The U.S. Securities and Exchange Commission (SEC or the "Commission") recently announced its enforcement results for FY21 (October 1, 2020 - September 30, 2021), highlighting what it considers significant in its enforcement practices and indicating important trends for future enforcement in the coming years. Since Chairman Gary Gensler was sworn in on April 17, 2021 and Enforcement Division Director Gurbir Grewal was appointed in late June 2021, much of the FY21 results stem from investigations and priorities that were in place before their tenures. The data from FY21 suggest that this new SEC will embrace an aggressive enforcement agenda, continue to impose-and even raise-significant penalties and test the waters with first-in-kind cases.
1. A Close Look at FY21 Enforcement Metrics Suggests Aggressive Enforcement in FY22
While the SEC brought fewer total enforcement actions in FY21, the 3 percent decrease in the number of enforcement actions brought in FY21 versus FY20 does not reflect a decline in the SEC's appetite for enforcement. The SEC emphasized in its announcement that among new actions-i.e., excluding matters merely expanding previously filed actions-for FY21, enforcement was up 7 percent over the prior year.
Although the SEC did not publish a formal report as it has in years past, its press release made special note of the variety in the types of enforcement actions it brought in FY21, including actions in a number of new areas. In light of Director Grewal's statement in the press release that the SEC expects its actions in FY21 to "lead to even more successful actions in the future," SEC enforcement in the coming years will likely grow, in both scope and volume.
While the number of enforcement actions against public companies in FY21 was down, this should not be seen as a trend that will continue. With only 53 total public company actions during FY21, this represents a 15 percent decrease from FY20 and represents the lowest number of public company enforcement actions since FY14.
A portion of the decrease in public company actions may be attributed to the ongoing effects of the COVID-19 pandemic and to the new chairman's transition. NYU and Cornerstone Research, which track data on SEC enforcement, noted in their analysis of the SEC's announcement that actions have historically decreased in years when a new chair has been sworn in.
The decrease in public company enforcement actions is not likely to persist. Chair Gensler, in remarks at the Securities Enforcement Forum earlier this month, emphasized the importance of taking "high-impact cases" to "change behavior" and send a message to the rest of the market.
2. Expect the SEC to Maintain Focus on Gatekeepers and Individuals
While the SEC described a broad range of enforcement areas in its press release, its first two listed targets follow long-term priorities: ensuring that gatekeepers of the securities markets such as attorneys and auditors live up to their obligations and holding individuals accountable for their actions.
In a speech at The Practising Law Institute's SEC Speaks in October 2021, Director Grewal emphasized gatekeeper accountability as one of the primary ways to ensure public trust in the capital markets. The SEC highlighted key enforcement actions in this area in its annual statement, including bringing administrative proceedings against an audit partner for improper professional conduct during an audit; barring an attorney from appearing or practicing before the SEC for fraudulently facilitating an offering; and bringing an administrative proceeding against a CPA for failing to register with the Public Company Accounting Oversight Board and for multiple failures in the audit process.
According to Director Grewal, lawyers and auditors are often the "first lines of defense" against misconduct in the markets, so we can expect that the Enforcement Division will continue to maintain a "significant focus" on these gatekeepers in the coming year.
Director Grewal also highlighted accountability of individuals and the importance of tailoring remedies to keep bad actors out of the capital markets. At SEC Speaks, he described officer and director bars as a "critical tool" in preventing further misconduct. If an individual has violated the securities laws, the SEC will think carefully about whether that individual could later be in a position in a public company and continue to harm investors, and impose a bar if necessary. Across the board, the SEC is looking closely at individual conduct and will likely continue to do so next year. In FY21, 70 percent of new enforcement actions involved at least one individual defendant or respondent.
3. Expect Higher Penalties
Enforcement modalities also shifted significantly in FY21. While the total amount of disgorgement judgments and orders ($2.4 billion) was down 33 percent from FY20, total penalty amounts obtained increased a commensurate 33 percent from the prior year. Following the Supreme Court's decision in Liu last year, which limited disgorgement to a wrongdoer's net profits, a reduction in disgorgement comes as no surprise.
