A Year of Firsts: SEC Under New Leadership

I. Introduction

All eyes have been on U.S. Securities and Exchange Commission Chair Gary Gensler as he closes out his first fiscal year at the helm of the Commission.  Gensler was widely expected to usher in a more aggressive regulatory and enforcement approach than did his predecessor; whether such predictions will play out in reality would be premature to say.[1]  Reversing the downward trend of the last few years of former Chair Jay Clayton’s tenure, enforcement activity ticked up slightly, from 405 “stand-alone” cases in fiscal year 2020 to 434 such cases in fiscal year 2021.  Much of the increase seems to have come in the latter half of the year; at the mid-year point enforcement actions in fiscal year 2021 were on par with what they had been in fiscal year 2020.

It is difficult to extrapolate too much from this data to predict what enforcement will look like under Gensler’s tenure.  Gensler has only been in office for six months, and many of the cases brought in that time had been in the pipeline from his predecessor.  Given this, enforcement results from fiscal year 2021, officially released on November 18, do not give a perfect view of what we might expect from the SEC moving forward.  That said, certain trends in enforcement patterns are worth noting, and could signal a refresh in the Commission’s priorities.

Source: U.S. Securities and Exchange Commission data. See below for the full table of all FY 2021 actions.

In many ways, fiscal year 2021 seems to have been a year of firsts.  In his remarks at SEC Speaks 2021, Gurbir Grewal, former New Jersey Attorney General and newly-appointed head of the Enforcement Division, highlighted a number of first-of-their-kind enforcement actions from the past year, including actions against decentralized finance technology, fraudulent digital asset securities offerings, illegal trading in crypto securities, and alternative data providers.[2]  Grewal pointed to these novel actions as evidence of the Enforcement Division’s renewed focus on restoring public trust in financial institutions.

At the same event, Gensler chose to speak on how the SEC is adapting to changing real-world conditions, focusing on how the rise in predictive analytics presents both challenges and opportunities in finance and financial regulation.[3]  His remarks discussed how broad adoption of predictive analytics could exacerbate issues of bias, conflicts of interest, and systemic risk, emphasizing that while technology can expand access and enable better risk management, it also raises novel challenges.

If the remarks at SEC Speaks are any indication, the Gensler tenure may be one of innovation and adaptation as the Commission responds to fast-moving fluctuations both internal and external to financial markets.

II. 2021 Enforcement Results

In the past year, the Commission brought 434 stand-alone cases—defined as civil actions filed or administrative proceedings instituted, excluding Section 12(j) proceedings against delinquent filers and follow-on administrative proceedings to obtain suspensions and bars based on prior enforcement actions by the SEC or other law enforcement agencies.  Following the convention used by Division of Enforcement, we track these cases in nine different categories.  The breakdown of these cases is as follows:

III. Notable Trends

A. Investment Advisers

Investment adviser actions rebounded from a low of 87 in FY 2020 to 120 actions in FY 2021—representing 28% of all stand-alone actions. The increase in investment adviser actions was concentrated in a handful of areas.

The SEC brought fourteen revenue sharing cases in the latter half of fiscal year 2021.  Of these cases, five had disgorgement values greater than $1 million.  The number of share class selection disclosure (“SCSD”) cases also increased towards the end of the fiscal year—the SEC brought 13 such cases in the latter half of FY 2021, as compared with six cases in the first half of FY 2021.  The total number of SCSD cases remained steady at 19, compared with 18 in fiscal year 2020.  Offering fraud cases involving investment advisers were also up in fiscal year 2021 as compared with fiscal year 2020 (seven compared to three).

New this year to the investment adviser category, and driving at least part of the observed increase, were Form CRS actions.  The SEC first rolled out Form CRS—which is intended to provide retail investors with information about a firm’s services, fees, and conflicts of interest— in June 2019, with a filing compliance date of June 30, 2020.  On July 26, 2021, the SEC announced that it had settled charges against 21 investment advisers for failing to file or deliver their Form CRS until being reminded twice by regulators.  Speaking about the announced actions, Grewal noted that the “cases reinforce the importance of . . . providing retail investors with information that is intended to help them understand their relationships with their securities industry professionals.”

