United States: SEC Spotlight: Enforcement And Regulatory Developments In The Second Quarter Of 2022

The US Securities and Exchange Commission (SEC or Commission) continued its aggressive enforcement and regulatory regime under Chair Gary Gensler in the second quarter of 2022, making good on its promise to remain active in vigorously protecting investors and maintaining fair markets.

Specifically, the Division of Enforcement (Enforcement) has kept up a brisk pace in bringing actions to quell misconduct by various market participants, including settled actions involving insider trading and investor fraud, along with continuing to expand enforcement activity into developing areas like environmental, social and governance (ESG) disclosures, and nearly doubling the headcount of the Commission's Cryptocurrency unit. In the rulemaking space, the Commission has continued to develop and finalize hefty proposals related to climate disclosures, ESG investment metrics, and special purpose acquisition companies (SPACs). The Commission also announced an aggressive calendar to finalize votes on many of the rule amendments proposed in the first quarter.

This Advisory continues our series of quarterly SEC enforcement and regulatory highlights, with links to additional Arnold & Porter advisories when available. Our analysis is informed by our experience as former leaders and attorneys in the Enforcement Division at the SEC: Dan Hawke as the former Chief of the Market Abuse Unit and Director of the Philadelphia Regional Office, Jane Norberg as the former Chief of the Office of the Whistleblower, and Christian Schultz as former Assistant Chief Litigation Counsel.

Enforcement

Accountants' Liability Conference Follows and Foreshadows Settled SEC Actions. In early June, Arnold & Porter co-sponsored and co-chaired the American Law Institute's Accountants' Liability Conference. The event included Arnold & Porter partner Paul Fishman's fireside chat with SEC Enforcement Director Gurbir Grewal and Acting Chief Accountant Paul Munter, as well as an enforcement panel featuring Senior Officers in the Division. As our recent Advisory highlights, the senior leaders discussed auditor independence, cooperation in investigations, the role of auditors as gatekeepers, and the regulation of digital currencies.

The day before conference, the Commission charged a national accounting firm and three of its partners with improper professional conduct related to the audits of two clients, imposed a significant penalty against the firm, barred two of the partners from appearing and practicing before the Commission, and censured a national office partner. Then, after the conference, the Commission ended the second quarter by announcing a settled action against one of the Big Four accounting firms.

Cryptocurrency. Continuing Chair Gensler's stated goal of treating cryptocurrency markets like other markets, the Commission announced in May that it had nearly doubled its (renamed) Crypto Assets and Cyber Unit, growing the section to 50 dedicated positions. The Enforcement Division also has continued to bring crypto-related actions, including most recently announcing fraud charges related to unregistered offerings and fraudulent sales to thousands of investors under the federal securities laws. The Commission is also reportedly investigating whether digital assets involved in Terraform Lab's project Mirror Protocol, which track the prices of traditional securities, should be considered securities. The continued ramp-up of the Commission's Crypto Asset and Cyber Units in the second quarter of 2022 is a clear continuation of Chair Gensler's focus on bringing crypto and other digital assets into the regulatory framework.

ESG Misstatements and Omissions. In its second ESG-related action since the creation of the Commission's Climate and ESG Task force, the SEC announced a $1.5 million settlement with BNY Mellon Investment Adviser, Inc. (BNYMIA), for representing or implying that all investments in their funds had undergone ESG quality review when not all had done so. The Enforcement Division said that the settlement was part of holding "investment advisers accountable when they do not accurately describe their incorporation of ESG factors into their investment selection process." As discussed in a prior Advisory, the BNYMIA allegations represent the type of "greenwashing" statements that are likely to be the focus of the Task Force going forward. Adopting robust policies and procedures can help to mitigate risk related to the inclusion of inaccurate or misleading statements related to ESG in documents and communications.

