SEC Spotlight: Enforcement and Regulatory Developments in the First Quarter of 2022
The US Securities and Exchange Commission (SEC or Commission) had an active first quarter of 2022, reflecting an aggressive enforcement and regulatory approach being taken by Chair Gary Gensler and Enforcement Director Gurbir Grewal since they assumed their respective roles last year.
The Division of Enforcement (Enforcement) was busy, including instituting settled and contested actions involving violations ranging from broker-dealer recordkeeping deficiencies to fraud involving cryptocurrency to insider trading. In addition, the Division of Examinations (Exams) announced its 2022 priorities, showing that there will be a focus on private funds, new technologies in the investment space, and the environmental and social aspects of financial services governance and resiliency. Finally, from a rulemaking perspective, the Commission has been particularly active by announcing new proposals related to private fund disclosures, climate disclosures, special purpose acquisition companies (SPACs), whistleblowers, and insider trading.
This Advisory discusses the key SEC enforcement and regulatory highlights from the first quarter, with links to additional Arnold & Porter insights where available. We include our takeaways as former leaders and attorneys in the Enforcement Division, including as the former Chief of the Market Abuse Unit and Director of the Philadelphia Regional Office (Dan Hawke), former Chief of the Office of the Whistleblower (Jane Norberg), and former Assistant Chief Litigation Counsel (Christian Schultz, who is our new Partner). We anticipate that this will be the first in a series of quarterly advisories discussing enforcement and regulatory developments at the SEC.
Recordkeeping Violations by Broker-Dealers and Investment Professionals. Leading into the first quarter, the SEC announced a $125 million settlement with the broker-dealer subsidiary of a multinational financial services company for “widespread recordkeeping failures” related to internal communications on personal devices, including personal email accounts and private messaging applications like iMessage and WhatsApp. Significantly, unlike the vast majority of SEC settlements, which are entered into on a “no admit or deny” basis, the firm “admitted the facts set forth in the SEC’s order and acknowledged that its conduct violated the federal securities laws.” Additional similar investigations are underway, and market participants—including broker-dealers, investment advisers, and fund managers—should prepare for similar scrutiny by both Exams and Enforcement.
Remediation and Cooperation Credit. In connection with a January 2022 settled fraud action, the Commission provided some real world guidance on cooperation and remediation credit under the current SEC enforcement program. While additional analysis of the case can be found in a recent Arnold & Porter’s Advisory, a key takeaway is that companies should ensure that they have a robust framework in place to receive and react to internal reports of possible misconduct in order to be able to take the necessary steps to show thoughtful and thorough remediation.
Cryptocurrency. Chairman Gensler recently expressed that there is “no reason to treat the crypto market differently just because different technology is used,” and Enforcement’s actions during the first quarter reflect this perspective. In addition to bringing a crypto-related contested lawsuit in March 2022, the SEC announced (i) settled charges in January 2022 related to the digital token offerings of two companies, and (ii) first-of-its-kind settled charges in February 2022 related to the crypto lending product of a financial services company.
Whistleblower Protection. Rule 21F-17 of the Securities Exchange Act of 1934 (Exchange Act) prohibits any action that would impede an individual from communicating with the SEC staff about a possible securities law violation. Leading into the first quarter, the SEC won a notable victory in its case to hold a company accountable for language contained in investor documents, when the Commission’s motion for summary judgment as to the impeding charges was granted. As discussed in a recent Arnold & Porter Advisory, this case was the second time the SEC has charged Rule 21F-17 violations for language found in investor documents, and it marks the first time the Commission’s authority was challenged in court. In light of the SEC’s activity in this area, companies and investment fund managers should review their investor documents to determine if confidentiality provisions run afoul of the rule.
In addition, just after the close of the first quarter, the SEC brought another notable case under Rule 21F-17. The settled action was against the Chief Information Officer of a company for actions he took to cut off an employee’s access to the company’s IT systems, among other things, after the employee threatened to provide company documents to investors and other “interested parties.” As Arnold & Porter partner Jane Norberg discussed in a recent interview with Law360, this case sets up a troubling precedent related to steps a company can take when an employee threatens to take information to a non-governmental third party, such as the media. Given the SEC’s aggressive and expansive reading of Rule 21F-17, companies should carefully consider with counsel steps taken after an employee internally reports a possible securities law violation.
