The Commodity Futures Trading Commission, the primary commodities and derivatives regulator, imposed nearly $1 Billion in civil monetary penalties, restitution and disgorgement during the fiscal year that ended on September 30. The CFTC Division of Enforcement imposed $947 Million in penalties, disgorgement and restitution, including $897 Million in civil penalties, a nearly threefold increase over last year’s total. The CFTC filed 83 enforcement actions, the most since 2012, and imposed $10 Million judgments in 10 cases, a CFTC high water mark. More than 2/3 of cases charged an individual executive, reflecting the CFTC’s priority to hold individuals accountable in part because it deters others who become “fearful of facing individual punishment.” The CFTC has also prioritized parallel criminal proceedings, setting enforcement records for the number of cases filed in parallel with criminal prosecutors.
The CFTC’s regulatory sphere has greatly expanded with the emergence of swaps, derivatives, cryptocurrencies, and alternative hedge funds. The CFTC, like the SEC, has ramped up its enforcement activities to historic levels.
The SEC Enforcement Division filed 32% more standalone enforcement cases against investment advisers and investment companies in fiscal 2018 (through September 30), as compared to 2017. Cases against investment advisers and investment companies (the second largest category) and broker-dealers (fourth largest) represented 35% of all standalone actions filed. Overall, the SEC Enforcement Division brought 490 standalone cases in fiscal 2018, a 10% increase over 2017. Excluding the municipal disclosure initiative, the Enforcement Division filed more cases than it did in 2016 and 2015, the last two years under the prior administration. The Enforcement Division obtained $3.9 Billion in penalties and disgorgement, which is consistent with amounts obtained during the prior several years. The Enforcement Division outlined five core principles, including a focus on individual accountability because “holding culpable individuals responsible for wrongdoing is essential to achieving our goals of general and specific deterrence and protecting investors by removing bad actors from our markets.”
The Enforcement Division continues to pursue its active litigation agenda, especially against the investment industry. Apparently, the Jay Clayton SEC is not much different from the Mary Jo White SEC when it comes to enforcement cases against adviser, funds, and broker-dealers.
The North American Securities Administrators Association (NASAA) reports that in 2017 the 51 state securities regulators brought cases resulting in 1,985 years of prison time and probation, a 47% increase over the prior year. The state regulators also commenced 4,790 investigations in 2017, a 10% increase over the prior year, and initiated 2,105 enforcement actions, a nearly 6% increase. State securities regulators continued their increased focus on registered investment advisers, taking 377 enforcement actions against RIAs as compared to 270 against BDs. NASAA reports that cases against unregistered firms and individuals exceeded those against registered firms and individuals. “Securities fraud is a constant, ongoing, ever-evolving threat to investors. But as this year’s enforcement survey demonstrates, NASAA members are well-prepared, well-organized, and uniquely qualified to continue to aggressively protect investors,” said NASAA’s Enforcement Chair.
OUR TAKE: Unlike the SEC, the state securities regulators have the power to pursue criminal penalties including prison time. Regardless of what happens at the federal level, the states appear ready to flex their enforcement muscles.
The SEC has upheld a FINRA bar of a registered rep for failing to timely respond to FINRA’s requests for information. Following the filing of a U5 indicating the rep was terminated for failure to comply with firm policies and disclosure obligations, FINRA initiated an investigation. The respondent repeatedly failed to respond to requests sent to his CRD address. Eleven months after the initial request and 9 months after the bar became effective, the respondent sought relief from the bar on the grounds that health issues prevented his timely response. The SEC rejected his argument because he continued to work and remain active and failed to timely respond as reasonably practical.
OUR TAKE: The regulators will proceed with penalties if you ignore their requests for information. Once penalties, such as an industry bar, are imposed, it becomes very difficult to demonstrate good faith.
In its 2017 fiscal report, the SEC’s Enforcement Division cites individual accountability as one of its core enforcement principles. The report expresses the Enforcement Division’s view that “individual accountability more effectively deters wrongdoing.” Since Chairman Clayton took office, the SEC has charged an individual in more than 80% of standalone enforcement actions. The report notes that it can be more expensive to pursue individuals, but “that price is worth paying.” The report notes a modest decrease in filed enforcement actions and recoveries since 2016: 754 vs. 784 cases (excluding municipal cases) and $3.8 Billion vs. $4 Billion in total money ordered.
OUR TAKE: “Just because you’re paranoid doesn’t mean they aren’t after you.” (Joseph Heller) The data and the explanation imply that the SEC will prioritize prosecuting individuals, even if the money ordered is smaller than in institutional actions, because of the fear and deterrent effect. If financial executives need another reason to engage a best-in-class compliance program, how about protecting yourselves from a career-ending enforcement action?
The North American Securities Administrators Association (NASAA), the organization of state securities regulators, reported that state securities regulators imposed $914 Million in restitution, fines and penalties in 2016, as compared to $766 Million in the prior year. In its Enforcement Report, NASAA also reported significant increases in criminal penalties including incarceration and probation. The number of investigations and administrative actions also increased especially against investment advisers, which, according to NASAA, may be due to “heightened state interest in individuals and firms who have transitioned from broker-dealer registration to investment adviser registration in recent years.” NASAA also reported significant information sharing with federal regulators.
OUR TAKE: Over the last several years, the state securities regulators have expanded examinations and enforcement along with the SEC and FINRA, making it much more difficult for any adviser or broker-dealer to avoid regulatory scrutiny. It’s worth noting that many state securities regulators have criminal enforcement authority.
An investment adviser was indicted in part for making a false declaration in a court proceeding by lying to the SEC during a sworn deposition. The deposition occurred during an enforcement case that alleges that the adviser defrauded retirees by lying about account balances, falsifying documents, and creating false wires. According to the SEC, the adviser lied in a deposition about providing false documents to investors.
OUR TAKE: Once a formal enforcement proceeding commences, any misstatements under oath can lead to criminal proceedings for perjury or lying to a regulator. It’s always wise to ensure that the lawyer defending the enforcement action has sensitivity to the possible criminal prosecution implications. An enforcement action may results in fines and industry bars, but criminal proceedings could result in jail time.
FINRA imposed nearly double the fines on the industry in 2016, assessing $173.8 Million in fines as compared to $93.8 Million in 2015, according to its annual report. The increase in fines helped FINRA report over $57 Million in net income versus a $39 Million loss last year, even though operating income was lower in 2016. FINRA also ordered another $27.9 Million in restitution. FINRA uses fines collected for “capital expenditures and regulatory projects.”
OUR TAKE: Most of the financial regulators use their enforcement powers to collect funds to support their activities. Rather than encourage this financial incentive to bring cases, policy-makers should consider other alternatives such as third party compliance reviews or user fees.
In recent testimony about the SEC’s proposed 2018 budget, Chairman Jay Clayton emphasized enforcement and examination activities. Mr. Clayton noted that 50% of requested budget resources will go to enforcement and examinations. He said that the SEC is on track to deliver a 20% increase in adviser examinations and plans a further 5% increase. He noted that the staff will put a special focus on cybersecurity efforts. Mr. Clayton also committed to continue the SEC’s “vigorous enforcement efforts to investigate and bring civil charges” including critical areas such as “investment professional misconduct.”
OUR TAKE: It appears that the Clayton SEC will continue the examinations and enforcement focus of the Mary Jo White SEC. The more things change, the more they stay the same.