Whistleblower Fine. The Commission settled a case with The Brink's Company (Brinks) over an alleged violation of whistleblower protections. The Commission determined that Brinks had "require[ed] employees to sign restrictive confidentiality agreements prohibiting the disclosure of any financial or business information to third parties, without an exemption for potential SEC whistleblowers." Such agreements violated Rule 21F-17(a) of the Securities Exchange Act of 1934 (Exchange Act). Brinks agreed to pay a civil penalty of $400,000 and consented to the issuance of a cease-and-desist order. The company also agreed to amend the language in employee agreements to include an appropriate carve-out for communications with "government authorities." However, in a dissent, Commissioner Hester Peirce noted her belief that the amended language exceeds what is required by Rule 21F-17.

As Arnold &Porter partner Jane Norberg discussed with Law360, companies should ensure that all documents in all company locations are updated to include appropriate carve-out language. In the Brinks matter, the in-house legal team in one location updated agreements but the in-house legal team in another location did not. Given that this is the second case brought under Rule 21F-17 in a little over two months, this is an active area of focus for the Commission. And, in light of the Commission's aggressive and expansive reading of Rule 21F-17, companies should carefully consider steps taken after an employee reports a possible securities law violation.

Anti-Money Laundering. The Commission settled charges against a dually registered broker-dealer and investment adviser for failing to file a number of Suspicious Activity Reports (SARs) in a timely manner. The firm agreed to pay a $7 million penalty for the two technical compliance failures that led to the enforcement action. The charges and Commission order were covered in-depth in a recent Advisory, and show that the Commission remains bullish on its authority to enforce Bank Secrecy Act record-keeping requirements post-Alpine (see our prior advisories and blog posts on Alpine here, here, and here).

Foreign Corrupt Practices Act (FCPA). The Commission announced a $78 million settlement with a global manufacturer and supplier of steel pipe products for paying bribes to Brazilian government officials on behalf of a Brazilian subsidiary. The bribes were funded by companies affiliated with the parent company's controlling shareholder. The company consented to the SEC's order without admitting or denying the findings. The settlement included disgorgement, prejudgment interest, and civil penalties, along with required undertakings relating to the company's ongoing remedial efforts over a two-year period. FCPA remains an active focus of the Commission. Companies should take steps to ensure that internal reporting mechanisms in all locations, both domestic and overseas, are clear and robust so employees feel confident to report internally and the company has an opportunity to investigate and remediate potential FCPA issues, if appropriate, before a regulator begins investigating.

Municipal Bond Violations. The Commission charged a Louisiana town, the town's former mayor, and its unregistered municipal advisor with misleading investors in a $5.8 million bond offering based on false projections, along with a failure for the advisor to register with the Commission. The Commission also charged a city in upstate New York and several of the city's financial officers with misleading investors in a $119 million bond offering, alleging that the defendants provided outdated financial statements and hid evidence of the city school district's financial distress.

Insider Trading. The SEC continued to be active in prosecuting insider trader violations during the second quarter. The Commission settled an action against a corporate accountant who had been trading ahead of his former employer's earnings announcements, and the accountant agreed to pay a nearly $2 million penalty as part of the settlement. The Commission also recently (i) charged several individuals with insider trading, including three software engineers who worked at a public company and used their access to financial databases to trade the company's stock and options and to tip family members and friends who then also traded, and (ii) charged two individuals with insider trading, including a software engineer who worked at the subsidiary of a public company and used knowledge of an upcoming $2 billion merger to benefit himself and a friend. In these two matters, the US Attorney's Offices for the Northern District of California and Eastern District of Pennsylvania announced criminal charges, respectively.

Important Court Decisions

Administrative Proceedings. The constitutionality of SEC administrative proceedings has again come under fire. As discussed in a recent Advisory, the cases of Lucia, Cochran, and Jarkesy could reshape how SEC enforcement actions are instituted and litigated. These cases raise foundational questions concerning the Commission's authority to discharge its adjudicatory function that are likely to be implicated in the Supreme Court's impending review of the Cochran case. As Arnold & Porter partner Dan Hawke recently discussed with FundFire: "Both Cochran and Jarkesy represent significant challenges to the constitutionality of the Commission's authority to proceed" with administrative enforcement actions—and the Jarkesy decision, unless overturned, "poses an existential threat to the SEC's ability to use its administrative process to bring enforcement actions."

