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SEC enforcement: the state of play

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Developing trends – Recent SEC investigations into hedge funds, investment advisers, officers, directors, and political intelligence firms have been indicative of two separate trends that are currently shaping SEC enforcement decisions.

One, under the leadership of Chair Mary Jo White, the SEC has increased its focus on enforcement and has made it a goal to pursue all types of violations, big and small. Second, it has been a few years since the adoption of Dodd-Frank and it has taken a while for the SEC to digest the legislation, implement regulations, and react. “For the first time since 2008, the SEC is beginning to see a post-Dodd-Frank certainty regarding regulations and case law,” says Mark Ruddy, attorney and founder of Ruddy Law Office, PLLC in Washington, DC. “We should expect these developing trends to portend a broadening of the violations that SEC chooses to pursue and how the SEC will go about doing it.”
Increased focus on enforcement – In several speeches dating back to 2013, Chair White has made clear that the SEC will attempt to cast a wide net with regard to securities law violations. Citing as a model for success the New York City enforcement techniques in the 1990s of then Mayor Rudy Giuliani and Police Commissioner Bill Bratton, she stated that the SEC would attempt to pursue infractions at every level to ensure investors that there was a strong watchdog monitoring the markets and protecting the retail investor. We are seeing this “Broken Windows” approach to regulation playing out today.
Recent SEC enforcement proceedings – The convergence of these trends can be seen in the September 10, 2014 SEC announcement that 28 officers, directors, or major shareholders have been charged with violating sections 16(a), 13(d), or 13(g) of the Exchange Act, which require these individuals and entities to promptly report information about their holdings and transactions in company stock. By rule, executives, directors, and 10 per cent shareholders of US public companies are required to report transactions in company stock on Form 4, and beneficial owners of more than 5 per cent of a class of company stock must report holdings on Schedule 13D or 13G. By using quantitative data and ranking algorithms, the SEC identified officers, directors, and investment firms that repeatedly filed late.
The announcement of these enforcement actions is significant for several reasons and predictive of future enforcement trends. The SEC acknowledged employing data mining software to leverage their enforcement capabilities. In order to cover more ground, the SEC has been looking for different analytical tools that will assist enforcement staff in detecting violations that otherwise would require more significant human capital to uncover. The quantitative analytics used to review the ownership filings are a good example of how the SEC is transitioning towards computer-driven analysis to further their Broken Windows enforcement strategy.
The SEC had previously announced that it was developing the Advanced Bluesheet Analysis Program (ABAP), a database that would be able to mine trade and account information to develop links between individuals and uncover trading-based violations such as insider trading. In 2013, the SEC filed 43 insider trading actions. This trend is likely to continue through 2014 and beyond. This pivot towards technology in enforcement is evidence of the SEC’s desire to be everywhere in the securities markets.
Another significant aspect of this September SEC announcement is that the SEC does not need to show intent to prosecute violations of 16(a), 13(d) and 13(g). While scienter-based violations require that the SEC show that the violator acted intentionally or recklessly, the SEC is demonstrating that it is willing to bring cases for strict liability offenses or for negligent conduct. In so doing, the SEC is attempting to maximise its use of resources by prosecuting violations that are more easily identified and settled.
“This marks a contrast with past enforcement techniques, where negligence-based actions were typically not brought on their own, but usually in conjunction with other intent-based violations as a type of catch-all violation,” explains Ruddy.
Since the implementation of Dodd-Frank, part of which required investment advisers with USD150m or more in assets to become SEC-registered, the SEC has seen a 50 per cent-plus increase in the number of SEC-registered investment advisers that advise private funds. This prompted the SEC’s Office of Compliance Inspections and Examinations to embark on a series of presence exams in 2012 targeting newly registered investment advisers. By focusing on risk-based areas – including marketing tactics, portfolio management, conflicts of interest, valuation processes – the SEC has steadily built up a deeper understanding of hedge funds.
“The OCIE will say that the reason for conducting these presence exams is to help educate in some ways the new registrant about proper policies and procedures. In reality, they’re conducting these visits to get more of an insight into how hedge funds operate,” comments Ruddy. The September 10, 2014 SEC announcement included charges against five investment advisers in connection with their beneficial ownership of publicly-traded companies. This exemplifies the post-Dodd-Frank state of SEC enforcement: Dodd-Frank regulations have been passed, the SEC has gathered information, and now they are beginning to bring cases.
As the amount of information and the body of Dodd-Frank case law increases, the SEC has demonstrated an increased willingness to bring enforcement action through administrative proceedings. In addition to benefitting from a settled regulatory framework, administrative proceedings are generally resolved faster than in the courts and provide the opportunity for better publicity. On June 30, 2014, the SEC announced that it had hired two new judges and three new attorneys to join the Office of Administrative Law Judges. Coupled with several other recent hires, the SEC has nearly doubled the size of this office and seems to be preparing for an increased number of administrative proceedings.
More recently, the SEC has publicised its use of the whistleblower programme, another by-product of Dodd-Frank, to assist the Commission in gathering information. On September 22, 2014, the SEC announced a USD30m award, the largest payment in the history of the programme, to one anonymous whistleblower who provided information that led to an SEC enforcement action. Since its inception three years ago, the whistleblower programme has received more tips and has paid out more in awards in each year.
The SEC enforcement division has started to take a cold hard look at the way hedge funds interact with Washington officials to potentially gain political intelligence. As the Wall Street Journal reported over the summer, the SEC is currently investigating more than 40 Wall Street entities including some of the largest US hedge funds. This has been a hot button issue for the past 12 months in the US. This heightened scrutiny and public attention has come about in the wake of the Stop Trading on Congressional Knowledge Act (the Stock Act), passed into law in 2012. The Stock Act attempted to combat political insiders from using or passing along non-public information that political insiders may gain in the course of their official duties for personal benefit.
Going forward, we can expect these SEC enforcement trends to continue. Specifically, aggressive enforcement of SEC rules violations at every level with an increased reliance on quantitative analytics and the development of information databases such as ABAP. The SEC has demonstrated an increased preference for bringing cases in administrative proceedings rather than filing in court, and this trend will likely continue into 2015. 

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