As the Securities and Exchange Commission Division of Enforcement signaled in its recent annual report, policing the asset management industry will be a key priority in its continuing focus on protecting retail investors. This renewed emphasis reaffirms the view that if a significant error or misconduct is detected, firms generally should not wait for SEC scrutiny to take corrective steps and mitigate investor harm. Voluntary remediation must be considered as part of any strategy for managing regulatory exposure as well as reputational and litigation risk. Where a firm does decide to remediate, it must proceed carefully to avoid pitfalls that could lead to fresh scrutiny from regulators or even private civil litigation.
This post provides guidance to regulated firms on managing risks once they determine to voluntarily remediate – as distinct from the fact-specific issue of whether to “self-report” errors or misconduct – in the SEC context. It begins with an overview of the benefits and risks of voluntary remediation and common types of remedial measures. It then identifies potential issues that can arise when undertaking remediation. Finally, it advises on structuring and implementing remedial measures to minimize risks of regulatory or litigation exposure.
1. Benefits of Voluntary Remediation
The SEC has traditionally emphasized the importance of remediation. The 2001 Seaboard Report identified remediation as one of four broad measures that the SEC uses to evaluate the extent to which it credits a company’s cooperation, which often means a reduction in the severity of charges and/or penalties. The Seaboard Report notes that the SEC credits prompt and robust remedial efforts “from the extraordinary step of taking no enforcement action to bringing reduced charges, seeking lighter sanctions, or including mitigating language in documents we use to announce and resolve enforcement actions.” Similarly, the SEC and DOJ “place a high premium” on remedial efforts in determining the resolution of FCPA cases. Remedial efforts are also a key consideration when seeking waivers of disqualification following certain regulatory or criminal actions.
For these reasons, among others, many firms choose to pursue remedial measures on their own accord prior to any SEC scrutiny, like an Office of Compliance Inspections and Examinations (OCIE) exam or an Enforcement investigation. This is particularly true today as the SEC’s whistleblower program continues to mete out significant awards to those inside firms who identify actionable misconduct. The SEC, however, will still favorably consider voluntary remediation measures undertaken before or during enforcement investigations. And, notwithstanding prior voluntary efforts, the SEC may subsequently order further remedial measures or require ongoing reports as to the progress of voluntary measures.
The SEC has not issued specific guidance outlining what it considers to be effective remediation, likely because there is no one-size-fits-all approach. Firms, however, can draw lessons from measures described or required in enforcement orders and settlements, and can consider a number of general goals when designing voluntary remediation plans.
- Preventing Recurrence: First and foremost, firms must take corrective actions in order to prevent repetition of errors or misconduct. No compliance regime is foolproof, but the entire objective (and related expense) of remediation can be undermined by adopting measures that do not reasonably guard against repeated problems. Remediation measures that strengthen compliance programs and enhance internal controls can prevent incidents from developing into persistent problems. Moreover, making systemic changes may demonstrate to regulators the firm’s commitment to compliance. Should similar problems subsequently occur, evidence of prior reform efforts geared towards detection and prevention could increase the likelihood of receiving credit for self-policing and deference to the firm’s internal investigation and help to avoid a finding that the firm violated SEC rules requiring the adoption and implementation of policies and procedures “reasonably designed to prevent” securities law violations.
- Reimbursing Injured Parties: When errors or misconduct result in financial consequences for third parties, remedial measures that reimburse for financial losses may be appropriate. Promptly disclosing issues to investors and offering full and fair reimbursement may disincline harmed investors from pursuing private legal action and obviate the need for SEC action to provide redress to investors or oversight of reimbursement efforts.
- Maintaining or Restoring Trust: Regulatory scrutiny or revelations of errors or misconduct can create negative publicity and lasting reputational damage. Proactive steps to correct and resolve issues early can help fortify or restore a firm’s relationships with its investors, clients, and other interested third parties (such as lenders and counterparties), and increase the chance of avoiding adverse publicity.