However, the increase in penalties may reflect more than a mere limitation on disgorgement as a remedy: it may also signal the beginning of a new approach within the SEC with respect to both the amount of penalties assessed and the justification for seeking such penalties. Earlier this year, Commissioner Caroline Crenshaw gave a speech to the Council of Institutional Investors where she stated that the SEC should focus more on the egregiousness of the wrongdoer's conduct than the impact to shareholders when assessing penalties.
Director Grewal also stated in recent remarks that while "penalties levied in the past are certainly a relevant data point," historic penalties will not be the "beginning and end of [the SEC's] analysis" when thinking about deterring conduct in future enforcement actions. According to Director Grewal, even first-time offenders could face significant penalties if they engage in conduct for which the SEC has penalized other actors. In short, this increase in penalties is likely just the beginning of the SEC's new approach to deterrence.
4. The Rise of "First-in-Kind" Cases Will Continue....and So May Litigation
In its press release, the Commission was eager to highlight some of its "first-of-their-kind" cases in a wide range of areas, which Director Grewal anticipates will "lead to even more successful actions in the future." For both public and private companies, the message is clear that SEC wants to incentivize proactive compliance, not merely reactive compliance.
The SEC is pushing the envelope and testing new theories of fraud in the courts, both in response to broker-dealer behavior and as an adaptation to new technologies. In the words of Director Grewal, the SEC is "trying to address emerging risks before they cause harm to investors" by bringing new test cases, such as in the cryptocurrency space and the first enforcement action directly against a special-purpose acquisition company (SPAC).
In August 2021, the SEC charged a former employee of a pharmaceutical company with insider trading when he allegedly traded in another company's options based upon confidential information about his own employer. In September 2021, the SEC reached a $10 million settlement with an "alternative data" provider for misrepresenting how its data was sourced and used and then encouraging its securities trader customers to rely on the improperly obtained data to estimate market performance.
While the pharmaceutical insider trading case will be tested in litigation, the SEC has sent a strong message to market participants that it is thinking creatively and outside the box to enforce the federal securities laws. Although many respondents may feel they have little choice other than to settle with the SEC, those who do choose to litigate may find the courts receptive to arguments that challenge inventive agency actions.
5. This Is the Heyday of the Whistleblower
This year, the SEC's whistleblower program passed a total of $1 billion in awards since it began in 2011, with over $564 million of that total coming in the last fiscal year alone. Four of the highest-ever SEC whistleblower awards were given in FY21, with a $36 million award given to a whistleblower who was culpable in the wrongful conduct and delayed reporting. Whistleblower tips to the Commission also skyrocketed: the SEC received 12,210 tips in FY21, a 76 percent increase over the prior fiscal year which represents nearly a quarter of all tips since the beginning of the program.
The Whistleblower Program's 2021 Annual Report noted that 75 percent of award recipients who were insiders of the reported entity had already raised their concerns internally before reporting them to the SEC. Given the SEC's appetite for increased enforcement and the large rise in tips and awards this year, companies should carefully assess their internal reporting mechanisms to ensure they can detect wrongdoing, encourage tipsters to report within the entity, and proactively address the problems.
The SEC's Whistleblower Rules were amended in 2020 to increase efficiency in the tip review process, make it easier for whistleblowers to report to the Commission, and give whistleblowers a presumption of the statutory maximum award for certain awards of $5 million or less. While it may be too early to say what impact the amendments have had so far, the numbers indicate that the Commission is looking closely at whistleblower tips and is sending a strong message to the public and to market participants that it is ready to act on information it receives about potential misconduct and reward those who share it.
Conclusion
Between an increasing appetite for aggressive enforcement and the offer of huge rewards for whistleblowers, the Commission's drop in overall cases in FY21 will not likely continue in the coming year. With the SEC thinking strategically about how to enforce the securities laws and protect investors, participants in the securities market should take a forward-looking approach to ensuring compliance programs with strong internal controls as well as lean into developing and maintaining a robust internal whistleblower response and game plan.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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