In the following guest post, Britt K. Latham and Brian Irving of the Bass, Berry & Sims PLC law firm take a look at the SEC’s enforcement action track record under the Trump administration and take a look ahead at what may be next for the agency. I would like to thank Britt and Brian for their willingness to allow me to publish their article as a guest post. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Britt and Brian’s article.
Enforcement Actions: New Administration, New Priorities?
Number of Actions Filed. In last year’s Securities & Shareholder Litigation 2017: A Look Ahead, we reported that the SEC filed a record 868 enforcement actions in FY 2016. That pace slowed to 754 enforcement actions in FY 2017, which raises the question: Is the drop due to the transition year, to a shift in priorities, or to something else?
The Division of Enforcement has taken pains to downplay the change in numbers, emphasizing that its overarching goal remains “vigorous enforcement of the federal securities laws.” The SEC explained that the year-over-year difference is largely attributable to the phase-out of the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative, and that excluding actions related to this program, FY 2017 looked much like FY 2016. The numbers bear this out. Excluding MCDC Initiative actions, the SEC filed 446 standalone actions in FY 2017, compared with 464 in FY 2016. 1
|Enforcement Actions Filed Excluding MCDC Initiative|
|FY 2017||FY 2016|
|Follow-on Admin Proceedings||196||195|
Despite the overall parity between FY 2017 and FY 2016, some data suggest enforcement activity slowed fairly dramatically in the second half of FY 2017, particularly against public companies. It remains to be seen whether this trend will result in fewer actions in FY 2018.
Types of Actions. The types of cases filed by the SEC in FY 2017 remained roughly the same as those filed in FY 2016. In both years, the majority of the SEC’s standalone actions concerned issuer reporting/accounting and auditing, securities offerings, and investment advisory issues. Each category comprised about 20% of the SEC’s standalone actions in both years.
Penalties/Payments. In total during FY 2017, parties in SEC actions were required to pay $2.9 billion in disgorgement, up from $2.8 billion in FY 2016, and $832 million in penalties, down from $1.2 billion the year before. The difference in penalties is attributable to a few high-penalty cases in FY 2016.
Assuming there is no continuation of the drop-off in enforcement actions seen in the second half of FY 2017, the similarities between FY 2016 and FY 2017 suggest FY 2018 is likely to be another strong year for SEC enforcement. That being said, the SEC has announced some notable new priorities, outlined below.
Focus on Main Street Investor. The SEC announced that it first intends to focus on the long-term interests of the Main Street investor. Based on SEC comments, we expect a focus on accounting fraud, sales of unsuitable products, abusive sales practices and pursuing unsuitable trading strategies, pump and dump fraud, and Ponzi schemes. The SEC has created a Retail Strategy Task Force to spearhead efforts to protect retail investors and has also announced the increased use of data analytics to ferret out suspicious behavior.
Focus on Individual Accountability. The SEC continues to believe that “individual accountability more effectively deters wrongdoing” and that it must make “vigorous pursuit of individual wrongdoers” a key feature of its enforcement program. As proof of that focus, in FY 2017, 73% of the SEC’s standalone actions included charges against an individual defendant.
Focus on Technological Change and Cybersecurity. The SEC announced the creation of a Cyber Unit to focus on efforts including hacking to obtain material nonpublic information and failures to adequately protect such intrusions; market manipulation through the spread of false information on electronic and social medial; misconduct on the “dark web”; and intrusions into retail brokerage accounts.
Continued Growth of Whistleblower Program
The SEC’s whistleblower program, which was created by the Dodd-Frank Act, directs the SEC to grant monetary awards of 10-30% for whistleblowers whose original information leads the SEC to collect $1 million or more in sanctions.
Monetary Awards Still Near Record Highs. Our Securities and Shareholder Litigation 2017: A Look Ahead explained that FY 2016 was a record year for the whistleblower program. FY 2017 was nearly as hot. In FY 2017, the SEC received 4,400 tips—a record—and awarded nearly $50 million to 12 individuals. This was just short of the $57 million awarded to 13 individuals in FY 2016. The SEC also awarded three of the ten largest whistleblower awards in FY 2017. Since the SEC reported its FY 2017 data, it has continued to issue new awards. The SEC recently announced it crossed the $1 billion threshold for total monetary sanctions ordered in matters involving whistleblower information since the program began in 2012.
Types of Allegations. In FY 2017, the top three categories of tips from whistleblowers were Corporate Disclosures and Financials (19%), Offering Fraud (18%), and Manipulation (12%), with many tips falling in the catchall “Other” category (26%). This tracks the top three categories from FY 2016 and FY 2015.
Protection of Whistleblowers. Over the last two years, the SEC has increased its commitment to enforcing SEC Rule 21F-17, which prohibits taking any action to impede an individual from communicating with the SEC about a possible securities law violation. In particular, the SEC brought actions targeting confidentiality, separation, and severance agreements that contain restrictive language prohibiting or dissuading individuals from reporting to the SEC. For example, in FY 2017, the SEC targeted severance agreements that required employees to forfeit nearly all severance if they reported disparaging information to regulators, including the SEC; separation agreements that required employees to waive their right to incentives for reporting misconduct under Dodd-Frank; and separation agreements that prohibited employees from voluntarily communicating with the SEC. The SEC has stated it remains committed in FY 2018 to “reviewing fact patterns of retaliation against whistleblowers and potential actions to impede communications with the Commission.” Corporate counsel would be well advised to review the confidentiality, separation, and severance agreements the company has entered to ensure there are no concerns about any provisions that may be considered a violation of this prohibition.
