SEC kicks enforcement into overdrive in 2022

The Securities and Exchange Commission's enforcement division posted a record $6.4 billion in penalties and disgorgement during fiscal year 2022 — the first full year with Chairman Gary Gensler leading the agency — and legal experts say the message is clear.

"It's certainly sending a message that the amounts of money that the SEC is going to be seeking in their enforcement actions is higher," said Jay A. Dubow, Philadelphia-based partner at Troutman Pepper Hamilton Sanders LLP's who co-leads the firm's securities investigations and enforcement practice group. "They want that message out there that if you violate the securities law, you're going to have to pay more than you did in the past."

What struck Sarah Heaton Concannon most about the agency's enforcement numbers was the ratio in penalties to disgorgement.

In past years, the disgorgement number — the amount in ill-gotten gains from a wrongdoer the SEC took away — was typically higher than the amount paid in penalties, said Ms. Concannon, Washington-based partner and co-chair of the SEC enforcement defense practice at Quinn Emanuel Urquhart & Sullivan LLP and former senior trial counsel at the SEC.

In fiscal year 2021, parties charged by the SEC were ordered to disgorge $2.4 billion and pay penalties of $1.5 billion. But this year, of the $6.4 billion total, parties charged by the SEC were ordered to pay penalties of $4.2 billion and disgorge $2.2 billion.

One of the year's largest enforcement actions was the $1.2 billion in cumulative penalties paid in connection with record-keeping violations. Those firms were penalized "for widespread and longstanding failures to maintain and preserve work-related text message communications conducted on employees' personal devices," the SEC said. The SEC said the penalties "made clear that the fines were not just a cost of doing business."

Also of note, the SEC announced in May that Allianz Global Investors agreed to pay more than $1 billion in combined penalties, disgorgement and prejudgment interest to settle SEC charges that it hatched "a fraudulent scheme to conceal the downside risks of its 'Structured Alpha' complex options trading strategy, which caused billions of dollars in losses to more than 100 institutional investors."

AllianzGI and its parent, AllianzSE, also agreed to pay more than $5 billion in "restitution to victims" as part of the settlement.

Gurbir S. Grewal, director of the enforcement division, in a speech at the Securities Enforcement Forum on Nov. 15, noted that in the five fiscal years prior to 2022, the commission ordered more than twice as much in disgorgement as it did in penalties. "To me, that ratio is backwards because it means, on a macro level, that the potential reward for getting away with violating the securities laws was much greater than the potential downside of being caught," he said, according to remarks posted on the SEC's website. "If you get $2 for violating the law, but are only fined $1 if you get caught, and required to return your ill-gotten gains, some people may see that as an acceptable calculated risk."

In a separate statement, Mr. Grewal said that the enforcement division doesn't expect "to break these records and set new ones each year because we expect behaviors to change. We expect compliance."

In speaking with SEC staff over the last year, Mr. Dubow said he was told not to look at old settlement numbers for similar enforcement actions as a guide to reaching a penalty figure because the agency's philosophy has changed.

"To deter future misconduct and enhance public accountability, the SEC in a number of actions recalibrated penalties for certain violations, included prophylactic remedies, and required admissions where appropriate," the SEC said in a statement.

The enforcement division is also focusing more on cryptocurrency firms, sources said. In May, the SEC bolstered its crypto assets and cyber unit by adding 20 dedicated positions, up from 30.

And even before the recent crypto market turmoil, including the crash of cryptocurrency exchange FTX, Mr. Gensler has said multiple times that there is not enough investor protection in the crypto finance, issuance, trading or lending area and has likened the cryptocurrency market to the Wild West.

The SEC's previous enforcement record was set in fiscal year 2020 at $4.7 billion, including $3.6 billion in disgorgement and $1.1 billion in penalties.

Michael D. Birnbaum, New York-based partner at Morrison & Foerster LLP and former senior trial counsel at the SEC, said he expects the top line penalty number to decrease in fiscal year 2023 because the fact that a large number of cases were closed this year.

Enforcement actions totaled 760 in fiscal year 2022, a 9% increase over the prior year's 697 actions. The total actions included 462 new, or "stand-alone," enforcement actions, a 6.5% increase over the 434 in 2021; 129 actions against issuers who were allegedly delinquent in making required filings with the SEC; and 169 "follow-on" administrative proceedings seeking to bar or suspend individuals from certain functions in the securities markets based on criminal convictions, civil injunctions or other orders, the SEC said in its annual enforcement report.

Ms. Concannon expects the proactive enforcement regime to continue in the coming years. "I think they continue to be very aggressive in the Gensler administration in the types of cases … and their willingness to think outside the box with charges and remedies," she said.

SEC enforcement was also discussed Nov. 7 in oral arguments before the U.S. Supreme Court. The case, SEC vs. Cochran, focuses on a procedural issue involving the SEC's use of administrative law judges, or ALJs, which handle administrative enforcement cases in-house.

The plaintiff, Michelle Cochran, an accountant facing SEC administrative charges of violating federal accounting standards, originally challenged the constitutionality of the SEC's ALJ system in the Northern District of Texas in 2019. She asked the court to allow her to challenge the constitutionality of the SEC's ALJs in a U.S. District Court before the conclusion of the agency adjudication. Currently, a person or company facing charges heard before an ALJ has to go through a lengthy administrative process before bringing a case to challenge the constitutionality of the ALJs.

Gregory G. Garre, a Washington-based partner with Latham & Watkins LLP and a former U.S. solicitor general, argued on behalf of Ms. Cochran on Nov. 15 and said that the SEC's ALJs are "unconstitutionally insulated from removal by the president" in violation of the president's executive authority under the Constitution.

Based on the oral arguments, Mr. Dubow said it's likely the Supreme Court will rule against the SEC in the case. And if that were to happen, "We're anticipating we'll see more of these challenges because it's an earlier stage in the process, people haven't had to spend all this time and money going through the administrative process," Mr. Dubow added.

The ramifications of the case are big, Ms. Concannon said, because if ALJs are deemed unconstitutional, it could dismantle the SEC's administrative courts and other federal agencies that use ALJs.

"By putting the SEC through the paces of having to go before an Article III judge" — a federal judge nominated by the president and confirmed by the Senate — "and often a jury, it both makes it more difficult for the SEC in many specific cases, and more generally, it makes it more difficult to litigate cases because you need to commit more resources," Mr. Birnbaum said.