Foreign Corrupt Practices Act (FCPA). In February 2022, the SEC announced a $6.3 million settlement with South Korea’s largest telecommunications operator for violations of the FCPA related to improper payments to Korean and Vietnamese government officials. In addition to disgorgement, prejudgment interest, and a civil money penalty, the company agreed to undertakings involving multiple internal reviews and periodic reporting to the SEC staff with respect to the company’s remediation and compliance measures.
Bank Spoofing. In recent years, the SEC’s Office of Investor Education and Advocacy has issued alerts warning investors to beware of spoofed websites seeking to sell fake certificates of deposit (CDs) as well as fraudsters posing as broker-dealers or investment advisers. In January 2022, the SEC announced charges against a former registered investment professional who perpetrated a $40 million fraud by offering fictitious CDs through spoofed websites of major financial institutions. This case relates to an action involving the same scheme that was previously brought by the Commission. While the SEC will continue to conduct surveillance to identify websites designed to trick investors, financial services companies, broker-dealers, and investment advisers should themselves closely monitor for phony websites mirroring their legitimate businesses.
Robo-Adviser Violations. In February 2022, the SEC announced settled claims against a robo-adviser related to false statements about the existence of proprietary funds and misuse of investor money. As discussed in Arnold & Porter’s recent Advisory, the use of developing technologies—including robo-advisers—is an area of focus for Exams.
Insider Trading. Demonstrating continued vigilance against insider trading violations, in January 2022, the SEC announced a lawsuit against three individuals and two investment vehicles for trades placed in advance of separate market moving events involving several companies, including an earnings announcement, a merger agreement, and an acquisition. On the same date, the US Attorney’s Office for the District of Massachusetts announced related criminal charges against the three individuals.
In March 2022, Exams announced its examination priorities for the coming year. As discussed in more detail in Arnold & Porter’s recent Advisory, Exams will focus on (i) private funds, (ii) Environmental, Social, and Governance (ESG) or impact investing, (iii) broker-dealers and their interactions with retail investors, (iv) information security and operational resiliency, and (v) financial technology and crypto-assets. The examination priorities were announced shortly after Richard Best was appointed as Exams’ new Acting Director. Mr. Best most recently served as the SEC’s Regional Director in New York after serving in similar roles in Salt Lake City and Atlanta, where he led both the examination and enforcement efforts of those three Regional Offices. We expect that the number of referrals from Exams to Enforcement is likely to increase, as today’s Exams priorities are a likely preview of tomorrow’s Enforcement actions.
The Commission has been particularly active in the rulemaking area since Chair Gensler took office, including announcing and seeking comment on wide-ranging topics. The resulting rules will be impactful and costly to companies. The deadlines for comment submission on these lengthy rule proposals have been short (30-60 days from publication in most instances) and overlapping. This has created a challenge for companies that are subject to and have an interest in the outcome of the rules.
While our discussion below does not cover all rules proposed during the first quarter, a full list of which can be found here, the following chart identifies certain proposed rules where the deadlines have not yet passed:
|Cybersecurity Disclosures for Public Companies
|May 9, 2022
|May 20, 2022
|May 31, 2022, or 30 days after publication in the Federal Register, whichever is later
Cybersecurity. The Commission has proposed rules to address cybersecurity concerns relating to funds and advisers and, separately, registrant companies. The proposals are intended to improve investor confidence and protections against emerging cybersecurity risks, and they provide consistency in how firms and issuers address and report cybersecurity risks and incidents to investors. For more in-depth analysis, please see the Arnold & Porter advisories relating to each of these proposals, which can be found here and here. The comment period on the fund and adviser rules has closed, but the comment period on the public company rules is open until May 9, 2022.