Gag Orders. The Supreme Court declined to hear a case in which the appellant, a former Xerox executive, challenged a Commission settlement that barred him from publicly denying the allegations against him. The appellant argued that the so-called gag order violated his First Amendment and due process rights. However, both the US District Court for the Southern District of New York and the Second Circuit found no violation of the appellant's rights. A Fifth Circuit panel recently heard oral arguments in a similar case and has yet to rule, leaving open the possibility for a circuit split to later be resolved by the Supreme Court.

Rulemaking Developments: Current Proposals

In the second quarter of 2022, the Commission slightly slowed the pace of proposed rulemaking activity after an exceptionally active first quarter, perhaps taking the time to review the comment letters received in response to the proposed rules announced in the first quarter. Nonetheless, the rulemaking proposals announced in the second quarter, along with the upcoming finalization of rules proposed in the first quarter, will have a substantial impact on regulated companies.

While our discussion below does not cover all rules proposed during the second quarter, a full list of which can be found here, the following chart identifies second-quarter rules for which the deadlines have not yet passed.

Recovery of Erroneously Awarded Compensation. The SEC has reopened comments on a rule proposal from 2015 rule that would create new listing standards regarding the recovery of erroneously awarded compensation. The rule, which was proposed to implement certain provisions of Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, would direct national securities exchanges and associations to require that listed companies adopt and comply with a policy to recover incentive-based compensation that is based on financial results that must later be restated, and to delineate and disclose what incentive-based compensation is subject to recovery. The comment period for this proposal closes July 14, 2022.

ESG Disclosures. The Commission has proposed rules to standardize the types of disclosures that funds and advisers make regarding their ESG practices, an area that has attracted significant investor interest. The proposal seeks to create a cohesive framework to allow investors to understand and differentiate between funds' ESG approaches and evaluate whether funds and advisers are meeting their stated goals. The proposal will create new minimum disclosure requirements depending on the extent to which the adviser or fund considers ESG factors in decision-making. For funds that consider ESG goals as a significant or primary component of their strategies, this will involve quantitative and qualitative disclosures about progress towards stated ESG goals. For funds that consider ESG goals among other factors in their investment process, the rules would create more limited disclosures about how the funds incorporate ESG goals into investment selection. The comment period for the proposal closes August 16, 2022.

Investment Company Names. The Commission is proposing to amend rules that address investment company names that are likely to mislead investors about a company's investments and risks. The rule currently requires investment companies whose names suggest a focus in a particular type of investment to adopt a policy to invest at least 80% of the value of their assets in those investments. The proposal would extend the Names Rule to a broader set of funds, including funds with terms such as "growth" or "value," or terms indicating that the fund's decisions incorporate ESG factors. As Arnold & Porter partner Christian Schultz explained to Pensions & Investments, the proposal appears to be designed to "ensure that both Main Street investors and institutional investors have transparency into the products that are being presented to them and the representations that are being made to them by investment companies." The comment period for this proposal closes August 16, 2022.

Rulemaking Developments: Upcoming Proposals and Final Votes

The Commission recently announced its regulatory agenda for fall 2022 and early 2023. In the near-term, it appears the Commission will focus on new proposals reforming equity market structure and revisions to shareholder voting policies. Next year, the Commission may require corporations to disclose additional diversity-related information about their boards of directors.

Most notably, the Commission announced that a final vote on many hotly watched amendments may take place in the near-term. While it remains to be seen if the Commission can meet the aggressive timeline it has set for itself, we note some prominent matters in the following chart:

Climate Disclosures. The second quarter saw the comment period close on an extensive set of regulations that would mandate disclosures around climate-related risks, their impact on financial performance, and how companies manage those risks. The proposal, covered in-depth in a recent Advisory, will now go back to the Commission for final review. The original Commission vote on the proposal was 3-1, and, recently, 129 Republican members of Congress signed a comment letter arguing that the proposed rules exceed the Commission's statutory authority and misappropriate the agency's rulemaking authority. Climate and other ESG practices continue to be a key focus of the Commission in its rulemaking efforts, and this proposal is slated for a final vote in October 2022.

