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The US Securities and Exchange Commission (SEC) Division of Enforcement recently issued its 2019 Annual Report (ENF Annual Report), which you can read in full here. Of course, the headline is always how many cases did the Enforcement Staff bring and how much money did they collect and distribute and, for fiscal year 2019,1 the Staff was likely relieved to announce that on each score they had, well, scored.

The Baker McKenzie Financial Regulation and Enforcement team will provide a deeper dive in the Enforcement Division’s fiscal year 2019, the cases of note and a look ahead to 2020, but we wanted to offer some initial takes on our review of ENF Annual Report.

Fiscal year 2019 represented the best year that the Enforcement Division has had since 2016, as the chart below demonstrates.

Fiscal Year Total Number of
Enforcement Actions
Number of “Standalone”
Actions
Total Penalties and
Disgorgement Collected
2015 807 508 $4.19 billion
2016 868 548 (96 MCDC) $4.08 billion
2017 754 446 $3.79 billion
2018 821 490 $3.945 billion
2019 862 526 (95 SCSD) $4.349 billion

 

As you can see, the number of cases brought for 2016 was improved by MCDC, the Municipalities Continuing Disclosure Cooperation self-reporting initiative, which encouraged municipal bond underwriters and issuers to self-report misstatements and omissions in municipal bond offering documents. Similarly, the 2019 enforcement action tally was improved by the SCSD, the Share Class Selection Disclosure Initiative, which invited investment advisers to self-report, if they had failed to make the required disclosures related to the selection for customers of mutual fund share classes that paid the adviser or an affiliated broker-dealer a 12(b)-1 fee, when a lower cost share class was available.

However, while the SCSD certainly directly targeted investment advisers, a closer look at the numbers over time suggests to us that advisers were in the crosshairs even before the Initiative was announced.

The Enforcement Division and the SEC, as a whole, continues to focus on “retail investors” and investors saving for retirement as “Principle 1” of its five core principles.2 As the financial services industry has shifted toward fee-based, investment advisory programs, and as the SEC largely has ceded the “hands on” retail broker-dealer regulatory space to FINRA, to focus on examinations of registered investment advisers, these shifts, together, have culminated in steady, consistent increases in enforcement actions against investment advisers.

This ongoing focus on investment advisers also is consistent with the SEC’s internal staffing decisions. The Office of Compliance Inspections and Examinations (OCIE) had previously transferred a number of examiners from the broker-dealer program to its investment advisers program. And Enforcement’s Asset Management Unit remains the largest national specialized unit in the division. Such a commitment in resources creates a bureaucratic momentum to do more cases against investment advisers.

In 2015,3 cases against Investment Advisers and Investment Companies comprised 15.6% of the total enforcement actions for the year; for each of 2016 and 2017, those numbers nudged up to 18%; then the total increased again to 22% in 2018; and finally, this past year, the number jumped to 36%, with the help of SCSD.4

The Division Staff also has been quite focused on the return of money to “harmed investors,” and fiscal year 2019 was the best year for that particular statistic in the past five years, as noted below.

Money Distributed to Harmed Investors

2015  2016  2017  2018 2019
$158 million $140 million $1.073 billion $794 million $1.197 billion

 

But a closer look at the source of the funds returned reveals that, while the distributions may have actually occurred this year, these funds derive from cases and conduct dating back several, even many, years. See ENF Annual Report at p. 17. See also, e.g., In the Matter of Citigroup Alternative Investment LLC, AP File No. 3-16757 (noting that the settled Commission Order was entered in August 2015, relating to conduct that occurred between 2002 and 2008, but the Order directing distribution of almost $185 million to “harmed investors” issued in September 2019).

This is of interest because most of the types of cases the Enforcement Division routinely pursues do not, by their very nature, result in distributions to harmed investors. In fiscal year 2019, securities offering and market manipulation cases comprised 138 of the 526 cases (26%). See ENF Annual Report at p. 28 (for all statistics in this paragraph). Unfortunately, given the nature of these matters – Ponzi schemes, affinity frauds, and other types of scienter-based frauds – generally there is little or no money left to distribute. The biggest money generators year over year tend to be FCPA matters (18 cases, or 3% for 2019), but those cases do not lend themselves to distributions, since there is not a straight line to harmed investors. The same can be said for issuer reporting/audit and accounting cases (92 cases/17% for 2019); the SEC’s broker-dealer cases (38 cases/7%), which tend toward larger market structure cases; as well as insider trading cases (30 cases/6%; public finance abuse cases (14 cases/3%); and the SRO/Exchange (3 cases/1%) and other similar matters.

