SEC Enforcement: A Review of 3Q21 (Part I)
Introduction
The new Director of the Enforcement Division, Gurbir Grewal, assumed his position during the Third Quarter of 2021. Even if he hits the ground running it typically takes time to adjust to the environment. Mr. Grewal brings a substantial amount of experience to the position, having served as the Attorney General of New Jersey and as an Assistant U.S. Attorney in the Eastern District of New York. At the same time, the Commission is not a prosecutor, it is a regulator, a very different function.
In his first public remarks Mr. Grewal focused on key points for crafting an effective enforcement program that trace to the earliest days of the Division: Corporate responsibility; gatekeeper accountability; and effective remedies. Each point has been a theme running through the program since the creation of the Division in the early 1970s first under Irv Pollock and then Stan Sporkin. These comments reflect a thoughtful approach.
Other points in the new Director’s comments, however, suggest what may become a more hard-edged approach. For example, the statement that the Division will return to the practice of requiring admissions and expand the use of officer/director bars may suggest a harsher approach than has been used in recent years. The blend of those points with key themes from the history of the Division, however, will ultimately be key.
The Statistics
During the third quarter of 2021 – the final quarter of the government fiscal year – the Division significantly picked up the pace at which new cases were filed. During the quarter 144 new actions were filed. That compares to a total of 123 for the first two quarters of 2021.
The overall mix of cases filed in the third quarter differed significantly from earlier periods. The mix was much more diverse. While a few categories of actions constitute the largest groups of cases, they were much smaller than in the past. The following table depicts the largest groups of cases and shows the percentage each group represents of the total number of actions.
Investment advisers 5%
Insider trading 4.8%
Microcap fraud 4.8%
Unregistered brokers 3.4%
These numbers contrast sharply with those from the second quarter. During the latter period 31% of the cases were offering frauds and 18% involved investment advisers. Yet during the third quarter the Division filed a much larger number of cases – 144 in the third quarter compared to the 75 new cases filed in the second quarter.
The difference reflects the fact that a larger array of cases were filed in the third quarter. During that period, for example, actions were initiated involving conflicts, false statements, financial fraud, investment controls, municipal bonds, the short tender rule, crypto rules, auditor independence and the safeguard rule, among others. While this suggests that the Division may be expanding its reach and presence in the market-place which should facilitate investor confidence in the markets, the longer term effect will have to be carefully evaluated.
Below is a selection of cases filed during the quarter. The first group centers on actions that fall into the largest groupings cited above. A second group of significant actions follows.
Select cases from leading categories
Investment adviser
Actions involving investment advisers have been one of the leading categories of cases brought by the division in recent years. The action below centered on one of the key charges involved, a failure to properly implement policies and procedures. Another key area involves undisclosed conflicts. The case also reflects a current concern of the agency – the use of complex products that may not be fully understood.
In the Matter of UBS Financial Services Inc., Adm. Proc. File No. 3-20401 (July 19, 2021) is an action which names as a respondent the dual registered broker-dealer investment adviser. These proceedings center on the failure of the firm to properly implement policies and procedures with respect to the VXX product as used in its discretionary Portfolio Management Program or PMP. Beginning in 2016 firm financial advisers put clients involved in the PMP program into the VXX. This product is typically built on short term futures products. Here the firm had policies and procedures in place to effectively prevent holding the VXX for long periods. Those policies and procedures did not, however, apply to the PMP program. When financial advisers put PMP clients into the VXX they failed to ensure that it was only held for the short term. Indeed, about 1,882 clients were involved with the product that was in hundreds of accounts. Those accounts held the product beyond the short term – many held the VXX for over a year. Accordingly, clients suffered losses. In resolving this matter, the firm took remedial steps. The Order alleges violations of Advisers Act Section 206(4) and Rule 206(4)-7. Respondent resolved the proceedings, consenting to the entry of a cease-and-desist order based on the Section and Rule cited in the Order and to a censure. The firm will also pay disgorgement of $96,344, prejudgment interest of $15,15,930 and a penalty of $8 million. A fair fund will be established.
Insider trading
Insider trading has long been a key focus for the Division. This case reflects a current approach used in settling many of these settling – not seeking disgorgement in favor of a penalty that is two times the amount of the trading profits, adopted after the Supreme Court’s decision in Liu v. SEC, 581 U.S. – June 22, 2020).
In the Matter of Zorayr Mikael Manukyan-Zakaryan, Adm. Proc. File No. 3-20457 (August 10, 2021) is an action which ultimately involved trading in the stock of AveXs, Inc. prior to an April 9, 2018 announcement that the firm had agreed to be acquired by Novartis AG. Respondent was Senior Director, Biostatistics for Pfizer, Inc. AveXis initially was in discussions about a potential deal with Novartis and Pfizer. During discussions Respondent was asked to participate in the transaction by reviewing certain research. During that work he learned of the discussions. The Pfizer transaction was not completed. After that, however, the AveXis – Novartis deal was consummated. Prior to the deal announcement Respondent traded in the shares of AveXis, reaping over $20,000 in trading profits. The Order alleges violations of Exchange Act Section 10(b). To resolve the matter Respondent consented to the entry of a cease-and-desist order based on the Section cited in the Order. He also agreed to pay a penalty in the amount of $40,997.26.
Conflicts
Undisclosed conflicts of interest are a key area of focus for market professionals such as the dual registered investment adviser and broker-dealer here. It is also a key area for the Division of Inspections.
In the Matter of TIAA-Cref Individual & Institutional Services, LLC, Adm. Proc. File No. 3-20392 (July 13, 2021) is a proceeding which names the registered investment adviser and broker-dealer as Respondent. The proceedings center on a failure to adequately disclose conflicts of interest and the distribution of false statements in connection with recommendations that clients invest in Teachers Insurance and Annuity Association of America (TIAA) record-kept employer-sponsored retirement plans or ESP roll over retirement assets into a managed account program called Portfolio Advisor. Over a five-year period, beginning in January 2013, Respondent created positive incentives and negative pressures for its Wealth Management Advisors to roll over ESP assets into Portfolio Advisor. In connection with this process Respondent and WMAs also made misleading statements to induce clients to execute the rollover. Respondent also failed to properly disclose related conflicts resulting from incentive compensation and failed to properly implement its applicable policies and procedures. The Order alleges violations of Securities Act Sections 17(a)(2) and (3). In resolving the matter Respondent took certain remedial acts. The firm also consented to the entry of a cease-and-desist order based on the Sections cited in the Order and to a censure. In addition, Respondent will pay disgorgement of $73,985,572, prejudgment interest of $14,014,428 and a penalty of $9 million. A fair fund is created for the penalties. The Order also states that the disgorgement and prejudgment interest does not exceed Respondent’s net profits from the violations.
Friday: Part II reviews a series of other significant cases filed during the quarter