On the eve of the U.S. presidential election last week, the SEC Enforcement Division released its annual report for fiscal year 2020 (the “Report”), providing an overview of the Division’s enforcement figures, developments, and areas of focus in what Director Stephanie Avakian described as “the most challenging year in recent memory.”[1]  This past year has marked, together with the longest shutdown in government history the year prior, a challenging but reasonably productive time for the SEC’s enforcement program.  Just as last year’s report highlighted the Division’s struggles during the fiscal shutdown, the final annual report of the Clayton-led SEC focuses on the significant disruption the COVID-19 pandemic has caused to the Division’s operations, investigations, and priorities, including the suspension of testimony for several months, establishment of a Coronavirus Steering Committee, and redirection of resources toward COVID-related fraud.  This time around, however, the Division could not avoid a drop-off in the number of enforcement cases, which seems attributable at least in part to the pandemic and its profound impact on the SEC’s operations.

More fundamentally, the Division’s stated enforcement and operational priorities remain largely consistent with recent annual reports, with no significant signals of a change in emphasis during the lame-duck session.  And while the election of President-elect Joseph Biden and the wind down of the Clayton era marks the opportunity for new leadership to begin crafting priorities from a clean slate, any significant shifts will likely take time to be expressed to the market.  Meanwhile, in the intervening months and even years, a number of the hundreds of ongoing investigations relating to the Division’s current priorities (including many in their early stages) will continue to materialize through enforcement actions.  Market participants should thus take note of the Division’s stated areas of focus, which themselves may color any new priorities of the new administration.

FY 2020 also reflected a year of transitions and changes at the Division itself, including the departure of former Co-Director Steve Peikin in August 2020 and the Division’s ongoing response to certain open questions relating to disgorgements in the wake of the Supreme Court’s decision in Liu v. SEC earlier this summer.  Taken together, one may view FY 2020 through the lens of disruption but also the Division’s last efforts to put a stamp on enforcement priorities: indeed, while the headline numbers indicate the number of standalone actions decreased nearly 25% from 526 in FY 2019 to 405 in FY 2020 they also show that, even in the face of uncertainty over a negative Supreme Court case, the Division managed to return more money to investors than at any time in its history.

Despite FY 2020’s challenges, the Report demonstrates considerable continuity with the Division’s priorities and activities in recent years, as described in our blog posts for previous reports.  For instance, we attribute the decrease in standalone actions in part to the conclusion in FY 2020 of years-long sweeps concerning the Share Class Selection Disclosure Initiative (which accounted for 95 settlements in FY 2019) and pre-released ADRs (which saw settlements with 13 firms and individuals from FY 2018 to FY 2019).  In fact, total monetary relief ordered in FY 2020 set a record of $4.68 billion – over $330 million higher than FY 2019 – as a result of increased disgorgement.  On the whole, with the marked exception of COVID-19, the Report generally develops and updates a number of priorities and challenges highlighted in recent annual reports:

