The SEC Report Card: 2020

Patricia Foster and David Peartree
BridgeTower Media Newswires

It was nearly 12 years ago that the arrest of Bernie Madoff stunned the world, bringing to light one of the largest financial frauds in history. Prior to his arrest in December 2008, Madoff was relatively unknown outside the financial sector. But the $65 billion fraud was epic in proportion to previous financial frauds, and it continued undetected by regulators over a period of several years, resulting in massive losses to thousands of investors. Many investors lost their life savings. After his arrest, the investing public quickly came to know Madoff as the fraudster who took a wrecking ball to the savings of thousands of his victims. Madoff pleaded guilty to numerous felonies in connection with his Ponzi scheme in 2009, and is now serving a 150-year sentence in a federal prison.

Regulatory failures and remedial actions

The failure of the Securities and Exchange Commission to discover the Madoff fraud, despite numerous red flags over the years, shined a light on the agency whose mission includes the protection of investors. This failure resulted in significant reputational damage to the agency. The 477-page report issued by the SEC’s Office of Investigations on August 31, 2009 includes some striking findings:

• The SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination of Madoff and his securities brokerage firm;

• Despite the fact that three examinations and two investigations were conducted, a thorough and competent examination was never performed;

• Between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s “hedge fund” operations, and should have led to questions about whether Madoff was actually engaged in trading; and

• The SEC had been aware of two articles relating to Madoff’s investment operations that appeared in reputable publications in 2001 that questioned Madoff’s “unusually” consistent investment returns.

Shortly after the revelation of the Madoff fraud, the SEC began taking decisive and comprehensive steps to reduce the chances that such frauds would occur or be undetected in the future. The agency continues to enhance its operations. Two years ago, the SEC’s Division of Enforcement implemented a practice of issuing annual reports relating to its operations. This initiative is an especially important one because these reports provide a window into important focus areas of, and actual results achieved by, the Division during a particular fiscal year. Below is a partial snapshot of the Division’s 2020 Annual Report. The entire report can be found online on the SEC’s website at http://sec.gov.

The Division of Enforcement’s 2020 Annual Report

The 2020 Annual Report released earlier this month by the Division of Enforcement illustrates the critical role that the Division plays in protecting investors and maintaining the integrity of the trading markets. Despite the extraordinary challenges presented by COVID-19, the Enforcement Division achieved extraordinary results. During the fiscal year ended September 30, 2020, it brought 715 enforcement cases. And, while the number of cases filed was down in comparison to the previous year, the financial remedies ordered set a new high — approximately $4.68 billion.  Because statistics alone do not illustrate the effectiveness of the SEC’s enforcement program, we highlight below two specific enforcement actions that illustrate the success of the Division’s efforts during fiscal 2020.

We begin with the concept that integrity and accuracy in financial statements and issuer disclosures are critical to the effective functioning of our capital markets. Many of the cases brought by the Enforcement Division during fiscal 2020 reflect the Division’s ongoing focus on the identification and investigation of securities laws violations in the financial reporting process and other disclosure failures.

Hilton Worldwide Holdings Inc. The Enforcement Division utilized enhanced risk-based data analytics to uncover potential violations related to corporate perquisites which led to a settled enforcement action against Hilton Worldwide Holdings Inc. for failing to fully disclose perquisites and personal benefits provided to executive officers. According to the Order issued on September 30, 2020, Hilton failed to disclose approximately $1.7 million worth of travel-related perquisites and personal benefits it provided to executive officers from 2015 through 2018. The perquisites included the CEO’s personal use of Hilton’s corporate aircraft and executive officers’ hotel stays. The Order also included a finding that Hilton failed to appropriately apply the SEC’s compensation disclosure rules to its system for identifying, tracking and calculating perquisites. Hilton’s disclosure failures resulted in violations of rules relating to proxy statements (from 2015-2018) and annual reports (2016-2019). According to the Order, the SEC took into consideration Hilton’s cooperation with the investigation and its remedial actions, in imposing a civil monetary penalty of $600,000.

Wells Fargo & Co. Earlier this year, the SEC charged Wells Fargo & Co. with violations of the antifraud provisions of the federal securities laws in connection with misleading disclosures made during the period from 2012 to 2016 about the success of a business strategy purportedly employed by its Community Bank business unit when, in fact, employees of that business unit were actually implementing a very different strategy involving fraud. According to the Order issued on February 21, 2020, during the period from 2012-2016, Wells Fargo made public statements and disclosures to the effect that that its Community Bank business unit employed a sales strategy based on the specific needs of its customers. During this period, Wells Fargo published in its Quarterly and Annual Reports a Community Bank “cross-sell metric” that purported to be the ratio of the number of accounts opened and products sold per retail bank household. During investor presentations and analyst conferences, it described this strategy as a key component of its financial success. However, because it had actually implemented a business model that emphasized sales volume rather than customer needs, Wells Fargo opened millions of accounts for customers of the Community Bank that were unauthorized or fraudulent and, in many cases, were unnecessary. From 2012 to 2016, Wells Fargo failed to disclose to investors that the Community Banks’ sales strategy had caused widespread unlawful and unethical sales practices involving misconduct that was inconsistent with its disclosures and that its publicly reported cross-sell metric included significant numbers of unauthorized accounts and unnecessary products. Wells Fargo agreed to pay $500 million to settle charges, which will be returned to investors. The $500 million payment is part of a combined $3 billion settlement with the SEC and the Department of Justice.

The 2020 Report Card

Last year, the Enforcement Division created the Office of Market Intelligence (OMI) to gather all tips and complaints in one place; combine them with other public and confidential information on the persons or entities identified; and match investigative resources with those tips presenting the greatest threat of investor harm. We applaud the SEC for the considerable initiatives that it has taken in the years following the Madoff arrest, many of which extend far beyond the restructuring and revitalization of the Enforcement Division. For example, in 2009, the SEC created the Division of Economic and Risk Analysis to integrate financial economics and rigorous data analytics into its core mission. This new division is involved across the entire range of SEC activities, including policy-making, rule-making, enforcement and examination. It serves as the agency’s “think tank,” and, in this role, relies on a variety of academic disciplines, quantitative and non-quantitative approaches and knowledge of market institutions and practices to help the Commission approach complex matters in a fresh light. It also assists in the Commission’s efforts to identify, analyze and respond to risks and trends, including those associated with new financial products and strategies. Through the range and nature of its activities, the Division of Economic and Risk Analysis serves the critical function of promoting collaborative efforts throughout the agency and breaking through silos that might otherwise limit the impact of the agency’s institutional expertise. Although 2020 may not go down as anyone’s favorite year, we think that it was a good year for the SEC.

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Patricia Foster is a securities law attorney whose experience includes representation of clients in various sectors of the financial services industry, including broker-dealers, investment advisers and investment companies. This column is a collaborative work by Patricia Foster and David Peartree. David Peartree is a registered investment adviser offering fee-only investment and financial planning advice. The information in this column is provided for educational purposes and does not constitute legal or investment advice.