On April 2 and 3, the U.S. Securities and Exchange Commission (SEC or Commission) presented its annual SEC Speaks program in conjunction with PLI, where senior members of the Commission provided updates on the current initiatives and priorities at the Commission. On April 3, Gurbir Grewal, the director of the Division of Enforcement (Division), and other members of the Division provided insights on the Division’s priorities, their approach to assessing cooperation and penalties, and responded to criticism they have been facing, particularly for regulation by enforcement.

Key Takeaways

• The Division will continue to aggressively focus enforcement action in the cryptocurrency space, where it will continue to rely on the Howey test to assert jurisdiction to bring these cases.
• The Division set out the factors it considers when assessing penalties in enforcement actions resulting from its “recordkeeping initiative” and “amended marketing rule initiative.” Specifically, self-reporting seemed to be the most important and impactful factor influencing the penalty amount. This discussion appeared to be in direct response to criticism that the Division was assessing penalties “at random” and that they were “not informed by individualized determinations.”
• The Division’s other priorities include an emphasis on appropriate and deterrent civil penalties, which appears to mean increased penalties, including executive compensation claw backs and non-monetary penalties, cooperation, gatekeeper accountability, and preventing whistleblower retaliation.

Cryptocurrency

Director Grewal’s comments focused on addressing criticism of the Commission’s ongoing efforts to rein in alleged securities violations in cryptocurrency. He stated that the Division has taken an approach to crypto enforcement actions that “has been consistent, principled, and tethered to the federal securities laws and legal precedent.”[1] He further indicated that the Commission has applied and will continue to apply the Howey test to each set of facts in any given crypto enforcement case.

Director Grewal claimed that notwithstanding the Commission’s consistent application of the Howey test to crypto transactions, the Commission has “confronted significant non-compliance” and faced claims that the Commission was “making it up as we go,” “regulating by enforcement” and “recklessly exceeding our authorities.”[2] Director Grewal characterized these criticisms as “just a backhanded way of saying, ‘[W]e want a different set of rules than those that apply to everyone else.’”[3] Director Grewal stated that from the Division’s perspective, courts have affirmed the Commission’s authority in the crypto markets and the Commission can now “address the very real issues present in this industry that lead to elevated investor risk: fraud, lack of transparency, commingling of assets, conflicts of interest, and lack of oversight,” among other things.[4]

Director Grewal made clear that the Division will continue to aggressively investigate and bring enforcement actions for alleged securities violations in the crypto space, stating: “We remain committed to using all the tools at our disposal to protect the investing public, including against risks in the crypto markets.”[5]

Civil Penalties

In his opening remarks, Sanjay Wadhwa, the deputy director of the Division, addressed criticism that the Commission was assessing penalties “at random” and not assessing civil penalties based on individualized determinations. Deputy Director Wadhwa addressed this criticism specifically in relation to the Commission’s “recordkeeping initiative” and “amended marketing rule initiative.”

The recordkeeping initiative refers to a series of enforcement actions against registrants for failing to maintain and preserve electronic records due to employees engaging in off-channel communications. Since December 2021, the Commission has charged nearly 60 firms with recordkeeping violations, with combined civil penalties of over $1.7 billion. Deputy Director Wadhwa provided clarity and listed the factors the Division will consider when assessing civil penalties in relation to the recordkeeping provisions as:

1. The size of the firm, measured by assessing the firms’ revenues from regulated parts of the business to ensure the size of the penalty is an appropriate deterrent.
2. The scope of the violation, including the number of professionals involved (but because the SEC generally deals with samples in these cases, there is not a strict correlation).
3. The firm’s efforts to comply with recordkeeping obligations and efforts to prevent off-channel communications.
4. Prior case precedent, although it was noted that prior cases are a guide and not determinative.
5. Whether the firm self-reported and cooperated with the Staff.

Deputy Director Wadhwa noted that the most significant factor is self-reporting and that it will “move the needle” with respect to a civil penalty recommendation.

