This is the fifth part in our 2023 series examining important trends in white collar law and investigations. Up next: ESG.
- The SEC’s Division of Enforcement set record-highs in total money relief ordered and total civil penalties assessed in fiscal year 2022.
- The SEC will likely focus its enforcement efforts on securing the cryptocurrency industry’s compliance with the registration requirements of the Securities Act of 1933 and ensuring statements made by investment advisers and issuers concerning their ESG-compliance are both truthful and not misleading.
- Amendments to the SEC’s Whistleblower Program designed to incentivize a broader and larger range of whistleblower awards will continue to provide the Division of Enforcement with a pipeline of investigative leads.
The U.S. Securities and Exchange Commission (“SEC”) continued its aggressive pursuit of investigations and enforcement actions in fiscal year 2022, setting records for the most money recovered and the most civil penalties assessed in a fiscal year. The SEC announced that its Division of Enforcement (“Enforcement”) brought 760 total enforcement actions in fiscal year 2022 (representing a 9% increase over fiscal year 2021), including 462 “stand alone” actions (enforcement actions excluding those brought against issuers for delinquent filings and “follow-on” administrative proceedings seeking bars against individuals), 129 actions against issuers for delinquent filings, and 169 “follow-on” administrative proceedings. Enforcement collected a record-setting $6.439 billion (up from $3.852 billion in fiscal year 2021), including a record-high $4.194 billion in civil penalties.
These metrics reinforce expectations that the SEC would take a more forceful regulatory stance under SEC Chairman Gary Gensler’s and Enforcement Director Gurbir Grewal’s leadership. We expect the SEC to continue to flex its regulatory muscles in fiscal year 2023, including by focusing on the priorities discussed below.
Crypto Likely to Headline Enforcement Efforts in 2023
Enforcement has advanced Chairman Gensler’s directives to pursue unregistered sales of digital assets under the Securities Act of 1933 (“Securities Act”). Those enforcement actions included charges against the founders of Forsage, an alleged “fraudulent crypto pyramid and Ponzi scheme” responsible for raising more than $300 million; charges against Payward Ventures, Inc. and Payward Trading Ltd. for their alleged failure to register the offer and sale of their staking-as-a-service program; and charges against Genesis Global Capital, LLC and Gemini Trust Company, LLC, for their alleged unregistered offer and sale of their Gemini Earn program, which provided investors with the opportunity to tender their crypto assets in exchange for a return. Of particular note, Director Grewal has made clear to the crypto space that Enforcement will continue to go after staking-as-a-service providers who fail to register their offerings, which generally provide investors with the ability to tender their crypto assets to a platform in exchange for a return.
The uptick and prominence of the SEC’s enforcement actions in the crypto space follow the SEC’s announcement that it was bolstering Enforcement’s Crypto Assets and Cyber Unit (formerly known as the Cyber Unit) with 20 additional positions, nearly doubling the unit’s size. According to the SEC, those additional personnel will be responsible for protecting investors in crypto markets, and will be specifically focusing on crypto asset offerings, crypto asset exchanges, crypto asset lending and staking products, decentralized finance platforms, non-fungible tokens, and stablecoins. Since its creation in 2017, the Cyber Unit has been responsible for commencing more than 80 enforcement actions relative to fraudulent and unregistered crypto offerings and has collected more than $2 billion in monetary relief.
With the high profile bankruptcy filings of crypto companies in recent months, and the SEC’s investment in the Crypto Assets and Cyber Unit last year, we expect the SEC’s regulatory and enforcement efforts into the crypto space to take center stage in fiscal year 2023.
Enforcement Tackles ESG Fraud
The SEC has continued its enforcement efforts into investment advisers and issuers characterizing their investment strategies and offerings as environmental, social, and governance (“ESG”)-compliant. Last year, the SEC charged BNY Mellon Investment Adviser, Inc. for certain statements it allegedly made about its ESG considerations in connection with mutual funds. Specifically, the SEC’s order alleged that BNY represented or implied that all investments in those mutual funds had undergone an ESG-quality review, when several investments in those funds did not have an associated ESG-quality review score at the time of the investment. In addition, the SEC charged publicly-traded Brazilian mining company Vale S.A. for its claims about the safety of its dams prior to the January 2019 collapse of the Brumadinho dam. The SEC alleged that Vale misled local governments, communities, and investors about the safety of the Brumadinho dam through various ESG disclosures. With ESG considerations taking increasing importance with retail investors, we expect the SEC to continue to probe ESG-related representations to ensure that the retail public is not being misled.
Individual Accountability Remains Priority
In November, the SEC released its Strategic Plan for the next four years, which emphasizes the agency’s desire to hold individuals accountable for securities laws violations: “The SEC will continue to pursue misconduct wherever its staff find it and will use all of the tools in its toolkit to deter those who might choose to violate the securities laws, including by holding bad actors – including responsible individuals – accountable.” More than two-thirds of enforcement actions in fiscal year 2022 involved at least one individual respondent, a trend we expect to continue into 2023.
