Since the outbreak of COVID-19, the U.S. Securities and Exchange Commission and FINRA have led the way among regulators in providing guidance and relief to market participants as the financial industry continues to confront the unprecedented challenges created by the pandemic. In a series of separate recent market discussions, SEC Division of Enforcement Co-Director Steve Peikin, FINRA Enforcement Department Head and EVP Jessica Hopper, along with FINRA’s Chief Legal Officer and senior executives in FINRA’s Member Supervision and Market Regulation teams, provided important updates to the industry on their respective efforts to continue to regulate effectively in the face of the current market.
On May 12, 2020, Co-Director Peikin discussed in his keynote address at the Securities Enforcement Forum West 2020 Program how the SEC Enforcement Division is responding to the crisis, including by forming a Steering Committee to coordinate the Division’s response to coronavirus-related enforcement issues, proactively identify and monitor areas of potential misconduct, ensure appropriate allocation of resources, avoid duplication of efforts, coordinate the response with other state and federal agencies as appropriate, and ensure consistency in how the Enforcement Division addresses coronavirus-related matters. Co-Director Peikin also discussed the Division’s efforts to provide meaningful guidance to the regulated community with respect to areas of potential focus, such as insider trading and corporate disclosures, and the Division’s concern for meaningful disclosure to retail investors in the municipal securities market.
On May 19, FINRA EVP Hopper; Bari Havlik, EVP, Member Supervision; Thomas Gira, EVP, Market Regulation; and Robert Colby, EVP and CLO, participated in a webcast hosted by SIFMA. They discussed FINRA’s enforcement and other regulatory priorities, including improving coordination and transparency in its enforcement efforts, use of market and data analytics to detect potential wrongdoing, and implementation, examination and potential enforcement of impending Regulation Best Interest (Regulation BI).
Although there is no debate that the pandemic has caused great disruption — to industry and regulator alike — the regulators left little doubt that they are moving full steam ahead with their enforcement efforts and regulatory priorities. They also conveyed a consistent message that, now more than ever, intra-agency teamwork and collaboration, as well as coordination between the SEC and FINRA, is critical to fulfilling their overarching mission to protect investors.
Regulator Responses to COVID-19 and Enforcement Priorities
In his keynote address, Co-Director Peikin assured the industry that the Enforcement Division, although working remotely like so many others, remains open for business. He dismissed any idea of a “blanket hiatus in investigations or litigation,” and emphasized that the Staff will go forward with recommending enforcement actions to the Commission and will do everything it can to preserve all available remedies in light of statute of limitations issues that may arise during this unprecedented time. Nevertheless, Co-Director Peikin recognized that everyone in the industry is confronting many of the same difficulties. As a result, he has directed the Enforcement Staff to work fairly with the people and entities who are on the other side of investigations to reach reasonable accommodations wherever possible, while at the same time cautioning that using the crisis as a cover for gamesmanship will not be permitted.
In addition to continuing to pursue its general enforcement priorities, Co-Director Peikin highlighted the Enforcement Division’s efforts to combat the basic and brazen frauds that one might expect to emerge during a crisis, noting particular attention to combating microcap fraudsters looking to turn a quick profit by making “specious claims of treatments, disaster-response capabilities, and the like.” Co-Director Peikin assured the public that the SEC has tools in place to dismantle such obvious and predatory frauds. He noted that the SEC had suspended trading in the securities of 30 issuers since Feb. 7 due to concerns about the accuracy of coronavirus-related information and had pursued investigations on an expedited basis.
Co-Director Peikin also highlighted concerns about issuers who, although not part of the industries directly affected by COVID-19, may nevertheless experience financial pressure as the economic effects of the crisis mount. He noted that in his experience economic downturns like the one caused by COVID-19 can expose “pre-existing accounting or disclosure improprieties,” or tempt issuers to engage in conduct that violates the securities laws to cope with the pressure caused by the crisis, including excessive debt, extreme leverage, and possible liquidity disruptions. In addition, the Enforcement Division will examine disclosures by issuers that are out of step with other issuers in their industry in order to detect attempts to disguise previously undisclosed problems or weaknesses as related to COVID-19 and mislead investors thereby.
Co-Director Peikin also noted that the COVID-19 crisis has resulted in dynamic and volatile markets not seen in decades. These market conditions, along with a regular stream of potentially market-moving announcements by issuers, provide increased opportunities for insider trading and market manipulation. He stated that the Division has been monitoring trading activity around announcements made by issuers in industries particularly impacted by COVID-19 and to identify other suspicious market movements for possible manipulation.
