Senior officials from the US Securities and Exchange Commission (SEC or the Commission), including current and former commissioners, came together last week for their annual gathering in Washington, DC, to discuss the Commission’s accomplishments from 2018, and goals for 2019. Each of the four commissioners gave speeches, providing their personal perspectives on Commission trends and priorities. Officials from the SEC’s Division of Enforcement (Enforcement) offered some advocacy tips for defending enforcement actions, and discussed the US Supreme Court’s recent decision in Lorenzo v. SEC. Additionally, officials from the Office of Compliance Inspections and Examinations (OCIE) discussed 2019 exam priorities.
Chairman Jay Clayton: Management’s Discussion and Analysis of the SEC[1]
Chairman Clayton opened the conference by providing an overview of the Commission, in an effort to give the audience “a look at the SEC through the eyes of management, similar to what public companies do in the “Management’s Discussion and Analysis,” or “MD&A” section of their SEC filings. This theme underscored the message that despite the challenges of the partial government shutdown in January, the Commission is back in full operational mode.
He reiterated the Commission’s three-part mission: (1) protect investors; (2) maintain fair, orderly, and efficient markets; and (3) facilitate capital formation. This mission statement was a unifying theme throughout the two-day conference. Continuing with his MD&A theme, Chairman Clayton next spoke about fiscal year 2019 expenditures, explaining that because of a hiring freeze, the Commission Staff is down more than 400 authorized positions compared to fiscal year 2016. Resources that Congress has provided to the agency for fiscal year 2019 will allow the Commission to lift the hiring freeze and add 100 much-needed positions.
Moving on to the Commission’s rulemaking agenda, Chairman Clayton highlighted that during fiscal year 2018, the Commission advanced 23 of the 26 rules on its near-term agenda. For example, in June 2018, the Commission issued a request for comment on enhancing disclosures by mutual funds, ETFs, and other types of investment companies to improve the investor experience, and in July 2018, the Commission adopted amendments that enhance the transparency requirements of alternative trading systems (ATSs).
Chairman Clayton next highlighted some of Enforcement’s successes in 2018. For example, in the digital assets space, the Division of Enforcement has brought cases that demonstrate that there is a path to compliance with the federal securities laws going forward, even where issuers have conducted an illegal unregistered offering of digital asset securities. This path to compliance, of course, must include appropriate disclosures to investors so they can make a more informed decision as to whether to seek reimbursement or continue to hold their tokens.
Commissioner Robert Jackson: New Areas for Consideration
Commissioner Jackson was the next Commissioner to speak, highlighting the importance of finally promulgating Regulation Best Interest[2]. In his view, the obligation should be simple: brokers should put their clients’ interests first. He explained that limits on compensation practices that lead brokers to engage in conflicted activities will be an important aspect of implementation. Commissioner Jackson added a note of cautious optimism: a “rule like this is going to be long litigated.” He continued, “This is a unique moment in which we can and should speak with one voice.”
Additionally, Commissioner Jackson provided a number of topic areas for the Commission to consider in the coming year. For example, he cited empirical studies showing that, a vast majority of the time, identity theft issues are not being disclosed in 8-Ks. Thus he proposed that the Commission consider developing disclosure rules in this area. Commissioner Jackson offered a few more areas for the Commission’s consideration, including: (1) why it is so expensive for small companies to become public; (2) whether current insider trading law fits the market today; and (3) whether the four-day rule before filing an 8-K still makes sense.
Commissioner Elad Roisman: Encouraging Small Business in Capital Markets[3]
Commissioner Roisman’s theme was encouraging smaller entrants in our capital markets. He explained that if business owners are motivated to keep their companies private, retail investors have fewer options and opportunities to grow their wealth. He believes “it is critical for the SEC to scrutinize whether its rules and regulations have contributed to this decreasing public company environment.”
Commissioner Roisman also considered market structure issues, not only for the equities market, but for the fixed income and treasuries markets as well. He explained, for the equities market, he would like to take a closer look at best execution requirements, especially in conjunction with the order protection rule. “Having lived with Regulation NMS for more than a decade (a decade of incredible technological and operational change), we should consider whether tweaks, or more significant changes, are appropriate.” He also reiterated his interest in improving the proxy process, as he had discussed in an earlier speech.[4]
Finally, Commissioner Roisman provided his views as to proposed SEC action. He hopes that the SEC will address the topic of “finders,” who introduce companies to prospective investors, typically for compensation. He hopes the SEC will provide clear guidance on the activity of finders in the context of our securities laws, including whether that activity implicates broker-dealer status. Commissioner Roisman also said he looks forward to the Commission revisiting the application of Section 404(b) of the Sarbanes-Oxley Act (404(b))[13] as they consider changes to the definition of “accelerated filer.”
Commissioner Hester Peirce: SECret Garden[5]
Against this backdrop of identifying specific goals and initiatives from the other commissioners, Commissioner Peirce provided a cautious note regarding the risk of the complexity of federal securities laws. She noted that this complexity can create a “compliance minefield” for market participants. Commissioner Peirce explained that in certain circumstances, staff-level guidance performs a critical function, helping to ensure that the Commission is responsive to our markets and that market participants are able to timely meet their obligations under the rules. However, she is concerned that this “necessary guidance—due to a lack of transparency and accountability—may have turned into a body of secret law.” Commissioner Peirce provided some examples, including, the Staff not accepting certain applications for entire categories of products, and examining firms using as guidance the terms of draft no-action letters and notes of calls with Commission Staff. Commissioner Peirce concluded with a call for the Commission officials to work together to “take down the walls of the secret gardens at the SEC.”
