Data analytics has evolved into a key tool of the SEC’s enforcement program. The most recent example of this is a series of settled administrative proceedings centered on the use of Exchange Traded Products. The products are complex. The theory, however, is detailed in the prospectus issued with each product. Understanding it takes time and study. Unfortunately neither the market professionals nor their clients in the Commission’s actions seem to have put in the study. The results were predictable: losses for the investors.

Typical of these proceedings is In the Matter of American Financial Services, Inc., Adm. Proc. File No. 3-20151 (Nov. 13, 2020). Respondents in this proceeding are American Financial or APFS and American Portfolios Advisors, Inc. or APA, respectively, a registered broker dealer and an investment adviser. The Exchange Traded Product involved is iPath S&P 500 VIX Short-Term Futures ETN or VXX.

VXX is traded on the NYSE Arca, Inc. It is a volatility-linked, complex exchange traded note which “offers exposure to futures contracts” of specific maturities on the VIX — the CBOE. The VIX tries to track the expected volatility of the S&P 500 but not its price level. The performance of VXX is not directly linked to the VIX. It is linked to a separate Index that tracks the price of futures contracts on the exchange. That Index is based on a “rolling portfolio of one-month and two-month futures contracts to target a constant weighted average of one-month maturity.” To do this each day the Index sells futures contracts that are the closest to the expiration and buys the next month out.

The VXX prospectus made it clear that that historically the exchange was in contango – the farther out contracts priced higher than those of the near-term contracts. When the market is in backwardation the reverse is true. Since the exchange is typically in contango, a significant cost is incurred over time from the daily roll of the futures contracts.

At times the VIX performance may vary from that of the Index and may have a positive performance during periods when the Index experiences poor performance. On the other hand, the VXX may experience a significant decline over time. In those instances, the risk increases the longer the VXX is held. In the end, however, the VXX has a limited upside potential, according to the prospectus, because over the longer term it usually reverts to a historical mean and its absolute level has been constrained within a band.

Registered representatives began early in 2016 to recommend investors buy and hold the VXX as a part of their overall portfolio. At the time there was a fear that political and other events would cause the market to drop. Many of the clients followed the advice, purchased the VXX and held it for over a year.

The VXX was viewed as a kind of hedge that would guard against the feared price drop. In making those recommendations the registered representatives failed to understand that the investments were not suitable for use as a short term hedge. Yet customers were told the opposite — buy and hold for the long term to protect against downward market risk. No mention was made of what is effectively a monthly reset and the resulting costs incurred in each instance.

The firms did have policies and procedures regarding complex products. Those policies and procedures mandated that representatives understand the products prior to making a recommended. The policies and procedures were ineffective in preventing the losses incurred by customers here because they were not properly implemented. Supervisory failure also facilitated the client losses. The Order alleges violations of Exchange Act Section 15(b)(4)(E) and Advisers Act Section 206(4) and Rule 206(4)-7.

To resolve the matter Respondents implemented certain remedial efforts. Respondent APA consented to the entry of a cease-and-desist order based on the Advisers Act Section and Rule cited in the Order. APFS consented to the entry of a cease-and-desist order based on the Exchange Act section cited in the Order. The two firms were censured and will also pay, jointly and severally, a civil monetary penalty of $650,000. A fair fund will be created for the portion of the losses tied to the product.

The Commission filed four similar cases at the same time this action was initiated. See In the Matter of Benjamin F. Edwards & Co., Inc., Adm. Proc. File No. 3-20153 (Nov. 13, 2020)(action tied to same product; settled with a series of remedial efforts, a consent to the entry of a cease and desist order based on the same Advisers Act Section and Rule, a censure and the payment of disgorgement of $31,417.62, prejudgment interest of $3,716.74 and a penalty of $650,000; $685,134.36 went to a fair fund); In the Matter of Summit Financial Group, Inc., Adm. Proc. File No. 3-20149 (Nov. 13, 2020)(based on same product; resolved with a cease and desist order based on the same Advisers Act Section and Rule and a censure; Respondent will also pay disgorgement of $3,083.59, prejudgment interest of $715.49 and a penalty of $602,799.08; a sum for client losses was paid into a Fair Fund); In the Matter of Securities America Advisors, Inc., Adm. Proc. File No. 3-20150 (Nov. 13, 2020)(based on two similar products; resolved with consent to entry of a cease and desist order based on same Adviser Section and Rule and a censure; payment of disgorgement of $3,399.42, prejudgment interest of $377.40 and a penalty of $600,000; fair fund created); and In the Matter of Royal Alliance Associates, Inc., Adm. Proc. File No. 3-20152 (Nov. 13, 2020)(based on VXX; settled with consent based on same Section and Rule; payment of $1,953.00 in disgorgement, $447.29 in prejudgment interest; and a penalty of $500,000; a fair fund was established). See also In the Matter of Morgan Wilshire Securities, Inc., Adm. Proc. File No. 3-29954 (Sept. 24, 2020)(Action centered on purchasing inverse EFTs without regard to the holding period where firm staff not properly trained).