Climate Disclosures. As climate change mitigation and resilience has become a matter of interest to investors, companies have begun voluntarily disclosing certain information relating to their sustainability practices. As discussed in a recent Arnold & Porter Advisory, the Commission has now proposed standards that would require public companies to annually disclose, among other things, climate-related risks, how they are likely to impact financial performance and strategy, and how the companies identify and manage these risks. The SEC’s proposal is substantial, with the proposing release spanning more than 500 pages, and includes phase-in dates for all registrants depending on filer status. The comment period on the proposed climate-related rule changes is open until May 20, 2022.
SPACs. As discussed in a recent Arnold & Porter Advisory, the Commission has proposed new rules signaling that significant change is coming for SPACs. The proposal would require, among other things, disclosures pertaining to SPAC sponsors, conflicts of interest, and dilutions, as well as disclosures upon the business combination (so-called “de-SPAC” transactions) as to the fairness of the transactions to SPAC investors. The changes also would make the protections of the Private Securities Litigation Reform Act of 1995 unavailable for projections used in the de-SPAC transaction and enhance disclosure regarding those projections. In addition, both the private operating company and the SPAC would have to be co-registrants—and, within four days of a de-SPAC transaction, there would be a redetermination of smaller reporting company status for the parties. The comment period on this proposal will close on May 31, 2022, or 30 days after publication in the Federal Register, whichever is later.
Whistleblowers. The SEC has proposed two rule changes that it contends would better incentivize potential whistleblowers to come forward. The first proposed change would allow whistleblowers who might recover under multiple whistleblower programs to choose which program to recover under based on potential payout. According to Chair Gensler, this change “is designed to ensure that a whistleblower is not disadvantaged by another whistleblower program that would not give them as high an award as the SEC would offer.” The second proposed change would eliminate the Commission’s authority, after calculating a whistleblower’s award using the framework set forth in the rules, to consider the dollar amount calculated (which could be very large) for the purpose of decreasing the award—but it would continue to permit the Commission to consider the dollar amount of the award to increase it.
Insider Trading and Rule 10b5-1. The Commission has proposed new rules related to insider trading and Exchange Act Rule 10b5-1. One proposal would require a 120-day “cooling-off” period for officer and director trading pursuant to 10b5-1 plans, with an analogous 30-day period for issuers. Other proposals would (i) limit 10b5-1 arrangements to one plan per 12-month period, (ii) institute a good faith requirement, and (iii) require officers and directors to certify they are not aware of material nonpublic information and state whether a transaction occurred pursuant to a 10b5-1 plan. In addition, issuers would be required to make annual disclosures about their policies and procedures to stem insider trading, their option grant policies and practices, grants made within 14 days of the release of material nonpublic information, and how that release affected market price of the security. Issuers also would need to make quarterly disclosures regarding the adoption or termination of 10b5-1 trading arrangements and the terms of those arrangements.
Private Fund Disclosures. As discussed in a recent Arnold & Porter Advisory, a divided Commission has proposed amendments to Form PF, which is the confidential reporting form that must be filed by certain SEC-registered investment advisers to private funds. The amendments would lower the threshold for “large equity fund adviser” to $1.5 billion in assets under management and require reporting on significant events within one day of their occurrence. Under the proposed rules, large private equity advisers would need to estimate the percentages of their funds that are invested according to differing strategies, while large liquidity fund advisers would be required to make substantially the same disclosures as money market funds.
The impact of the SEC’s enforcement and regulatory priorities will only be seen as new enforcement initiatives are developed, examinations are conducted, and proposed rulemaking is approved. Nonetheless, these priorities reveal a clear tone being set by the Commission’s new leadership. Companies, individuals, and other market participants should take notice of the shift in approach, including the overall renewed emphasis on active and aggressive enforcement, and take proactive steps to ensure compliance with the federal securities laws.
We will continue to monitor and report on the key enforcement and regulatory developments at the SEC. In the meantime, please reach out to any author of this Advisory or your regular Arnold & Porter contact with any questions about the issues discussed herein or the state of play at the Commission.
© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.