Top SEC Enforcement Events of 2014

By William R. McLucas, Douglas J. Davison, Jason S. Flemmons, Martin S. Wilczynski and Leila J. Ameli-Grillon

I.               Introduction

This past fiscal year, ending September 30, 2014, was an active one for the Division of Enforcement at the U.S. Securities and Exchange Commission (“SEC”).  The SEC brought 755 enforcement actions and collected $4.16 billion in disgorgement and penalties, 10 and 22 percent increases, respectively, from fiscal year 2013.[1]  The SEC attributed the increase in enforcement actions in part to new investigative approaches as well as the SEC’s expansion into a number of new areas, resulting in several first-ever cases.[2]  This article reviews a selection of the top SEC enforcement matters of 2014.

II.            Continued Aggressive Posture

There can be no question that Chair Mary Jo White has taken an aggressive approach to enforcement matters since becoming SEC Chair in April 2013.  As Chair White recently stated, “[m]aintaining a robust enforcement program is always a principal area of focus for the SEC and has, not surprisingly, been one of my top priorities.”[3]  Chair White’s commitment to “vigorously pursue wrongdoers”[4] was evident in many ways, including actions against a “wide swath of the securities markets,”[5] creating new task forces, and requiring public admissions of wrongdoing in certain matters.[6]

One notable manifestation of Chair White’s desire to send a strong message of deterrence was the pursuit of the “broken windows” approach to SEC enforcement.[7]  Analogizing the new enforcement policy to that used by New York City in the 1990’s, Chair White declared that the SEC would pursue minor securities law violations in an effort to deter more significant ones and would  “strive to be everywhere.”[8]  Accordingly, the SEC brought charges under the approach in several “sweeps,” premised on what historically were viewed as relatively minor violations, particularly because they did not include fraud.  For example, in September 2014, the SEC brought charges against 34 parties, including 28 individuals and 6 companies, for failing to file timely and accurate reports regarding transactions and holdings, and against 19 firms for short sale violations.[9]

This approach has not been without criticism, including from within the SEC itself.  Commissioners Kara Stein and Michael Piwowar have both spoken out against the policy.  Commissioner Piwowar is concerned that, “[i]f every rule is a priority, then no rule is a priority,”[10] and Commissioner Stein has explained that, where enforcement resources are limited, the broken windows approach may be imprudent.[11]  In response, Enforcement Director Andrew Ceresney has explained that the broken windows approach is “not about turning every violation into an enforcement action” but, rather, is about “targeting… rules [where] we have seen a lack of compliance and bringing a number of cases to send a strong message.”[12]  Regardless of the merits of the broken windows approach, we believe we will see more action to further the initiative.

III.          Increase in Enforcement Actions: More Litigation and More Administrative Proceedings

The SEC’s continued trend of aggressive enforcement is also evidenced by the fact that the SEC had a record number of trials this last fiscal year.  It had 30 trials, including 17 in federal court, with a mixed record of successes and losses.[13]

This increase in litigation resulted in part from a sharper assessment of the liability of individuals,[14] who in the end have been unable or unwilling to agree to severe sanctions demanded in settlements.  Director Ceresney recently explained:  “I always have said that actions against individuals have the largest deterrent impact.  Individual accountability is a powerful deterrent because people pay attention and alter their conduct when they personally face potential punishment.”[15]

In addition to more litigation as a general matter, the SEC is making increasing use of its power under the Dodd-Frank Act to bring more cases administratively.  While the total number of enforcement actions increased, the SEC filed only 145 cases in the judicial forum, compared to 207 last year.[16]  However, the SEC filed 610 cases administratively in fiscal year 2014, compared to 469 last year.[17]  To handle the increased caseload, the SEC announced this year that it had doubled the size of its office of ALJs.[18]  Director Ceresney and Kara Brockmeyer, Chief of the FCPA Unit, have commented that the SEC has and will continue to use the administrative forum more frequently.[19]  Director Ceresney has explained what he views as the benefits of proceeding administratively, including: “prompt decisions,” “specialized factfinders,” and that ALJs are “not obligated to strictly apply” the federal rules of evidence.[20]

Many have criticized the SEC’s increased use of the administrative forum, including those who face administrative charges.[21]  In addition, U.S. District Judge Jed Rakoff for the Southern District of New York has discussed the “dangers” of bringing more cases administratively, including concerns that securities laws are being interpreted in a non-judicial forum and over the fairness of administrative proceedings due to the inapplicability of the federal rules of evidence, the lack of a jury trial, and the deference the decisions are entitled to on appellate review.[22]  Judge Rakoff also pointed out that the SEC won all of its administrative hearings in fiscal year 2014, but only 61 percent of its federal trials.[23]

Despite the criticism of the SEC’s increased use of the administrative forum, Director Ceresney has defended this shift and the SEC has made clear that it will continue to bring more cases administratively.[24]

IV.          Focus on Insider Trading

The SEC brought 52 insider trading actions, charging 80 people, an increase over the 44 cases brought in 2013.[25]  Despite this uptick in charges, this year saw a streak of insider trading trial losses in federal court for the SEC.[26]

But the most significant development in insider trading matters is the Second Circuit’s decision to reverse the convictions of two hedge fund managers in United States v. Newman.[27] The court held that a tippee can be liable for insider trading only if he or she has knowledge that the tipper obtained a personal benefit.[28]  The court also found that the evidence in the case was insufficient to establish that any personal benefit existed.[29]  The court explained that there is no personal benefit “in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”[30]

