Kurt and Chris break down their top five securities, regulatory, and enforcement developments to expect in 2020, including blockbuster cases coming down the pike, SEC enforcement trends and more.
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[00:00:14.58] CHRIS EKIMOFF: As we spoke about on our previous episode, 2019 was a banner year for SEC enforcement and regulatory issues. Here we are, back again to talk about 2020 and what might be coming down the road.
[00:00:33.12] Hello, and welcome to inSecurities, a new podcast from PLI, the Practising Law Institute. I'm Chris Ekimoff, and I'm here as always with my co-host, Kurt Wolfe.
[00:00:42.45] KURT WOLFE: Good to be with you, Chris.
[00:00:43.83] CHRIS EKIMOFF: On each episode of the podcast, we'll get you up to speed on hot topics and trends in the securities regulatory world, offering a practitioner's perspective on the rules, regs, and cases you should be following.
[00:00:54.66] So as we discussed at the beginning, 2019, a lot of content, a lot of activity, rulemaking, enforcement trends, big cases, some accounting developments. We wanted to attempt to think about what's coming in 2020.
[00:01:08.19] KURT WOLFE: That's right. So much like we did in our last episode, thinking back over 2019, we're going to give you a breakdown of our top 5 securities regulatory and enforcement developments to expect in 2020. Those are going to include a couple of blockbuster cases we see coming down the pike, some new SEC rule makings or the implementation of some SEC rule makings, SEC enforcement trends that we expect to play out this year, some accounting developments that will take shape throughout the year, and some potential programmatic shifts over at the Securities and Exchange Commission.
[00:01:43.68] CHRIS EKIMOFF: It's due to be another great year in the SEC enforcement and regulatory space.
[00:01:47.94] KURT WOLFE: All right, Chris, sounds like we've got a good show lined up. Let's get into it.
[00:01:56.83] CHRIS EKIMOFF: So as we get into our top five that we see ahead in 2020, Kurt, why don't you tell us a little bit about one of the blockbuster cases you see coming down the road?
[00:02:04.30] KURT WOLFE: Yes, so we talked about this a little bit on the last podcast. The past few years have been unusually busy times at the Supreme Court for securities regulatory matters, or cases in which the SEC is a party to an action. We've seen the Kokesh case, the Lucia case, Digital Realty.
[00:02:23.04] On the last podcast, we talked about Lorenzo v SEC, which, as I explained, is the copy and paste fraud case. There's one that is coming down the pike in 2020, and it is Liu versus SEC. I alluded to it last time because it touches on a question that is being addressed in one of the legislative fixes we discussed. And that is whether or not the SEC can in fact seek a disgorgement remedy in enforcement matters it brings in federal district court.
[00:02:54.84] So let me back up a little bit. The SEC is absolutely by statute allowed to seek disgorgement in administrative proceedings before its own administrative law judges or ALJs. That authority is not so clear with respect to the types of remedies that it can seek in matters that it litigates in federal district court.
[00:03:18.30] It has, however, been a pattern or practice for years-- for decades, really-- that the SEC may seek disgorgement in cases that litigants in federal district court. It's sort of just been a given and it hasn't ever been challenged until last year.
[00:03:35.37] The thing that seems to have kicked off this challenge was actually a footnote in the Kokesh case. So as we explained on the last pod, Kokesh now famously limited the statute of limitations for the SEC to seek disgorgement to five years. In that case though, in a footnote, footnote 3, the court wondered whether the SEC has the authority at all to seek disgorgement in cases it litigates in federal district court.
[00:04:02.25] And the court made clear at the time that it was not taking up that issue, but they basically begged some litigant somewhere to bring it before the court, and it didn't take long for one of these cases to start winding its way through. And so we now have one that has worked its way all the way up to the Supreme Court. It's currently scheduled to be heard in March, I believe.
