SEC and CFTC Close Out Fiscal Years

SEC and CFTC Close Out Fiscal Years

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The third quarter will mark the end of FYE 2020 for the CFTC and the SEC (the “Regulators”).  They will be releasing statistics on enforcement actions and other priorities closer to the end of 2020. If there are decreases in enforcement cases and examination (the trend has been upward over the last several years), the Regulators may cite the disruption caused by the COVID-19 as a factor as they have done in previous government shutdowns.

While we await the release of the statistics, we assembled a list of the top five trends and areas of regulatory focus:

Remote Examinations: The industry expected COVID-19 to be hampered by the Regulators’ ability to examine registrants. However, once everyone settled in to working from home, the pace of examinations was similar to years past. All examinations were completed remotely and, like the rest of us, examiners seem to have become used to working from home. Even limited scope examinations are a drain on resources; perhaps remote exams will become a viable, more efficient option if not generally, then particularly for non-U.S.-based firms. With the examination staff not traveling, the Regulators might have a significant budget surplus.

Whistleblowers: One uptick is in the area of whistleblower activity. Back in May, Steve Peiken, co-director of the SEC’s Enforcement Division, cited a 30% increase in the number of tips received from the same period last year. The increase could be due in part to both Regulators pushing awareness of the program. It is also hard to ignore the possibility that employees may find it easier to report tips when they do not have to interact with the subject of the claims in person. In addition to the sheer number of tips, the number of whistleblower awards increased, as did the total amount awarded. The Regulators will tout these statistics, and we expect the upward trend to continue.

Spoofing Enforcement: The CFTC has vigorously pursued enforcement in this area for years. They generally seek massive disgorgements, including a recent record setting order of $60.4 million against The Bank of Nova Scotia. Many of the spoofing cases cite the fact that someone internally had raised concerns or that mechanisms to detect spoofing were insufficient. Given how successful this effort has been, and the fact that spoofing has a significant effect on market pricing, the trend is sure to continue.

Insider Trading and Material Non-Public Information (“MNPI”): There were two major cases this year. First, the Blaszczak case was heard by the Second Circuit Court of Appeals. The court ruled that federal wire fraud statutes allowed for insider trading prosecutions that did not require Newman’s personal benefit test. This significantly reduces the hurdle for proving an insider trading case versus the traditional cases brought under the Securities Act of 1933’s anti-fraud provision.

In the other case, the SEC announced a $1 million fine against Ares Management LLC (“Ares”) for policy failures. The shocking aspect about this case was the absence of  insider trading charges. Rather, the violation was due to Ares having insufficient procedures for preventing and detecting the misuse of MNPI. Though a perennial area for enforcement and prosecutions, firms can expect even higher scrutiny plus lower thresholds for establishing liability.

OCIE’s recent Risk Alert highlights the handling of MNPI as a recurring compliance failure. In addition, the formation of a new exam team indicates a more nimble and forward-looking approach to exams. Reviewing one’s policies and procedures is no longer enough. Advisers should conduct a deeper, more practical assessment of how their investment and compliance functions interact. In particular, compliance teams need to be more knowledgeable about their firm’s conduits for MNPI and more diligent in vetting information with the potential for MNPI.

Retail Customers: Protecting retail customers remains a top priority for the SEC. This year, Regulation Best Interest took effect amongst a flurry of enforcement cases. The SEC’s share class initiative also came to a close with wide success. Other cases included advisers recommending that clients engage in premature unit investment trust rollovers and variable annuity switches. Collectively, this demonstrates the SEC’s multi-pronged approach to protecting retail customers through rulemaking, enhanced disclosure requirements and enforcement actions. The impact of Regulation Best Interest on customer protection is still to be determined; the SEC will undoubtedly issue guidance, fine-tune Form CRS and/or consider rule amendments as needed.

2020 was certainly not what the Regulators expected with the global pandemic still unfolding.  Nevertheless, this has been an active fiscal year that included significant cases, actions and rulemakings. Plus, we are still waiting on other rule proposals to become final, notably the SEC’s advertising and cash solicitation rule amendments (not on the agenda for the Commission’s September 16 meeting), and the higher threshold for 13F reporting. Both of these specifically highlighted a desire to catch up with how the industry has grown and conducts business.   Finally, while the transition from LIBOR is still on track for 2021, the Regulators have yet to establish a clear plan on what a LIBOR-less world will look like.

This next fiscal year will be an interesting one with much to be discussed and determined, especially as we continue to navigate the global pandemic and a volatile market.

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