Keynote Speech at Southeastern Securities Conference 2019
Sept. 6, 2019
Thank you for that kind introduction, and thank you for inviting me to speak here this morning. Before I begin, I am required to give a standard disclaimer that the views I express here today are my own, and do not necessarily represent the views of the Commission or its staff. 
So, Labor Day is in now the rearview mirror and for those of us in the federal government, the end of the fiscal year is just a few weeks away. That makes this a good time to take stock, look back on the work of the Division of Enforcement over the past year, and discuss some of our priorities for the next year.
Over the next few weeks and months, we at the Commission are going to hear a lot of questions about FY 2019, and many of them will relate to the Division’s statistics. How many Enforcement actions did the Commission bring? What’s the total amount of penalties and disgorgement ordered by the Commission or federal district courts? How many individuals did the Commission charge? Are the numbers up or down over last year? Why didn’t we send anybody to jail? In all seriousness, we actually do get that question.
Joking aside, at some level I understand the desire to keep score. We work on behalf of the public, and they are entitled to know whether we are doing our jobs and how well we are doing. And quantitative metrics do have some value as a rough measure of our overall activity level. But I believe statistics are a poor proxy for the quality and effectiveness of our efforts. Indeed, in my view, judging our work primarily through the lens of statistics can not only be misleading, but also counterproductive – incentivizing the wrong sorts of behaviors.
To assess whether we in the SEC’s Division of Enforcement are effective in accomplishing the Commission’s mission, my co-Director Stephanie Avakian and I have emphasized the importance of a different, more qualitative, set of questions:
- Are our efforts protecting retail investors?
- To what extent is the Commission holding individuals accountable for violations of the law?
- Are we keeping pace with technological change?
- Do the remedies we recommend effectively further enforcement goals?
- And, are we efficiently allocating the Division’s resources?
This morning, I’d like to discuss some of what we have done this past year with an emphasis on three of these questions – how effectively are we protecting retail investors, how efficiently are we leveraging Division resources, and what are we doing to keep up with technological changes. To get down to specifics in these areas, I’m going to focus on three projects the Division has undertaken under Chairman Clayton, all of which bore significant fruit this past year. I will also speak briefly about some priorities for the coming year.
Under Chairman Clayton, the Commission and the Division have focused significant attention on retail investor protection. Retail investors are often particularly vulnerable to bad actors in the securities markets, and we’ve made protecting them a top priority.
As one component of this effort, in September 2017, the SEC announced the formation of a Retail Strategy Task Force. We established the Task Force with two primary objectives in mind: first, to develop data-driven analytic strategies for identifying practices in the securities markets that harm retail investors and generating enforcement matters in these areas; and second, to collaborate within and beyond the SEC on retail investor advocacy and outreach. Each of these objectives directly impacts the lives of Main Street investors.
Since its formation, the RSTF has undertaken a number of lead-generation initiatives that have led to swift enforcement actions built on the use of data analytics. These initiatives involve several key risks to retail investors, including: offering fraud; market manipulation; and inadequate disclosures concerning fees, expenses and conflicts of interest for managed accounts. In partnership with the Division’s Cyber Unit, the Microcap Fraud Task Force, and the Division of Corporation Finance’s Digital Asset Working Group, the RSTF has launched a lead generation and referral initiative that led to trading suspensions in the cryptocurrency and distributed ledger technology space. The Retail Strategy Task Force is also developing ways to more proactively identify and then aggressively pursue recidivists who target the most vulnerable retail investors.
These initiatives remain ongoing, and they have already helped generate enforcement actions taken in the past year. For example, we recently charged a former New York investment adviser and his daughter with conducting a nearly multi-million dollar Ponzi scheme that targeted retail investors. Enforcement used data analytics both to identify victims and to successfully locate assets in brokerage and bank accounts controlled by the defendants, which should assist the Commission in returning ill-gotten gains to victimized investors.