Common remediation measures consistent with the goal of preventing recurring problems are ones that promote systematic changes, including reviewing and revising policies and procedures, enhancing existing or implementing new internal controls to detect future errors and misconduct, and redesigning training programs to ensure staff focus on the relevant issues. Disciplining firm personnel who engage in misconduct, informing and compensating injured parties,and hiring an independent consultant, where appropriate, to comprehensively evaluate polices and internal controls, can go a long way towards placing the firm in the best light possible for any regulatory or other scrutiny that may later occur.
2. Risks of Voluntary Remediation
While voluntary remediation may produce significant benefits, it can also create pitfalls that potentially expose firms to additional risk. Thus, remedial measures should be carefully tailored to avoid introducing new problems. There are a number of ways in which remedial measures can generate further scrutiny or even additional legal exposure.
- Incomplete or Misleading Disclosures: Failing to adequately disclose the underlying problem and the remediation to investors, clients or regulators can create an additional violation that could lead to an enforcement action. The SEC has shown an appetite to aggressively use the negligence-based provisions of the Investment Advisers Act and Investment Company Act to police misleading statements and incomplete disclosures in the remediation context. For example, a recent SEC settlement found violations of Sections 206(2) and 206(4) of the Investment Advisers Act and Section 34(b) of the Investment Company Act for failure to inform harmed investors that initial remedial payments only estimated, instead of fully conformed to, standard error correction procedures, and that the remediation process treated shareholders differently based upon whether they transacted with the fund directly or through an intermediary. This concretely illustrates the Enforcement Division’s willingness to impose liability based on remedial acts.
- Inadequate Reimbursement to Injured Parties: Firms may confront significant difficulties in creating a reasonable methodology for determining the proper reimbursement amount for injured parties. For example, historical records may be inadequate to calculate necessary distributions. It may be difficult to accurately calculate interest rates or expected rates of return for assets that should have been invested or determine where costs should lie in cases of horizontal misallocations between investors and clients. Decisions about whether to net gains and losses of affected investors may also be necessary and could impact investors’ perceptions of the sufficiency or fairness of the remediation. In cases where judgment must be applied in calculating required remedial payments, firms should establish and document a principled process that treats affected parties equitably. The SEC may later second-guess the firm’s handling of these factors and order additional compensation or revisions to the calculation methodology.
- Undermine Confidence in Initial Policies and Record of Compliance: At least one former senior SEC official has noted the tendency for firms to focus on the strengths of their remedial measures without adequately demonstrating the robustness of their compliance policies and procedures on the front end. In the process of highlighting new remedial measures and compliance systems, investment managers may inadvertently minimize their historical record of compliance and ethical conduct. Revisions to policies, additions to training programs and other remedial measures should be expressly tailored to the aspects of a firm’s compliance program that had deficiencies.
- Attract Regulatory Scrutiny: When firms undertake remedial efforts, the breadth and timeliness of the firm’s actions can come under scrutiny. Failure to address identified issues in a prompt and comprehensive manner can draw the attention of OCIE during future examinations and potentially review by the Enforcement Division. Firms should design, approve and document remediation plans with this scrutiny in mind.
- Encourage Private Civil Litigation: When firms disclose errors or misconduct and undertake remedial actions, parties that did not receive remedial payments, or those who believe they were insufficiently compensated, may investigate their own accounts and discover previously unidentified issues. In a recent civil lawsuit brought against WL Ross, for example, former employees of the firm allegedly discovered that management fees had been wrongly charged to their investment accounts after the SEC investigated similar issues with limited partners’ accounts the prior year. The heightened attention that parties may give to their own records can result in further private civil litigation following remedial measures. In addition, remediated parties themselves could bring suit alleging that their payments were insufficient.
3. Guidance on Structuring Remedial Efforts
Given these potential risks, asset managers should keep a number of considerations in mind when structuring remedial efforts to avoid additional exposure and scrutiny and reap the full benefits of remediation.
