by T. GormanPosted on Posted in SECActions

Earlier this year the SEC’s Enforcement Division published its annual report, reviewing FY 2019 which ended on September 30, 2019. As in the past, the Report reviewed not just the statistics from the year but also the entire program and its goals.

Nevertheless, statistics from the program remain a key issue metric for many who track trends SEC enforcement actions. Cornerstone Research, in conjunction with the Pollack Center for Law and Business at NYU, published their annual report which focuses largely on statistics (here). Overall the Report tracks largely statistics on actions involving public companies and their subsidiaries, documents trends which echo those in the Enforcement Division Report.

The report

The 526 enforcement actions filed by SEC Enforcement in FY 2019 is the largest number over the last seven years with the exception of 2016 when 548 cases were brought. The number filed last year eclipses that from FY 2018 when 490 cases were filed and 2017 with 446.

During that same seven-year period the Commission filed 95 actions involving public companies and their subsidiaries. That compares to 2018 with 72 such cases, 2017 with 65 and 2016 with 91. Fiscal 2019 thus has the largest number of actions involving public companies and their subsidiaries.

As the Report notes, however, 26 of the actions counted as involving public companies and their subsidiaries in FY 2019 were from the highly successful Share Class Initiative program that centered on investment advisers purchasing mutual fund shares for clients that paid fees back to them rather than the lower price shares which did not make such payments.

When the actions tied to the Share Class Initiative are removed from the total, only 69 actions were filed against public companies and their subsidiaries. That compares to FY 2018 when 72 were filed, 2017 with 65, 2016 with 91 and 2015 with 82.

For FY 2019 Cornerstone and NYU report that for the first time actions involving investment advisers and investment companies was the largest group of cases. This is consistent with the statistics reported by the Division. Cases involving issuer reporting and disclosure were the second largest category. The third largest group of cases were those involving broker-dealers and FCPA allegations.

Finally, statistics regarding cooperation and the amount of disgorgement and prejudgment interest are reported. While the percentage of cases that involved cooperation and no monetary settlement ticked up slightly in FY 2019, at 5% it remained a very small component of the actions reported. Indeed, the percentage of cases involving cooperation and no penalty has been consistently quite small since 2013. In contrast, from 2010 through 2013 the percentage ranged from as high as 18% to a low of 10%.

The largest component of settlement dollars in 2019 was disgorgement and prejudgment interest at 59%. That compares to 49% in FY 2018, 63% in 2017 and 54% in 2015. Overall, the 59% in 2019 is the highest percentage since 2010 with the except of three years — 2013 a 63%, 2014 at 71% NS 2017.

Comment

As the Division notes in it is earlier reports, statistics are only one point of consideration when evaluating the Enforcement Program. Nevertheless, they do serve to highlight certain trends.

First, the trend that has been developing for several years fully emerged last year. The largest group of cases involved investment advisers and investment companies. That trend traces back several year and while it was no doubt impacted by the Share Class Initiative, it reflects a key focus of SEC Enforcement.

Second, there is no doubt that the Share Class Initiative was very successful. That result should be considered in conjunction with the percentage of actions resolved without a financial component. While the number ticked up to 5%, in 2019 for that group of actions, over the last several years it is quite low, particularly compared to the earlier part of the decade. Some might argue that those numbers may in part reflect the insistence of the agency on obtaining disgorgement. While that may be correct, that point could also be asserted with respect to the early part of the period.

Third, although the Division’s Report cited the negative impact of Kokesh, the statistics here fail to support the contention. To the contrary, as a percentage of the overall amount of dollars in Commission settlements, the amount of disgorgement and prejudgment interest in FY 2019 is one of the larges figures this decade. While one might argue that additional disgorgement and prejudgment interest could have been obtained but for the Supreme Court’s decision and the short limitation period (which is being addressed in draft legislation), the agency could avoid much if not all of the impact of that case if it limited its requests to actual equitable disgorgement to be returned to those harmed.

Finally, the success of the Share Class Initiative, coupled with the statistics on cooperation and monetary awards, more than suggests that the Division consider its approach to the question of cooperation. Reserving the question of cooperation credit to its discretion until the end of the action may seem prudent. Yet the Share Class Initiative and the dismal percentage of cases that involved cooperation with no monetary settlement component more than suggests that a new approach in merited.

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by T. GormanPosted on Posted in SECActions

A key focus of SEC enforcement has been the retail investor. To that end the Division formed a special unit to focus on cases tied to those investors. Numerous cases have been brought. That focus may also be at least in part responsible for the continued increase in enforcement cases brought against investment advisers.

At the same time, it is not difficult to lose track of what the retail investor focus actually means – particularly through a seeming maze of regulations and enforcement actions.

Recent remarks by Joshua Sterling, Director of the Division of Swap Dealers and Intermediary Oversight at the CFTC, speaking at an Investment Management Conference in Chicago earlier in November 2019 (here) provides a reminder.

The remarks

Mr. Sterling discussed the markets, asset managers, regulators and the retail investor. He began with the bar and its relation to the markets. Those markets, a function of an open society based on respect for natural rights and law, have afforded a “broad and grand wealth unparallel in human history . . .” he noted. The bar is a “protector of freedom . . .” and the system which created those markets, echoing ideas introduced to the securities markets as the “access theory” by Irv Pollack and Stanley Sporkin in the early 1970s. Under that theory it is the bar and other market professionals which help safeguard the markets by acting as gatekeepers.

Today the asset management business is bigger, faster and stronger than ever, according to the Director. Bigger means that over the past “several years, investors have generally pushed their assets into a smaller set of very large funds.” Bigger also translates into more efficiency and better pricing to the point where some funds are offering “no fee” share classes.

Faster in the asset management business is often a function of technology with new ways to invest. Some firms, for example, rely entirely on algorithms and other quantitative tools. Others are a blend of traditional methods and new techniques. And, larger is the product of strategic transactions and business flows tied to investor preference.

The result is that asset managers are among the largest participants in the markets today. They have become the providers of market liquidity which “is also to transmit risk,” according to the Director. As the these trends continue, asset managers will grow to have an even larger impact on the markets.

Bigger, faster, stronger couples not only with the transmission of risk, but also means that regulators must evolve the way they oversee investment management. The role of regulators such as the CFTC should be “not to call the shots in the evolution of the asset management industry, but to promote the strength, and vibrancy of the markets in which asset managers operate.”

Better, faster, stronger also only ties to the retail investor, illustrated by Mr. Sterling with a very personal story: “As a kid, I remember the day my father came home with a new and rather basic Ford Ranger pickup; the only extra was the red paint. Times were tight. But my parents always invested, and they had the opportunity to make prudent choices based on the myriad of sound investment products available to retail investors. My parents are now enjoying their golden years with a solid nest egg built over decades of hard work and savings.”

Comment

The markets afford all significant opportunities as the Director notes. In years past those opportunities permitted sound investment decisions by many who were retail investors. While that may still be true today, much has changed.

Today “better, faster, stronger” means it is likely those same retail investor investment decisions are being made by investment managers, whether they are in the securities or commodity markets. The goal, however, is still the same – to create the opportunity that Mr. Sterling’s parents had and which they are now enjoying. This comes from a balance of market professionals adhering to the access theory, regulators facilitating fair and liquid markets, and investment professionals honoring their duties to their retail investor clients.

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