To achieve its investor-education mission, the RSTF collaborates closely with the Commission’s Office of Investor Education and Advocacy on investor outreach. That messaging is focused on increasing investor awareness about common investment frauds in the marketplace and red flags that everyday investors should look out for when making investment decisions.
This year, the SEC announced two new initiatives to build on its ongoing efforts to protect retail investors: The Teachers’ Initiative and the Military Service Members’ Initiative. The initiatives are focusing additional resources on educating teachers, veterans, and active duty military personnel on savings and investment, investment fees and expenses, retirement programs specific to educators and service members, and the red flags of investment fraud. The Commission recognizes that teachers, active duty military, and veterans provide a tremendous service to our country, often at great personal and financial sacrifice to themselves and their families, yet they are often targeted and fall victim to securities fraud and other misconduct. We have several ongoing investigations in this space. And when we find instances where teachers, veterans, and service members have been targeted or victimized by fraudsters, you can expect we will spare no resource in pursuing appropriate enforcement action.
I should say one more thing about our focus on retail investor protection. I reject the premise that we face a binary choice between protecting Main Street investors and policing Wall Street. To the contrary, I believe the two are complementary. Retail investors fall victim not only to smaller time Ponzi schemers and microcap fraudsters, but also to the misconduct of large financial institutions and intermediaries. Our focus on conduct in the mutual fund space – which I will turn to in a moment– is one prime example of this.
III. Resource Allocation - Share Class
As with all federal agencies, the Commission’s resources are limited, and so are the Division of Enforcement’s. Every case we pursue comes with opportunity costs in terms of cases not pursued. On an annual basis, the Commission receives some 20,000 tips, complaints, and referrals, some 4,000 of which come through our whistleblower program. So when we choose to work on one matter, we are necessarily forgoing the chance to work on another. And this situation is exacerbated by the fact that we are just now emerging from a two-and-a-half year hiring freeze that has resulted in a decline in our overall enforcement resources.
For this reason, we are constantly looking at ways to leverage our efforts. Which brings me to the second project I’d like to talk about today: The Share Class Selection Disclosure Initiative. The Share Class Initiative is a self-reporting program that seeks to protect investment advisory clients from undisclosed conflicts of interest and to return money to investors. The initiative arises from the fact that mutual funds often have different classes of shares – some of which may carry fees that are shared with the adviser or its affiliates, while other classes have no fee or provide for a waiver of the fee. The classes are for the same exact investment, except the fee reduces the investor’s return. If an investment adviser recommends a fee-paying share class when an identical no-fee class is available, the adviser may have a conflict of interest that must be disclosed. Stated differently, the adviser will typically need to tell its client that it is recommending a share class that will result in the client paying a fee in which the adviser or its affiliates share, when the same exact investment is available without the fee.
Going back to 2015, the Commission has brought cases against advisers for failing to disclose this conflict of interest. Yet the Commission’s examination staff continued to identify this non-disclosure issue in their examinations of investment advisers. Rather than continue to play a game of whack-a-mole, the Division came up with the idea for a self-reporting initiative.
As announced, settlement terms for eligible advisers that have participated in the Initiative have included, among other things, standardized statutory charges, cease-and-desist orders, disgorgement to harmed clients of ill-gotten gains with prejudgment interest, but no penalty. To prevent further violations by participating advisers, Share Class Initiative settlements also include either an acknowledgment that the adviser has voluntarily taken certain remedial steps, or an undertaking requiring that the adviser take those steps within 30 days of the SEC’s order against the adviser. By structuring the Initiative to facilitate and incentivize self-reporting, we hoped to efficiently leverage Commission resources and expertise in ways that would remedy the past misconduct and also take meaningful steps to prevent future similar violations throughout the adviser industry.
I think the results speak for themselves. This past March, barely a year after Enforcement first announced the initiative, the Commission announced the first set of settled charges, when it filed actions against 79 investment advisers. Disgorgement ordered in these cases has already returned more than $125 million to advisory clients, with a substantial majority of the funds going to retail investors.