  • COVID-related Investigations. A central theme of the Report is the Division’s considerable efforts in pursuing COVID-related investigations across a wide-range of potential misconduct, including insider trading and companies’ stewardship of material nonpublic information generally, financial fraud, and issuer disclosure.  This focus reinforces the many public statements and guidance issued by the Division’s Co-Directors and other SEC officials emphasizing the importance of continued compliance with disclosure requirements and protection of material nonpublic information amidst the pandemic.[2]
  • Enforcement Priorities. The Division’s enforcement focus in FY 2020 featured a number of similar priorities to the prior year, including financial and issuer disclosure cases, retail investor protection, and digital assets, with monetary penalties concentrated in a few headline cases, including a $1.2 billion penalty against Telegram relating to the unregistered offering of digital tokens, a $539 million penalty against Ericsson relating to FCPA charges, a $500 million penalty against Wells Fargo relating to the opening of customer accounts, and a $112 million penalty against Novartis relating to FCPA charges.
    • Financial and Issuer Disclosure. The Report confirms the Division’s continued focus on financial and accounting cases and issuer disclosures, particularly relating to COVID-related disclosure issues.  The Report also highlights new “risk-based data analytics” being utilized by the Division to identify potential wrongdoing, which may explain the difficulty some of our clients have encountered in attempting to determine what prompted the Division to open an investigation.  Notably, the Division’s stated priority to “recommend[] actions against issuers that distort non-GAAP metrics, key performance indicators, and related disclosures” could potentially signal a return of “earnings management” cases that we saw consistently before the financial crisis as in, for example, the SEC’s action against Bausch Health (formerly Valeant Pharmaceuticals) and certain of its former executives for improperly recognizing revenue derived from sales to a mail-order pharmacy that Valeant helped to fund and subsidize.
    • Investment Advisers. The Report reiterates the Division’s emphasis on the protection of retail investors, with a focus in particular on investment advisers – what we believe to be part of a larger trend of holding investment advisers to a higher standard in connection with the SEC’s 2019 interpretive guidance on fiduciary duties and examination priorities announced by the Office of Compliance Inspections and Examinations.  While there was a significant decrease in the number of cases involving investment advisers, this decrease was likely due to the close of the Share Class Selection Disclosure initiative, as discussed above.
    • Digital Assets. The Report’s highlighting of the SEC’s prominent victories against Telegram and Kik suggests that the SEC may well continue to focus on digital assets, in both the antifraud and Section 5 areas.  After making its way through the plainly fraudulent initial coin offerings in the 2016-2018 time period, the Division’s cyber unit expanded its focus by bringing cases against entity defendants that involved Section 5 charges only, and has notched some impressive wins.  In a sign that there may be more enforcement to come in this space, in 2018 the SEC founded the Strategic Hub for Innovation and Financial Technology (FinHub), which is led by a former Enforcement Division Assistant Regional Director.  Among its other functions, FinHub serves as a resource for FinTech-related knowledge within the agency and acts as a liaison with other regulators concerning emerging technologies.  Given its mandate, we expect FinHub to continue to drive the Division toward emerging issues for potential investigation and enforcement activity.
    • Individual Accountability. The Report also reaffirms the Division’s focus on holding individuals accountable, with 72% of standalone actions involving charges against individuals (compared with 69% in FY 2019).  Because individuals tend to litigate at a higher rate than companies, this may also explain the increase to 40% of cases involving a litigated component in FY 2020.
  • Quicker Investigations. The Division followed through on its previously-announced goal of accelerating the pace of investigations in FY 2020.  However, although the Report noted that the median time to file during FY 2020 was 21.6 months, this number does not tell the whole story.  Financial fraud and issuer disclosure cases, a stated priority area of the Division, averaged 34 months to complete.  This does reflect a reduction from 37 months in FY 2019, but it remains significantly longer than the median for all cases.  These cases can be highly complex and involve nuanced evidentiary issues, particularly concerning showing scienter, which often translates to more time to complete.  As such, we would expect the Division to employ other tools it has in order to drive improvement in this area.  The Report highlights one of those tools – cooperation as a potential way to speed up cases and offering the potential for a significant penalty reduction or no penalty to incentivize company cooperation.  Likewise, the Division’s stated openness to “think creatively” around undertakings or other forms of non-monetary relief may further facilitate and accelerate settlement negotiations.
  • Whistleblower Program. In light of the recent publicity and string of high-profile awards announced by the SEC’s Office of the Whistleblower, we are not surprised that the Report emphasizes the Division’s continued development of and reliance on the Whistleblower Program, which set records in FY 2020 by awarding 106 individuals approximately $562 million.  In light of these significant financial incentives, companies should take particular care to maintain strong internal whistleblower processes and regularly review them for possible improvements in order to facilitate their own internal investigations and to ensure that any whistleblower complaints are taken seriously and handled appropriately.
  • Disgorgement Authority. The Report notes that the impact of the Supreme Court’s decision in Liu v. SEC as a limitation on the SEC’s disgorgement power remains uncertain.  The Court confirmed the SEC’s ability to request disgorgement as an equitable remedy but placed potentially important limitations on disgorgement for lower courts to determine on a case-by-case basis.  To date, there have been virtually no lower court decisions interpreting the decision.  It thus remains to be seen the extent to which lower courts will pare back the SEC’s disgorgement power in practice, and this is plainly an area of risk to the SEC’s enforcement program given that disgorgement has traditionally represented a key metric of success for the SEC.  This is likely to be an area of significant attention for the Staff, all the more so should the Division continue to litigate cases at a higher rate as it has from FY 2019 to FY 2020.

While predictions of the Division’s focus from one year to the next are generally subject to uncertainty, there are two additional factors that make it particularly challenging this year.  First, the ongoing pandemic and potential economic fallout – neither of which the Division can control – will likely continue to shape and drive priorities.  Second, the transition of new senior leadership at the SEC in the coming year will invariably have a significant impact on the Division’s priorities.

On the other hand, the potential for COVID-related fraud, whether targeted at vulnerable investors or more general pandemic-related accounting abuses, would generally intersect with the Division’s existing emphases on retail investors and financial fraud – core areas of focus that we believe are likely to continue in the incoming administration.  Other trends, such as the growing use of whistleblowers and proliferation of digital currencies, are longer term developments unlikely to be reversed by the above factors alone.  Despite the lingering uncertainties, we thus expect the Division under the Biden administration to continue to press forward with a number of these priorities as it has in this past fiscal year, tumultuous as it was.

[1] U.S. Securities and Exchange Commission, Division of Enforcement 2019 Annual Report (Nov. 2, 2019), https://www.sec.gov/news/press-release/2020-274.

[2] See, e.g., Press Release, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity (Mar. 23, 2020), https://www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity; Public Statement, Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (April 3, 2020), https://www.sec.gov/news/public-statement/statement-teotia-financial-reporting-covid-19-2020-04-03.