The Securities and Exchange Commission (SEC or Commission) has remained open for business throughout these unprecedented times, making clear that it will do everything within its considerable power to continue to ensure the integrity of the markets and protect investors. As we previously discussed, the SEC’s Division of Enforcement (Enforcement Division) continues to be active throughout the pandemic with an eye on the protection of “Main Street” investors, which is consistent with the agency’s overall enforcement priorities that we highlighted earlier this year. While its annual SEC Speaks conference went virtual, the SEC made clear it comfortably has embraced the “new normal” and that it continues to adapt to carrying out its enforcement priorities. The SEC continued to express, in no uncertain terms, that its Staff will continue to pursue its mission to ensure the integrity of the markets and protect investors. While the pace of certain investigations may have slowed due to logistical challenges in the early days of the pandemic, the SEC has made clear that it intends to maintain its traditional pace of investigations and expects individuals and companies to engage and cooperate with the Staff.
Highlights from Chairman Clayton’s Reports on FY 2020 Commission Operations
In early October, the SEC remotely hosted its annual SEC Speaks conference where it highlighted its accomplishments over the past fiscal year and offered a preview of the year to come. As always, the Staff highlighted notable enforcement actions, along with new and ongoing initiatives including the Commission’s increased use of data analytics to aid its oversight of the financial markets and root out misconduct. Stephanie Avakian, Director of the Enforcement Division, reminded attendees that investigations are continuing at a strong pace, emphasizing the Staff’s nimble ability to take remote testimony and other methods of advancing investigations while working from home. Among other things, Avakian noted the importance of cooperation by defense attorneys during the pandemic and the Staff’s expectations of such, including flexibility regarding remote depositions and overall leveraging of technology.
Some hypothesized that the enduring pandemic would result in a drastic decrease in enforcement actions, yet the SEC has shown no signs of slowing down. To the contrary, the FY 2020 statistics Chairman Clayton reported at the recent SEC Speaks conference (the formal FY 2020 annual report has yet to be released) indicate that the Commission has been as active this year as in years prior, and in some areas—particularly enforcement—has increased its activities compared to recent years. While the overall number of enforcement actions decreased this year (over 700 in FY 2020, down from over 850 in FY 2019), the Enforcement Division’s other key metrics remained strong: the division triaged more tips, complaints and referrals (up 68% from FY 2019), opened more investigations (up 7% from FY 2019), and obtained more than $4 billion in financial remedies (an increase from FY 2019). Chairman Clayton emphasized that the Enforcement Division has paid particular attention to misconduct during the pandemic, issuing three dozen trading suspensions, bringing six COVID-19-related fraud actions, and opening over 150 COVID-19-related investigations and inquiries. There is every reason to believe that the SEC continues to be focused on COVID-19-related misconduct and will continue to devote staff resources to investigating and prosecuting COVID-19-related violations.
The Enforcement Division’s whistleblower program has been similarly active in FY 2020, awarding approximately $175 million to whistleblowers since mid-March—a figure twice that of any prior fiscal year, and representing one-third of the total whistleblower awards ever made by the SEC. These record numbers, combined with the Enforcement Division’s recently stated commitment to “further streamline and accelerate the evaluation of claims” and “substantially increase the rate at which whistleblower claims are evaluated and awards are issued,” suggest companies are well-advised to take internal whistleblower complaints seriously and investigate them thoroughly, especially since, according to previous reports from the Office of the Whistleblower, the majority of whistleblower award recipients are company insiders who unsuccessfully raised their concerns internally before reporting them to the Commission.
Not to be outdone, the Divisions of Investment Management and Corporation Finance remained active in FY 2020, reviewing and monitoring corporate disclosures both routine and pandemic related. In his remarks, Chairman Clayton emphasized that these two divisions have initiated over 30 rulemaking-related releases, and contributed to more than 20 temporary rules, exemptive orders, no-action letters, and Staff guidance statements specifically related to COVID-19 relief. While some of this work was most clearly relevant in the first half of FY 2020—for example, joint guidance on holding virtual shareholder meetings and meeting manual authentication document retention requirements—given the ongoing status of the pandemic and the likelihood that social distancing requirements will continue well into calendar year 2021, investors and companies should continue to pay close attention to updates coming out of the Divisions of Investment Management and Corporation Finance as they plan their disclosures and shareholder meetings in the coming months.
Relatedly, it remains important for companies to evaluate closely their disclosures concerning the COVID-19 pandemic and impacts it may have on their financial circumstances. The Commission has emphasized the importance of many companies’ responses to the pandemic to an investment decision, and Enforcement Division Staff undoubtedly will have the Commission’s guidance close at hand, causing financial reporting cases to remain an ongoing enforcement priority. Pundits expect the securities markets to continue to be volatile, emphasizing the risk for private plaintiffs’ shareholder litigations in the event of a material drop in a company’s share price. Companies should evaluate their director and officer insurance policies, including, depending on specific circumstances, consideration of whether to provide carriers with appropriate notice.