[00:04:26.64] And we'll just have to see what happens. I mean it could be, for example, that the court never has to hear this case because the bill that just passed the House, which would make clear that the SEC can seek disgorgement and that a 14 year statute of limitations applies, if that passes on the other side of the Hill, then the Supreme Court really doesn't need to say anything, right? So the question has been answered.
[00:04:50.55] It'll be interesting to see whether they punt while that legislation is working its way through the process. In any event, definitely a case that we should watch in 2020.
[00:05:01.11] CHRIS EKIMOFF: So a couple of things on that, Kurt. First, it sounds like the SE-- or excuse me, the Supreme Court is now using footnotes as a potential litigation roadmap. So be sure to read through all of your decisions to see if there's anything else there for you. And second, Kurt, not to be too crass, but why would I care if the SEC is coming after me in the administrative court or in the federal court? Does it make a big difference to the defendant?
[00:05:24.04] KURT WOLFE: Well, I think the Liu case, right, if that is ultimately what determines whether or not the SEC can bring disgorgement in federal district court. If that is what rules the day, and let's just say, for example, that the court says, no, there's no statutory authority for the SEC to seek it disgorgement remedy in federal district court. Which is entirely possible, right? Because we have a court right now that focuses greatly on what specifically is in a statute, what are the words of the statute, right?
[00:05:54.03] That would ultimately change the case mix, I think, for the SEC. Over the years, they have increasingly brought cases in administrative proceedings, and they have a really high win percentage in those proceedings.
[00:06:06.86] CHRIS EKIMOFF: I remember hearing criticism about that.
[00:06:09.42] KURT WOLFE: It's always the-- you always want to play on your home court as you went there all the time is the argument. Look, people come down on different sides of that issue. I don't think that the SEC has an unfair advantage or that defendants are necessarily desperately treated in ALJ hearings. But I think you'd see more cases brought in those proceedings than you currently do if you can no longer get disgorgement in court.
[00:06:35.55] CHRIS EKIMOFF: Yes. Understood.
[00:06:40.90] We're talking about a blockbuster case in 2020. Where you think it's going to happen with rulemaking, Kurt?
[00:06:45.77] KURT WOLFE: So I think rulemaking it sort of can't continue at the same pace that it did in 2019.
[00:06:52.57] CHRIS EKIMOFF: We had 40 rules brought up, 20 of which were finalizes--
[00:06:54.90] KURT WOLFE: 40 rules proposals, right, something like that. It was just a blistering pace. Sure, we'll see some new rule makings. There are some things that still need to be finalized with respect to Dodd-Frank. As we talked about on the last podcast, they just released a rule proposal relating to the definition of accredited investors. That's going to play out over the course of 2020.
[00:07:17.83] I think what's going to be most interesting over the next six months or so will be, first, what in fact happens to RegBi? Do any of the lawsuits that are seeking to set aside RegBi for one reason or another will they be successful? Will there be new lawsuits that seek to set aside RegBi on other grounds?
[00:07:38.13] There is an important legal argument that hasn't been tested yet with respect to RegBi, and that is whether or not the pre-emption applies, right? So one of the things we talked about on the last part was whether or not states, or the fact that states securities regulators and legislatures are considering implementing their own conduct standards, would those be preempted by the federal law? There isn't a lawsuit right now pending that asks that question.
[00:08:04.36] So sort of what is the future of RegBi, and then, if it goes into effect as designed, June 30, July 1, you have to be in compliance, what will be the knock on effects for firms that have the exam staff rolling through in the second week of July? Are we going to start seeing enforcement referrals or enforcement matters in the near future? I mean, I think they've been pretty careful to say, look, we're not looking to go out and catch anybody out immediately. But firms need to be getting ready for this.
[00:08:37.01] The other thing is the advertising rule, which, again, we talked a little bit about this on the last podcast. Once we get through the comment period and start moving toward a final rule, it's going to be interesting to see whether the commission takes into account, or the extent to which they take into account, some of the questions or comments that are certain to come up through the comment period. Things like, can you be more prescriptive? Will no action letters and other guidance survive such that we can rely on some of the safe harbors that exist in those materials?
