“Punishing Every Small Violation . . . Means Casting Discretion Aside in Favor of Making the SEC Look Tough.”

May 21, 2018 The weekly news source for investment management legal and compliance professionals “Punishing every small violation . means casting discretion aside in favor of making the SEC look tough.” SEC Should Not Prioritize Enforcement Over Other Parts of its Mission: Peirce SEC enforcement is important and must continue, but has gone too far. While enforcement is necessary, agency staff should use it as a last resort and rein in the kind of Inside Insights enforcement-by-numbers philosophy that the SEC has been using over the past few 8 Note to Readers years. Those are the views of commissioner Hester Peirce, who spoke8 May 11 in Denver on why she sometimes votes “no” on approving enforcement actions brought by the Division of Enforcement. She cited an article in Bloomberg Law which she said noted continued on page 2 Hedge Fund Adviser Execs May Face Personal Fines if They Ignore Red Flags A chief financial officer at a hedge fund advisory firm on May 8 settled8 SEC charges that he failed to act on red flags involving asset mismarking and insider trading. The firm ended up paying more than $10 million, and the CFO agreed to separately pay a $100,000 fine. The lesson: Advisory firm executives need to be on the lookout for signs of fraud, and act on them when they find them. What happened, according to the SEC, was that two portfolio managers of New York City-based Visium Asset Management, a SEC-registered hedge fund adviser with continued on page 4 Technology: IAA Urges Treasury to Recommend a Principles-Based Approach As new technologies and networks proliferate among advisory firms and other non-bank financial institutions, many will require regulation, but will that regulation encourage innovation, or stifle it? The Investment Adviser Association, in a recent letter8 to the Department of the Treasury, urged the Department to support innovation by recommending and encouraging regulators to adopt regulations that are principles-based. Principles-based regulations generally avoid the prescriptive instructions that many continued on page 6 SEC Should Not “When I believe that we ought not [emphasis Peirce] to continued from page 1 have spent our Enforcement Division’s time and effort on a matter, I am likely to vote against it,” she said. that she casts a “no” vote 15 percent of time, a higher rate than any other commissioner. Cleary Gottlieb partner and former SEC chief litigation counsel Matthew Solomon said that Peirce’s comments “The SEC is not an enforcement agency, but enforce- about a more calibrated approach to enforcement in ment is an important tool for the SEC,” she said, noting view of resource constraints “is no surprise – they mir- that the Enforcement Division is currently the largest of ror statements made by Enforcement Division leader- the divisions and offices within the agency, with more ship which presumably reflect the chairman’s views. than 1,100 personnel. Enforcement, however, should be But she also noted that the vast majority of enforcement viewed as part of the SEC, and “properly calibrated” actions win unanimous Commission approval, and that into “part of the regulatory framework within which our the Enforcement Division plays a critical role in the capital markets operate. To appropriately calibrate Commission’s overall mission.” our enforcement program, we must spend our limited enforcement resources wisely.” No more broken windows Peirce also used her comments to urge the Commission In terms of more recent history, Peirce advocated a to tread carefully when considering whether to impose rollback of former SEC chair Mary Jo White’s “broken liability on chief compliance officers. “CCOs advocate windows” approach to enforcement, although she did for compliance at registered entities,” she said. “They not mention her name. Under “broken windows,” the implement and update compliance programs. They agency investigated and prosecuted small violations, monitor for violations. We need to empower them, not as well as large. dissuade them from taking the jobs in the first place.” “In the past, we sometimes have taken a less What Peirce’s speech, as well as SEC chairman Jay resource-conscious approach – a more-is-always- Clayton’s stated goal of prioritizing capital formation, better approach,” Peirce said. “From 2013 to 2016, for represents is a “swing of the pendulum back to how example, the SEC embraced a ‘broken windows’ phi- the SEC operated prior to the Bernie Madoff problem,” losophy of enforcement. Punishing every small said Buckley Sandler partner and former SEC Office of violation, however, means casting discretion aside in Market Intelligence chief Thomas Sporkin. “She comes favor of making the SEC look tough. Violations are not from the same school as former agency commission- all equally serious.” She noted Piwowar’s past state- ers Paul Atkins and Daniel Gallagher, as well as current ment that “if every rule is a priority, then no rule is