The “New Normal” and Looking Ahead
Over seven months into the pandemic, the SEC has taken substantial measures to adjust to the “new normal.” Once considered a last resort both by the Enforcement Division and defense counsel, the Staff seems to have seamlessly adapted to taking investigative testimony and conducting witness interviews via video conference. Although there is no provision of the SEC’s Rules of Practice that explicitly authorizes the staff to compel remote testimony, witnesses have generally complied with the SEC’s requests. At the SEC Speaks conference, the Enforcement Division made clear that if a witness declines to testify remotely, the Staff will factor that into its charging recommendations to the Commission. We expect this protocol to be part of the new normal for the foreseeable future, and recipients of testimony subpoenas must carefully evaluate the potential risks before declining to appear virtually. Relatedly, while the SEC staff appropriately demonstrated considerable patience with the slow pace of document productions in the early phases of the pandemic, there are indications that the staff expects that market participants have adapted to the remote work environment and are able to meet customary (i.e., pre-pandemic) timeframes for responding to subpoenas and other requests.
With the election just one week away, it is evident that Chairman Clayton’s enforcement legacy will be marked by protecting retail investors, targeting misconduct in the cryptocurrency markets and other cyber-related violations, and steering the SEC’s response to COVID-19. Although the Commission will continue to devote resources to punishing individuals and entities who seek to capitalize on market disruptions caused by the pandemic even after Clayton departs, under a potential Democrat-led Commission, the Enforcement Division is likely to shift its focus to traditional Wall Street misconduct, including insider trading, issuer reporting and accounting fraud, and Foreign Corrupt Practices Act violations. A Democratic Commission may also be more inclined to bring enforcement actions to give teeth to recently enacted rules, including the retail investor-focused Regulation Best Interest and enhancements to disclosures concerning environmental, social or governance matters (ESG), which are gaining traction among investors, especially institutional investors who increasingly are demanding information regarding issuers’ social (e.g., workplace diversity) and environmental (e.g., climate risks, including decarbonization) goals. The SEC has been grappling with certain recommendations in favor of greater disclosure regarding ESG commitments. While the current Commission has resisted these recommendations, we would not be surprised if pressure continues to build in the year ahead. Finally, while we do expect a Commission with a Democratic Chair will continue to bring cyber enforcement actions, it is reasonable to anticipate that the SEC will be less willing to bring cases regarding failures to comply with the registration provisions of the securities laws in the absence of more egregious violations (e.g., fraud charges).
In addition to shifting enforcement priorities, a Democratic-led Commission may also take other steps that will result in a more aggressive enforcement regime. For example, during the tenure of Chair White (Chairman Clayton’s predecessor), the Commission hired various subject matter experts (e.g., market structure specialists, quantitative analysts, accountants) to assist enforcement attorneys in bringing complex cases. A Biden Commission might also be inclined to recruit additional industry experts, and more generally, is likely to aggressively lobby Congress to allocate substantial funds to the SEC’s enforcement function.
Relatedly, we expect the next Commission to invest in improving its ability to detect misconduct through the use of data analytics and other risk-based tools to identify wrongdoing, including with respect to issuer disclosures, registered entities, and retail frauds. In recent years, both the Enforcement Division and the Office of Compliance Inspections and Examinations (OCIE) have developed increasingly sophisticated tools to capture and analyze large volumes of complex data. Enforcement’s Market Abuse Unit, for example, has developed—and continues to refine—specialized software to sift through vast trading data and identify potential insider trading and market manipulation. Additionally, the Commission has expanded its use of data to policing financial reporting, as evidenced by two recent enforcement actions charging issuers with accounting misconduct in which the Commission touted the expansion of its use of “risk-based data analytics.”
And on the examination front, OCIE utilizes its National Exam Analytics Tool and other technologies to rapidly analyze multiple years’ worth of data across registrants to detect a wide array of misconduct, including churning, money laundering, excessive fees, and failure to supervise. In light of the Commission’s success in using data tools to protect investors and punish wrongdoers, we expect a more enforcement-focused Commission to substantially expand the use of analytics.
As the pandemic drags on, we expect the Commission to keep its foot on the pedal for FY 2021, reminding market participants that this is no time to take advantage of societal disruption. Companies should prepare for the Enforcement Division to remain active, along with the inevitably related private litigation, by focusing on internal controls and fostering a culture of compliance, including increased oversight and thoughtfulness with respect to COVID-19-related measures and disclosures.