclosures and failure to comply with registration requirements for digital assets and distributed ledger technology.[7] Discussion about regulation of these emerging technologies will certainly continue. We will look for more commentary from “CryptoMom” Commissioner Hester Pierce, who said last year that she “does not see a clear path for a functioning token network to emerge given the current regulatory framework.”[8] She supports a non-exclusive safe harbor period within which a token network could blossom without securities laws crushing before it becomes functional, but it’s not clear that other commissioners share that view. Until then, we will continue to analyze enforcement actions, staff guidance documents, and no-action letters to understand the landscape.
Insider trading prosecution strategies will continue to evolve
It is unclear whether the Insider Trading Prohibition Act that was passed by the House late last year will be passed by the Senate and signed by the president. If so, the Act would probably make it easier for the government to bring successful insider trading cases and provide some consistency to market participants who may be confused by the constantly changing goalposts. In our view, whether or not the Act becomes law, the SEC and DOJ will continue to explore new ways to pursue this cornerstone of their securities enforcement agendas.[9]
For example, the Second Circuit recently upheld the insider trading conviction of a healthcare consultant, holding that the personal benefit requirement that has made it harder for the government to prove tipping cases is not necessary to prove in a criminal insider trading case based on the wire fraud statutes.[10] The SEC’s enforcement requirements have not changed because the government still must prove that a tipper breached a duty in exchange for a personal benefit, or that a remote tippee knew of a personal benefit to the tipper in a civil insider trading case. However, the decision could make it easier for the government to bring criminal charges for insider trading than civil charges, which is certainly of concern. We will be watching both the SEC and the DOJ very closely in this area in 2020.
SEC’s authority to recover disgorgement of funds
We are carefully watching the Supreme Court’s upcoming decision in the matter of Liu v. SEC, which addresses whether the SEC has the authority to request “disgorgement” (the return) of money obtained in a fraud involving the securities laws. This decision is highly significant, in our view, because disgorgement is one of the SEC’s most-powerful tools in its enforcement of the securities laws. Disgorgement is a different remedy used by the SEC than penalties: Penalties are specific fines set by statute for certain violations. The SEC typically obtains less money in fines than disgorgement; in 2019, it obtained $1.1 billion in fines versus $3.2 billion in disgorgement from defendants.
While the law clearly provides for the SEC’s power to seek fines, the law is not clear, and some lower courts have questioned, whether the SEC was granted the authority by Congress to recover disgorgement of ill-gotten gains. That is the question that the Supreme Court will take up in Liu v. SEC, which we expect to be heard in mid-March of this year.
If the Court decides that Congress did not authorize the SEC to recover disgorgement, that may lead to a rush of cases in which parties that previously paid disgorgement seek to overturn those prior orders. Congress could pass legislation that expressly authorizes this authority in the SEC, but that new law would not be likely to help the SEC with prior decisions under current law.
Expedited investigations
For the past two years, the Office of the Inspector General has noted that the “timeliness of Enforcement investigations remains a concern.”[11] In fiscal year 2019, approximately 24 months elapsed between case opening and filing of an enforcement action. The SEC is “striving to further lower this metric in Fiscal Year 2020.” In particular, the SEC is focused on expediting investigations in financial fraud and issuer disclosure cases, which took, on average, 37 months from opening to filing in 2019.[12] The speed of the SEC’s investigations is also likely to be affected by the Commission’s choice of forum for the cases it brings in 2020. Given the continued uncertainty after the 2018 Lucia decision,[13] choosing the proper forum may prove difficult for the SEC. We will be watching closely to look for trends.
We anticipate this year to be another active one for SEC enforcement. We will continue to review the SEC’s enforcement actions, guidance, and judicial decisions to identify new trends and practices that affect our clients’ businesses in 2020 and beyond.
- U.S. Securities and Exchange Commission 2019 Division of Enforcement Annual Report.
[Back to reference] - Id.
[Back to reference] - Speech, What You Don’t Know Can Hurt You (Nov. 5, 2019).
[Back to reference] - Speech, Keynote Speech at Southeastern Securities Conference 2019 (Sept. 6, 2019).
[Back to reference] - See https://www.sec.gov/spotlight/cybersecurity
[Back to reference] - See https://www.sec.gov/rules/interp/2018/33-10459.pdf
[Back to reference] - See our prior alert on this topic.
[Back to reference] - Speech, Broken Windows: Remarks before the 51st Annual Institute on Securities Regulation.
[Back to reference] - See our previous alert on this topic here.
[Back to reference] - United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019).
[Back to reference] - https://www.sec.gov/files/Inspector-Generals-Statement-on-the-SECs-Mgt-and-Performance-Challenges-Oct-2019.pdf.
[Back to reference] - SEC annual report at p. 7.
[Back to reference] - Lucia v. SEC, 585 U.S._(2018).
[Back to reference]