B. Cryptocurrency

Security offerings cases typically make up a meaningful portion of the SEC’s annual enforcement actions and FY 2021 proved no different—total security offerings cases ticked up slightly to 142, or about 33% of total actions.  In remarks at the Securities Enforcement Forum in early November of this year, Gensler emphasized that while the SEC will continue to protect the public from “penny stock scammers, Ponzi scheme architects, and pump-and-dump cons,” they must balance “everyday fraudsters” against “high-impact cases” which “change behavior . . . [and] send a message to the rest of the market, to participants of various sizes, that certain misconduct will not be permitted.”[4] A focus on so-called “message cases” could suggest that the heavy docket of run-of-the-mill securities offering frauds might take a dip in the future in exchange for higher-impact cases. But given that over 60% of all enforcement actions by the SEC involve offering fraud or investment adviser misconduct, it seems unlikely that these types of cases will not continue to dominate the SEC’s enforcement agenda in the future.

Cryptocurrency enforcement—generally considered a subset of this category in the SEC’s classification of its enforcement program—amounted to 14 cases this year, up from the 13 cryptocurrency cases brought the past fiscal year.  Of particular note is the ongoing litigation against Ripple Labs, Inc.  The Commission has alleged that Ripple tokens (XRP) were a security, and that the company and its executives sold over $1.3 billion in unregistered securities.  Despite the ongoing litigation, the value of the token surged in April to over three times what its price was immediately after the SEC announced its action.  As of the date this article was published, the token remained steady at more than twice its price in the days before the SEC announced the charges.  CFTC Commissioner Dawn Stump indicated that her agency is monitoring the litigation closely, as it could provide long-sought clarity on “the scope of the SEC’s authority in the digital assets space.”[5]

Gensler is expected to be particularly active in imposing tougher restrictions on cryptocurrency.[6] Observers have noted Gensler’s experience with digital currencies, given his teaching role at MIT, and the role such experience will play in navigating the challenges around regulation of Bitcoin and cryptocurrencies.  In his Senate confirmation hearing, Gensler said that “[m]arkets—and technology—are always changing.  Our rules have to change along with them . . . .  I believe financial technology can be a powerful force for good—but only if we continue to harness the core values of the SEC in service of investors, issuers, and the public.”[7]

A new digital product called non-fungible tokens (“NFTs”) sparked trading mania among NBA and NFL fans, digital art connoisseurs, and even a New York Times tech columnist,[8] and poses a new challenge in the area of crypto-regulation.  First launched in 2015, NFTs surged in popularity this past year, exceeding $2.5 billion in sales in the first half of 2021.[9]  NFTs use blockchain technology to certify digital assets similarly to cryptocurrency.  SEC Commissioner Hester Peirce, who supports cryptocurrencies, has warned NFT sellers to “be careful that you’re not creating something that’s a security” by selling fractions of NFTs.[10] While not precisely the same, NFTs and cryptocurrency share enough similarities such that the SEC’s attitude towards NFTs—still an open question—may well be informed by how it develops the regulatory framework surrounding cryptocurrency. 

C. Issuer Reporting / Audit & Accounting

Issuer reporting / audit & accounting cases were down slightly in FY 2021, dropping to 53 from 62 in FY 2020. The largest decrease came in accounting cases, which fell from 35 in fiscal year 2020 to 15 in fiscal year 2021.  In contrast corporate disclosure cases increased to 30 in FY 2021, up from 18 in FY 2020.  The rise in corporate disclosure cases was driven in part by eight late-filer cases announced on April 29, 2021—the first such cases the SEC has brought in a number of years. All eight complaints related to the companies’ failures to disclose to the SEC that their request for a delayed filing was caused by anticipated, significant changes or corrections to prior financial reporting.  In the press release covering the charges, then-Acting Director of the Enforcement Division, Melissa R. Hodgman, pointed to the Commission’s targeted initiative to track down deficient Forms NT, emphasizing the importance of data analytics to identify otherwise difficult-to-find violations.