A number of the SEC’s enforcement actions included high-profile individual respondents. For example, the SEC charged the Boeing Company’s former CEO with making materially misleading public statements regarding the safety of Boeing’s 737 MAX airplanes for his role in editing and approving company press releases and making other public statements following two airplane crashes. In another example, the SEC charged Eagle Bancorp, Inc.’s former CEO and Chairman of the Board with negligently making false and misleading public statements concerning certain related party loans Eagle Bancorp made to his family trusts. The SEC’s pursuit of individuals in fiscal year 2022 extended beyond those circumstances where senior company leaders allegedly made false and misleading statements to the public, and included instances where the SEC charged senior executives at public companies for their failures to prevent misconduct at their firms, even where those executives themselves were not charged with the misconduct. These enforcement actions signal the SEC’s intention to keep individual accountability at the heart of Enforcement’s investigations.
SEC Enhances Whistleblower Program with Two Amendments
The Whistleblower Program received 12,300 whistleblower tips in fiscal year 2022, representing the largest number of tips the Program has received in a fiscal year. Despite these record-setting figures, the Program dramatically decreased the amount of monetary awards provided to whistleblowers from 2021. The SEC awarded approximately $229 million in 103 different awards in 2022, less than half of the total amount of money provided in 2021 ($564 million in 108 different awards). The largest awards in 2022 were a $40 million award in October and a $37 million award in January, a notable decline from the largest awards in 2021 ($110 million and $114 million awards). Despite these drop-offs, the SEC continued to revamp the Program through multiple rule changes designed to incentivize more whistleblowers to come forward.
The SEC adopted two amendments to the Securities Exchange Act of 1934 in Rules 21F-3 and 21F-6, which became effective October 3, 2022. The amendments largely reverse controversial Trump-era policy changes to the Program that we discussed in our previous installment. The two amendments (1) provide the SEC with the ability to award whistleblowers for information resulting in enforcement actions brought by other agencies or regulators where those alternative whistleblower programs contain more limited statutory award ranges, award caps, or discretionary awards, provided that the whistleblower waives any claim to the other program’s award; and (2) affirmed the SEC’s statutory authority to consider the dollar amount of a whistleblower award to increase, but not reduce, the award. Together, these amendments reinforce the SEC’s commitment to incentivizing whistleblowers to report wrongdoing.
In addition to these policy changes, the SEC instituted enforcement actions against individuals and entities who allegedly retaliated against and obstructed would-be whistleblowers. For example, the SEC assessed a $97,523 penalty against the co-founder and former Chief Information Officer of NS8, Inc. for allegedly retaliating against an employee-whistleblower by removing his access to the company’s computer systems, surveilling his laptop activities, and prompting his termination. In another case, the SEC assessed a $400,000 penalty against The Brink’s Company for allegedly requiring employees to sign restrictive confidentiality agreements that prevented employees’ communication with the SEC. These actions suggest the importance of the Program to the SEC’s enforcement directives, and we expect the SEC to continue to rely upon the pipeline of information received by whistleblowers.
SEC’s Reliance on Data Analytics Uncovers Insider Trading
The SEC increasingly relied on data analytics to ferret out potential securities law violations in 2022. In particular, Enforcement’s Market Abuse Unit (“MAU”), which uses data analytics to detect suspicious trading patterns, contributed to significant insider trading enforcement actions within the last year. With assistance from the MAU, the SEC charged the former chief information security officer of Lumentum Holdings, Inc. and others in connection with an alleged insider trading ring that generated more than $5.2 million in illicit profits. The SEC alleged that the officer purchased securities of a target after learning about Lumentum’s acquisition plans and tipped his friends about another target in advance of the information becoming public. The SEC was able to detect suspicious trading patterns using advanced data analytics, ultimately revealing the alleged insider trading, despite the fact that the officer used his wife’s brokerage account and one of his friends siphoned the gains through a relative in India. In another case, the SEC charged an investment banker and his friend with insider trading after the MAU identified suspicious trading activity occurring before four acquisition announcements in 2017.
We expect the SEC to continue to rely on their advanced technology developments and the MAU to uncover difficult-to-detect insider trading. As expressed in its Strategic Plan, the SEC aims to leverage emerging technologies such as machine learning and artificial intelligence to evolve and sharpen its data analytical tools in 2023 and beyond.
Enforcement Credits Cooperation with Recalibration of Penalties
Despite the SEC’s announcement last year that it intended to take a more rigid stance on cooperation credit than it had during the Trump era, the SEC notably recalibrated penalties for companies that provided the SEC with meaningful cooperation. For example, the SEC charged HeadSpin, Inc. with fraud for the company’s alleged inflation of certain financial metrics and fabrication of sales records, but did not impose a penalty on account of the company’s extensive remedial actions. According to Director Grewal, the significant remedial actions taken by the company weighed against the imposition of a penalty. In another case, the SEC charged Baxter International, Inc. with engaging in improper intra-company foreign exchange transactions. But because of the company’s remediation actions, including self-reporting; internal investigation; adoption of a new, GAAP-complaint foreign exchange rate convention; and recoupment of bonuses paid to the CEO and CFO, the SEC limited the penalty assessed against Baxter to $18 million.