Turning to FINRA’s efforts to combat fraud and abuse arising from the crisis, in the SIFMA-hosted webinar, EVP Hopper stated that FINRA has also seen fraud related to COVID-19. EVP Hopper discussed FINRA Enforcement’s general priorities, building on the priorities she enumerated in a recent podcast. EVP Hopper reiterated that her team’s goal is to be tough but fair. She explained that FINRA Enforcement expects to achieve that goal by focusing on (i) the most vulnerable customers, such as retail investors and seniors, and (ii) quickly obtaining as much restitution as possible for harmed customers. As later pointed out by Robert Colby, FINRA’s Chief Legal Officer, the elderly are a focal point for enforcement efforts partly because they own most of the wealth entrusted to brokerage firms, and because they may be susceptible to confusing or manipulative conduct. EVP Hopper’s statements indicate that FINRA Enforcement’s attention will be on the misconduct that poses the highest risk to retail investors. EVP Hopper cautioned in the podcast against judging FINRA’s enforcement program by its lack of high fines as high fines are not always necessary to accomplish those outcomes. Therefore, the Enforcement Staff could be satisfied with a bar against a broker or firm that aligned with their priorities, even if fines were not part of the resolution. Restitution to harmed investors, however, remains one of Enforcement’s primary goals.
One of the major upcoming issues for FINRA will be its response to the industry’s efforts to implement the forthcoming Regulation BI. The SEC adopted Regulation BI in June 2019. Although the SEC has been granting regulatory relief in a number of areas as a result of COVID-19, it has confirmed that Regulation BI will go into effect on the scheduled compliance date of June 30, 2020.
EVP Havlik, Head of Member Supervision, described FINRA’s approach to examinations after the compliance deadline as member entities acclimate themselves to Regulation BI. For the first six months following the deadline, FINRA examinations will focus on how firms approach implementing policies, procedures and controls to comply with Regulation BI. FINRA will learn from these examinations what is working or not working for firms’ implementation efforts and that will inform guidance from FINRA. EVP Havlik noted that, in determining the focus of examinations, FINRA had worked closely with the SEC. She does not believe that FINRA examiners will take a “hard-line” approach on Regulation BI until sometime in 2021.
With respect to enforcement actions brought under Regulation BI, EVP Hopper stated that her division will not be looking for “gotcha moments.” Rather, she noted that enforcement will follow the lead of examination staff. Regulation BI enforcement actions brought during the first six months after implementation will be in areas where FINRA previously would have brought an action for violations of suitability obligations, such as churning and excessive trading. EVP Hopper does not envisage enforcement “trailblazing” through actions brought under Regulation BI.
Enforcement Chiefs Emphasize Teamwork and Transparency
Drawing on lessons learned from prior emergencies, such as the Sept. 11 attacks and the 2007-2008 global financial crisis, the SEC’s Enforcement Division formed a Steering Committee to coordinate the Division’s response to the unique challenges of the present crisis. The Steering Committee is comprised of two dozen leaders from the Division of Enforcement, including the Offices of Market Intelligence and Market Abuse and the Microcap Fraud Task Force, to rapidly gather information and monitor trading activity to identify suspicious activity. In addition to coordination within the SEC, the Steering Committee is also responsible for communicating with other federal agencies, state securities regulators, the securities exchanges and SROs like FINRA to ensure a coordinated response to COVID-19 that protects investors.
For example, Co-Director Peikin stated that the Steering Committee, together with the Enforcement Division’s Asset Management Unit, is monitoring investment advisers facing increasing redemption requests, the stresses of which might indicate an underlying issue at the fund. The Steering Committee is also working with the Complex Financial Instruments Unit to monitor the impact of the crisis on the performance of complex structured products, so as to detect and identify improper marketing and sale of those products to retail investors. And, as noted above, given the volatile market conditions, there are increased opportunities for insider trading and market manipulation. Here, the Steering Committee is working with the Division’s Market Abuse Unit to monitor trading activity around corporate announcements to identify suspicious market movements for possible manipulation.
Like the SEC, FINRA formed a comprehensive COVID-19 Task Force in March to manage a centralized repository of intelligence gathered from across the organization to help ensure efficiency and maximum coordination. The task force is focused on potential fraud by broker-dealers and registered representatives, over-the-counter issuer fraud, insider trading, market manipulation, and investor harm, including fraud targeting seniors and vulnerable investors. The task force is making enforcement referrals to the SEC, including referrals leading to trading suspensions.