a commissioner Michael Piwowar, which is to pull back priority.” from the overly aggressive enforcement approach em- Peirce suggested that, during this time, “perhaps the ployed by the SEC since Madoff and the 2008 financial SEC should have changed its name to the ‘Sanctions’ crisis and turn the SEC back into a regulatory and capital and Exchange Commission, because it acted like a formation agency.” branch of the U.S. Attorney’s Office for the Southern “As I consider enforcement matters before the District of New York.” That U.S. Attorney’s Office, Commission, one of the things I think about is wheth- coincidentally – or perhaps not-so-coincidentally – was er we are using our enforcement resources wisely,” the Office White headed as U.S. attorney. “Maybe this Peirce said. “Was there a meaningful violation? Is this approach is natural for a prosecutor, although in the a matter that could have been handled by OCIE or that criminal context, discretion is important too,” Peirce another foreign or domestic authority is already han- continued. dling? Would a rulemaking, an interpretive release, or She then listed five “major problems” that she said an investor alert be a more appropriate response to an occur with “an enforcement philosophy that pursues issue?” ACA Insight 2 minor violations with the same vigor as it does major number of enforcement actions is likely to be high. A violations:” key metric to gauge success becomes the number of enforcement actions. By holding up raw numbers as 1. Diverts resources from high priority issues. “The the measure of success, the broken-window era SEC unsurprising result of the broken windows approach felt pressure to excel its previous year’s enforcement – one that aligned perfectly with our metrics of choice actions. It was an arms race as our lawyers rushed to – was that the SEC brought a lot of enforcement settle a case or sprint to the courthouse – or the admin- actions with lots of penalties,” Peirce said. “But the istrative law judge – to file the next action, especially end goal is better functioning markets and investor as the SEC’s fiscal year end neared: our own version of protection.” earnings management.” 2. Discourages contact with the SEC. “An enforce- She noted that in 2013, the agency brought 686 enforcement-first approach sends the message to regulated ment actions with monetary sanctions of $3.4 billion. entities and others that picking up the telephone to Of these, however, 132 involved what she described ask the SEC a question about how to comply is risky,” as “simple filing matters, in which a company was she said. “Why draw attention to yourself by asking deregistered for being delinquent in their Commission a compliance question of an agency that thinks every filings.” foot fault is enforcement-worthy?” “Deregistering delinquent filers is important, but giving 3. Provides bad incentives for Commission staff. “It these types of matters the same weight as a complex rewards enforcement staff for the number, rather accounting fraud in a count of enforcement actions is than the quality of cases,” Peirce said. “It nudges misleading,” Peirce said. staff to recommend charging some violation [emphasis Peirce] – even a minor one – rather than clos- In 2016, the final year of “broken windows,” the SEC ing an investigation without bringing an enforcement brought 868 enforcement actions with monetary sanc- action.” tions of $4 billion, she said. 4. Contributes to an unhealthy capital formation en- “Again, though, we have to delve deeper into the vironment. “Companies considering an initial public numbers to understand what happened. Of these 868 offering (IPO) have one more reason not [emphasis enforcement actions, 404 actions – 47 percent – Peirce] to conduct an IPO,” she said. “Why should resulted from the following: first, ‘follow-on’ adminis- companies expose themselves to a potential enforce- trative proceedings seeking bars based on the outcome ment action based on a slight misstep in complying of Commission actions or actions by criminal authori- with the extensive public company ruleset?” ties; second, proceedings to deregister public companies that were delinquent in their Commission filings; 5. Imposes unwarranted costs on companies and indi- and third, actions brought as part of the Commission’s viduals. “The effects of an investigation or proceed- voluntary, self-reporting program that targeted mis- ing on a private party can be devastating,” Peirce statements and omissions in municipal bond offering said. She quoted from the SEC’s canon of ethics: documents.” “’The power to investigate carries with it the power to defame and destroy.’ This price is too high for vio- Today is different, Peirce said, with the SEC “no longer lations that are minor.” measuring its success by tallying up enforcement statis- tics.” The agency instead is “making a more concerted The numbers game effort to bring only meaningful enforcement “An enforcement program that pursues every minor actions .

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