By Anne Sherry, J.D.
Highlights of the SEC’s enforcement program for fiscal year 2019 included the Share Class Selection Disclosure Initiative, an emblem of the agency’s focus on retail investors under Chairman Clayton’s leadership, said former SEC officials at a Securities Docket webcast. The panelists also offered insights into the whistleblower program, cybersecurity, and internal controls before looking ahead to next year.
The panel featured Bill McLucas, who was the Director of the Division of Enforcement for eight years in the 1990s, the longest tenure in that role in the SEC’s history. Doug Davison is a former Enforcement supervisor and counsel to Chairman Arthur Levitt. Martin Wilczynski was with the SEC for six years, five of those within Enforcement, and Steven Richards was an assistant chief accountant in the Division as well as an advisor to the PCAOB’s enforcement director and its chairman.
A big year for enforcement. Summarizing the SEC’s enforcement activity during the last year, McLucas first noted that the Division’s co-directors, Stephanie Avakian and Steven Peikin, believe the best measure of efforts is the quality and nature of enforcement cases rather than the bare numbers. However, he said, when the fiscal year-end approaches, other departments of the SEC take an interest in the numbers. By this measure, the enforcement program was quite active in 2019, with an increase both in the number of actions and the amount of disgorgement and penalties. McLucas emphasized that the increase occurred despite the Supreme Court’s decision in Kokesh restricting disgorgement and the SEC’s 35-day closure due to the government shutdown.
McLucas observed that the increase may in part be due to an emphasis by the agency on accelerating the pace of investigations and resolutions. He believes that this is a healthy approach because speed and finality are usually good for a respondent or the subject of an investigation. The Division also expects to see an increase in its appropriation and the lifting of its two-year hiring freeze, both of which suggest an active year ahead in 2020.
A win-win self-disclosure program. Davison emphasized the success of the SEC’s Share Class Selection Disclosure Initiative, which encouraged 95 investment advisory firms to come forward and return $135 million to advisory clients. The program made a lot of sense even from a defense perspective, he said: there was a defined process, a standard settlement procedure, and no civil penalties. He relayed that Peikin was surprised by the success of the initiative and said that a few broker-dealers even tried to apply even though the program was limited to investment advisers.
McLucas said the response was similar to an initiative in the mid-1970s through which hundreds of public companies came forward to admit to making illicit payments overseas or to domestic political candidates. This resulted in a report to the Senate Banking Committee that was the predicate for the Foreign Corrupt Practices Act. Davison added that given the success of the latest initiative, there may be something new in the coming year. Although both Enforcement directors have said they don’t have anything in mind, Avakian also said that they are looking at other undisclosed conflicts like sweep arrangements, unit investment trusts, and teacher retirement plans. This may suggest that the Commission is taking efforts to protect groups such as the military and teachers and to use enforcement matters as teaching tools.
Cybersecurity. Another focus in 2019 was cybersecurity, Davison said. He said the Commission tends to view an issuer as a victim in the event of a cyber attack and will only take enforcement action where it’s warranted, such as when Yahoo failed to disclose what was at the time the largest cyber breach, despite having known about it for years. Although not related to cybersecurity, the SEC’s case against Facebook last year is instructive in terms of the company’s disclosure: it was misleading, in the SEC’s view, to talk about the risk of misuse of personal data in terms of hypotheticals when the company knew that data had in fact been misappropriated and misused. Finally, Davison said that the SEC’s report of investigation at the very beginning of FY2019 is worth a read because it describes internal control failures that allowed bad actors to misappropriate funds by posing as corporate executives or as vendors. The Section 21(a) report allowed the SEC to educate issuers without taking specific enforcement action.
The whistleblower program. Wilczynski observed that the number of whistleblower tips dropped slightly in the past year and the number of awards as well. While he said there was no question that whistleblowers have an impact on enforcement, there is some criticism that the process for whistleblowers and their counsel takes too long—as long as 8 years. McLucas called himself "at a minimum a skeptic" of the whistleblower program and said he would like to see a cost-benefit analysis. After the Madoff scandal, he said, SEC staff live in fear of missing something, so there is an obligation to track down every tip, and there are thousands of tips every year. He called the award program a self-fulfilling prophecy because by offering an incentive, the SEC gets more and more tips, and only a fraction of them are actionable. Wilczynski said that at least in some cases, the staff can do a bit more investigation and then close out the inquiry if there is not enough to it, saving themselves from investing a lot of time chasing a lead.
What to watch for 2020. Looking forward to fiscal year 2020, the panelists discussed the future of the disgorgement remedy and other potential legislative acts. McLucas said that the Supreme Court’s decision in Liu v. SEC will likely be a close case, but no matter what side the Court comes out on the availability of disgorgement in district courts, there will likely be a legislative fix. Speaking of legislation, the Insider Trading Prohibition Act passed overwhelmingly in the House. There is a good chance some legislation will come out, McLucas said, adding that it’s curious that securities law should be the basis for agreement within Congress.