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News October 1, 2018 Issue

SEC Enforcement Co-Director: Success Should Not be Measured by Statistics Alone

Most years for the past several years, the number of enforcement actions brought by the SEC’s Division of Enforcement have generally increased year after year. The implicit message inferred by at least some observers was that the agency saw “more” as an indication of success. Now, with a new team running the agency, that may now no longer be the case.

The enforcement focus instead will be on a variety of factors, of which statistics will be just one, said agency Division of Enforcement co-director Stephanie Avakian September 20 in a speech during a conference in Dallas. “While statistics provide some information, they do not present a real, full picture of the nature or effectiveness of an enforcement program.” Avakian, like her fellow co-director Steven Peikin, is wrapping her first year at the helm of the Enforcement Division. “Steven and I fundamentally reject the premise these analyses embrace – that numbers – standing alone – can adequately measure the success or impact of an enforcement program,” she said.

“Statistics such as the number of actions the SEC brought in a fiscal year and the dollar amount of judgments and orders obtained in that year are interesting as far as they go, but they only tell us so much,” she said. “Put simply, statistics do not provide a full and meaningful picture of the quality, nature and effectiveness of the Division’s efforts.”

If that were not plain-spoken enough, Avakian was more blunt near the end of her speech: “Any assessment that suggests our effectiveness should be measured solely based on the number of cases we bring over any particular period of time is misguided.”

“The numbers for the 2018 fiscal year aren’t going to be good, and Ms. Avakian’s speech was directed at preempting criticism and finger pointing when those numbers are soon reported,” said Morgan Lewis partner and former SEC Division of Enforcement associate director Steve Korotash. “She said what has needed to be said for many years: numbers don’t tell the real story for many reasons, some of which she highlighted.”

“What she didn’t mention,” he said, “is that numbers can be manipulated. During my many years with the Commission there was always an end-of-the-fiscal-year scramble to find stats – even meaningless ones – that could be added to the pile. It struck me that we still had not learned a main lesson of the Vietnam experience: judging success on the basis of body count was foolish. Unfortunately, numbers become the metric of choice when it is difficult to perform a more thorough and reasoned analysis of performance.”

Avakian herself, in her speech, lent some credence to the idea that she was preparing the ground for the FY 2018 statistics, which are likely to be released later this month or in November. “In the coming weeks,” she said, “as has happened in past years, I expect to see many commenters analyze the SEC’s enforcement performance over the past fiscal year and draw conclusions about the effectiveness of SEC enforcement based on their slicing and dicing of the various numbers.”

“These recent comments by SEC leaders suggest a potential shifting of the Division of Enforcement priorities,” said Lewis Baach partner Jason Berland. “While it can be argued that statistics do not always provide the truest measure of effective policy, there could be a few underlying factors which led to these remarks. First, under President Donald Trump, the number of completed enforcement actions against corporations has appeared to drop significantly, as have corporate penalties. Second, a 2017 ruling by the Supreme Court, Kokesh v. Securities and Exchange Commission, shortened the SEC’s statute of limitations for bringing lawsuits against wrongdoers to five years. Third, the SEC has faced a reduction in enforcement resources, cuts which could be affecting enforcement activity.”

Moving forward

Avakian, in her speech, said that the Division is “committed to quality [emphasis Avakian]: to have as broad an impact on the landscape we police as possible; to bring cases that send messages of general and specific deterrence; and to seek and obtain remedies tailored to the conduct at issue and the message we want to send.”

She and Peikin are relying on five previously announced principles to help guide their decisionmaking as to the enforcement actions they want to investigate and possibly bring:

  1. Focus on the Main Street investor,
  2. Focus on individual accountability,
  3. Keep pace with technological change,
  4. Impose sanctions that most effectively further enforcement goals, and
  5. Constantly assess the allocation of our resources.