- Act Swiftly and Proactively: Although the SEC may still credit delayed remediation, it favors prompt action. Thus, firms should take timely steps upon identifying errors or misconduct. Swift internal reporting to appropriate legal, compliance and other personnel, implementing temporary systems and process changes, and appointing an individual or group to be responsible for evaluation and action, can demonstrate to regulators the firm’s commitment to prompt and proactive remediation.
- Properly Frame the Remedy: Remedial efforts should be reasoned and readily explainable. The sufficiency of the measures should be considered from the perspective of each of the firm’s various constituencies, including regulators, harmed investors and clients, unharmed investors and clients, and other third-parties such as lenders or counterparties. Moreover, to the extent possible, the remediation should be consistent with the firm’s existing policies and procedures. This may have the added benefit of demonstrating that any misconduct is simply an outlier in a firm driven by an active culture of compliance.
- Treat Harmed Parties Equitably: When reimbursing injured parties, firms should seek to avoid any remediation that disparately treats certain parties absent an objective and defensible reason that is consistent with its fiduciary duty and Investment Advisers Act obligations. For example, in the Calvert case, the SEC criticized the firm’s use of estimated data to calculate reimbursements because that methodology treated shareholders who transacted directly with its funds differently than those who transacted through an intermediary. Disparate treatment could also anger investors and enhance the risk of further litigation or negative business consequences.
- Consider the Big Picture: In addition to correcting the discrete problem, firms should be sure to consider the need for systemic changes to policies and procedures. This may involve hiring external counsel or consultants to identify other potential issues and recommend broader revisions to internal policies.
- Make Comprehensive Disclosures: Thorough and carefully crafted disclosures are key to avoiding regulatory or litigation liability based on misstatements or omissions. This is particularly important when remediating historical misconduct outside the statute of limitations because inadequate disclosure may provide the SEC with a hook to bring an enforcement action where one otherwise would be time-barred. While this generally does not require complete disclosure of every line-item related to the remediation efforts, disclosures should accurately capture the situation and circumstances behind the remediation measures and, as appropriate, transparently explain the methodology used to calculate remediation amounts. Disclosures also should neither minimize nor exaggerate the harms caused by the underlying issues.
- Create a Communications Plan: Firms should aim to minimize the overall number of communications related to the remediation efforts, but may consider preparing targeted communications with varying levels of detail based on the audience. For example, while all current investors should be notified about policy changes made as a result of remediation, firms may choose to notify only impacted investors about the underlying issue and remediation process and methodology. A detailed initial disclosure should reduce the need for future communications. While written communications are generally preferable, any calls with investors or other interested parties should be conducted based on pre-written talking points to maintain an accurate and consistent message. Similarly, firms should designate a point-of-contact for queries and draft standard responses for potential questions.
Voluntary remediation is often a necessary step towards resolving historical issues, mitigating the scope or severity of an enforcement action, and minimizing the risk of future litigation. Yet, remedial measures themselves can create exposure. Being mindful of these risks and drawing lessons from prior SEC actions can help members of the asset management industry navigate these tricky waters and prevent additional harm.
 See Matthew Solomon, Robin Bergen & Alexis Collins, Analysis of SEC Enforcement Division Annual Report, Harvard Law School Forum on Corporate Governance and Financial Regulation (Dec. 6, 2017), https://corpgov.law.harvard.edu/2017/12/06/analysis-of-sec-enforcement-division-annual-report/.
 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Release No. 44969 (October 23, 2001), http://www.sec.gov/litigation/investreport/34-44969.htm (the “Seaboard Report”); see also Enforcement Cooperation Program, U.S. Securities & Exchange Commission, https://www.sec.gov/spotlight/enforcement-cooperation-initiative.shtml (last modified Sept. 20, 2016).
 The Seaboard Report, supra note 2.
 U.S. Dep’t of Justice & U.S. Sec. & Exchange Comm’n, A Resource Guide to the U.S. Foreign Corrupt Practices Act 54 (2012), https://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf.