Proposal to Lower the Threshold Definition of "Exchange," and Other Crypto News. The SEC proposed expanding the definition of "exchange" to include any system that "brings together buyers and sellers of securities using trading interest" and "makes available established, non-discretionary methods (whether by providing a trading facility or communication protocol, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade." By using this expansive definition, the SEC may deem most digital asset trading platform to be exchanges. This would result in, among other things, individuals having to register as broker-dealers and alternative trading protocols to be subject to SEC regulation. If passed, the rule proposal would upend existing no-action letters and have significant impacts on service providers and individual users. The final vote for this proposed rule is slated for October 2022.

Additionally, Chair Gensler has commented that he is a proponent of "one rule book" for cryptocurrency regulation that would involve other financial regulators, such as the Commodity Futures Trading Commission (CFTC), in order to create a comprehensive regulation regime. He revealed that the Commission is already working to set up a "memorandum of understanding" with the CFTC. Chair Gensler added that such a rule book would cover "all trading regardless of the pair—a security token versus security token, security token versus commodity token, commodity token versus commodity token." In addition, Chair Gensler recently affirmed that Bitcoin is a commodity in a "highly speculative asset class."

Whistleblowers. The SEC proposed two rule changes that it contends would better incentivize potential whistleblowers to come forward. The first proposed change would allow whistleblowers who might recover under multiple whistleblower programs to choose which program to recover under based on potential payout. According to Chair Gensler, this change "is designed to ensure that a whistleblower is not disadvantaged by another whistleblower program that would not give them as high an award as the SEC would offer." The second proposed change would eliminate the Commission's authority, after calculating a whistleblower's award using the framework set forth in the rules, to consider the dollar amount calculated (which could be very large) for the purpose of decreasing the award—but it would continue to permit the Commission to consider the dollar amount of the award to increase it. The SEC's proposal to strengthen its whistleblower program is slated for a final vote in October 2022.

Cybersecurity. The Commission proposed rules to address cybersecurity concerns relating to funds and advisers and, separately, public companies. The proposals were intended to improve investor confidence and protections against emerging cybersecurity risks, and they provide consistency in how firms and issuers address and report cybersecurity risks and incidents to investors. For more in-depth analysis, recent advisories relating to each of these proposals can be found here and here. The final vote for both proposals is tentatively scheduled for April 2023.

SPACs. The SEC has moved one step closer to finalizing new rules that would significantly affect SPACs. The comment period has closed for a wide-ranging set of new guidelines for SPAC disclosures, registration requirements, and projections, discussed at length in a recent Advisory. The proposal has received criticism from investment banks and trade associations for its breadth, and potential new rules on liability for IPO underwriters and third-party investors have led some banks to consider scaling back their involvement in SPACs. The proposal is now back with the agency to evaluate public comments. No final rule vote date has been proposed yet.

Securities-Based Swaps. The Commission has proposed a rule to create a regime for the registration and regulation of security-based swap execution facilities (SBSEFs). The proposal also seeks to tackle conflicts of interest at SBSEFs, adopt rules of practice to allow persons aggrieved by an SBSEF to apply for review by the Commission, and create certain exemptions from the Exchange Act for SBSEF brokers and funds. Rules relating to SBSEFs were proposed back in 2011 and 2013 but have been superseded with this proposal. The comment period for the proposal recently closed, but no final rule vote date has been proposed yet.

Electronic Filing Requirements. SEC filers should be aware that the Commission voted unanimously to finalize amendments to rules requiring that certain applications and confidential treatment requests be filed online, rather than through paper submission. The Commission also has changed requirements for updating amendments to certain forms.

Conclusion

The SEC's enforcement and regulatory actions in the second quarter of 2022 continue the aggressive approach of the agency under the leadership of Chair Gensler and Enforcement Director Grewal as they enter the second year of their tenure. Companies and their boards of directors, executive officers, and auditors, along with other market participants, should take notice of the Commission's shift in approach, including the agency's renewed focus on gatekeepers, and take proactive steps to ensure compliance with the federal securities laws.

We will continue to monitor and report on the key enforcement and regulatory developments at the SEC. In the meantime, please reach out to any author of this Advisory or your regular Arnold & Porter contact with any questions about the issues discussed herein or the state of play at the Commission.

*Samarth Gupta and Harry Rube contributed to this Advisory.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.