The Department of Justice is seeking en banc review of the Newman decision.[31]  It is arguing that the panel’s definition of personal benefit “defies practical application” and conflicts with prior holdings of the Supreme Court, the Second Circuit, and other circuit courts, and that, under the previously existing standard, the evidence was sufficient to support the convictions.[32]  Moreover, it is arguing that the panel’s definition of personal benefit threatens the integrity of the securities markets because it will “dramatically limit the Government’s ability to prosecute some of the most common, culpable, and market-threatening forms of insider trading.”[33]  The SEC is seeking leave to file an amicus brief, arguing:  “The panel’s narrowed definition of personal benefit and lack of clarity about the evidence required for establishing such benefit could negatively affect the SEC’s ability to bring insider trading actions.”[34]

While it is clear that these developments are significant and will have a real impact on insider trading cases, the full scope is not yet known.  For example, in another insider trading case, United States v. Conradt, the government argued that Newman should be construed narrowly.[35]  The government argued that, while “[t]he Newman decision dramatically (and, in our view, wrongly) departs from thirty years of controlling Supreme Court authority,” the decision does not apply in Conradt.[36]  Conradt was brought under the misappropriation theory of liability and Newman, the government argued, applies only to insider trading cases brought under the classical theory of liability.[37]  U.S. District Judge Andrew Carter of the Southern District of New York rejected the Department of Justice’s interpretation of Newman and vacated the guilty pleas, finding that Newman applies regardless of whether the tipper’s duty arises under the classical or misappropriation theory of liability.[38]   In response, the Department of Justice asked the court to dismiss the case, stating that Newman “creates a novel evidentiary bar for tipper benefit and tippee knowledge of such a benefit, that the Government cannot now meet.”[39]  Newman has also caused the SEC to postpone an appeal by Michael Steinberg, a former SAC Capital Advisors trader.[40]  Following a criminal conviction for insider trading, an SEC ALJ issued a decision barring Steinberg from the securities industry.[41]  Steinberg requested that the SEC stay the proceedings on his industry ban until the government’s petition in Newman is “finally resolved.”[42]

V.             Financial Fraud

            The SEC’s 2014 fiscal year marked the first full year of activity since the establishment of the Financial Reporting and Audit Task Force in July 2013,[43] and the first full year in which the financial fraud area was targeted by the SEC as an area of “renewed focus.”[44]  In the SEC’s “Select SEC and Market Data” statistics for fiscal year 2014, the SEC reported that 99 actions were brought in this area, representing a meaningful jump from the prior year.[45]

Upon closer inspection, however, the cases listed in this category may suggest that the SEC’s real emphasis in this program area is yet to be felt.  Of the 99 actions in this category, 27 involved “stop order” proceedings under Section 8(d) of the Securities Act, including 20 actions filed on the same day against companies that were controlled by the same stock promoter.[46]  Backing out these numbers and a small number of other non-issuer reporting cases, the level of enforcement activity in the financial statement accounting and disclosure area was nearly identical with the prior fiscal year.

The pace of enforcement actions in this area during fiscal 2014 should not, however, be interpreted as being predictive of what lies ahead.  Comments made publicly by the SEC’s Enforcement staff indicate that the pipeline of accounting matters has increased substantially since the establishment of the Financial Reporting and Audit Task Force, and that the area continues to be a priority.[47]  During 2014, the SEC brought a variety of financial and accounting actions, including fraud and non-fraud charges.[48]  The Division’s continued efforts in the cross border arena yielded 11 actions against 27 parties associated with China-based issuers and related auditors.[49]

The settlements and charging decisions made by the SEC in financial and accounting actions during the year were scrutinized and, in some cases, criticized by individual commissioners for being too lenient.  For example, in one case, Commissioner Luis Aguilar issued a public dissent to highlight his views regarding the leniency of the charges in a settlement involving the former CEO and CFO of the registrant.[50]  In his dissent, Aguilar characterized the punishment agreed to by the SEC as a “wrist slap at best,” and asserted that the settlement reflected the SEC’s “lack of conviction to charge what the facts warrant and to bring appropriate remedies.”[51]

Finally, during fiscal year 2014, the SEC also continued to file a number of cases involving auditors, particularly with respect to independence violations.[52]  As an important component and check on the integrity of the financial reporting process, auditors and gatekeepers are continuing to be a priority focus of the SEC and the Enforcement Division, as noted above.

VI.          Looking ahead

There are not yet any new “burning crises” that require the SEC’s attention in 2015.[53]  Director Ceresney recently said that, if he had to identify priorities for this year, he would point to:  financial reporting and audit fraud, including disclosure and accounting issues, audit deficiencies, and failures of internal controls; market structure cases, such as those involving exchanges, broker-dealers, and manipulation cases; and complex financial-instrument cases, including rating agencies, complex-instrument disclosure, and valuation of such instruments.[54]

In addition to the priorities identified by Director Ceresney, we can expect the SEC to continue to focus on the area of potential conflicts of interest in various pockets of market relationships.  This focus is reflected not only in the private equity and auditor independence cases from the past fiscal year, but also in the recent charges against a credit rating agency for  alleged misconduct arising from the ratings of commercial mortgage backed securities.[55]

It is hard to conclude that we will not witness another year of tough enforcement not only in these areas, but across a broad spectrum of the securities markets.

William R. McLucas and Douglas J. Davison are partners and Leila Ameli-Grillon is an associate with the law firm WilmerHale. 

Jason S. Flemmons and Martin S. Wilczynski are Senior Managing Directors in the FTI Consulting Forensic and Litigation segment.