On October 14, 2021, just a few weeks after the official close of fiscal year 2021, the SEC announced that it was reopening the comment period on the compensation clawback rules that the Commission had first proposed in 2015.  The proposed rules implement Section 954 of the Dodd-Frank Act, and would mandate that companies required to prepare an accounting restatement to correct a material error must also retroactively claw back incentive-based compensation awarded to executive officers based on the previously-inaccurate financial statement.[11]

D. Broker-Dealer

Broker-dealer cases were also down slightly in FY 2021, decreasing to 36 from the 40 cases in FY 2020. As we’ve previously discussed, this decrease may be a result “of the shift away from broker-dealers and toward investment advisers in the agency’s exam program, which historically has been an important source of enforcement matters for the SEC’s regional offices.”[12]

The relatively steady trend in total broker-dealer cases hides greater fluctuation within the subcategories.  On the same day that it announced settlements with twenty-one investment advisers over delinquent Form CRS filings, discussed above, the SEC settled similar charges with six broker-dealers.  Unregistered broker-dealer cases were also up—jumping to nine cases from six in FY 2020.  In contrast, unauthorized trades actions dropped to one, from five cases in the prior fiscal year.

Grewal recently emphasized that firms need to implement proactive compliance programs to monitor off-channel broker-dealer communications.  While acknowledging that “[r]ecordkeeping violations may not grab the headlines,” he signaled more aggressive SEC enforcement of recordkeeping obligations, at least insofar as they relate to the preservation of “off-channel communications,” as such records are “essential to market integrity and enforcement.”[13]

E. FCPA

Despite President Trump’s open criticism of the law, the Foreign Corrupt Practices Act (“FCPA”) seems to have survived to see a new administration.[14]  FCPA cases tallied at five in FY 2021—a slight drop from the 10 cases brought in FY 2020. In addition to the Goldman Sachs settlement, the SEC also reached a $19.2 million agreement with WPP PLC over allegations of bribery in India, China, and Brazil.

IV. Other Noteworthy FY21 Enforcement Trends

A. Special-Purpose Acquisition Companies

Gensler has been open about his belief in the need to strengthen the disclosure rules applied to special-purpose acquisition companies (“SPAC”), having publicly referred to them as “blank-check IPOs”:  the SEC has been correspondingly active in exploring and formulating guidance on SPAC regulation this past fiscal year.[15]  The SEC’s annual regulatory agenda, released June 11, 2021, highlighted special purpose acquisition companies as a notable area of proposed and final SEC rulemaking.  On September 9, 2021, the Investor Advisory Committee unanimously voted to approve a series of recommendations relating to the rise of SPACs—the recommendations focused on stricter enforcement of existing disclosure rules, and encouraged the Commission to conduct an analysis of key players in the SPAC landscape, which could potentially form the basis for other recommendations from the Committee.

A recent notable case involving SPACs may be a signal of the SEC’s enforcement agenda to come.  In July 2021, the Commission charged Stable Road Acquisition Company and its proposed merger target Momentus Inc. with misleading investors about the viability of the company’s propulsion technology, and about the company founder’s ability to obtain the needed governmental licenses.  The SEC ultimately settled with Stable Road, Momentus, and Stable Road’s CEO Brian Kabot for $8 million.

The market seems to have taken note of the Commission’s attention to SPACs.  In an April 12, 2021 statement, the SEC staff accountants released a statement that warrants—typically issued by SPAC sponsors to encourage investment—should sometimes be treated more properly as liabilities rather than equity investments.  Whether or not the announcement actually had a chilling effect is difficult to say, but SPAC IPOs—which had raised $92.3 billion in the first quarter of 2021—plunged to just $6.8 billion in the second quarter.[16]  It will be interesting to see how the SEC’s continued focus on this area will affect the longevity of the SPAC surge.

B. Increased Activity by the Cyber Unit

Recent SEC enforcement actions may be a warning that the Commission will continue to carefully monitor cybersecurity vulnerabilities.  On August 30, the Commission announced its sanction of eight firms in three actions for violating Rule 30(a) of Regulation S-P (also known as the Safeguards Rule).  The Safeguards Rule requires registered broker-dealers and investment advisers to adopt “written policies and procedures that address administrative, technical, and physical safeguards for the protection of customer records and information.”  The firms agreed to settle charges that they had failed to adequately protect email accounts, resulting in a takeover by unauthorized third parties that ended up exposing the personal information of thousands of their customers and clients.

