SEC enforcement looks forward to strong FY2022

As the Securities and Exchange Commission adapts to the challenges posed by both the global coronavirus pandemic and a new administration, the SEC's Division of Enforcement brought 3% fewer cases in FY2021 compared to the prior year, including drops in many key program areas. Nevertheless, as the SEC has settled in under its new leadership, the number of cases brought has steadily ramped up over the course of the year. In this most recent quarter, the Division of Enforcement has brought more cases than in the first two quarters combined. In addition, the overall mix of case types has become increasingly diverse as the SEC continues to bring a number of first-of-their kind enforcement actions.

Gurbir Grewal, the newly appointed director of the Division of Enforcement, has discussed key focus points for the division, emphasizing corporate responsibility, gatekeeper accountability, and effective remedies. Deputy Attorney General Lisa Monaco has also recently highlighted changes in corporate criminal enforcement going forward for the Department of Justice, including increased disclosure requirements for cooperation credit eligibility, evaluation of all prior misconduct in reaching resolutions, and increased imposition of corporate monitors whenever appropriate.

Whistleblower Program

FY2021 was another record-breaking year for the SEC's whistleblower program, with the most awards granted since its inception: approximately $564 million to 108 individuals. The program also issued the two largest awards in the program's history this year, including a $114 million award to a whistleblower in October 2020, and a combined $114 million award to two whistleblowers in September 2021. Another $50 million was awarded to joint whistleblowers in April 2021.

Outside of monetary awards, the SEC has demonstrated its commitment to protecting the rights of whistleblowers through enforcement actions against employers who attempted to limit whistleblowing. The SEC brought two such actions in FY2021 pursuant to Rule 21F, which prohibits employers from impeding the efforts of whistleblowers to report misconduct. In the first action, the SEC alleged that the defendant had included language in separation or transition agreements that impeded former employees from reporting misconduct. In the second action, the SEC charged a broker-dealer with using compliance policies and training materials that prohibited employees from communicating with any regulator without receiving prior approval.

Digital Assets

In recent years, the market for cryptocurrency and digital assets has sparked an increasing amount of investor interest. In an attempt to keep up with the rapid pace of innovation involving digital assets, the SEC is scrutinizing this sector with a particular focus on unregistered and fraudulent offerings, unregistered exchanges, and crypto-lending platforms. According to one study by Cornerstone Research, many of the cases the SEC has filed do not involve allegations of fraud, focusing instead on a failure to register the offer and sale of digital assets. These cases reflect divergent and evolving views of the SEC's jurisdiction over digital assets. Of note, the SEC brought its first enforcement action involving securities purportedly using decentralized finance ("DeFi") technology and governance tokens. Looking forward, expect the SEC to continue its focus on digital assets, pushing the boundaries of its jurisdiction and, undoubtedly, causing defendants and other regulators to push back.

Insider Trading

Despite a decrease in the number of insider trading cases brought compared to last year, the SEC has brought several novel cases this year expanding the types of material, nonpublic information that may commence an insider trading enforcement action. In March, the SEC pursued its first enforcement action involving selling "insider tips" on the dark web. In August, it brought a case against an executive under a novel theory of "shadow trading" (using material, nonpublic information concerning one company to trade securities of one of its competitors that could be affected by the information). The SEC also brought its first case ever against an alternative data provider for misrepresentations about material, nonpublic information even though the SEC alleged nothing about actual trading. For 2022, expect the number of insider trading cases (and novel legal theories) to increase.

SPACs: Special Purpose Acquisition Company Scrutiny

SEC focus on SPAC filings has increased over the past few years, following a rapid proliferation of these types of filings. The Division of Corporation Finance ("CorpFin") issued a staff statement in March identifying shell company restrictions, books and records and internal controls requirements, and initial listing standards of securities exchanges as SPAC issues to watch. In April, CorpFin's acting director called into question whether legal protections for IPOs applied to SPACs. Also in April, CorpFin issued a statement questioning a commonly used accounting treatment of warrants issued in connection with SPACs. Not surprisingly, in light of these comments, the SEC proceeded to bring several enforcement actions involving SPACs this year, including an action against a SPAC for misleading claims about its merger target. The SEC is likely to bring more SPAC cases in this fiscal year involving purported disclosure violations and undisclosed conflicts of interest.

