SEC: Record fines show enforcement priorities, compliance failures

Enforcement boss said SEC goal is compliance with rules to protect shareholders, but SEC view of individual shareholders may be misguided when applied to funds, Peirce argues.

The SEC – which has been under pressure all year to ease up on a regulatory agenda even supporters describe as aggressive – responded last week by showing that its enforcement has been at least as aggressive as its rulemaking.

The commission pulled in a record-setting $6.44bn in penalties and disgorgements during fiscal year 2022, which is 67% higher than the $3.85bn the SEC pulled in during fiscal 2021, according to a Nov. 15 report.

The number of enforcement actions increased only 9% year over year, to a total of 760, though the number of new stand-alone actions increased only 6.5%, to 462.

The dollar value of the penalties involved is “the most on record in SEC history,” the report said.

The largest part of the increase came from just two incidents, however, according to analysis from Kevin LaCroix, attorney and executive vice president of insurance intermediary RT ProExec.

Of the $6.44bn, $1.24bn came from a series of settlements with 17 firms the SEC accused of allowing employees to talk business using off-channel communications via personal text and WhatsApp, LaCroix wrote.

Another $1.02bn came from a settlement with Allianz Global Investors US LLC, which the SEC accused of having defrauded investors by concealing risks involved in a complex trading strategy.

Those two incidents –and others such as the $35m paid by Morgan Stanley Smith Barney LLC for having failed to delete customer data from servers and hard drives later sold at public auction – may inflate total penalty numbers, but the rest of the report contains enough “portentous” statements to make clear the SEC is not focusing only on those few incidents, LaCroix wrote.

The SEC’s Enforcement Division is being aggressive in its enforcement and is pressing for high-dollar fines, primarily as part of an effort to get registrant firms to understand just how sloppy they often are about compliance even with regulations that are well-known and well-established, Gurbir S. Grewal, director of the enforcement division, said in the announcement of the report.

“While we set a Commission record this past fiscal year for total money ordered at $6.4 billion, including a record $4.2 billion in penalties, we don’t expect to break these records and set new ones each year because we expect behaviors to change,” Grewal said. “We expect compliance.”

Requiring that public companies or registered investment advisers (RIA) comply collectively is one goal, but the real goal is to get the fiduciaries who are supposed to stand up for the best interests of shareholders to actually do so, SEC Chair Gary Gensler said at the start of the Compliance Outreach Program seminar on compliance and enforcement that the SEC held Nov. 15.

SEC enforcement efforts are focused, most basically, on making sure the conflicts of interest inherent in any investor/adviser relationship can be managed effectively using a combination of laws, rules, regulations and the ethically driven decisions of gatekeepers who can be counted on to act in the best interest of shareholders, Gensler said.

“Advisers have to comply with specific duties relating to care and loyalty. Advisers—guided by their compliance officers—need, among other things, to prevent their own interests from inappropriately influencing their recommendations and advice,” Gensler said. “You have to put your clients’ interests first.”

The SEC has updated its guidance on that issue, Gensler said, pointing to bulletins on Regulatory Best Interest and the investment-adviser fiduciary standard posted by SEC staff earlier this year.

Complex investment vehicles, new platforms and other changes often make it difficult to put investor interests first, which is why the SEC continues to update, and enforce, rules such as those on derivatives, valuations and ESG-related marketing and investment strategies, he said.

It’s also why the SEC has fought so hard to control cryptocurrencies and other digital assets, and why it is paying so much attention to changes in the valuation and derivatives rules that went into effect earlier this year.

“Fraud is fraud, regardless of the investors being defrauded and the types of securities used in the fraud,” Gensler said. “New rules can give ‘good counselors’ additional tools to help ensure that funds’ valuation and derivative use stay in line with investor protections. Let me emphasize how important segregation of duties are, particularly as relates to derivatives and valuations.”

Enforcement and protection of shareholder interests are important, but the commission also sometimes loses sight of the difference between the personal financial advisers who recommend investments to individual consumers, and the portfolio managers of fund advisers who are responsible for the strategy and performance of a fund with thousands of shareholders, SEC Commissioner Hester Peirce argued in remarks at yet another enforcement-related event held Nov. 15.

Individuals make the decision to invest in a fund, Peirce said, but once they buy in, they become part of a collective of investors who have all agreed to follow the investment strategy and policies outlined in the marketing or investment materials circulated by that fund, she said.

“Fiduciary duty runs to each fund as a whole,” Peirce said. “Once an investor puts money into a fund, she owns a piece of the fund, but her money belongs to the fund, and the fund’s adviser must invest according to the fund’s stated objective.”

Portfolio managers and fund boards are responsible for making sure the fund follows the strategies and policies laid out at the start, but are not responsible for conflict with the priorities of shareholders who may not agree with the purchase of a particular asset even if it fits in with the overall strategy advertised for the fund, she said.