Likewise, EVP Hopper noted that FINRA Enforcement’s recent consolidation of the enforcement team handling trading-based matters resulting from Market Regulation’s surveillance and examination programs into one Enforcement team (as part of FINRA’s 360 review) has enabled FINRA to be more efficient and uniform in carrying out its enforcement activities and generate more national consistency in case outcomes. In particular, EVP Hopper highlighted the creation of the position of Counsel to the Head of Enforcement, who is responsible for reviewing enforcement recommendations and identifying potential inconsistencies in connection with FINRA Enforcement staff’s approaches to resolving matters.
EVP Hopper also emphasized that FINRA Enforcement continues to work with the Market Regulation and Member Supervision teams, beginning at an early point in the investigative process, so FINRA Enforcement can move swiftly through the investigative process and quickly determine whether enforcement proceedings are appropriate. To help FINRA identify overlapping or duplicate requests from its various teams, EVP Hopper encouraged the industry to notify FINRA if it receives redundant requests in order to help streamline FINRA’s processes.
Both enforcement leaders identified increased transparency as a key component of their enforcement programs. For instance, EVP Hopper noted FINRA Enforcement’s efforts to improve its settlement documents to provide more clarity to the industry regarding why FINRA brought a case, what the facts were in that case, and how the facts led to the specific sanctions against the member. EVP Hopper highlighted a recent settlement involving unit investment trusts as an example of the kind of guidance FINRA Enforcement hopes to provide in its settlement documents. One element of that settlement stated that the member received credit for cooperation in light of its substantial assistance to the investigation, identifying the customers eligible for restitution, and voluntarily implemented corrective measures. EVP Hopper also discussed FINRA Enforcement’s expectations for cooperation under Regulatory Notice 19-23, stating that FINRA Enforcement expected “complete and total cooperation.” In EVP Hopper’s view, that cooperation included sharing the results of an internal investigation, though EVP Hopper also emphasized that the enforcement staff would be mindful of privilege issues inherent in such disclosure.
Co-Director Peikin also highlighted the Division of Enforcement’s efforts to improve communication with market participants during the COVID-19 crisis. Here, the Division has worked to provide visibility and transparency regarding enforcement initiatives to educate market participants and deter potential wrongdoers.
For example, in March 2020, Co-Directors Peikin and Stephanie Avakian issued a statement emphasizing the importance of maintaining market integrity and following corporate controls and procedures in light of the disruption caused by COVID-19. The Co-Directors noted that in these “dynamic circumstances” corporate insiders received access to material nonpublic information that may have even greater value than normal, because the crisis could delay corporate disclosures. The Co-Directors emphasized the need for these insiders to be especially mindful of their obligations to keep the information confidential and comply with prohibitions on insider trading as well as for regulated entities to comply with policies and procedures designed to prevent the misuse of material nonpublic information. For further analysis of the Co-Directors’ statement, please see McGuireWoods’ Subject to Inquiry blog post that covered this statement. Likewise, the Enforcement Division’s Retail Strategy Task Force and Office of Investor Education and Advocacy issued an alert on April 10, 2020, that it has updated as the crisis has progressed. The alert identified a number of frauds so Main Street investors would be better able to spot fraudsters trying to take advantage of them in the crisis. The alert provided guidance on how to identify fraudulent stock promotions and market manipulation, fraudulent unregistered offerings, charitable investment scams, community-based financial frauds, and bogus CDs offering high returns. FINRA, too, issued a regulatory notice highlighting the increased fraud risk from the disruptions caused by COVID-19 and set out recommendations for firms to address those risks.
In addition, Co-Director Peikin pointed to a statement released together with the Office of Municipal Securities on May 4, 2020, calling for greater transparency in the municipal securities market. The municipal securities alert emphasized the need for issuers of municipal securities to make high-quality disclosures to investors. The need for this quality disclosure was especially imperative in the municipal securities market, which is dominated by retail investors who have to navigate a complex and fragmented market of very diverse issuers. Therefore, the Enforcement Division and its Office of Municipal Securities urged municipal issuers to “provide investors with as much information about their current financial and operating condition as is reasonably practicable,” including forward-looking information regarding the impact of COVID-19. Notably, they also encouraged financial professionals to discuss the importance of issuer-specific and security-specific disclosures with the Main Street investors they serve and to consider the extent of such disclosures when providing recommendations and investment advice to Main Street investors. For further analysis of this disclosure, please see McGuireWoods’ blog post that covered this statement.
Regulator Use of Data Analytics
The FINRA participants highlighted as a priority the use of data analytics to enhance enforcement functions. EVP Havlik noted that Member Supervision had hired a Head of Data Analytics and Technology in September 2019. The focus of this role is to build out a data analytics capability within Member Supervision that would be able to “spot risk bubbling up” and improve FINRA’s efforts to identify insider trading and fraud. The role of analytics, to EVP Havlik’s mind, was to inform the examinations program as to where to look for risk and to facilitate a more efficient hand-off of matters to enforcement.
