United States: SEC enforcement and COVID-19 - How Lessons from the financial crisis apply today

In brief

Based on public statements, including a recent speech discussing the operation of the Division of Enforcement’s COVID-19 Steering Committee (Enforcement speech), it is clear that the SEC Enforcement Staff (the Staff) is already thinking ahead to the types of enforcement investigations and actions that may follow the COVID-19 Crisis. In doing so, the Staff likely will draw on its experience following the 2008 global financial crisis (2008 Crisis) to identify potential patterns of misconduct that occur during periods of extraordinary market volatility and financial stress. Below we discuss the various areas that the SEC Enforcement Division is currently focused on, as well as our analysis of the enforcement actions arising out of the 2008 Crisis, with a particular focus on the asset management industry.


Contents

As discussed below, a key lesson from the 2008 Crisis is that public companies and asset managers, even in the midst of tackling the immediate problems of a crisis, should develop the situational awareness to identify conduct or deficiencies that may be subject to hindsight scrutiny by the SEC. And when issues are identified, firms should take reasonable steps to document their processes and analyses, augment or amend their policies and/or disclosures and make necessary adjustments to their business and plans to protect clients and/or investors, so when the SEC comes knocking after this crisis, they can demonstrate their good faith judgment and efforts.

Enforcement actions arising from the 2008 Crisis may inform COVID-19 cases

When we reviewed prior enforcement actions from the 2008 Crisis, we found they generally shared one or more of the following themes:

  • Failure to adequately disclose “bad news” in the face of red flags, including a variety of valuation and liquidity issues
  • Crisis, as a form of real life stress test, with the result that certain products or investments are exposed as riskier than represented (either at sale or in subsequent reporting or disclosures) or certain financial operations or controls are proven to be deficient
  • Actual “bad acts” taken in response to the crisis, such as insider trading, market abuse, risky trading strategies, and mismanagement of redemption requests

With these themes in mind, we expect that SEC enforcement investigations coming out of the COVID-19 Crisis will cover: (i) public companies with operations or finances impaired by the crisis; (ii) investment vehicles with underlying assets affected by the current crisis; and (iii) investment advisers and broker-dealers with business operations impacted by this crisis, or whose sales practices will be reviewed with the benefit of hindsight in the wake of market impacts from the crisis. These categories are not mutually exclusive, and some of the enforcement risks discussed below may apply to varying degrees for all market participants.

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*Originally published on Investment Adviser Association1

 


1 https://www.investmentadviser.org/iaatoday/compliance-corner/compliance-corner-may-27-2020

 


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