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Cornerstone Research, in conjunction with the NYU Pollack Center for Law and Business, published its annual report on select SEC enforcement statistics (here). Specifically, the Report centers on SEC enforcement activity related to public companies and their subsidiaries (collectively “public companies”) with few exceptions. The Report has four key areas: Filings, venue, allegations and settlements.

Filings: Filings for enforcement actions, and those involving public companies, were down compared to earlier years. In fiscal 2020 the Report notes that 405 standalone enforcement actions were filed – the same number noted in the Enforcement Division’s Report, discussed in an earlier article (here). This is the lowest number since 2013 when 341 cases were filed. By comparison in 2019 526 cases were filed – a number which includes actions from the Share Class Selection initiative – while in 2018 there were 490 and in 2017 490 cases were filed.

Only 61 cases were filed in fiscal 2020 involving public companies, again the lowest number in years. Last year saw the lowest number of cases filed since 2013. In 2019, in contrast, there were 95 actions initiated against public companies while in the prior year there were 73 new standalone cases brought.

Most of the enforcement actions in fiscal 2020 were filed in the second half of the year. Indeed, perhaps the largest group of cases filed in 2020 were brought in the last quarter of the fiscal year with 18 filed in the last two weeks. And, during the last part of the fiscal year the Commission brought two actions based in its new EPS initiative. Most of the cases filed involving public companies were initiated as administrative proceedings.

Allegations: A heat map in the Report shows that 49% of the actions centered on company and disclosure issues. The next largest category was cases brought involving investment advisers which had been the leading category the prior year.

Issuer reporting and disclosure has long been the traditional leader in this area, although increasing numbers of actions have focused on investment advisers in recent years. Other areas reflected on the heat map for fiscal 2020 include actions involving the FCPA and broker-dealers.

Venue: Another key issue discussed in the Report is venue. The Report notes that 89% of the filings last year involving public companies were brought as administrative proceedings – only 11% of the actions were brought in federal court. Those numbers are comparable to the results in recent years. For example, in 2019 about 93% of the cases involving public companies were brought as administrative proceedings with only 7% of the cases being filed as civil injunctive actions in federal court – the traditional venue for initiating enforcement actions.

A review of statistics regarding venue in recent years reflects similar statistics: In 2018 84% of the cases involving public companies were brought as administrative proceedings while only 16% were brought in federal court. In 2017, 2016 and 2015 89%, 91% and 93% of the cases involving public companies, respectively, were brought as administrative proceedings.

Settlements: In fiscal 2020 corporations paid a total of $1.6 billion in monetary settlements to resolve actions initiated by the SEC. That amount is slightly above the $1.5 billion paid in the prior year. It is equal to the average amount paid over the last decade.

Disgorgement and prejudgment interest was imposed in about 35% of the settlements. While the report discusses the Supreme Court’s decision in Liu v. SEC, handed down in late June 2020, it does not detail how many of the settlements were impact by the decision. Nor does it state how many of the settlements entered into after Liu was decided calculated the amount of disgorgement in accord with traditional equitable principles discussed in the case and returned the funds to those injured by the wrongful conduct as the Court directed rather than transferring the funds to the U.S. Treasury.

Finally, the Report states that the majority of public companies cooperated with the Commission – 62%. That number represented a decline from 77% for the prior year. And, a chart shows the fact that only a small fraction of corporate settlements in recent years involved cooperation and no monetary component.


The Report provides a good look at an enforcement program that by the numbers underperformed in some areas in fiscal 2020 compared to earlier years but overall clearly operated in the best tradition of the agency. Continuing with an effective enforcement program with much of the country closed – as well as all of the Commission’s office – with masks, social distancing, and virtually no travel was an incredible achievement.

That is not to say there are not questions. The Report suggests that venue seemed to have shifted to administrative proceedings. While it does not offer any discussion of this point, for at least last year it may reflect the fact that most of the corporate cases are settled and the ease of filing under the circumstances.

The Report also does not discuss the declining percentage of cases involving cooperation or the fact that only a sliver of cases involved a settlement with no monetary component. Perhaps a more meaningful statistic would have been the number of settled cases where no penalty was involved since cooperation typically impacts the amount of the penalty, not disgorgement.

In the end if in fact cooperation is declining it bodes ill for the program in future years, perhaps suggesting that the potential reward is not worth the effort. For 2020 however, the Enforcement Results reflect success by a group of dedicated public servants.

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