On April 2 and 3, 2024, U.S. Securities and Exchange Commission Chair, Gary Gensler, Division of Enforcement Director, Gurbir Grewal, and other senior SEC officials convened at the SEC Speaks conference held in Washington, DC to discuss the Commission’s accomplishments in fiscal year 2023 and announce its priorities for 2024.
Introducing the Enforcement Division panel, Director Grewal reflected on the Division’s commitment to investor protection and the Enforcement Staff’s perseverance despite “significant headwinds,” including attacks on the Commission’s authority, motivation, and integrity. Recognizing the criticism surrounding crypto-related enforcement actions, he stressed their inherent importance, due to what he described as “predatory inclusion tactics” that crypto entities employ to target marginalized communities as well as the negative effect that non-compliance with federal securities law has on the investing public.[1] Director Grewal emphasized that the SEC’s approach to crypto has been consistent, principled, and tethered to the federal securities laws.
Deputy Enforcement Director Sanjay Wadhwa shared the Enforcement Division’s fiscal year 2023 results, during which the SEC filed a total of 784 enforcement actions (a 3% increase over 2022), noting the $4.949 billion in financial remedies, the second largest in history after fiscal year 2022. During 2023, the SEC also focused on individual accountability – charging individuals in more than two-thirds of its cases and barring 133 individuals from serving as officers and directors of public companies. These statistics signal an ongoing trend of the Commission’s commitment to aggressive enforcement, including a heavy focus on charging individuals. SEC Enforcement officials also offered guidance to securities law practitioners on the (i) benefits of cooperating with the Staff in examinations and investigations, by repeatedly emphasizing the importance of self-reporting, (ii) pitfalls of certain confidentiality agreements that might prevent individuals from contacting the SEC with evidence of potential violations, and (iii) best advocacy practices in defending enforcement actions.
Enforcement Highlights:
Ongoing Enforcement Sweeps as an Efficient and Effective Means of Changing Behavior
Both Deputy Director Wadhwa and Associate Regional Director Tejal Shah spoke of sweeps as an effective tool to shape market behavior, particularly noting the industry’s widespread reaction to the off-channel communications sweep and resulting remedial efforts. The Staff also discussed the investment adviser sweep related to the SEC’s amended Marketing Rule (Rule 206(4)-1 under the Investment Advisers Act of 1940).[2] Director Shah emphasized the timing of the sweep, occurring one year after the Rule’s compliance date, and the hope that this would prompt other investment advisers to review their policies and procedures and come within compliance of the new rule.
Individualized, Not Random, Penalty Determinations
Deputy Director Wadhwa rebutted the defense bar’s critique that the SEC engaged in random penalty determinations in its off-channel initiative. Since 2021, the SEC has charged 60 firms with record-keeping violations, imposing over $1.7 billion in monetary penalties, which ranged from $125 million to $2.5 million per firm. According to Deputy Director Wadhwa, self-reporting was a crucial factor when assessing penalties. Moreover, the Division considered: the firm’s size as determined by revenue from the firm’s regulated business, the scope of the violations (e.g., the number of individuals and communications involved), the firm’s efforts to timely comply, precedent, and cooperation. In discussing penalty determinations for violations of the amended Marketing Rule, the Staff noted again that self-reporting was the most significant factor, in addition to cooperation, disciplinary history, prompt remediation, and the need for the SEC to promote accountability and deterrence. Since taking over the enforcement helm, Director Grewal has made a conscious effort to make sure penalties are having the intended deterrent effect to shape corporate conduct and restore faith in the system.
The Importance of Cooperation on the Staff’s Disposition of Matters
The Staff provided examples of credit-worthy cooperation which could have an impact on a matter’s disposition (e.g., whether to bring formal action, reduced penalties, or no penalty), including: self-reporting, providing documents the SEC cannot compel or compilations of key documents, waiving attorney-client privilege[3] (including results of internal investigations), translating foreign language documents, and providing substantive financial analysis.[4] For example, in one action against a public company for alleged material misstatements in filings, the SEC did not impose a civil penalty because of the firm’s prompt self-reporting, undertaking of affirmative remedial measures, and substantial cooperation with the Commission, including, among other things, presenting the findings of an internal investigation and facilitating testimony from former employees.