[00:09:08.83] And then firms are going to have to start thinking, if they aren't already, firms are going to have to start thinking about how do we build a compliance framework around a new advertising regulatory regime.
[00:09:20.58] CHRIS EKIMOFF: Sounds like there's going to be a lot of continuing developments from 2019 to 2020, which is, obviously, an outcropping of the pace at which those rules were brought down in 2019.
[00:09:29.00] KURT WOLFE: Absolutely.
[00:09:34.40] CHRIS EKIMOFF: Similar vein but different topic, what about enforcement trends, Kurt? What do you see happening on the enforcement side of the coin?
[00:09:39.72] KURT WOLFE: So a few things I think we should expect in an enforcement. I mean, one is I think that the dogged focus on protecting retail investors will continue in 2020. I think that that will, again, involve a large percentage of cases against investment advisors, broker dealers, and other financial services, professionals, those folks that really interact most closely with retail investors.
[00:10:06.63] I think that there have always been questions, certainly in the Trump administration, about how vigorously the SEC is pursuing regulated entities and persons from an enforcement perspective. You know, contrary to what many expected, which was a precipitous drop in the number of enforcement actions, in the amount of disgorgement and penalties ordered, we've seen it sort of stay basically flat and start ticking up. You know, certainly last year was a big year in terms of the amount of disgorgement and penalties ordered.
[00:10:40.49] I'm not sure that the SEC can keep that pace. As we discussed on the last podcast, one of the things that I think really boosted their enforcement efforts was the SSD initiative, which resulted in 95 settled actions and $135 million in penalties. 12 cases in a sweep relating to pre-release ADR practices that resulted in $350 million in penalties.
[00:11:06.50] You know, just right there, if you stripped out 105 cases and $500 million in penalties, if everything else stays the same, it's going to look like a pretty average year, and I think people will be talking about how they didn't keep up the pace.
[00:11:25.25] CHRIS EKIMOFF: I want to touch on the disgorgement issue again, just to kind of play devil's advocate. Do you think that there are those cases the commission is seeking right now where the defendants may kind of read the tea leaves with what might happen down the road and say, hey, I don't want to be subject to 14 years worth of disgorgement. Right now it's only five. Can I get in the door before Congress changes its mind? Or am I being a little bit too flippant with how people would pursue their cases?
[00:11:47.93] KURT WOLFE: Yeah, I mean, it's interesting. And the answer is maybe. It's often the SEC that's trying to wrap these things up quickly because they're under increasing time pressure, or sometimes because it's like September 15 and they would really like to ink a deal before the end of they--
[00:12:03.13] CHRIS EKIMOFF: They want to put out their report, right?
[00:12:04.75] KURT WOLFE: Exactly. But yeah, there are reasons why defendants might want to wrap up a case more quickly. I think what will be critically important to that determination is whether or not we think that this piece of legislation would be retroactive, right? So if you're sort of already in the middle of a case right now, might you wake up tomorrow and go, oh, man, this statute of limitations is looking back a lot farther, you know? Which we sort of chuckle about, but that very thing happened last summer with respect to New York's Martin Act.
[00:12:38.27] CHRIS EKIMOFF: That's right.
[00:12:38.66] KURT WOLFE: By legislation, overnight, the statute of limitations got longer. And there were questions at the time about, how does this apply to my pending case? You know, some of those answers I think played out in the following months. People will have to come to a view on what they think will be the thrust of the legislation if it is ultimately passed in the Senate.
[00:13:05.48] All right. So Chris, last time we talked a little bit about some of the audit and accounting developments in 2019. You kind of teased us a little bit with the conversation around CAMs or Critical Audit Matters. And I think you're going to tell us a little bit about how that will play out in 2020.