The “amended marketing rule initiative” refers to a series of enforcement actions against registrants for violations of Rule 206(4)-1 under the Investment Advisers Act of 1940 for misrepresenting hypothetical performance of advisory products. With respect to civil penalties assessed against firms for violations of the marketing rule, Deputy Director Wadhwa emphasized that there was an individualized assessment of a civil penalty amount for each firm. The factors the Division will consider when assessing a civil penalty include:

1. A firm’s reported regulatory assets.
2. The nature of the regulatory history of a firm.
3. Whether there was prompt remediation.
4. The need to send a strong message of accountability and deterrence.
5. Whether a firm self-reported and cooperated with the Staff’s investigation.

Other Division of Enforcement Priorities

The larger panel of the Division Staff members reiterated the Division’s focus on effective penalties, gatekeeper accountability, the emphasis on cooperation with Staff in investigations and preventing whistleblower retaliation, among other things.

Of note is the Commission’s renewed emphasis on executive compensation claw backs. From the Division’s perspective, the claw back of executive compensation incentivizes CEOs and CFOs to implement robust internal controls and to encourage a culture of compliance. Importantly, the claw back amount is not limited to the “fraud delta,” but rather the Commission will seek to claw back the full amount of compensation, regardless of whether the executive engaged in the misconduct.

The Commission continues to emphasize that it is recommending penalties that are meaningful and adequate to provide deterrence and are not just “the cost of doing business.” The Division believes that nonfinancial relief, such as requiring affirmative steps to establish policies and procedures to prevent future violations or bringing in consultants to design policies and procedures, can be the most effective form of deterrence. The Division also noted that it may require specific admissions of wrongdoing when appropriate.

Consistent with previous statements by the Commission, Staff members affirmed that cooperation is key in the assessment of penalties. To maximize cooperation credit, companies and individuals should cooperate out of the gate. Forms of cooperation include providing documents that the Staff otherwise would not be able to compel, conducting an internal investigation and providing the results to the Staff, producing privileged documents, translating documents when necessary, and providing helpful financial analyses or compilations of key documents. The Staff will not consider subpoena compliance or providing truthful testimony for purposes of granting cooperation credit. When evaluating what type of cooperation credit an individual will receive, the Commission considers the value of the cooperation, the significance of the matter, the potential need to hold the cooperator accountable and whether the cooperator is a recidivist. With respect to corporate cooperation credit, the Division pointed to the factors set forth in the Seaboard Report.[6]

The Division’s Chief Enforcement Accountant Ryan Wolfe asserted that gatekeeper accountability is also an enforcement priority. Wolfe stated that accountants, auditors and assurance providers are fundamental to the capital markets and are critical gatekeepers. Despite uncertainty in the courts, the Commission will not retreat from holding gatekeepers accountable, including accounting and auditing firms of all sizes.

Also of note is the Division’s continued emphasis on preventing whistleblower retaliation. The Division Staff stated they continue to see violative provisions in separation agreements and confidentiality agreements that impede individuals from speaking with the Commission despite eight years of enforcement actions. The Staff emphasized that confidentiality provisions are permissible provided they make clear that they do not apply to communications with the Commission. The Staff specifically highlighted that companies should not require individuals to forgo financial compensation if they make a report to the Commission and should not require that individuals notify a company either prospectively or retrospectively that they have been in contact with the Commission.

Conclusion

The Division is expected to continue aggressive enforcement in the cryptocurrency space, against gatekeepers for alleged whistleblower protection violations and for alleged recordkeeping and marketing rule violations. Significantly, with regard to cryptocurrency, the Division’s view is that the courts have answered many of the legal questions raised by the defense bar. Current litigations indicate that the defense bar disagrees. The Division is also focused on the deterrence effect of penalties, in terms of both executive compensation claw backs and ensuring penalty amounts are large enough to serve that purpose. The Commission Staff’s focus on cooperation credit and factors impacting penalty assessment are important issues to consider when faced with SEC investigations and enforcement actions. 

[1] Gurbir S. Grewal, Remarks at SEC Speaks 2024 (Apr. 3, 2024), https://www.sec.gov/news/speech/gurbir-remarks-sec-speaks-04032024?utm_medium=email&utm_source=govdelivery#_ftnref25.

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Release No. 44969 (Oct. 23, 2001), https://www.sec.gov/litigation/investreport/34-44969.htm.

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