FINRA Enforcement is also focused on data analytics, collaborating with both Member Supervision and Market Regulation. EVP Hopper touted a group within her division tasked with developing data analytics capabilities. The work of this group involves close collaboration with Member Supervision, as well as leveraging Market Regulation’s experience in working with market data. Thomas Gira, head of Market Regulation & Transparency Services, emphasized the high volume of market data FINRA was collecting. As a result of this, EVP Gira recognized that FINRA had to increase its data analytics capabilities and reliance on artificial intelligence. Such capabilities would also assist FINRA in responding to the COVID-19 crisis. EVP Gira noted FINRA had seen a nearly 200 percent increase in market alerts for best execution, pricing issues and “micro-manipulations,” such as inter-day manipulations, wash sales, spoofing and layering. EVP Gira also noted a significant rise in potential account intrusion attempts, especially in the options space.
With regard to trade reporting alerts, EVP Gira encouraged firms to review the report cards that FINRA makes available to them so they can see what FINRA is seeing. This will allow them to proactively address issues that may have popped up and quickly respond to FINRA when it raises questions about the firms’ reporting. On the whole, however, EVP Gira was pleased to report that the industry remained at a 99 percent compliance reporting level.
Co-Director Peikin also identified areas of regulatory concern where the Staff was scrutinizing data in the marketplace. Here, the Enforcement Division is scrutinizing trading activity around announcements by issuers in industries “particularly impacted by COVID-19.” Such scrutiny raises the likelihood that issuers in the healthcare space and others will receive insider-trading inquiries related to trading by its officers or employees. Co-Director Peikin also highlighted a significant uptick in tips, complaints and referrals the Staff has triaged since March 2020 (a 35 percent increase over the same period last year) and the information the Enforcement Division received from whistleblowers, noting that since March 23 the Commission had issued awards to nine whistleblowers, with one award totaling $27 million.
Additional FINRA Regulatory Focus
As the enforcement chiefs emphasized in their public comments, FINRA and the SEC remain open for business and committed to carrying out their enforcement goals even in the midst of the COVID-19 disruptions. FINRA previewed a few additional concerns, which will persist even once the crisis is over.
Protection of Customer Records
FINRA’s panel discussed the ongoing importance of member compliance with Regulation S-P. Promulgated by the SEC in 2000, Regulation S-P places certain restrictions on financial institutions’ ability to disclose customer records and requires disclosure of privacy policies. Most important to the panel’s discussion, Regulation S-P also places certain responsibilities on financial institutions to protect their customers’ data.
EVP Havlik stated that a firm’s obligations under Regulation S-P are and will continue to be a focus of FINRA examinations. Echoing similar sentiments, EVP Hopper encouraged firms to know their customers, know their products and know their businesses when thinking about Regulation S-P compliance.
Zero Commission Model
The FINRA panelists also briefly discussed the regulatory implications of the emerging zero commission model. EVP Gira stated that this relatively new trading model is not in itself problematic, but that FINRA would be undertaking a sweep exam of firms with these models. FINRA’s approach to zero-commission trading, EVP Gira explained, would start with ensuring that customers are not being compromised by moving to that model: a customer is entitled to the same level of service even if the customer did not pay a commission. In particular, a broker’s duty of best execution remains without regard to the amount of commission paid by its customers.
What Does All of This Mean?
Regulators are signaling that, despite the disruptions caused by COVID-19, they are appropriately adjusting and moving forward with their enforcement and regulatory programs. Firms and companies would be wise to take note and take time to revisit supervisory and compliance programs. Issues impacting retail investors are squarely in regulators’ scope, making sure that recommendations are sound, disclosures are appropriate and investors are getting fair pricing and trade execution. Firms might also consider issuing reminders or guidance to employees regarding potential scams and the potential exploitation of seniors in line with the SEC and FINRA’s alerts in this area.
Now also is a good time for companies to revisit insider trading policies and procedures, and to review corporate compliance programs with employees who have access to market moving information. Companies also should ensure that their public disclosures take into account recent regulator pronouncements on the kinds of disclosures they are expecting, given the business and financial disruptions caused by COVID-19, and review corporate controls over financial reporting functions.
Further, given what appears to be an uptick in potential whistleblower complaints, companies should be sure that employees are given appropriate avenues to raise complaints, that they have strong measures in place to prevent retaliation against employees, and that they have a robust plan in place to quickly investigate and, if appropriate, remediate any concerns raised.