 Waivers of Disqualification under Regulation A and Rules 505 and 506 of Regulation D, U.S. Securities & Exchange Commission, https://www.sec.gov/divisions/corpfin/guidance/disqualification-waivers.shtml (last modified Mar. 13, 2015).
 E.g. Cambridge Investment Research Advisors, Inc., Investment Advisers Act Release No. 4361, at 10 (April 5, 2016), https://www.sec.gov/litigation/admin/2016/ia-4361.pdf.
 E.g. Envoy Advisory, Inc., Investment Advisers Act Release No. 4764 ¶ 23 (Sept. 8, 2017), https://www.sec.gov/litigation/admin/2017/ia-4764.pdf; Capital Dynamics, Inc., Investment Advisers Act Release No. 4746, at 5 (Aug. 16, 2017), https://www.sec.gov/litigation/admin/2017/ia-4746.pdf.
 Canterbury Consulting, Inc., Investment Advisers Act Release No. 4801 ¶¶ 19-23 (Oct. 26, 2017), https://www.sec.gov/litigation/admin/2017/34-81959.pdf; Cambridge Investment Research Advisors, Inc., supra note 6 at ¶¶ 50-51; Calvert Investment Management, Inc., Investment Advisers Act Release No. 4554 ¶¶ 33-34 (Oct.18, 2016), https://www.sec.gov/litigation/admin/2016/ia-4554.pdf.
 Stephen L. Cohen, Assoc. Director of Enforcement, U.S. Sec. & Exchange Comm’n, Remarks at SCCE’s Annual Compliance & Ethics Institute (Oct. 7, 2013), https://www.sec.gov/news/speech/spch100713slc.
 E.g. 17 C.F.R. § 270.38a-1 and 17 C.F.R. § 275.206(4)-7.
 Compare Capital Dynamics, Inc., supra note 7, at 4-6 with Cadaret, Grant & Co., Inc., Investment Advisers Act Release No. 4736, at 7-8 (Aug. 1, 2017), https://www.sec.gov/litigation/admin/2017/34-81274.pdf.
 Cambridge Investment Research Advisors, Inc., supra note 6, at 10; Envoy Advisory, Inc., supra note 7, at ¶ 25.
 Calvert Investment Management, Inc., supra note 8, at ¶ 32.
 Capital Dynamics, Inc., supra note 7, at ¶ 14.
 Canterbury Consulting, Inc., supra note 8, at ¶ 18.
 Id. at ¶¶ 19-20.
 Cohen, supra note 9; Envoy Advisory, Inc., supra note 7, at ¶ 25; Capital Dynamics, Inc., supra note 7, at ¶ 14.
 SEC v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992) (citing SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963)); see also Cadaret, Grant & Co., Inc., supra note 11, at ¶ 23.
 Calvert Investment Management, Inc., supra note 8, at ¶¶ 21, 26-27, 29.
 Id. at ¶¶ 33-34.
 Cohen, supra note 9.
 OCIE National Exam Program Risk Alert, Observations from Cybersecurity Examinations, (Aug. 7, 2017), https://www.sec.gov/files/observations-from-cybersecurity-examinations.pdf.
 Complaint, Storper v. WL Ross & Co., Index No. 656932-2017 (N.Y. Sup. Ct. Nov. 15, 2017).
 Enforcement Cooperation Program, supra note 2; e.g. Envoy Advisory, Inc., supra note 7, at ¶ 23; Capital Dynamics, Inc., supra note 7, at 5.
 Calvert Investment Management, Inc., supra note 8, at ¶¶ 17-25 (finding that the remediation was derived from an insufficient process in part because it was not effectuated in accordance with existing policies and procedures).
 Cohen, supra note 9.
 Calvert Investment Management, Inc., supra note 8, at ¶ 21.
 This post was prepared with the assistance of Molly B. Calkins, Richard R. Cipolla, and Adam Motiwala.