Those firms that participated in SCSDI have not only paid tens of millions back to their harmed clients; they are also aligning their share class selection practices and disclosures going forward so that clients can make more informed choices about the fees they are willing to pay for advisory services. Fees can be a significant drag on investment returns; therefore, these improvements will make a real difference for the future returns for retail investors.
The lack of a penalty recognizes that the firms self-reported their conduct and cooperated with the Commission staff to get to a quick resolution. I think this trade off was the right decision in light of the alternative of employing our traditional investigative approaches to try to identify each of these advisers on our own. For reference, over the twelve months that preceded the filing of first orders in the SCSD, we issued separate orders against nine advisers for this type of misconduct; those nine investigations took an average of just over two years each. So, it likely would have taken years of time from many Division staff to investigate and charge the same number of advisers we have charged this year under SCSD.
In addition to the significant time and staff resources that SCSD avoided, and the related enforcement opportunity costs also averted, the SCSD’s efficient approach helped maximize the potential disgorgement ordered to be repaid to injured investors in light of the five-year statute of limitations for disgorgement under the Supreme Court’s decision Kokesh. Therefore, we believe the Initiative is a success story for many investors – we expect the settling firms to return money to their affected clients 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. The SCSD effectively leveraged the expertise of the agency in crafting an efficient approach to remedy a pervasive problem. Most of the advisory clients harmed by the disclosure practices were retail investors, and in just a year’s time, the Commission made significant headway in putting money back into their hands while improving the quality of firms’ disclosures.
The third ongoing project I want to discuss is the Division’s Cyber Unit. The success of the unit, and other significant, ongoing efforts across the Division, illustrate how we are adapting to rapid technological changes that affect our markets.
I’ve already alluded to one aspect of our response to this change: our use of data analytics to generate leads and identify risk areas. In recent years, the Division has developed a number of proprietary tools and capabilities for analyzing vast quantities of data to identify suspicious patterns. As I mentioned, these tools have helped develop and strengthen retail-focused cases such as offering frauds. In the past year, the Commission also brought significant insider trading cases that may not have been possible without our ability to analyze voluminous amounts of data, including trading data and communications metadata. The EDGAR hacking case that the Commission brought in January is a perfect example.
In that case, the Commission filed charges against nine defendants—many of them overseas—for their alleged roles in a scheme to hack into the SEC’s EDGAR system and extract nonpublic information for use in illegal trading. This case, which the Division’s Cyber and Market Abuse Units conducted in parallel with prosecutors from the U.S. Attorney’s Office for the District of New Jersey and Main Justice, required painstaking analysis of numerous events in which the defendants allegedly traded during the window between when the material nonpublic information was extracted and when it was disseminated to the public, and it showcased a number of our complex analytic tools and capabilities. Market and trading specialists, using both proprietary, in-house systems and tools from outside vendors, identified suspicious trading in advance of more than 150 announcements. Economists in our Division of Economic Research and Analysis crunched the numbers and determined that the odds the defendants would have randomly chosen to trade in front of these disparate events ranged from less than 7 in 10 million to less than 1 in 1 trillion. And our IT Forensics Lab analyzed IP addresses that accessed various communications and other systems to help flesh out the connections among seemingly unrelated participants in the alleged scheme. This is a type of case that, quite frankly, might not have been possible a few years ago due to the geographical dispersal and technological sophistication of the perpetrators.
The Cyber Unit, and the Division as a whole, have also continued to focus on cybersecurity threats to public companies. Last October, the Commission issued an investigative report on “business email compromises” in which perpetrators posed as company executives or vendors and used emails to dupe company personnel into sending large sums to bank accounts controlled by the perpetrators. That report was based on the Enforcement Division's investigations of nine public companies that fell victim to cyber fraud, losing millions of dollars in the process. As my Co-Director stated when we issued the report, “[the] report emphasizes that all public companies have obligations to maintain sufficient internal accounting controls and should consider cyber threats when fulfilling those obligations.”
