United States: Heightened Examination And Enforcement Capabilities In The U.S.

Last Updated: October 30 2018
Article by Ken C. Joseph

Some industry pundits have pointed to objective year-to-date statistics on the number of white collar prosecutions, securities enforcement actions and related financial penalties as evidence of a deregulatory turn in the U.S. financial markets. Yet all is not what it seems.

Studies have shown that white collar prosecutions in the U.S. are projected to fall to their lowest level in 20 years.1 This trend appears evident in the U.S. regulatory enforcement statistics as well:

  • In FY 2017, the U.S. Securities and Exchange Commission (SEC) reported that it brought 754 enforcement actions, down approximately 13% from FY 2016. It also obtained judgments and orders totaling more than US$3.7 billion in disgorgement and penalties, a decline of approximately 7% from the previous year.2
  • The Financial Industry Regulatory Authority (FINRA) has also reported declines with 1,369 new disciplinary actions filed in FY 2017, down from 1,434 in 2016, and fines of US$64.9 million in FY 2017, compared to US$173.8 million the previous year.3

SEC Enforcement Results: Fiscal Years 2014 – 20174

While there is an evident downtrend in enforcement actions and related penalties, U.S. market participants may unduly be taking comfort and significantly misjudging the risks and costs of landing in the regulatory cross-hairs. There are two innovations employed by the U.S. regulators that either have, or will, sharpen and maintain the regulators' ability to identify and target actual or potential violations of the U.S. federal securities laws and related rules: Over approximately the past five years, the SEC has increased its reliance on both human sources and data analytics. This has been to inform its decisions on whether to allocate resources to examinations and investigations, to identify emerging risks, to scope areas for review, and to risk-rate or profile persons or entities who may be involved in misconduct.

Human Sources
Whistleblowers, incentivized in part by multimillion-dollar bounties for supplying data that help the SEC uncover and stop securities law violations, continue to flood the agency with valuable information. In its FY 2017, the SEC received 4,484 tips from whistleblowers — almost 33% more than it received five years earlier.5 This figure does not include the thousands more in tips, complaints, or referrals the agency received from federal and state law enforcement partners, SROs, and other market participants.

The quality and value of whistleblower information is evidenced by the fact that since approximately 2012, the SEC has imposed almost US$1.5 billion in monetary sanctions on alleged violators that could be traced, at least in part, to information provided by whistleblowers.6 During the same timeframe, 53 whistleblowers collected more than US$262 million in bounty payments, including awards to three whistleblowers in early 2018 totaling US$83 million.7 

In addition, the SEC's examination and investigative strategy and tactics are increasingly shaped by onboard industry experts, and by highly-trained legal, accounting, finance, and other professionals who now routinely collaborate across traditional organizational silos. In its FY 2017 Congressional Budget Justification, the SEC discussed the enhancements to its National Examination Program (NEP) and specifically highlighted the "internal collaboration [and recruitment of] more staff with specialized expertise and experience."8 Similarly, the agency's Market Abuse Unit's Analysis and Detection Center within the Division of Enforcement utilized industry specialists with unique analytical, statistical, programming, or investigative skills.9

Big data and predictive analytics
The SEC has also made great strides in the adoption of sophisticated 'big data' analytical tools and techniques, coupled with predictive analytics and forms of machine learning to significantly increase its ability to detect and deter potential misconduct. The agency's commitment to compiling and mining the vast amount of public and confidential-filed data at its disposal has significantly increased the likelihood of a 'positive' outcome for the agency. For example, the agency's deployment of the National Exam Analytics Tool (NEAT) and the Advanced Relational Trading Enforcement Metrics Investigation System (ARTEMIS) has given the agency unprecedented ability to identify actual or potential violations relating to insider trading, market manipulation, illegal short sales, unauthorized transactions, inflated valuation, and misrepresentation of performance, to name a few.

In the same vein, the agency's Division of Economic and Risk Analysis (DERA), in conjunction with seasoned examiners and investigators, has developed and deployed sophisticated algorithms and machine learning tools to detect patterns and anomalies that bear the badges of fraudulent conduct. Not to be outdone, FINRA launched its Cross-Market Auction Ramping surveillance pattern whilst also noting that it is "working on incorporating machine learning techniques to aid in further detection of manipulative layering activity."10

The Outlook
The declining amounts of monetary fines and enforcement actions do not tell the full story of the risk of detection and prosecution. U.S. regulators have innovated and responded to the realities imposed by strained budgets, dwindling resources, and an increasingly sophisticated marketplace. As such, U.S. market participants who fail to conduct their business in a legally compliant manner run the risk of exposure to the regulatory hammer.

Footnotes

1 Trac.syr.edu. (2018). "White Collar Prosecutions Fall to Lowest in 20 Years." [online] Report date: 24 May 2018 (http://trac.syr.edu/tracreports/crim/514/?et=editorial&bu=National%200-Law%20Journal&cn=20180530&src=EMC-Email&pt=Compliance%20Hot%20Spots
2 SEC Division of Enforcement FY 2017 Annual Report (https://www.sec.gov/files/enforcement-annual-report-2017.pdf)
3 FINRA Statistics: Regulatory Actions and Corporate Financing Review 2013 – 2017 (https://www.finra.org/newsroom/statistics)
4 SEC Division of Enforcement FY 2017 Annual Report (https://www.sec.gov/files/enforcement-annual-report-2017.pdf); SEC Summary of Performance and Financial Information FY 2016 (https://www.sec.gov/files/2017-03/sec-summary-of-performance-and-financial-info-fy2016.pdf); SEC Press Release: SEC Announces Enforcement Results for FY 2016 (https://www.sec.gov/news/pressrelease/2016-212.html)


5 2017 Annual Report to Congress: Whistleblower Program (https://www.sec.gov/files/sec-2017-annual-report-whistleblower-program.pdf)
6 SEC Press Release "SEC Awards Whistleblower More Than $2.1 Million." 12 April 2018 (https://www.sec.gov/news/press-release/2018-64)
https://www.sec.gov/news/press-release/2018-44)
8 SEC FY 2017 Congressional Budget Justification, FY 2017 Annual Performance Plan, and FY 2015 Annual Performance Report (https://www.sec.gov/about/reports/secfy-17congbudgjust.pdf)
9 Ehret, Todd. "SEC's Advanced Data Analytics Helps Detect Even the Smallest Illicit Market Activity." Reuters. 30 June 2017 (https://www.reuters.com/article/bc-finreg-data-analytics-idUSKBN19L28C)
10 FINRA 2018 Annual Regulatory and Examination Priorities Letter (http://www.finra.org/industry/2018-regulatory-and-examination-priorities-letter)

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