SEC Enforcement and COVID-19

Pillsbury Winthrop Shaw Pittman LLP

Expect the SEC to aggressively enforce the securities laws during and after the COVID-19 pandemic, particularly against market participants who act opportunistically.

TAKEAWAYS

  • The SEC as well as senior staff within the Division of Enforcement and the Division of Corporation Finance have made clear that the Commission will vigorously pursue individuals and entities that take advantage of market vulnerabilities during the COVID-19 pandemic, including by trading on material nonpublic information and failing to disclose material information regarding the impact of the pandemic.
  • The Division of Enforcement’s reactions to prior disruptions to the SEC’s operations—including its response to the 2018-19 four-week government shutdown—suggest that there will be no decrease in enforcement activity as a result of COVID-19.
  • Market participants should consider taking steps to address the risks posed by the pandemic including by assessing the adequacy of policies, procedures, systems and controls related to insider trading and disclosure issues, closely reviewing and adhering to SEC guidance related to COVID-19, and implementing training regarding remote work practices and other areas of risk.

Introduction

Although many of the Securities and Exchange Commission’s (SEC) office doors have shuttered due to the ongoing threat of the COVID-19 Coronavirus, the Commission remains very much open for business. The SEC’s Division of Enforcement has issued a clear message: in light of the impact of the COVID-19 pandemic on the financial markets, the Division will do everything within its considerable power to continue to ensure the integrity of the markets and protect investors. In that regard, in a March 23 statement, the Enforcement co-directors noted that “[t]he Enforcement Division is committing substantial resources to ensuring that our Main Street investors are not victims of fraud or illegal practices in these unprecedented market and economic conditions.”

The ongoing focus on “Main Street” investors is consistent with the agency’s overall enforcement priorities, which we highlighted earlier this year. In addition to continuing to focus on its longstanding priorities, we expect the Enforcement staff to be particularly active in two areas: policing insider trading and disclosures relating to the COVID-19 pandemic.

Insider Trading

Even during unremarkable times, insider trading matters often arouse public attention, prompting cries that ordinary retail investors cannot get a fair shake due to securities markets being rigged to favor opportunistic “insiders.” While this perception may or may not fit reality, it is underscored by the reaction to recent allegations that members of Congress sold millions of dollars of stock following their receipt of confidential information regarding the virus, enabling them to avoid substantial personal financial losses.

Although there are obvious obstacles to a successful SEC enforcement action (or DOJ prosecution) against the members of Congress—including arguments that the information regarding the pandemic was already publicly available and a constitutional prohibition against using information that a member of Congress acquired during a congressional hearing in a prosecution against that member—we expect the SEC to target others who trade on material nonpublic information regarding the pandemic. The Enforcement co-directors said as much on March 23, when they cautioned that “new material nonpublic information [] may hold an even greater value than under normal circumstances.”

In light of this enhanced regulatory risk, market participants—especially broker-dealers and investment advisers—should ensure that their trading policies and procedures reflect current market realities and that those policies and procedures are reasonably designed to prevent the misuse of material nonpublic information during and after the pandemic. Among other measures, companies should consider mandating training regarding what constitutes insider trading in the context of the current pandemic. Although many registrants are adjusting to the realities of working remotely, it is unlikely that the SEC will view difficulties caused by remote work as a defense against charges of inadequate supervision. In that regard, broker-dealers and investment advisers promptly should assess whether their technological and surveillance systems can sufficiently monitor unlawful trading while employees work from home.

COVID-19 Disclosure Issues

Considering the stock markets’ recent volatility, it is not surprising that the SEC has released guidance regarding issuer disclosures concerning the COVIC-19 pandemic. The SEC’s overarching message is clear: companies must provide the public with thorough, accurate, and timely information regarding the impact of the pandemic on their financial circumstances. Chairman Clayton has also noted that “how companies plan and respond to the events as they unfold can be material to an investment decision.” Following the chairman’s remarks, the Division of Corporation Finance provided detailed guidance, offering an illustrative list of items on which companies should focus, including: 1) the impact of the pandemic on a company’s financial condition and results of operations, 2) U.S. GAAP considerations presented by the pandemic, and 3) the impact of COVID-19 on the demand for the company’s products and services.

Companies should review this guidance (and the other items listed in Corp. Fin’s release) to ensure that they are thoughtfully considering each item’s application to the company’s operational and financial circumstances. Division of Enforcement staff undoubtedly will have Corp. Fin’s guidance close at hand, further emphasizing the importance of documenting steps considered to implement such guidance.

When assessing adequacy of disclosures, including controls and procedures relating to such disclosures, companies should be mindful that financial reporting cases have been an ongoing enforcement priority for the SEC—i.e., predating the pandemic. In 2019, the SEC brought 108 total issuer reporting, audit and accounting matters, comprising 13 percent of all enforcement cases and reflecting a substantial increase from 79 such matters in fiscal year 2018. We expect this trend to continue and would not be surprised to see the Division of Enforcement form a task force or create a division-wide initiative to address disclosure and financial reporting failures in the wake of COVID-19.

Finally, companies should prepare for the likelihood that private plaintiffs will file shareholder litigation in the event of a material drop in share price. We suggest that companies evaluate their director and officer insurance policies, including, depending on specific circumstances, consideration of whether to provide carriers with appropriate notice.

Business as Usual

As with virtually every other aspect of our everyday lives, the COVID-19 pandemic will undoubtedly have an impact on business at the SEC. Over the past few years, the SEC has gained considerable experience in dealing with disruptions in various forms, including those resulting from the impact of severe budget cuts and resulting staffing shortages.

Perhaps the best predictor of how the SEC likely will respond to the current crisis is its response to the government shutdown which halted most enforcement activity for a four-week period during parts of 2018 and 2019. While some hypothesized that the shutdown would result in a drastic decrease in enforcement actions, the Commission actually brought 862 total enforcement actions in fiscal year 2019, surpassing fiscal year 2018 for the second highest total ever. We similarly caution against predictions of a significant slowdown in enforcement activity due to the COVID-19 pandemic (particularly since enforcement employees continue to investigate matters remotely). If anything, do not bet against an uptick in SEC actions related to insider trading, disclosure violations, and other cases in which the staff believes market participants are taking advantage of our ongoing national crisis.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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