Fittingly, the Securities and Exchange Commission (SEC) came into March like a lion. In addition to numerous SEC enforcement actions being filed this month, there were important developments with respect to the SEC’s enforcement and examination programs.  This notice briefly describes three of these SEC developments.

March 3:  SEC Division of Examinations Releases 2021 Examination Priorities

The SEC’s Division of Examinations (formerly the Division of Compliance and Examinations) released its 2021 Examination Priorities.  The Division publishes examination priorities annually to provide insights into its current approach to conducting examinations of registered broker-dealers and investment advisers and to highlight the areas it believes present potential risks to investors and market integrity.

Some of the key SEC examination priorities identified in the release are:

  • Compliance with Regulation Best Interest and whether registered investment advisers have fulfilled their fiduciary duties of care and loyalty.
  • Whether firm business continuity and disaster recovery plans are accounting for the growing risks associated with climate change.
  • Adequacy of the compliance programs of registered investment advisers.
  • Compliance with anti-money laundering requirements.
  • Firm exposure to LIBOR and firm preparations for the discontinuation of LIBOR.

The release also contains useful discussions of key industry developments and trends, including with respect to the COVID-19 pandemic; the Division’s exam program; Regulation Best Interest; risk, technology, and industry Trends; and firm and investor outreach and risk alerts.

Takeaway:  Compliance counsel for registered broker-dealers, investment advisers, and investment funds should review the 2021 Examination Priorities and consider which topics should be addressed as part of their compliance and risk management processes.

March 4:  SEC Creates Climate and ESG Task Force

Consistent with the Biden administration’s focus on increasing reporting and accountability regarding climate change and environmental, social, and corporate governance (ESG) issues, the SEC announced its creation of a Climate and ESG Task Force.  The Task Force, which will be housed in the Division of Enforcement, will develop initiatives to proactively identify ESG-related misconduct – for example, material gaps in disclosures by issuers relating to climate risks.  The Task Force will also analyze disclosure and compliance issues relating to ESG strategies followed by investment advisers and investment funds.  The Task Force will be staffed with 22 members from across the Division of Enforcement.

Takeaway:  Given the primacy shown by the Biden administration for climate change and ESG-related issues, SEC-regulated entities should expect to see increased regulatory and enforcement attention paid to these areas by the SEC.

March 9:  SEC Commissioner Crenshaw Delivers Speech to Council on Institutional Investors

In a speech delivered to the Council on Institutional Investors, SEC Commissioner Caroline Crenshaw discussed her views on a number of issues and highlighted the importance of the SEC’s enforcement mandate.

Most significant, Crenshaw challenged as “fundamentally flawed” an existing SEC policy that the amount of corporate penalties imposed in enforcement actions should reflect whether the corporation’s shareholders benefited from the misconduct or whether they will be harmed by the assessment of the penalty.  In 2006, the SEC issued a statement identifying factors the agency would consider when deciding whether to assess a penalty against a corporation.  In this statement, the SEC was critical of imposing penalties that unduly burden shareholders and has since considered whether a corporation’s shareholders would be harmed by a proposed penalty (i.e., whether the costs may be passed on to shareholders).

Commissioner Crenshaw opined that considering the harm to investors was flawed for the following reasons:

  • The primary focus for shaping a penalty should be the egregiousness of the actual misconduct.
  • The SEC should not treat the presence or absence of a shareholder or corporate benefit as a threshold issue to imposing a penalty.

Regarding the latter, Commissioner Crenshaw observed that there is no way to accurately measure the benefits enured to a company from its violative conduct and therefore she disagreed with “the notion that a corporation should pay any less of a penalty simply because the total benefit it received from its misconduct is difficult to quantify with exact precision.” Crenshaw also challenged the view that SEC penalties harm investors, noting for example that a stiff penalty could benefit shareholders by motivating the company to remediate problems, strengthen internal controls, clarify lines of responsibility, and prioritize individual accountability.

Commissioner Crenshaw advocated for a new approach whereby penalties are based on the actual misconduct and reflect any cooperation afforded by the defendant to the SEC and whereby higher penalties are imposed for violations that cause more harm or that are more difficult for the SEC to detect.  Commissioner Crenshaw also took the opportunity to remind issuers that the SEC “takes cooperation and self-reporting seriously.”

Takeaway:  Counsel negotiating a settlement on behalf of a public company should be prepared for the possibility of the SEC being less receptive to arguments that a lower penalty is warranted to minimize the impact on shareholders and be prepared to explain why the conduct warrants the penalty amount being proposed by counsel.

If you have any questions about how these recent SEC actions might impact your business, please contact the author.