Identifying and pursuing misconduct that harms retail investors will remain a top enforcement priority for the Securities and Exchange Commission in 2020. But knowing what compliance pitfalls the SEC will be watching for could help reduce the risk of an enforcement action.

If this past year is any indication, the SEC’s Enforcement Division will continue to focus on compliance matters like fee disclosures and conflicts of interest. “I don’t expect a major sea change in 2020,” says Timothy Newman, a partner at law firm Haynes and Boone. “I think we should expect to see more of the same that we’ve seen in the last couple of years.”

According to the Commission’s annual enforcement report, the regulator brought 862 enforcement actions and obtained judgments and orders totaling more than $4.3 billion in disgorgement and penalties in fiscal year 2019, which is an uptick from the 821 enforcement actions and $3.9 billion in disgorgement and penalties obtained in the previous fiscal year.

Of the 862 enforcement actions, 526 were “standalone” cases, brought in federal court or as administrative proceedings; 210 were “follow-on” proceedings seeking bars based on the outcome of SEC actions or actions by criminal authorities or other regulators; and 126 were proceedings to deregister public companies that were delinquent in their Commission filings. 

Protecting retail investors

Most prominent is the Enforcement Division’s continued laser-like focus on misconduct that occurs in interactions between investment companies and “Main Street” retail investors. “That will continue to be the case going forward, certainly into next year,” says Kurt Wolfe, a lawyer at law firm Troutman Sanders.

Furthermore, in its 2020 budget report, the SEC has requested six restored positions to be focused on retail investor fraud. “Protecting retail investors is a key priority of the Division. And ensuring that appropriate resources are devoted to retail investor matters is critical to the SEC’s investor protection efforts,” the SEC said. The agency added that its Retail Strategy Task Force “will focus on harnessing the Commission’s ability to use technology and data analytics to identify large-scale wrongdoing.”

“I don’t expect a major sea change in 2020. I think we should expect to see more of the same that we’ve seen in the last couple of years.” 

Timothy Newman, Partner, Haynes & Boone

In 2019, enforcement actions against registered investment advisors (RIAs) and investment companies made up the biggest chunk (36 percent) of the 526 standalone actions, largely attributable to the Share Class Selection Disclosure Initiative, accounting for 95 cases and $135 million in disgorgement and penalties. The Enforcement Division launched this initiative in February 2018 as a voluntary program for investment advisers to self-report to the Commission disclosure failures relating to marketing and distribution fees paid by advisory clients, often referred to as “12b-1 fees.” As an incentive for self-reporting these disclosure failures, RIAs could receive favorable settlement terms with no civil penalty for a resulting enforcement action.  

Excluding actions brought as part of the Share Class Initiative, 69 percent of the Commission’s standalone actions involved charges against one or more individuals. The individuals charged in these actions include top executives—such as chief executive officers, chief financial officers, and chief operating officers—as well as gatekeepers, including compliance officers.

Public company actions

Many of the SEC’s enforcement actions have involved public companies and a wide range of alleged misconduct, including accounting fraud, deficient disclosure controls, and misleading risk factor disclosures.  

A few illustrative examples cited by the Commission include:

  • Facebook’s $100 million settlement with the SEC for making misleading disclosures. For more than two years, Facebook’s public disclosures presented the risk of misuse of user data as “merely hypothetical” when the company knew a third-party developer had misused its user data.
  • Nissan’s $15 million civil penalty reached with the SEC in September over false financial disclosures for omitting more than $140 million to be paid to former CEO Carlos Ghosn in retirement.
  • Mylan’s $30 million settlement finalized with the SEC in September for alleged accounting and disclosure failures surrounding its popular EpiPen, its largest revenue and profit-generating product.
  • Hertz’s $16 million civil penalty reached with the SEC in January for materially misstating pretax income due to accounting errors made in several business units and over multiple reporting periods.
  • A $40 million settlement that Fiat Chrysler Automobiles and its U.S. subsidiary, FCA US, reached with the SEC in September for inflating monthly sales results. In months when FCA US would have fallen short of certain targets, it dipped into its so-named “cookie jar” and reported the old sales as if they had just occurred. 

“Collectively, these cases demonstrate the Division’s and the Commission’s focus on financial statement integrity, the accuracy of issuer disclosures, and the willingness to punish significant corporate wrongdoing,” the SEC stated in its annual enforcement report.  

At least one settled action resulted in no financial penalty, demonstrating the value of self-reporting and remediation. In that case, the Commission found painting supply company PPG Industries failed to properly record various expense accruals and misclassified certain income, which resulted in PPG providing inflated income in its published financial results for two years. But because of PPG’s extensive cooperation, including self-reporting and remediation, the Commission decided not to impose a monetary penalty.

Expedited investigations

Moving forward, the Enforcement Division has announced its intent to accelerate the pace of investigations, particularly related to financial fraud and issuer disclosure cases. This push is due, in part, to the Supreme Court’s 2017 decision in Kokesh v. SEC, which held Commission claims for disgorgement are subject to a five-year statute of limitations.

“The Kokesh decision has had a significant impact, as many securities frauds are complex, well-concealed, and are not discovered until investors have been victimized over many years,” the SEC said in its enforcement report. The Enforcement Division estimated Kokesh has caused the SEC to forgo approximately $1.1 billion dollars in disgorgement in filed cases. The impact of Kokesh will likely continue unabated in fiscal year 2020.

The Kokesh ruling followed yet another significant blow suffered by the SEC last year when the Supreme Court, in the case Lucia v. SEC, ruled in a 7-2 vote the SEC’s selection of its five current administrative law judges was unconstitutional because they were chosen—and could be dismissed—through a civil service process, rather than by a quorum of commissioners acting as a presidential stand-in. The Court ruled they are “inferior officers” and subject to the Appointments Clause in the U.S. Constitution. Over the years, defendants have argued the deck is stacked against them with in-house judges they claim are biased in favor of the agency.  

In March 2020, the SEC will face yet another battle in the Supreme Court in the case Liu v. SEC, which tackles the deeper question of whether the SEC may seek and obtain disgorgement from a federal court as “equitable relief” for a securities law violation, even though the Supreme Court has determined such disgorgement is a penalty. “Disgorgement is a significant part of the remedies that the SEC seeks in all of its cases, and so a finding or a determination that it is not authorized to impose disgorgement would have a significant impact on its enforcement program,” says Susan Resley, a partner at law firm Morgan Lewis.  

“You don’t have SEC cases being reviewed by the Supreme Court annually like that; that’s a big deal,” says Jina Choi, a partner at law firm Morrison & Foerster. “The cases are really going at some of the fundamental tools—seeking disgorgement and the use of administrative proceedings—of the SEC’s enforcement program.”

Despite budgetary constraints and mounting legal headwinds, however, SEC Co-Directors Stephanie Avakian and Steven Peikin have indicated that, while these hurdles may redirect their enforcement efforts, they’re not going to slow them down. Even its whistleblower program remains strong, with the SEC fielding 5,212 total tips in 2019, the second highest number in any fiscal year.  

“The exam staff continues to be busy and aggressive,” says Julie Riewe, a partner at law firm Debevoise & Plimpton and former co-chief of the Commission Enforcement Division’s Asset Management Unit. Compliance officers—and business personnel—must continue to be vigilant, she says, and should continue to focus on disclosures and conflicts of interest.