Ten Trends in SEC Enforcement Actions

Jonathan N. Eisenberg is partner in the Government Enforcement practice at K&L Gates LLP. This post is based on a K&L Gates publication by Mr. Eisenberg. The complete publication, including footnotes, is available here.

As 2015 winds down, we offer the following observations about ten important trends in SEC enforcement actions.

1. Increased Number of Enforcement Actions

The number of SEC enforcement actions continues to grow. In FY 2015, the SEC filed 807 enforcement actions, of which 507 were independent actions for violations of the securities laws and 300 were either follow-on actions (e.g., seeking bars against individuals based on prior orders) or actions against issuers who were delinquent in making required filings. This was up from 755 enforcement actions in 2014, of which 413 were independent actions, and that in turn was up from 676 enforcement actions in 2013, of which 341 were independent actions. Total monetary relief ordered rose from $3.4 billion in 2013 to $4.16 billion in 2014 to $4.19 billion in 2015.

2. More Broker-Dealer Cases, Fewer Issuer Offering Cases

The current Commission enforcement staff is far more focused on broker-dealers than it is on securities offerings. From FY 2010 to FY 2014, the number of broker-dealer enforcement cases rose from 70 to 166, while the number of issuer offering cases fell from 144 to 81. That’s all the more striking because between 2010 and 2014, the number of initial public offerings increased by 44% from 253 a year to 364 a year while the number of enforcement actions involving offerings fell by roughly the same percentage. Over the same period in which enforcement actions against broker-dealers more than doubled, the number of broker-dealers fell slightly.

3. Reversal of the Trend Towards Directing Contested Cases to Administrative Law Judges

At least for now, the Commission has reversed the trend towards bringing cases administratively rather than in federal court. An October 11, 2015, article in the Wall Street Journal found that in the three months through September 30, 2015, the SEC sent just 11% of its contested cases to administrative law judges, down from 40% in the like period of 2014 and down from nearly 50% in the second quarter of 2015. This probably reflects two factors. First, four decisions have held that the SEC administrative law process is, or likely is, unconstitutional because SEC administrative law judges are “inferior officers” within the meaning of Article II of the Constitution but are not appointed either by the President or the head of the agency, as required for inferior officers. Thus, the SEC runs a substantial risk that decisions by administrative law judges will be found unenforceable. Second, there has been widespread criticism that the administrative process is an unlevel playing field in which the SEC enjoys home court advantage and that SEC administrative law judges almost always rule in the Commission’s favor. In any event, it now appears that the SEC will send more contested cases to federal court. The SEC still prevails in most federal court cases, but federal courts provide a more level playing field and the SEC’s win percentage is less than it is when it litigates administratively.

4. Increased Reliance on Big Data

Over the past few years, the Commission has significantly increased its ability to analyze large volumes of data, especially trading data. Indeed, it surpasses the ability of the firms that it regulates. The Enforcement Division works closely with the recently created Division of Economic and Risk Analysis. In FY 2015, the two Divisions collaborated on over 120 projects involving market manipulation, insider trading, structure products, accounting fraud, and abusive practices by brokerage firms and investment advisers. The Office of Compliance Inspections and Examinations also relies extensively on its ability to aggregate and analyze massive amounts of data in its examination program. It relies on such data to identify firms with aberrant changes in business activities, potential fraudulent or other suspicious activities, migration of bad actor industry participants, and other possible indicia of heightened risk.

5. The Jury Is Out on the Effectiveness of the Whistleblower Program

Among the many changes contained in the 2010 Dodd-Frank Act was a whistleblower provision directing the Commission to make monetary awards to individuals who voluntarily provide original information that leads to successful Commission enforcement actions resulting in monetary sanctions over $1 million. Awards are required to be made in an amount equal to 10 to 30% of the monetary sanctions collected.

Over the past four years, the number of whistleblower tips grew modestly each year, from 3,001 (FY 2012) to 3,238 (FY 2013), to 3,620 (FY 2014), to 3,923 (FY 2015). Since the beginning of the whistleblower program, however, awards have been made only in connection with 16 covered actions. During that same period, the Commission brought over 2,500 enforcement actions. One individual alone submitted 54 non-meritorious claims for whistleblower awards, all of which were denied. Whether the benefits of the program outweigh the distractions from non-meritorious tips remains to be seen.

6. Heightened Risk for Compliance Professionals

Perhaps no issue has provoked more public statements by Commissioners and the staff than its current focus on compliance professionals. In describing its “Accomplishments” between 2013 and 2015, the SEC recently highlighted the actions it has filed against “gatekeepers” to hold them “accountable for the important roles they play in the securities industry.” It described gatekeepers as including “attorneys, accountants, and compliance professionals.” Between 2010 and 2014, the Commission brought over 70 cases against chief compliance officers. Commissioner Gallagher recently dissented from two Commission enforcement actions against chief compliance officers, stating that recent Commission enforcement actions flew in the face of his concern that the Commission should tread carefully when bringing enforcement actions against compliance personnel. Compliance officers are particularly vulnerable because with hindsight one can almost always charge that either an absence of a particular policy or a failure to adequately enforce a policy contributed to the underlying violation. But compliance officers deal with literally hundreds of different policies and procedures, and ensuring that every single procedure is appropriately designed and enforced is not realistic. Chair White and Andrew Ceresney, the Director of Enforcement, have stated that compliance professionals should not fear enforcement “if they perform their responsibilities diligently, in good faith, and in compliance with the law,” but that is little comfort since such judgments are made with hindsight and are often the types of judgments on which reasonable people may disagree. In the abstract, no one need fear enforcement actions if they act diligently, in good faith, and in compliance with the law because there would not be a basis for an enforcement action against anyone in those circumstances. Unfortunately, these statements suggest that most of the current Commission and enforcement staff look at compliance professionals much like they look at any other potential defendant in an enforcement action.