Lorenzo v. SEC: Enforcement Expects Broad Reading
The Division of Enforcement shows no signs of retrenchment after the shutdown. The Lorenzo v. SEC[6] decision appears to have given them renewed confidence. Enforcement does not view this decision narrowly—whether conduct involves scienter or negligence, drafting a false statement or directing someone to draft a false statement will all be fraudulent under Lorenzo.
“You’re going to face a fair bit of skepticism from the folks up here if you’re arguing that the court’s reasoning doesn’t extend to other kinds of deceptive conduct in connection with misstatements,” said Joseph Brenner, Chief Counsel of the Division of Enforcement.
Cooperation: As Important as Ever
Enforcement Staff spent a fair portion of the panel reiterating the importance of cooperation. They explained it is as important now as it has ever been. Marc Berger, Regional Director of the New York Office, said they are making efforts to provide clear messages in orders about cooperation. The panel explained that cooperation should start early on and, depending on the case, it may be helpful to provide a factual presentation to the Enforcement Staff early on to help streamline the investigation, and help “illuminate some of the false positives.” With respect to the privilege waiver issue, the Enforcement Division does not take the position that a waiver is necessary for cooperation, nor do they deduct cooperation points if a waiver is not given. The goal is to come up with a plan where counsel can balance privilege concerns with cooperation. However, if a company simply declines to share information related to, for example, its internal interviews of witnesses and, as a result, the Staff has to undertake an investigation over years, it is harder to afford the same sort of cooperation credit as the Staff would to a company that figures out how to share this information. Real-time remediation, which the Staff noted is a Seaboard[7] factor, can also be meaningful for cooperation credit—particularly where a company remediates on its own. The Enforcement Staff is also making efforts to flag the importance of remediation in orders.
Practical Advocacy Tips
Additionally, Enforcement provided some tips for effective advocacy in connection with the Wells process. The panel made a point to emphasize that less is more in written submissions. They suggest prioritizing and focusing on what is most important and what is really in dispute, rather than responding to every potential claim or issue. Explications of the law of, for example, insider trading, or what the elements are of a Section 10(b) violation, or other long discussions on settled points of law or just unhelpful—but rather, the Staff recommended practitioners focus, in writing and in oral presentations, on the areas where the Staff’s case theory may be vulnerable. The panel explained that citing or quoting from Commissioners’ speeches is not necessarily helpful either, since the Staff communicates with the commissioners every day, and as such, they have a real and nuanced understanding of each commissioner’s view than any single quote from a speech. They further suggested that it is important to be thoughtful about when it is appropriate to request meetings with senior Staff, or going over a staffer’s head even within his or her own office. Furthermore, the Enforcement panel explained that it can be helpful in a Wells meeting to focus on trial logistics. For example, it can be productive to highlight for Staff how difficult it might be to get a certain document into evidence, or how easy it would be for the defense to attack the credibility of an SEC witness during cross-examination. With respect to experts, it can be helpful to have an expert at a Wells meeting or append an expert report to a Wells submission only if there is something novel on which the expert might move the needle—it is not helpful to bring an expert solely to show Enforcement that the defense has retained one.
During their panel, OCIE officials provided an outline of their 2019 Exam Priorities, including: (1) continued focus on protecting retail investors, including seniors and retirement products; (2) compliance risks in exchanges and clearing; (3) digital assets; and (4) cybersecurity. Specifically, OCIE’s focus on cybersecurity will continue, particularly around governance and risk assessment and data loss prevention, and with an emphasis on cybersecurity measures of advisors with multiple branch offices.
Regarding some of the highlighted 2019 focus areas, the OCIE panel discussed:
Finally, the OCIE panel said they are making efforts to publish additional Risk Alerts to provide more guidance for examinees. They are also working on a deficiency letter review project in the Investment Adviser space. They have reviewed every Investment Adviser deficiency letter over the last two to three fiscal years to create a version of “Top 10” Investment Adviser deficiencies.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Boston
Michael D. Blanchard
David C. Boch
Timothy P. Burke
Jason D. Frank
Thomas J. Hennessey
Jason S. Pinney
T. Peter R. Pound
Emily E. Renshaw
New York
Michele A. Coffey
Bernard J. Garbutt III
Brian A. Herman
Ben A. Indek
Kenneth I. Schacter
San Francisco
Joseph E. Floren
Susan D. Resley
Charlene S. Shimada
Washington, DC
Ivan P. Harris
[1] Chairman Jay Clayton, Management’s Discussion and Analysis of the SEC: Remarks at the “SEC Speaks” Conference (April 8, 2019).
[2] Regulation Best Interest, 17 CFR Part 240, Release No. 34-83062; File No. S7-07-19.
[3] Commissioner Elad L. Roisman, Remarks at SEC Speaks: Encouraging Smaller Entrants to Our Capital Markets (April 8, 2019).
[4] Commissioner Elad L. Roisman, Keynote Remarks: ICI Mutual Funds and Investment Management Conference (March 18, 2019).
[5] Commissioner Hester M. Peirce, SECret Garden: Remarks at SEC Speaks (April 8, 2019).
[6] Lorenzo v. SEC, 139 S. Ct. 1094 (2019).
[7] 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 (Seaboard Report) (Oct. 23, 2001).