We also continue to work to ensure that public companies’ disclosures about cybersecurity and customer data do not include materially misleading statements or omissions. That’s why, less than two months ago, the Commission filed fraud charges against Facebook for disseminating materially misleading statements about the risk of misuses of its customers’ data.
But technological change does not only affect the systems that public companies use to do their business and investors use to access markets; it also drives the creation of new products. I’m talking, of course, about digital assets. Since late 2017, the Division and the Cyber Unit have investigated and recommended a number of cases involving distributed-ledger technology and digital assets.
Whereas the Cyber Unit’s initial cases in this area focused primarily on fraudulent conduct involving so-called “Initial Coin Offerings” (or “ICOs”), many of the recent cases focused on non-fraud violations. For example, since last October, the Commission filed settled proceedings against a pair of celebrities who had promoted an ICO without disclosing that they were compensated for doing so. These actions taught investors the important lesson that Floyd Mayweather and DJ Khaled may not be the most trusted people to turn to for investment recommendations.
In a series of cases, the Commission charged issuers of digital assets who had failed to register their ICOs with the Commission, and, in a set of undertakings agreed to by the token issuers, provided a roadmap for them to bring the tokens they had issued into prospective compliance with the securities laws.
We believe these cases have had a significant impact, reminding investors and ICO issuers alike that if a product is a security, then those who issue it, promote it, or provide a platform for buying and selling it must comply with the federal securities laws. The Commission is not opposed to the creation and use of digital assets; but whenever new technologies are deployed in ways that violate the securities laws, we will continue to enforce those laws. There is no “innovators’ carve-out” to our law-enforcement and investor-protection mandates.
By now, you may have noticed that the three questions I started with – concerning retail investor protection, technological sophistication, and leveraging resources – often overlap. The Share Class Initiative efficiently leveraged Division resources to the benefit of numerous retail investors; in the EDGAR hacking case, we used our new technological capabilities to leverage our human resources. These questions, just like the statistical metrics I discussed at the outset, don’t tell the whole story. But I believe that the story they tell for 2019 is one of a Division that is working as hard, and as resourcefully, and as intelligently as ever, and is having a positive effect for investors.
So what’s next for the Division? Well, to some extent more of the same; the Retail Strategy Task Force and Cyber Unit remain very active, and the Share Class Initiative is ongoing. But we must also continue to cover the broad landscape involving the wide variety of cases that I haven’t even mentioned today, from accounting fraud to FCPA to valuation cases and the like. Our responsibilities are as broad as ever.
VI. Conclusion (Parallel Cases)
Before I close, I want to offer a few thanks. First, I want to thank all of you in the audience, the criminal prosecutors, state regulators, and others, who work alongside the Division. Many of our biggest and most important cases are conducted in parallel with you, and this was certainly true in FY 19. One of the best examples of our parallel work is the line of cases growing out of the Woodbridge Ponzi scheme. Starting in late 2017, and continuing through as recently as last month, the Commission has filed a series of charges against the alleged perpetrators of this scheme, including not only the mastermind behind the fraud, but also a series of broker-dealers and other essential participants. We’ve obtained meaningful relief in these cases, including a significant fair fund for harmed investors, and we could not have done so without the exemplary coordination between the SEC’s Miami Regional Office, the Miami USAO, and the IRS; in addition, regulators from at least seven states – including Florida – made valuable contributions that greatly enhanced the impact of these cases. This collaboration between federal and state civil, criminal, and regulatory agencies is a model for parallel securities investigations, and I certainly hope we see more of the same in FY 20 and beyond.
While I’m on that topic, I’d like to invite all of our colleagues in federal criminal law enforcement to a conference we are hosting on October 3 in Washington, DC, to talk about coordination and best practices in parallel cases. If you are interested, please contact Richard Best or Eric Bustillo for details.
And on that note: to our hosts, thank you for inviting me to this event; I know this is a very challenging week for many in the southeastern US, and I am grateful that you were able to join me.
Thank you for your time today.
 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the staff of the Commission.