Because many enforcement cases result from exam referrals, the Staff suggested a firm could best position itself early for cooperation credit right out of the gate by promptly complying with exam staff requests. When faced with an enforcement action, the panel highlighted the positive impact of objective voluntary presentations—which may include sharing information that may be unfavorable to the respondent.
Ensuring a Culture of Compliance by Requiring Admissions and Undertakings or Rewarding Voluntary Remediation
To deter future misconduct, Deputy Chief Counsel Charlotte Buford focused on non-monetary remedies, including undertakings (e.g., engagement of independent consultants) and requiring admissions when there is a particular need for accountability. Where an entity voluntarily takes remedial measures and cooperates, the Staff noted that the SEC will include such measures in its orders and may decrease the potential penalty. The Staff highlighted one recent no-penalty settlement, in which the entity promptly undertook remedial measures such as forming a special committee to investigate the issues, strengthening its internal accounting controls, and retraining relevant employees. The upshot of this and other examples is that self-reporting and voluntarily remediating issues will matter for the ultimate penalty imposed (if any at all) and may limit the SEC’s imposition of non-financial remedies.
Emphasis on Individual Accountability to Protect the Markets
To encourage a compliance culture, Associate Director Stacy Bogert stated that the SEC will seek clawbacks of executive compensation under Sarbanes-Oxley Section 304. The Staff explained the clawback is not limited to the compensation attributable to the misconduct; rather, the SEC could seek the full amount of the executive’s compensation, including bonuses, regardless of whether the executives engaged in the underlying misconduct.
Prophylactic remedies against individuals – specifically, bars and injunctions – were another focus. The Staff noted the 133 officer and director bars in 2023 was the highest number in a decade. Importantly, the SEC seeks such bars for scienter-based (intentional or reckless) violations, but also has secured such bars for negligent conduct. Moreover, the SEC remains committed to seeking conduct-based injunctions, such as prohibitions on respondents offering securities.
Effective Advocacy Through the Wells Process Starts Early
Associate Director Bogert explained that the Wells process actually begins before the Staff issues a formal Wells notice. Thus, it is important to establish credibility with the Staff from the outset of an inquiry, which includes refraining from unreasonable document production delays, coaching witnesses, and over-asserting privilege. Moreover, Staff noted that it could be helpful to raise early key legal and factual issues even before the commencement of the Wells process, and Wells submissions themselves should focus on “what really matters” – that is, the key issues in dispute, rather than a broad attack on the entirety of the Staff’s investigation.
Confidentiality Language Could Violate Whistleblower Protection Rules
The Whistleblower Program remains an important component to the SEC’s enforcement program—with a record-breaking year in 2023 as the SEC issued awards totaling nearly $600 million, the most awarded in one year (a record-breaking $279 million to one whistleblower). Office of the Whistleblower Chief Creola Kelly also reported on recent actions under Securities Exchange Act Rule 21F-17 (governing Staff communications with individuals reporting possible securities law violations), alleging efforts that could impede whistleblowers from coming forward to report violations. In these actions, the Commission emphasized that firms cannot include provisions in confidentiality, separation, employment, or other similar agreements preventing individuals from contacting the SEC with evidence of wrongdoing. Agreements that could violate whistleblower protection rules include overly broad prohibitions on the disclosure of confidential information to anyone outside the company and provisions waiving severance rights should individuals choose to communicate with the Commission.
Accordingly, in drafting confidentiality agreements with employees, the Staff recommended clear carve-outs allowing disclosure to regulators and that any carve-out should be consistent across communications (e.g., handbooks, employment agreements, releases). The Staff also warned that firms should not require individuals to: (i) forgo financial compensation for disclosing to the SEC, (ii) disclose if they have spoken to the SEC, or (iii) attest that they have not spoken to the SEC.
