28 March 2016
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Securities
Enforcement
Thirteen Observations About the SEC’s Enforcement
Program
U.S. Government Enforcement Alert
By: Jon Eisenberg
Over the last two months, the SEC issued two reports that provide useful perspectives on its
enforcement program. In February, it issued the combined 136-page “FY 2017
Congressional Justification & FY 2015 Annual Performance Report and FY 2017 Annual
Performance Plan.” In March, it issued its “SEC Accomplishments: April 2013 – March
2016.” We glean the following important lessons from these reports:
1.
The Commission Brought a Record Number of Enforcement Actions in 2015. In
2015, the SEC brought 507 standalone enforcement actions, a record number, plus
300 additional follow-on and delinquent filing actions.
2.
The SEC Obtained Relief in 95 Percent of Its Enforcement Actions: In fiscal year
(“FY”) 2015, the SEC obtained relief in 95 percent of the cases that it brought, which
matched the highest SEC success percentage in at least the past five years. The
report does not break out the SEC’s record in contested cases, which constitute a very
small but important percentage of the cases brought. The Commission, however, is
successful in most contested cases as well.
3.
The Commission Obtained Orders for $4.2 Billion in Disgorgement and Penalties
But Distributed Only $158 Million to Investors. The SEC obtained orders for $4.2
billion in monetary relief in FY 2015, which consists of both disgorgement and
penalties. It only distributed, however, $158 million to investors in FY 2015. Some of
the explanation is that penalties are not earmarked for investors, the SEC only
collected 46 percent of the amount ordered ($1.935 billion collected vs. $4.195 billion
ordered), and there is a lag in distributing Fair Funds to investors — for instance, the
SEC reports that in FY 2015 96 percent of Fair Funds were distributed within 24
months of the approval of a distribution plan but does not state how long it took to
obtain approval of the distribution plans. Still, the discrepancy is puzzling when one
considers that in FY 2014, the SEC distributed $424 million and in FY 2012 it
distributed $815 million. The $158 million distributed in FY 2015 was by far the lowest
amount distributed since the SEC began reporting distributed amounts beginning with
FY 2012.
4.
One Quarter of the Commission’s Enforcement Actions Resulted from National
Priority Investigations. In 2015, 25 percent of enforcement actions resulted from
investigations that the Commission described as “high impact” or “national priority.” In
the prior four years, that number ranged from 10 percent to 20 percent. On the other
hand, that means that in FY 2015, the high-water mark for national priority enforcement
actions, 75 percent did not involve matters that 1) present an opportunity to send a
particularly strong and effective message of deterrence; 2) involve particularly
egregious or extensive misconduct; 3) involve potentially widespread or extensive
Thirteen Observations About the SEC’s Enforcement Program
harm to investors; 4) involve misconduct by persons occupying positions of substantial
authority or responsibility or who owe enhanced duties to investors; 5) involve potential
wrongdoing prohibited under newly-enacted legislation or regulations; 6) concern
misconduct in connection with products or practices and pose particularly significant
risks for investors or a systemically important sector of the market; 7) involve a
substantial number of potential victims and/or particularly vulnerable victims; 8) involve
products, markets, transactions, or practices that the Enforcement Division has
identified as priority areas; or 9) provide an opportunity to pursue priority interests
shared by other law enforcement agencies on a coordinated basis. The SEC has
another category of enforcement actions — actions involving “enhanced risk”
misconduct — that, in addition to the “national priority factors,” includes factors such as
1) the conduct was identified through risk analytics, 2) the misconduct was difficult to
detect, or 3) the Commission used innovative investigative or analytical techniques.
Fifty-eight percent of the Commission’s investigations involved such “enhanced risk”
conduct.
5.
Ten Percent of Investment Advisers, 15 Percent of Investment Companies, and
50 Percent of Broker-Dealers Were Examined in FY 2015. In FY 2015, the
Commission examined 10 percent of investment advisers and 15 percent of investment
companies, and either the Commission or FINRA examined 50 percent of the brokerdealers. The Commission is seeking 127 new positions for the National Examinations
Program, of which 102 would be devoted to improving coverage pertaining to
investment advisers and investment companies. It states that investment adviser
examinations will increase from 1,221 in FY 2015 to 1,550 in FY 2017, that brokerdealer examinations will increase from 484 in FY 2015 to 548 in FY 2017, and that
Technology Controls Program Inspections will increase from 20 in FY 2015 to 115 in
FY 2017. While the number of examinations of investment companies is not expected
to increase, the Commission states that it will focus, in particular, on investment
companies’ use of alternative investment strategies, significant growth in certain types
of funds (such as exchange-traded funds), and the relative riskiness of certain funds,
including fixed income funds, that may be affected by rising interest rates.
6.
Eleven Percent of Examinations Resulted in Referrals to Enforcement. In FY
2015, 11 percent of examinations resulted in referrals to enforcement. Fortunately, this
means that despite the Commission’s “broken-windows” policy, most deficiencies
identified in examinations do not result in referrals to enforcement. In FY 2015, 77
percent of examinations identified deficiencies and 31 percent identified “significant
findings” of deficiencies.
7.
The Average Time between the Commencement of an SEC Investigation and the
Filing of an Enforcement Action Is 24 Months: In FY 2015, the average time
between opening a matter under inquiry and commencing an enforcement action was
24 months. One of the defense bar’s objections to the SEC’s process is how little time
is given for defense counsel to try to convince the SEC not to bring a case. In contrast
to the roughly two years that the staff often takes to complete its investigation and
formulate a recommendation, the staff normally grants defense counsel only two
weeks (often extended to four weeks) to file a “Wells Statement” responding to the
staff’s recommendation. Assuming one month to file a Wells Statement, that means
that on average 96% of the investigation is devoted to the staff’s development of its
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Thirteen Observations About the SEC’s Enforcement Program
case, and 4% is allocated to defense counsel to prepare a response. Unfortunately,
that may suggest that the staff places little value on the Wells process.