As examples of enforcement efforts from the past year that were guided by these considerations, she pointed out two:

  • Initial coin offerings and digital assets. “Given the potential of ICOs to fundamentally alter the process by which issuers raise money, they have a significance to our markets that far outweighs strict notional dollar amounts,” Avakian said. She noted that cryptocurrency and ICO markets have grown into a phenomenon, with ICOs having reportedly raised $16.7 billion as of the second quarter of 2018, compared to approximately $4 billion in all of 2017, and less than $100 million in 2016. “So, matters related to ICOs and crypto-assets must be a focus for the Division of Enforcement. And so far, our focus and work is paying dividends.” 
  • Share class selection disclosure initiative. Under this initiative, advisers that have failed to disclose to clients that they have invested client dollars in a higher-cost share class when a lower-cost share class of the same fund is available were able to voluntarily report their violations by June 12, 2018 and receive more lenient sanctions (under certain circumstances, paying disgorgement only, rather than disgorgement and a civil money penalty). Avakian said that the Division has found this to be a “worthwhile tradeoff. . . . We’ve received a substantial number of self-reports and we believe the initiative will ultimately be a success story for many investors – we expect to return money back to investors on a much broader scale, much more quickly, than we could have done if we had continued to pursue these investigations in the traditional way.” 

“This initiative, like the Enforcement Division’s work in the ICO space, is reflective of several of the five principles – it exemplifies our focus on Main Street investors, imposing remedies that further the Commission’s enforcement goals, and assessing how we allocate resources,” Avakian said. She described it as “an efficient and effective way to remedy a harm on investors” that “enables us to identify violations much faster than would be done through the ordinary investigative process.”

“Using the substance of the cases themselves and their import to the industry is a much smarter way to document the annual success of the Division of Enforcement,” said Mayer Brown partner Richard Rosenfeld. “The idea of basing success in a report to Congress on the number of cases brought was not optimal”

A departure

One will, of course, have to wait until the next SEC enforcement report, expected in or around this November, to see if the Division spent much of fiscal year 2018 trying to beat its FY 2017 numbers, or whether the past year will have seen a quantitative dip as the Enforcement Division instead focused on a number of qualitative measures in performing its responsibilities.

Should Avakian’s speech prove to be a new philosophy for the Enforcement Division, that will be quite a change from how the Division was perceived to be operating during the years when Mary Jo White chaired the SEC. Unlike current chairman Jay Clayton, whose background is in Wall Street-type law, White was a veteran prosecutor, having previously served as the U.S. District Attorney for the Southern District of New York.

In FY 2016, according to the SEC, the agency brought a total of 868 enforcement actions. That compares to 807 total enforcement actions in FY 2015, 755 in FY 2014, and 676 in 2013.

An exception to the steady rising in enforcement actions occurred in FY 2017, when the agency brought 754 total enforcement actions, a drop from the 868 the previous year. A major reason for the drop was that many of the Division’s standalone enforcement actions – cases where the SEC initiated the charges on its own through an administrative hearing without having been previously heard in federal court – reflected a drop in municipal actions brought in FY 2016 under a voluntary self-reporting program.

During White’s tenure, the SEC pursued minor violations vigorously, if not as vigorously as it did major violations. This was part of the agency’s well-publicized “broken windows” philosophy, which she brought down to the SEC from her experience in New York City, and which she, former New York mayor and Southern District of New York U.S. attorney Rudolph Guiliani and others pursued during their times in office. The Division’s reliance on data analytics also increased under White’s tenure.

Yet some, including then-SEC commissioner Michael Piwowar, questioned whether the use of statistics was the best measure.

“When the agency and the media make the number of enforcement actions a key measure, it is bound to create pressure on the staff to increase those numbers year after year,” he said in a 2014 speech in which he criticized the use of statistics as “flawed metrics” in measuring the success of the SEC’s enforcement efforts.

“It harks back to the adage, ‘what gets measured gets done,’” he said. “But we need to make sure that the focus is on measuring outcomes, not outputs. . . .Most Americans would be outraged if we measured the effectiveness of traffic safety efforts primarily based on the number of tickets issued by police officers and the amount of monetary fines collected. Rather, we look to a more important metric – whether the number of deaths from traffic accidents has increased or decreased.”

A better measurement for enforcement success would be how much it reduces fraud, he said.