Post-Liu Developments in Disgorgement Awards
Since the Supreme Court decision in Liu,[5] which limited the SEC’s disgorgement power, Congress passed the National Defense Authorization Act (“NDAA”)—codifying and expanding the SEC’s authority to obtain disgorgement.[6] Despite the Fifth and Second Circuit split on the application of the NDAA and Liu,[7] Chief Litigation Counsel Olivia Choe asserted that post-Liu court rulings have confirmed the SEC’s authority to seek disgorgement of ill-gotten gains and affirmed the SEC’s burden is to provide a reasonable approximation of a defendant’s ill-gotten gains attributable to defendant’s violation. Once satisfied, the burden shifts to the defendant to rebut.
The Staff recognized the Second Circuit in SEC v. Govil limited the ability of the SEC to obtain disgorgement if there is no finding of pecuniary harm to victims, but emphasized that under Govil and other precedent, once a pecuniary harm to victims is established, the disgorgement amount is based on the calculation of ill-gotten gains—which could be greater than the pecuniary harm. The Staff further asserted that defendants invoking Govil to avoid disgorgement during early phases of litigation (e.g., discovery) have been unsuccessful and cast doubt on the impact of Govil outside of the Second Circuit.
Crypto-related Compliance
In addition to Director Grewal’s remarks summarizing recent developments with crypto-related Enforcement actions, Assistant Director Rich Hannibal reminded investment advisers of their fiduciary duties in recommending crypto-securities products and advising clients, particularly retail and retirement fund investors, and the need to be compliant with the Custody Rule. The Staff recommended that broker-dealers understand the crypto asset securities, the way they are sold, and how it impacts firm operations, all with a goal of ensuring the safety of funds and customer assets. Broker-dealers must also ensure the crypto securities are suitable for investors. Both investment advisors and broker-dealers should consider corporate governance, sales practices, surveillance, and other similar factors when engaging in crypto-securities business.
[1] See Press Release, “SEC Charges 17 Individuals in $300 Million Crypto Asset Ponzi Scheme Targeting the Latino Community,” (Mar. 14, 2024), available at https://www.sec.gov/news/press-release/2024-35.
[2] See Press Release, “SEC Sweep into Marketing Rule Violations Results in Charges Against Nine Investment Advisers,” (Sept. 11, 2023), available at https://www.sec.gov/news/press-release/2023-173.
[3] However, SEC guidance makes clear that the voluntary disclosure of information need not include a waiver of privilege to be an effective form of cooperation and a party’s decision to assert a legitimate claim of privilege will not negatively affect that party’s claim to credit for cooperation. SEC Enforcement Manual, Section 4.3.
[4] Regarding company cooperation, the Staff’s statements were consistent with the long-standing Seaboard Report factors – in which the agency considers self-reporting, self-policing, and remediation in its ultimate determination. See “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions,” (Oct. 23, 2001), available at https://www.sec.gov/litigation/investreport/34-44969.htm.
[5] In Liu,the Supreme Court held that the SEC could not seek disgorgement beyond a defendant’s net profits in civil actions under 15 U.S.C. § 78u(d)(5) and that disgorgement “is awarded for victims.” Liu v. Securities and Exchange Commission, 140 S. Ct. 1936, 1937 (2020). For more background on Liu and the dicta further limiting the SEC’s disgorgement power, see “Still Standing SEC Disgorgement Survives with Limitations,” (June 24, 2020), available at https://www.subjecttoinquiry.com/2020/06/still-standing-sec-disgorgement-survives-with-limitations/.
[6] National Defense Authorization Act For Fiscal Year 2021, Pub. L. No. 116-283, § 6501(a)-(b), 134 Stat. 3388, 4625-26 (codified at 15 U.S.C. § 78u(d)(3), (7)-(8)).
[7] Compare SEC v. Hallam, 42 F.4th316 (5th Cir. 2022) (holding that disgorgement under 15 U.S.C. § 78u(d)(7) is legal disgorgement and therefore not constrained by Liu’s equitable limitations) with SEC v. Ahmed, 72 F.4th379, 396 (2d Cir. 2023) (holding that 15 U.S.C. § 78u(d)(7) authorizes the same disgorgement contemplated by Liu and is therefore bound by its equitable limitations) and SEC v. Govil, 86 F.4th 89 (2d Cir. 2023) (finding pecuniary harm to alleged victims is a prerequisite to awarding disgorgement).