7. Market Structure Issues Continue to Attract Enforcement Attention

As Andrew Ceresney pointed out in a recent speech, the equity markets have been transformed in less than a decade. Less than a decade ago, the New York Stock Exchange handled almost 80% of the volume for stocks listed on the exchange; today it handles less than 15% of that volume. Today’s equity trading volume is divided among 11 separate exchanges and 40 dark pool alternative trading systems. In addition, high frequency trading now accounts for 50% or more of the total market volume. In this new market structure, the Commission’s enforcement program has been highly focused on fairness in trading markets, protection of confidential customer order information, manipulative activities such as spoofing and layering, and policies and procedures to guard against the risks of direct market access, including the risks of coding errors resulting in the transmission of erroneous orders.

8. Unclear Effect of “Broken Windows” Policy

In an October 9, 2013 speech, Chair White announced what became known as the “broken windows” policy, declaring that no infraction is too small to be uncovered and punished and that “it is important to pursue even the smallest infractions.” She stated that violations such as control failures, negligence-based offenses, and violations of rules with no intent requirement are examples of the types of cases that the Commission will bring.

It is unclear what impact, if any, the broken-windows policy has had on the enforcement program because, even before the broken-windows speech, the Commission’s enforcement program was never limited to violations requiring proof of intent. For example, delinquent filing cases would appear to be the quintessential broken-windows type of case. The Commission brought 107 such cases in 2014 (the year following the speech), but in the two full years preceding Chair White’s broken-windows speech it brought 121 and 127 such cases. Thus, the number of delinquent filing cases went down after her broken-windows speech.

The number of enforcement actions increased from 676 in 2013 to 755 in 2014 and 807 in 2015, and that could be because there are more broken-windows cases. But it is equally possible that is because of an increase in other types of cases. For example, the number of market manipulation cases increased from 46 in the year before the broken-windows speech to 63 in the year after, but manipulation cases are the opposite of what might be characterized as broken-windows cases.

One indication of broken-windows cases might be the number of referrals originating from OCIE examinations. In FY 2015, OCIE made 200 enforcement referrals. Still, only a small percentage of OCIE exams result in referrals and the referrals usually involve not minor deficiencies but allegations of fraud, failure to disclose material information, allocation issues, failure to properly value illiquid securities, and breach of fiduciary duty. It is by no means clear that the OCIE enforcement referrals often broken-windows issues.

The average fine per case changed little between 2013 and 2015—it was $5.03 million in FY 2013, $5.5 million in FY 2014, and $5.2 million in FY 2015. That too does not suggest a significant change from of broken-windows cases.

We suspect that the broken-windows policy has had little impact on the aggregate enforcement numbers, but that in select areas—for example, short sale violations and policies and procedure deficiencies—the policy may have resulted in a small number of message cases that might not have been brought in previous years.

9. Admissions in Settlements Remain the Exception Rather than the Rule

In June 2013, the SEC changed its policy and decided to require admissions of wrongdoing in a limited number of settlements. Prior to that, the Commission only required admissions where there was a parallel criminal proceeding that resulted in an admission. Since the change in policy, there have been over 30 enforcement settlements with admissions—a very small fraction of the roughly 700-800 enforcement actions that are brought each year. The Commission sometimes uses admissions in low-culpability cases—for example, when a firm’s “blue sheet” responses were deficient—in order to emphasize the Commission’s concerns in an area. It is a way of bringing more attention to a case that otherwise might not be viewed as noteworthy. In other situations, it requires admissions where it regards the conduct as particularly egregious, but there are plenty of serious fraud cases that the Commission settles without an admission. Unfortunately, despite the staff’s articulation of the factors it considers, there is not a great deal of predictability in this area and, once the staff decides a settlement should require an admission, there is usually little chance it can be persuaded to change its position.

10. The Commission Gives Credit for Self-Reporting, but Don’t Expect a Pass

Andrew Ceresney gave two speeches in 2015 that focused on the credit firms and individuals get for cooperation, by which he mostly meant voluntarily reporting of wrongdoing rather than simply acting cooperatively in the Commission’s investigation. Two key points, however, should be kept in mind. First, it is rare (though not unprecedented) for a cooperator to get a pass in an enforcement action if it is viewed as having engaged in wrongdoing. In most instances, the credit is a lower penalty than the staff says it would otherwise have required to resolve the action against the cooperator. Charges are still brought, disgorgement is required, and a penalty is usually imposed. Second, for a corporation to get cooperation credit, increasingly it needs to identify culpable individuals. These days, the first focus of the SEC and other government enforcement agencies is, “Where were the individuals?” Indeed, the Department of Justice’s recent issuance of the Yates Memorandum makes that explicit in both civil and criminal cases.

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In short, 2015 reveals an aggressive enforcement program, with cases up significantly, a greater focus on gatekeepers and less focus on offering cases, a reversal of the trend towards directing contested cases to administrative law judges, increased reliance on the Commission’s impressive ability to gather and analyze huge amounts of trading and other data, limited impact to date of the whistleblower program, heightened risk for compliance professionals, more enforcement attention to market structure issues, only small changes from the Commission’s “broken windows” policy, very selective use of admissions, credit for self-reporting but mostly in the form of a penalty reduction rather than avoidance of actions altogether, and a continued focus on individual liability

The complete publication, including footnotes, is available here.

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