Kristina Littman, Chief of the SEC Enforcement Division’s Cyber Unit, signaled that the Unit would look not just to whether companies could write sufficient policies enhancing their cybersecurity measures, but also hold companies accountable to abiding by the terms of their policies and ensuring that they could adequately defend information against known attacks.

C. Insider Trading and Rule 10b5-1

Insider trading cases continued to trend downwards, dropping to 28 cases in FY 2021.  During the Trump administration, the SEC’s enforcement of insider trading reached a two-plus decade low,[17] with just 30 cases brought in FY 2019 and 33 brought in FY 2020.[18]  While there was an uptick in the number of such cases brought in the second half of the fiscal year—from seven to twelve—it was not enough to overcome the year’s slow start.

Notably, the SEC brought its first complaint under a novel “shadow trading” theory in August 2021 against Matthew Panuwat.  The complaint alleged that Panuwat, a then-employee of a biopharmaceutical company, had improperly used information gained from his employer to buy stock in a third company.  While the third company was unrelated to the pending merger, its stock would likely have been positively impacted by the planned acquisition.   The SEC’s theory of enforcement aligned with what an article published in the beginning of FY 2021 termed “shadow trading”—in which corporate insiders use private information to trade in economically-linked firms, while circumventing the technical limits of insider trading restrictions.[19]  The SEC’s action against Panuwat seems to signal that it is paying close attention to developments in insider trading, and will be scrutinizing corporate insiders accordingly.

Another recent enforcement action could exemplify the SEC’s newfound willingness to be creative about its use of insider-trading concepts.  In an action announced September 2021, the SEC charged App Annie, an alternative data provider that sells market data on mobile app performance, with misrepresenting to its customers the internal safeguards it had in place to prevent the misuse of confidential data from companies.  While App Annie was not directly charged with insider trading, the case seems to signal the Commission’s commitment to proactively responding to quickly-shifting market trends.

V. Penalties and Other Monetary Remedies

Civil money penalties and other monetary remedies were down to $3.85 billion total in fiscal year 2021—compared with $4.68 billion and $4.35 billion in FY 2020 and FY 2019 respectively.  This decline came mostly from a dip in disgorgement, which fell from $3.59 billion in FY 2020 to $2.40 billion in the current fiscal year.  In contrast, total civil penalties were up in FY 2021, from $1.09 billion the preceding year to $1.46 billion total this year.

In its annual reports, the Commission disclosed the following monetary recoveries for the Commission in the past six fiscal years:

Making up, perhaps, for the small number of total FCPA cases brought in FY 2021, the Commission’s largest claimed recovery was just over $1 billion in an FCPA action against Goldman Sachs, over allegations involving the company’s activities in Malaysia and Abu Dhabi.

In addition, General Electric Company entered into a $200-million settlement for allegedly failing to disclose material information related to two “key reportable segments” from 2015 to 2017 on the basis that, among other issues, a subsidiary (GE Power) had engaged in a practice wherein it sold its long-term receivables to another GE entity (GE Capital) in order to boost cash flows in the present quarter.  GE Power purportedly engaged in this practice without disclosing to investors that doing so was depleting future cash flows.  In addition, the SEC alleged that GE’s insurance business failed to disclose rising claim costs and the potential for material insurance losses, and failed to disclose that increases in revenue profits for its power segment were because of reductions in cost estimates to complete multi-year projects.

Other large recoveries included $137.5 million from South Carolina Electric & Gas Co. to settle allegations that it raised more than $1 billion from investors after misleading them into believing that a project would qualify the company for billions in tax credits when the company knew the project was behind schedule and was unlikely to qualify for the tax credits.  Also of note was a $170 million settlement with BlueCrest Capital Management Limited, a U.K.-based investment adviser, which was accused of failing to disclose that it had transferred its best-performing traders to a proprietary fund and replaced those traders with “an underperforming algorithm” that “benefitted its own personnel to the detriment of fund investors.”