Narrowing Definition of Whistleblowers. On February 21, 2018, the Supreme Court issued an opinion in Digital Realty Trust, Inc. v. Somers that significantly limits who qualifies as a whistleblower under Dodd-Frank. By its terms, Dodd-Frank extends anti-retaliation protection only to individuals who provide information “to the Commission.” Despite this limitation, in Digital Realty, the Ninth Circuit held that a former employee was entitled to protection under Dodd Frank even though he reported alleged misconduct internally and not to the SEC. In a unanimous decision, the Supreme Court reversed, holding that an individual may sue under Dodd-Frank’s anti-retaliation provision only after providing information to the Commission. The Supreme Court’s decision resolves a split between the Ninth, Fifth, and Second Circuits. That said, employees who report misconduct internally may still be entitled to anti-retaliation protection under the Sarbanes-Oxley Act.
Issues for the Year Ahead
While predicting trends in SEC enforcement actions can be difficult, here are some issues affecting SEC enforcement to consider:
Continued SEC Enforcement Efforts and Whistleblower Program. As discussed, although there was much speculation about what enforcement would look like under the Trump administration, FY 2017 was, by the numbers, similar to FY 2016, and historically one of the most active years ever. This suggests FY 2018 will be another strong year for SEC enforcement. It remains to be seen whether the SEC’s explicit prioritization of Main Street investors will lead to a shift in either the type or number of enforcement actions. The SEC has given no indication that its reliance on the whistleblower program will decrease, and with record numbers of tips coming in and record awards being made, the whistleblower program may continue to grow despite the Supreme Court’s decision that will require whistleblowers to contact the SEC directly or through counsel.
Constitutionality of Administrative Proceedings. Several defendants have sued in federal court challenging the constitutionality of the SEC’s administrative proceedings, arguing that under the Appointments Clause, SEC ALJs are “officers” who must be appointed by the President or by the head of an agency, rather than “employees” who can be appointed by the chief ALJ, as they currently are. On January 12, 2018, the Supreme Court decided to take up one of these cases, Lucia v. SEC, to resolve a split between the D.C. and Tenth Circuits on this issue. Interestingly, the SEC, which initially argued that its ALJs were employees, reversed course under the Trump administration and informed the high court it now supports the defendant’s position. The Supreme Court decided to hear the case anyway. Lucia not only implicates the future viability of SEC administrative proceedings – a favored venue for the SEC – but raises the question whether past ALJ decisions can be unwound.
Will SEC Disgorgement Survive? The Supreme Court’s opinion in Kokesh v. SEC, which was issued in June 2017, has fueled speculation about whether courts have authority to order disgorgement in SEC enforcement actions. The case putatively concerned the proper statute of limitations applicable for claims for disgorgement, with the Supreme Court holding that disgorgement claims are subject to the five-year statute of limitations for enforcing fines, penalties, or forfeitures. What has driven interest, though, is a footnote in which the Supreme Court declared “nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings.” Stay tuned, as this seems to be an invitation for defendants to challenge disgorgement orders, which are a mainstay of SEC enforcement proceedings.
Duty to Disclose Known Trends and Uncertainties. A final Supreme Court opinion of interest is Leidos, Inc. v. Indiana Public Retirement System, in which the court was asked to decide whether a company can be subject to liability under Section 10(b) for failing to disclose a known trend or uncertainty, as required by Item 303 of Reg S-K, even when the omission does not make the company’s affirmative statements misleading. The case seeks to resolve a split between the Second, Third, and Ninth Circuits. The case was set for argument in November 2017, but was removed from the argument calendar pending an agreement in principle between the parties to settle the litigation. If the case settles, the circuit split will remain.
Future of Dodd-Frank. In June 2017, the House passed the CHOICE Act, which would have repealed much of Dodd-Frank. Notably, the CHOICE Act largely retains the whistleblower program, although it would prohibit recovery by any whistleblower “who is responsible for, or complicit in” the misconduct, which could disincentivize certain company insiders from coming forward. The CHOICE Act also contains a provision entitling any defendant in an SEC administrative proceeding to remove the action to federal court, and raises the standard of proof in administrative proceedings to clear and convincing evidence. More recently, the Senate Banking Committee advanced a bipartisan financial regulatory reform bill with bipartisan support. That effort, the Economic Growth, Regulatory Relief, and Consumer Protection Act, proposes narrower reforms than the CHOICE Act, and would not alter the whistleblower program or the course of SEC administrative proceedings. The Trump administration has repeatedly signaled its support for financial reform, including rolling back Dodd-Frank. It remains to be seen whether any of these efforts will gain traction in 2018.
 The majority of statistics used in this article come from two SEC publications, SEC Division of Enforcement, Annual Report, A Look Back at Fiscal Year 2017 (Nov. 15, 2017), https://www.sec.gov/files/enforcement-annual-report-2017.pdf, and SEC 2017 Annual Report to Congress, Whistleblower Program (Nov. 15, 2017), https://www.sec.gov/files/sec-2017-annual-report-whistleblower-program.pdf.
About the authors: Britt K. Latham is a member with Bass, Berry & Sims and counsels corporate defendants in securities and business-related litigation, including class actions, shareholder disputes and derivative actions in state and federal court, and represents corporate defendants in SEC investigations and enforcement proceedings. Brian Irving is an associate with Bass, Berry & Sims and represents corporate defendants in business disputes and government investigations, including SEC investigations and enforcement proceedings arising from alleged violations of federal securities laws.