The most obvious exceptions to this list are cases against investment advisers, which manage to serve multiple stated goals of the Division, and the Commission more broadly. Enforcement actions against investment advisers, in most instances, can most directly be said to serve and protect the interests of retail investors and, usually, the settlement of such matters return monies to “harmed investors” in a timely manner, efficiently, since the advisers themselves often undertake the distributions. ENF Annual Report at p. 2. For all of the noted reasons, and based on what we are seeing among our clients and in the market more broadly, we anticipate that when we review next year’s Annual Report, the Division will be reporting on more investment adviser focused enforcement actions.


[1] The SEC fiscal year runs from October 1 through September 30.
[2] The Enforcement Division identifies five core principles that guide its work: “(1) focus on the retail investor; (2) focus on individual accountability; (3) keep pace with technological change; (4) impose remedies that most effectively further enforcement goals; and (5) constantly assess the allocation of our resources.” See ENF Annual Report at p. 10.
[3] Before 2015, the Division of Enforcement did not report statistics that segregated “standalone” cases from follow-on proceedings, making comparisons of the numbers prior to that year difficult and less meaningful.
[4] Interestingly, if the SCSD cases are excised from the totals, the 2019 numbers are at 22%, the same as last year; however, we expect that more cases against investment advisers would have been brought this past year, were the SEC staffers in the Asset Management Unit not busy with SCSD, so this likely is not that meaningful a take.

Author

Jennifer L. Klass serves as the Co-chair of Baker McKenzie's Financial Regulation and Enforcement Practice in North America. Jen is an experienced investment management lawyer with particular focus on investment adviser regulation and the convergence of investment advisory and brokerage services. She regularly represents clients before the US Securities and Exchange Commission (SEC), both in seeking interpretative guidance and in managing examination and enforcement matters. Jen is a leading practitioner in digital investment advice and the use of FinTech in the asset management industry. Jen provides practical advice that is informed by her experience as Vice President and Associate Counsel at Goldman, Sachs & Co., where she represented the asset management and private wealth management businesses.

Author

Amy serves as the Co-chair of Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Previously, Amy has served as chief litigation counsel at the US Securities and Exchange Commission's (SEC) Philadelphia regional office and managed a team of lawyers overseeing a wide variety of enforcement matters and investigations.

Author

Peter K.M. Chan is a member of Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Peter brings two decades of experience at the US Securities and Exchange Commission (SEC) to his litigation and counseling work. His tenure at the SEC, as well as a stint as Special Assistant US Attorney in the Northern District of Illinois, have given Peter experience with civil and criminal matters. At the SEC, Peter served as assistant regional director in the Chicago regional office, where he led investigations and litigations of high-profile enforcement cases. In the course of his SEC career, he handled corporate issuer disclosure and reporting violations, financial fraud, auditor independence violations, insider trading, broker-dealer misconduct and failure to supervise cases, hedge fund and investment company fraud, and Dodd-Frank and Sarbanes-Oxley violations. As the head of the Municipal Securities and Public Pensions Unit at the SEC's Chicago office, he oversaw cases involving municipalities and public pensions throughout the Midwest, including disclosure failures by states, cities, and underwriters in municipal bond offerings; pay-to-play and public corruption; and securities fraud victimizing municipalities and public pensions. Peter also served in national leadership roles within the SEC's Enforcement Division. Peter acted as national leader of the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. He also served as co-chair of the Priorities and Resources Subcommittee of the Division of Enforcement Advisory Committee and was one of the original architects of the SEC Financial Reporting and Audit Task Force. Peter's experience in criminal securities fraud cases includes serving as Special Assistant US Attorney in the Northern District of Illinois in a criminal investigation into market abuse by a Chicago broker-dealer, resulting in guilty pleas by several senior executives at the firm. In 2014, Peter received the SEC's prestigious Paul R. Carey Award for his [e]xceptional personal commitment and effectiveness as a member of the Division of Enforcement.

Author

Jerome Tomas is Chair of the Firm's SEC and Financial Institutions Enforcement Group and has been recognized by Chambers for White Collar Crime & Government Investigations. He represents multinational companies faced with government investigations and conducts internal investigations to assess and remediate legal and compliance concerns in domestic and global operations. With his experience as a former member of the SEC Division of Enforcement’s Cyberforce, the agency’s internet and cyber fraud unit, Jerome regularly advises companies involved in data security breaches and incident response. Jerome now leads teams of lawyers to address government law enforcement perspectives and where necessary, meet and refute government legal theories of corporate and individual liability head-on, while also being pragmatic and business-oriented for management and boards to compete internationally.

Author

Kristal Petrovich is an associate in Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling.