The Securities and Exchange Commission’s Enforcement Division on Nov. 2 issued its annual report, highlighting the Division’s activities in fiscal year 2018 from both a qualitative and quantitative perspective. But focusing on enforcement numbers and penalty amounts alone is meaningless, SEC Commissioner Hester Peirce said in recent remarks.
“The current Commission is not humming happily about heaping up penalties or belting out bad ballads about burgeoning enforcement statistics,” Peirce said in her remarks at the 26th Annual Securities Litigation and Regulatory Enforcement Seminar on Oct. 26. To Chairman Jay Clayton’s credit, she said, “the SEC is now focused on a meaningful enforcement agenda that focuses on the quality and not quantity of cases.”
“The number of enforcement cases initiated or settled in any particular twelve-month period … is a meaningless measure of the effectiveness of the enforcement program,” Peirce continued. “It is an overly simplified metric that tells nothing about the quality or nature of our enforcement recommendations.”
Part of the problem with looking to raw numbers, she said, is the diversity of cases. She cited as examples the following four enforcement recommendations approved by the Commission in fiscal year 2018:
- Four entities ordered to refund $97 million to retail clients for misconduct involving faulty investment models;
- Financial firm Voya Financial Advisors paying a $1 million fine to settle charges after customer funds were compromised due to lax cyber-security measures;
- The shutting down of a $1.2 billion Ponzi scheme; and
- Mining company Rio Tinto and two former top executives charged with fraud for inflating the value of coal assets.
In contrast, in fiscal year 2017, the SEC brought 112 enforcement actions to deregister public companies that were delinquent in their Commission filings. “To argue that a delinquent filing enforcement action should be viewed as comparable to any of the above examples I just cited is ridiculous,” Peirce said. “Yet, that is exactly what focusing on numbers alone does.”
A better exercise that would “present a more accurate snapshot of the agency’s enforcement work,” she said, would be to delve into the kinds of cases the SEC is bringing, and how quickly they are brought. It would also be helpful to look at more qualitative measures, “such as the degree to which our enforcement program contributes to the attractiveness of our capital markets to investors and companies raising capital.”
Peirce also stressed that raw numbers alone regarding the SEC’s total in penalties collected in fiscal year 2018 is also “meaningless as a measure of how effective the Commission’s enforcement program is,” pointing out that the size of a given year’s cumulative penalty number “usually turns on a handful of cases.”
In fiscal year 2017, for example, 38 of 754 enforcement actions that were brought by the SEC constituted $514 million of the $832 million in total received penalties. Fiscal Year 2016 points to similar findings, when 43 of the SEC’s 868 enforcement actions constituted $954 million of the $1.3 billion in received penalties. “A few large penalties can skew the results dramatically,” Peirce said.
In some cases, the SEC “should not have imposed any penalty at all,” she said, citing the case the SEC brought earlier this year against the successor company to Yahoo! for failing to disclose to its shareholders a large hack of user information. “Withholding material information like that is a serious violation, but the $35 million penalty we imposed was borne by the deceived shareholders. In fact, often we give the money right back to the shareholders through a fair fund.”
“The bottom line is that analyzing our enforcement program by counting up penalties is no more enlightening than is analyzing the program by counting up numbers,” Peirce said. “Instead, we have to look at the cases to assess their merits.”
In her remarks, Peirce highlighted many other areas of concern, including the following:
Better guidance needed. Peirce commented that she is “skeptical” of enforcement actions involving a firm’s failure to file Suspicious Activity Reports (SARs) “in instances when a firm has an operational SARs program in place but did not file a SAR in every instance we think it ought to have done so.” She cited as an example Charles Schwab’s $2.8 million civil penalty and more recently an $800,000 fine against clearing firm COR Clearing, announced on Sept. 28.
“I fear that news of our enforcement actions will inspire a spike in the quantity, but not the quality of SAR filings,” Peirce said. “Perhaps we ought to provide firms better guidance about when they need to file and what information those filings should contain.”
Areas of improvement. She also talked about areas where better rules are needed, as well as other areas of improvement: “To address some of the issues we see in the microcap space, for example, the Commission could consider a rulemaking to amend the transfer agent rules and reporting requirements.” Peirce said. This is not a new idea, as the Commission published a concept release in December 2015 regarding transfer agents, championed by former Commissioner Luis Aguilar, she said.
Regarding Foreign Corrupt Practices Act (FCPA) matters, where companies face massive penalties for violating the FCPA, even if they had a program in place to prevent such violations, “are there more productive ways for us to help public companies build effective FCPA programs?” she asked.
Private bar responsibilities. Peirce stressed that those in the private bar have to help, too. “If the SEC has a responsibility to investigate and make timely charging decisions, we should—and do—expect those in the private bar to move quickly with us. [I]ntentional delays and gamesmanship with document productions and witness testimony will not be viewed kindly by those of us on the Commission who are responsible for voting on enforcement recommendations. We welcome your input about how we can improve our processes, but we count on you to work with us in good faith, even as you vigorously represent your clients.”