SEC Stakes Out Tough Enforcement Agenda for 2022

In 2021, the Securities and Exchange Commission’s Division of Enforcement struggled with remote working conditions and a new chairman, bringing 3% fewer total cases compared to the prior fiscal year, including the lowest number of actions against public companies in the past seven years.

The SEC saw drops of 50% in Foreign Corrupt Practices Act cases, 22.5% in broker dealer cases, 15% in insider trading cases, 7.7% in delinquent filing cases, and 5.4% in financial reporting and audit cases compared to the previous year. In its recent annual report, the SEC put the numbers in the best light possible, touting a 7% increase in “new” or “stand-alone” actions from the prior fiscal year. (The SEC fiscal year runs from Oct. 1 to Sept. 30)

The SEC has staked out an enormous 2022 enforcement agenda addressing a wide number of issues, novel legal theories, and products, and respondents spanning the globe. As a result, look for the number of cases in the following key program areas to rebound from 2021.

Digital Assets

Given the rapid pace of innovation involving digital assets, the SEC is scrutinizing this sector with an eye towards unregistered and fraudulent offerings, unregistered exchanges, and crypto-lending platforms.

According to one study, many of these cases do not involve allegations of fraud, focusing instead on a failure to register the offer and sale of digital assets and reflecting divergent and evolving views of the SEC’s jurisdiction in this area. Of note, the SEC in 2021 brought its first enforcement action involving securities purportedly using decentralized finance (DeFi) technology and governance tokens.

Looking forward, expect the SEC to continue its focus on digital assets, pushing the boundaries of its jurisdiction and, undoubtedly, causing defendants and other regulators to push back.

Insider Trading

The overall number of insider trading cases decreased from last year, but the SEC expanded the types of cases brought regarding material, nonpublic information about public companies.

This year, the SEC pursued its first enforcement action involving selling “insider tips” on the dark web, and brought a case against an executive under a novel theory of “shadow trading.” The SEC also brought its first case ever against an alternative data provider for misrepresentations about material non-public information even though the SEC alleged nothing about actual trading.

For FY 2022, expect the number of insider trading cases and novel legal theories to increase.

SPAC Scrutiny

The popularity of special purpose acquisition company (SPAC) filings in recent years has created a lightning rod for SEC focus.

The Division of Corporation Finance (CorpFin) issued a staff statement in March identifying shell company restrictions, books and records and internal controls requirements, and initial listing standards of securities exchanges as SPAC issues to watch.

In April, CorpFin’s acting director called into question whether legal protections for IPOs applied to SPACs. Also in April, CorpFin issued a statement questioning a commonly used accounting treatment of warrants issued in connection with SPACs.

Not surprisingly, in light of these comments, the SEC proceeded to bring several enforcement actions involving SPACs this year, including an action against a SPAC for misleading claims about its merger target. 2022 will only see more such actions.

Environmental, Social, and Governance Issues

In early 2021, the SEC directed CorpFin to enhance focus on public companies’ climate-related disclosures. In addition, the SEC created the Climate & ESG Task Force to prioritize ESG-related misconduct.

The Division of Examinations issued a risk alert that pointed out existing weaknesses in ESG-related disclosures and provided guidance for investment advisers offering products and services geared towards demand for ESG-focused investments. The SEC also released a sample comment letter regarding companies’ climate-related disclosures, reaffirming greater emphasis in this area.

Look for the enforcement division to bring actions in 2022 against public companies and investment advisers for what the SEC deems inadequate or misleading disclosures and characterizations on all manner of ESG topics.

Cybersecurity

The enforcement division has focused on actions to ensure companies are taking cybersecurity risks and related disclosures seriously.

In June, the SEC took the unusual step of announcing its investigation into a widely publicized cyberattack involving compromised software. The SEC also settled charges against a company for disclosure violations related to a cybersecurity vulnerability, and against a public company for misleading investors about a 2018 cyber intrusion.

Going forward, the SEC has stated it will focus on government contractors and grantees who provide cyber services to the government, as well as companies who knowingly provide deficient cyber products, who make misrepresentations, and who engage in failures to report breaches.

Collision Course With China-Based Companies

SEC Chairman Gary Gensler noted in July particular risks to investors posed by Chinese-based companies because of their reliance on “variable interest entities” to overcome China’s restrictions on foreign investment. The Public Company Accounting Oversight Board’s (PCAOB’s) implementation of 2020’s Holding Foreign Companies Accountable Act (HFCAA) will only increase scrutiny of China-based companies listed on U.S. exchanges.

The HFCAA requires U.S.-listed companies to be audited by accounting firms subject to inspection by the PCAOB and, if they are not, to disclose certain information regarding the companies’ ownership or control by foreign governments.

Should a U.S.-listed company fail to comply with the HFCAA’s auditing requirements for three consecutive years, that company’s securities will be banned from trading through any trading method within the SEC’s jurisdiction.

Look for SEC enforcement activity focused on disclosures to ratchet up in fiscal year 2022 and FY 2023 before a potential surge in trading restrictions in FY 2024, as the first tranche of foreign companies hit three consecutive years out of compliance with the HFCAA.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Thomas A. Zaccaro is a partner at Paul Hastings LLP in Los Angeles, with a practice focused on civil, commercial, and criminal litigation. He defends corporations and executives in government investigations and criminal and regulatory proceedings. Previously, he was chief trial counsel of the SEC and an assistant U.S. attorney for the Southern District of New York.

Nick Morgan is a partner at Paul Hastings LLP in Los Angeles, where he focuses on complex securities litigation and representations involving government investigations and white-collar crime allegations against individuals and businesses. Previously, he was senior trial counsel at the SEC.

Kyle Jones and Jennifer Yu are associates at Paul Hastings LLP, where they focus on civil litigation, corporate and government investigations, and white -collar defense.