Data Analytics

The SEC continues to use data analytics to inform enforcement actions. Last year, the SEC started the EPS (earnings per share) initiative, which has begun to bear fruit. For example, in August the SEC announced a settlement with a company that had engaged in violations enabling the company to report inflated EPS. Although data analysis helps identify anomalies that may otherwise go undetected, investigative work remains necessary to confirm EPS manipulation. Therefore, although there may not appear to be a large amount of EPS cases currently, there is no question the SEC will continue to use and refine its tools in this area. The DOJ has also been focused on using data-based probes, and has formed a specialized group within the FBI to assist with data-based investigations and prosecutions. Enforcement through the use of data analytics should only be expected to grow.

ESG: Environmental, Social and Governance Issues

In early 2021, the Acting Chair Allison Lee directed the Division of Corporation Finance to enhance focus on public companies' climate-related disclosures. In addition, the SEC created the Climate & ESG Task Force to prioritize ESG-related misconduct. This task force is focused on using data analysis to identify potential ESG-related violations, specifically material gaps or misstatements in disclosures of climate risks by issuers. The Division of Examinations issued a risk alert that identified existing weaknesses in ESG-related disclosures and provided guidance for investment advisers offering products and services geared towards demand for ESG-focused investments. The SEC also released a sample comment letter regarding companies' climate-related disclosures, reaffirming greater emphasis in this area. Look for the Enforcement Division to bring actions in 2022 against public companies and investment advisers for what the SEC deems inadequate or misleading disclosures and characterizations on all manner of ESG topics.

The SEC has also approved the NASDAQ Board Diversity Rule. This will require most NASDAQ-listed companies to have, or disclose they do not have, at least two diverse directors, as well as disclose their board diversity annually. There have been court cases challenging similar California board diversity laws on equal protection grounds. Nevertheless, for the time being, companies will need to comply with the disclosure rules by the latter half of 2022, and have at least one diverse director by the latter half of 2023.

Cybersecurity

Two decades ago, Regulation S-P was initially released to give guidance on cyber breaches and disclosures required for public companies. Since then, the SEC has ramped up its emphasis on cybersecurity cases. Over the course of 2021, the Division of Enforcement has focused on actions to ensure companies are taking cybersecurity risks and related disclosures seriously. In June, the SEC took the unusual step of announcing its investigation into a widely publicized cyberattack involving compromised software. The SEC also settled charges against a company for disclosure violations related to a cybersecurity vulnerability, and against a public company for misleading investors about a 2018 cyber intrusion. Going forward, the SEC has stated it will focus on government contractors and grantees who provide cyber services to the government, as well as companies who knowingly provide deficient cyber products, make misrepresentations, or fail to report breaches.

Collision Course with China-Based Companies

Stricter regulation of foreign companies listed on U.S. markets has been an area of focus for the SEC, and Chinese companies in particular have found themselves under heightened scrutiny in recent years. In July, SEC Chairman Gary Gensler noted particular risks to investors posed by Chinese-based companies because of their reliance on "variable interest entities" to overcome China's restrictions on foreign investment. The Public Company Accounting Oversight Board's implementation of 2020's Holding Foreign Companies Accountable Act will further increase scrutiny of China-based companies listed on U.S. exchanges. The act requires U.S.-listed companies to be audited by accounting firms subject to inspection by the board and, if they are not, to disclose certain information regarding the companies' ownership or control by foreign governments. Should a U.S.-listed company fail to comply with the act's auditing requirements for three consecutive years, that company's securities will be banned from trading through any trading method within the SEC's jurisdiction. Look for SEC enforcement activity focused on potential disclosure violations to ratchet up in 2022 and 2023 before a potential surge in trading restrictions in 2024, as the first tranche of foreign companies hit three consecutive years out of compliance with the act.

Conclusion

For FY2022, look for the SEC to expand both the quantity and diversity of its enforcement actions. Based on the pace of enforcement actions in the recent quarter, expect the number of cases to continue recovering from the marked drops in the past two years. In addition, the SEC will continue its focus in reaching a wide array of different issues, novel legal theories and products, and respondents around the world in an attempt to boost investor confidence in the market and the institutions that regulate it. 