VI. Progress on Key SEC Priorities

A. Efforts to Identify, Understand, and Address Financial Risks of Climate Change

In his confirmation testimony, Gensler discussed the importance of transparency around climate-related risks.  In response to questioning on the reasonable investor and materiality standards for disclosure of climate risks, Gensler commented, “[i]t’s the investor community that gets to decide what’s material . . . it’s all about that reasonable investor, and do they think it’s significant in the mix of information.”[20]  He added that “[i]n 2021, there are tens of trillions of dollars of invested assets [and investors] . . .  are looking for more information about climate risk, and I think then the SEC has a role to play to help bring some consistency and comparability to those guidelines.”[21]

Climate-related risk disclosures will be the subject of new rulemaking for the Division of Corporation Finance and likely an increased priority for the Enforcement Division in the coming years.[22]  On February 24, then-Acting Chair Allison Herren Lee said that she was “directing the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings” and, in taking account of developments from the last decade, to update the Commission’s 2010 guidance, which describes existing disclosure obligations as they regard climate-change issues.[23]  She observed that now especially “investors are considering climate-related issues when making their investment decisions,” thereby requiring the SEC to ensure that those investors have material information.[24]  In early March, the Commission announced the creation of a Climate and ESG Enforcement Task Force that “will develop initiatives to proactively identify ESG-related misconduct,” with an “initial focus” on “identify[ing] any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.”[25]

On September 22, 2021, the Commission published a sample letter to companies regarding climate change disclosure, which aims to provide an illustration of what kinds of climate-related disclosures the SEC may seek moving forward.[26]  The letter focused on two types of information:  risk factors related to climate change, and management’s discussion and analysis of financial conditions and results of operations.  These questions are consistent with what the SEC has signaled as its primary concerns with regards to disclosure of climate-related risks, with Commissioner Roisman highlighting that while the details of ESG disclosure requests will vary by company, the bottom-line consideration will always be “what information is material to an investment decision.”[27]

B. Broader Focus on Corporate Governance and Social Issues

Along with its attention to climate-related disclosures, the SEC has also indicated a broader focus on the intersection between corporate governance and the challenges posed by racial injustice, economic inequality, and other social issues.  At his Senate confirmation hearing, Gensler described, in broad terms, the value of disclosure rules that require transparency on board diversity.  Gensler noted, “I do think that diversity in boards and senior leadership . . . benefits decision-making and it’s something that I am committed to at the SEC.”  Gensler made similarly open-ended comments in response to questioning on whether the SEC should require disclosure of workforce diversity issues: “I think human capital is a very important part of the value proposition in so many companies.”[28]  In line with these remarks, the SEC recently approved proposed rule changes from Nasdaq that require companies to have at least “one female board member and at least one who identifies as an underrepresented minority or LGBTQ,” or provide an explanation as to why they do not.[29]

Speaking before the 2021 Society for Corporate Governance National Conference, Commissioner Allison Herren Lee observed that “environmental and social issues, once perhaps treated as more peripheral, are now central business considerations.”[30]  Her remarks charged corporate boards with three ways in which to maximize ESG opportunities:  enhance board diversity, increase board expertise in relevant climate and ESG issues, and use financial incentives to spur innovation on corporate strategies to address these topics.  Commissioner Lee cautioned boards to avoid “woke washing”—using social movement to benefit the company’s bottom line without undertaking real reform in the company’s practices—and to ensure that public statements on ESG issues are backed with real corporate action.

C. Whistleblower Program

On September 15, 2021, the SEC also announced that its Whistleblower Program had officially paid over $1 billion total to 207 whistleblowers since the program’s first award in 2012.[31]  Fiscal year 2021 in particular was a banner year for the program, with the Commission awarding over $500 million to over 100 individuals.  In comparison in FY 2020 the SEC reported awards totaling $175 million to 39 individuals (a then-record, up from $60 million to eight individuals in FY 2019).  The SEC also awarded its two largest whistleblower payments in FY 2021: $110 million in September of 2021 and $114 million in October 2020.

VII. Conclusion

The first six months of Gensler’s tenure have already seen some noticeable trends—a sharp rebound in the number of investment adviser actions, novel theories of enforcement including shadow trading, and renewed focus on innovations within financial markets such as SPACs and cryptocurrency.

Gensler has stepped into his role at an interesting time, in the midst of a change in presidential administrations (and its corresponding politics), fast-moving innovations in technology and data analysis, and increased focus on the interplay between financial markets and environmental and social governance issues.  How the new SEC leadership will steer the Commission to confront these challenges remains to be seen.

The following Covington lawyers and law clerk assisted in preparing this client update: Gerald Hodgkins and Ashley Joyner Chavous..