[00:13:21.92] CHRIS EKIMOFF: I think 2020 is going to be a big year in terms of auditor responsibility. For the recent past, if not many decades, the auditor's report in which the auditor provides its opinion upon the financial statements as presented, has had a very strict formula. And that formula requires a significant amount of awareness or issue with any particular topic in order to deviate from what they call the clean opinion, or the unqualified opinion, on the financial statements.
[00:13:49.38] The CAMs discussion and the requirement of CAMs kind of muddies the waters, and that there is no longer a hard and fast rule for what would qualify as a CAM in the first situation where, if many things were the same in the second situation, it may not be listed as a CAM. Colloquially speaking, auditors that have talked about this over the past few years have said, this is what keeps quote "the audit team" up at night. It doesn't necessarily mean that there is an issue with the way the financial statements are presented, but it is a significant effort for the auditor to gain comfort around that issue.
[00:14:19.01] So you know, classic examples are developing industries and software and tech, where revenue recognition or the value of intellectual property is somewhat hard to determine. There's no market for the latest app or the newest algorithm technology. How does an auditor get his arms around that? That's something that would keep them up at night if that makes up 60%-70% of the assets on the balance sheet, obviously, that would be a material item for the financial statements and potentially something the auditor would want to disclose in the auditor's report.
[00:14:50.99] KURT WOLFE: Does that tie in at all with this concept we explored a little bit in the past about GAAP versus non GAAP accounting measures? I mean, when they're thinking about valuing the assets that potentially are an outsized proportion of a company's value, how does that play in with the CAMs discussion?
[00:15:09.18] CHRIS EKIMOFF: So I view them as two separate issues. Non GAAP metrics are usually viewed in their release to the market. An auditor's job is usually to sit in the GAAP camp for lack of a better word and say, when you say your GAAP revenue is x dollars, I need to make sure that that's accurate to a material degree.
[00:15:29.45] When you start mixing in non GAAP metrics, it's all about the presentation. If that appears within the financial statements and it's not clear that it's a non GAAP metric, you might find yourself in a little bit of a gray area there.
[00:15:40.11] The important thing is to look for for CAMs if you're a company or legal counsel to a company who's worried about CAMs, expectations management is key. Be sure that the auditors and the audit committee, and management of the business, understand the purpose of any CAMs that are potentially going to be in the auditor's report and what those impacts are. Knowing that ahead of time will make any blowback in the industry or potential impacts to a stock price well known.
[00:16:03.63] This is going to be a period of change. Whenever a new rule is enacted, especially for our first go round here with the year end being under the CAMs regime. So we're going to see a lot of movement related to that, and it's going to be developing.
[00:16:15.35] KURT WOLFE: All right, I think those are important things to bear in mind. Let's keep the alphabet soup going.
[00:16:21.26] CHRIS EKIMOFF: One of the other issues we're going to talk about today is ICFR.
[00:16:24.20] KURT WOLFE: ICFR. What does it mean, Chris?
[00:16:26.12] CHRIS EKIMOFF: Internal Controls over Financial Reporting. So it became a huge issue with the Sarbanes-Oxley act of 2002, where management was required to review and maintain a system of internal control over financial reporting. This has been a tried and true method over the past almost 20 years, in which management is reviewing and keeping track of the ways that information is brought into the business from its long long flung offices and sales points and expense issues, so that that information is protected and kept succinct and consolidated well through the business, and that's controlled appropriately.
[00:17:00.03] One of the elements that came up late last year and is starting to develop more from an accountant an auditor side is the role of cybersecurity in the ICFR or Internal Controls for Financial Reporting debate. A paper came out from the SEC in October of 2018 basically talking about how cybersecurity needs to be considered in a program of ICFR, similar to how all of that information is passing through computerized systems and may be subject to hack or attack.
[00:17:27.71] We've seen some of those things happen on the SEC's website with EDGAR filings being manipulated and things along those lines. So cybersecurity has always been a stand alone effort from the company's side, but now the commission and other regulators are asking accountants and auditors to consider that as they perform their work. So there may be some more activities, some more litigation, potentially some cases brought against accountants and auditors related to their lack of ability to respond to the evaluation of cybersecurity and internal control environment.
