By John Filar Atwood
The SEC’s Division of Enforcement has tried to take a measured approach to enforcement in the crypto asset space in order to address violations without stifling innovation, according to co-directors Stephanie Avakian and Steven Peikin. The division’s cyber unit is closely watching the space, and looking for situations where investors do not have adequate disclosure about crypto products, they said at Practising Law Institute’s conference on securities regulation.
Peikin said the crypto cases generally involve outright fraud, where entities do not have the product they claimed to have, or trading suspensions because there was not enough information about the product in the marketplace. The staff also is beginning to bring actions for regulatory violations such as a failure to register, such as the December 2017 case against Munchee Inc., which was selling digital tokens through unregistered offers and sales.
More recently, the division has started cracking down on the operation of unregistered digital exchanges, Peikin said. He cited the first unregistered exchange case brought last week against an individual that operated EtherDelta, an online platform that had executed more than 3.6 million orders for tokens over an 18-month period.
Given the uncertainty surrounding regulation of the digital asset space, Peikin was asked if the Enforcement Division is engaging in regulation by enforcement. He said the staff is sensitive to that concern, but argued that the division’s work in this area has been incremental and has progressed logically. As evidence, he cited the decision to issue a Section 21(a) report in the DAO investigation instead of bringing an enforcement action, and the decision not to impose penalties on Munchee because it quickly and fully cooperated and gave all of the money back. Those were responsible approaches to the two cases, in his opinion.
Supreme Court decisions. Avakian and Peikin also discussed the impact on enforcement of the Supreme Court decisions in Kokesh v. SEC and Lucia v. SEC. In Kokesh, the Supreme Court ruled that the SEC’s imposition of disgorgement constitutes a penalty and, as a result, is subject to a five-year statute of limitations. In Lucia, the Court determined that administrative law judges are officers of the U.S. and so must be appointed by the full Commission.
Peikin said that Kokesh has had a dramatic impact on the division, noting that it has had to forego about $900 million in disgorgement. The staff is more thoughtful about case selection because of Kokesh, he added, and looks at the age of a case before deciding whether to proceed.
Avakian agreed, saying that if misconduct in a pending case is four years old, the enforcement staff may bypass it. However, if the fraud in the case is ongoing, then the division will certainly take action, she stated. If the agency is only going to get an injunction and no remedies at the end of a case, it is hard to decide it is worth the resources, she said. The staff is not at a loss for cases, she added, noting that it received 20,000 tips and referrals last year, and so must choose where to put its resources.
Lucia also has had a measurable impact on the SEC’s enforcement program, according to Avakian, who noted that more than 200 cases came back to the division because of the ruling. She said the staff will work through those cases over the coming year, and may have to use a significant amount of litigation resources to retry some of them. She believes that the backlog caused by Lucia should clear out it about a year.
2018 annual report. The Enforcement Division released its fiscal 2018 annual report recently, and Avakian said observers should not read too much into the decrease in the number of financial fraud cases during the past year. Fraud cases remain a high priority for the staff, she insisted, citing the litigation in significant cases such as those against Theranos and Rio Tinto.
Peikin emphasized the importance of the share class selection disclosure initiative that the staff implemented last February. Under the program, the staff agreed to recommend favorable settlement terms for investment advisers that self-reported their failure to make required disclosures relating to their selection of mutual fund share classes that paid the adviser a fee when lower-cost share classes were available.
It was a big concession by the division not to pursue these cases, Peikin said. However, the initiative generated dozens of reports that will allow the Commission to return money to investors. The conduct involved is extraordinarily hard to detect, he noted, so the self-reporting program was a huge help to the division.
Avakian said the enforcement staff tries to be as responsive as possible, while managing the work in a way that enables the division to pivot to a new case if necessary. Peikin noted that the staff works through tips and referrals as quickly as possible. The division will not make the right call every time about whether to pursue a particular matter, he said, but it tries to get the important ones right.