8.
The SEC Shares Investigative Materials Widely with Other Enforcement
Authorities. In FY 2015, the SEC shared information about 498 investigations with
other enforcement authorities. Beyond that, the SEC provided cooperation in response
to 531 requests from foreign authorities, and itself made 929 requests for cooperation
to foreign authorities. In FY 2015, 134 criminal actions were brought in connection with
conduct investigated by the SEC. Cooperation among enforcement agencies has
been a fixture for many years and comes as no surprise. Many financial institutions,
which have borne the brunt of multi-agency investigations in recent years, object not
that regulators cooperate in their investigations, but that often multiple regulators
investigate, and seek multiple penalties for, identical conduct. In this respect, the U.S.
is unique — to our knowledge, no other country has anything close to the same
number of enforcement authorities with overlapping jurisdiction over identical conduct.
9.
The Principal Accomplishments of the Enforcement Program. The Commission
states that the principal accomplishments of the enforcement program include, among
others, the following: 1) bringing a record number of standalone actions; 2) obtaining
orders for disgorgement and penalties of approximately $4.2 billion; 3) implementing
an admissions policy; 4) maintaining a strong litigation record in contested cases; 5)
awarding tens of millions of dollars to whistleblowers; 6) developing models and data
analytic techniques to aid in uncovering misconduct; 7) bringing significant actions
involving dark pools, high frequency trading, spoofing, and other market structurerelated actions; 8) holding gatekeepers accountable; 9) bringing a wide range of
actions against investment advisers, investment companies, and participants in
municipal bond issues; and 10) enhancing the Enterprise Data Warehouse, which
combines data from electronic filings, exam reports, and investigations into a
centralized database allowing for the application of enhanced analytical capabilities.
10.
Key Challenges Facing the Enforcement Program. Among the challenges that the
Commission states that the enforcement program faces are: 1) the increase in the
number of enforcement actions and the number of trials; 2) the Commission has
obtained admissions in over 30 actions and that trend may lead to more litigation; 3)
the Commission is receiving more whistleblower tips than ever (in FY 2015, it received
approximately 4,000 tips, complaints, and referrals from whistleblowers); 4) the
fragmented and complex equity markets, including high-frequency trading, complex
algorithmic trading, and off-exchange trading venues, have made unlawful trading
strategies increasingly complex and difficult to identify; 5) the Commission is hosting
nearly 525 terabytes of electronic data in connection with its investigations and that is
continuing to grow; and 6) the Commission needs additional resources to focus on
high-priority areas.
11.
For FY 2017, the SEC Is Seeking an Enforcement Budget 12 Percent Higher than
Its FY 2015 Enforcement Budget. For FY 2017, the SEC is seeking an enforcement
budget of $543.2 million, up 12 percent from $485 million in FY 2015 and 6 percent
from $513 million in FY 2016. That reflects roughly 8 percent more enforcement
employees (1,435) compared to FY 2015 (1,331) and 4 percent more than in FY 2016
(1,376).
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Thirteen Observations About the SEC’s Enforcement Program
12.
Enforcement Priorities. The Commission states that it needs additional staff to
litigate the growing number of contested cases and that it needs sophisticated
technology tools, as well as the ability to continue devoting investigative resources to
high-priority areas, such as accounting and reporting fraud and market structure cases.
The Commission’s enforcement priorities include financial reporting, accounting fraud,
improper conduct by key market participants, and illegal practices by broker-dealers
and investment advisers. It is also particularly focused on insider trading, violations of
the Foreign Corrupt Practices Act, and misconduct related to complex financial
instruments.
13.
Morale at the Commission Has Improved. In FY 2015, the SEC was ranked 10th
out of 24 mid-sized federal agencies in an Office of Personnel Management survey of
employee morale and employee engagement. That was up from 27th in a similar
survey conducted in FY 2011 and 14th in FY 2014. SEC turnover in FY 2015 was only
6.2 percent, which the report states reflected an increase in employee retirements
offset by decreases in voluntary resignations and transfers to other federal agencies.
In short, the Commission is bringing a record number of cases, obtaining orders for large
amounts of penalties and disgorgement, planning to increase the number of examinations of
investment advisers and broker-dealers, cooperating with other U.S. and non-U.S.
enforcement authorities, maintaining a strong litigation record, continuing to insist on
admissions in a significant number of cases, increasingly relying on sophisticated data
analytics to analyze huge amounts of data, and receiving more whistleblower tips than ever.
Its enforcement priorities going forward include accounting and reporting fraud, market
structure cases, and improper conduct by key market participants, including illegal practices
by broker-dealers and investment advisers. Employee morale is also up significantly. On
the less positive side, 1) it distributed far less to investors in FY 2015 than in prior years, 2) it
took an average of two years to complete its investigations but typically only allowed defense
counsel two to four weeks to respond to its enforcement recommendations, 3) it said nothing
about addressing the risk of regulatory multiplicity in its investigations, and 4) while it brought
a record number of “national priority” investigations in FY 2015, for 75 percent of the cases
that it brought, it devoted its limited resources to cases that did not involve a single one of
the nine factors that broadly define a national priority investigation.
Author:
Jon Eisenberg
jon.eisenberg@klgates.com
+1.202.778.9348
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Thirteen Observations About the SEC’s Enforcement Program
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