[00:17:57.71] KURT WOLFE: It's interesting that that is sort of spreading to now envelop the accounting firm space. Or because it's been moving in that direction with respect to financial services firms and issuers for some time. It's not fully baked, and we certainly don't see a lot of enforcement in that space. I mean, it continues to be-- all things cybersecurity I think still at some point breakdown along this line of when are you going to charge the victim of a crime.
[00:18:26.13] CHRIS EKIMOFF: If you were hacked, how much would you have forked out?
[00:18:28.31] KURT WOLFE: And I don't know that that has really been resolved as a programmatic matter. But it's interesting that the same kinds of considerations are now applicable equally to accounting or audit firms.
[00:18:42.72] CHRIS EKIMOFF: And then, finally, you know, we always kind of watch the comment letter process to understand what's coming down the road. There have been a few very large changes to the accounting guidance in the past five years. Revenue recognition, I'm sure everyone's heard of 606. 842, which is related to accounting for leases. And then there's also a new standard around Current Expected Credit Losses or CECL as we call it.
[00:19:04.48] So we're seeing a lot of comment letters from court fan related to the ways that accounting is being done for those three areas specifically. But we're also seeing common letters related to your classic issues around IP, intangible assets, some of those issues.
[00:19:19.27] So I think it's going to be more the same in 2020, not to make it sound kind of parody between the two years. But those emerging issues that have really changed the landscape in the past five or six years are going to continue to be a question point for registrants and under the commission's eye going forward.
[00:19:36.00] KURT WOLFE: Right. Something to keep an eye on.
[00:19:40.95] CHRIS EKIMOFF: Kurt, you mentioned a little bit at the top about programmatic shifts from the SEC.
[00:19:44.94] KURT WOLFE: Yeah, I think there are some things that are starting to play out that I think are going to continue to play out in 2020 and potentially beyond. I mean, I think the cryptocurrency or the digital asset space is going to be an increasingly important part of the SEC regulatory program. But also the enforcement program, thinking about what are the types of entities that act in this space over which we have some kind of regulatory authority or should have some kind of oversight.
[00:20:17.44] What are the types of products or sales that we need to develop a regulatory framework or rules around? What are the types of products or sales where we need to be thinking about enforcement action, right? It can't always be some kind of fraudulent ICO. At some point, you're going to have a digital asset that most would acknowledge is a security. We see some that some issues are starting to register as such.
[00:20:45.54] So it'll be interesting to see how the rulemaking and enforcement programs continue to evolve, and how that causes some shifts in the SEC's thinking, or maybe just a reallocation of resources and the rulemaking and enforcement space to deal with that.
[00:21:02.76] Another area is just new or different products. I mean, in some respects, you could think of digital assets like this. But I'm thinking about some new kinds of ETFs that are coming out that I think the SEC is trying to figure out, how do we want to treat these? Do we want to approve them to be sold and traded in the US capital markets?
[00:21:23.41] So again, there's going to have to be maybe not a reallocation of resources, but just thinking about new products that are entering the market. And because of the commission's ongoing focus on retail investors, so much of that conversation is going to be about if we are selling an ETF or some kind of new mutual fund to retail investors, what is the impact? What are the fees? What are the disclosures? What do investors understand from an enforcement standpoint, perhaps, some basic suitability questions? So I I'll continue to watch that space.
[00:21:58.12] And then, finally, I think ESG is just increasingly becoming a hot topic of conversation.
[00:22:05.02] CHRIS EKIMOFF: Alphabet soup for the listener, Kurt. ESG.
[00:22:07.44] KURT WOLFE: Environmental Sustainability and Governance. These are either usually funds that say they are only going to invest in certain types of issuers that they think from an ESG standpoint are socially responsible, I think, for lack of a better description. It's something that some investors are interested in, right? Maybe people don't want to invest in certain types of issuers or certain categories of products. And so this is an alternative to that.
[00:22:42.51] I think on the back end of that, an area that really needs to play out-- probably not in 2020, but in the future-- will be any disclosures, any ESG disclosures. I think figuring out what ought to be disclosed, right? In some areas, it's pretty obvious the types of things that you're going to want to disclose to the market, what's going to be material to an investor.
[00:23:05.61] In this space, maybe not so much, right? I mean, in terms of thinking about sustainability, what would be the required disclosures? I don't know that the SEC wants to or is in a place where it's going to jump into this from a rulemaking perspective, but it's something that could start happening organically. And I think we need to pay a little bit of attention to ESG disclosures and what's happening in the fund space with respect to funds that are building portfolios around some ESG criteria or metrics.
[00:23:34.77] CHRIS EKIMOFF: Do you see this relating at all to the push maybe five or six years ago related to conflict mineral disclosures? Or we had businesses having nothing to do with conflict minerals, having to put a statement in their disclosures that they don't interact or trade or have any knowledge of conflict minerals? Well away from the jewelry and mining industries.
[00:23:55.35] KURT WOLFE: Yeah. I think they're sort of cousins, and maybe they're thinking is similar. And I've heard horror stories about that, too, where someone makes a wheel that goes on certain types of planes, and they had to figure out, did any of the bolts in the wheel-- were they made of minerals that came from-- Like, what is the supply chain? And you have to do this--
[00:24:15.61] CHRIS EKIMOFF: How far do we have to go down the road to be able to say it?
[00:24:16.79] KURT WOLFE: --tortured analysis to figure out that, no, in fact, none of that stuff came from a country that we need to be concerned about.
[00:24:25.36] Part of the concern around the conflict mineral disclosure rules was that the criteria weren't necessarily clear or applicable to everyone. People were trying to figure out what they had to do. And you've got the same thing here, right? We're talking about squishy concepts. And in terms of disclosure, they're usually a little bit more clear, you know, what is the materiality threshold, what are the things that we even care about.
[00:24:52.17] CHRIS EKIMOFF: Yeah.
[00:24:52.66] KURT WOLFE: You know, if I'm worried about the environmental impact, how am I going to measure that? There are many different ways. So yeah, I think that they are related. And because the conflict mineral disclosure rules really wasn't popular with Republican commissioners, I'm not sure that we are now in a commission that's going to want to go down that road.
[00:25:12.97] CHRIS EKIMOFF: Understood. So it sounds like 2020 is going to be an exciting year, although I think Kurt and I both feel that there's not going to be any ground shaking developments early on. We're going to see a lot of the continuations in the SEC enforcement and regulatory world.
[00:25:25.72] There may be some good nuances in there, too, with some of the cases coming down, whether these potential or alleged criminals will be subject to 5 years of disgorgement or 14 years, as well as some of the cases Kurt talked about.
[00:25:37.72] KURT WOLFE: Yeah, and the good news is we're going to be here with you for all of that. I hope that you'll stay tuned through 2020. We're going to continue to bring you updates on some of the key securities, regulatory, and enforcement happenings in DC and around the country.
[00:25:52.30] We're also, from time to time, going to try to bring you some what we call evergreen episodes, where we'll do a little bit of a deeper dive to explore some core securities regulatory concepts that you should know if you're new to the space, or if you just need to brush up. So please stay tuned.
[00:26:08.90] CHRIS EKIMOFF: We're really looking forward to talking to you all this year. If you guys have other questions or things you want to be brought up throughout the year that Kurt and I can speak to, we're happy to take those suggestions. So thanks again for listening, and we look forward to a great year.
[00:26:29.65] Thanks for listening to inSecurities, a podcast from PLI, the Practising Law Institute. PLI is a nonprofit provider of authoritative professional services training and continuing education. In an increasingly complex business environment where intricate corporate structures reign, inSecurities can help you make sense of it all. A special thanks goes to the producer of inSecurities, Daniel Painitz, as well as host Chris Ekimoff and Kurt Wolfe.
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