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SEC advisor enforcement on the rise amid limited resources

Nearly a quarter of the standalone enforcement cases that SEC attorneys brought in fiscal 2018 were against advisors, marking a dramatic uptick from the previous year. And that figure might be even higher were the Division of Enforcement not grappling with an array of challenges, including a hiring freeze and a pair of setbacks at the hands of the U.S. Supreme Court.

The actions against advisors and fund companies accounted for 22% of the 490 standalone cases brought -- excluding what the commission calls follow-on administrative cases and actions brought to deregister public companies that are delinquent in their filings. Cases brought against broker-dealers accounted for 13% of standalone cases the commission brought in 2018.

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Joe Ratterman of Bats Global Markets Inc., Nasdaq OMX Group Inc arrive for a meeting at the Securities and Exchange Commission in Washington, D.C., U.S., on Monday, May 10, 2010. The chief executive officers of the biggest U.S. stock markets were called to a meeting at the U.S.Securities and Exchange to discuss last week’s selloff in equities, according to four people familiar with the situation. Photographer: Joshua Roberts/Bloomberg

The 108 cases brought against IAs and ICs in 2018 represented nearly a 31% increase over 2017, when the commission brought 82 cases against those registrants. All told, the SEC brought 821 enforcement actions last year, up from 754 in 2017.

The commission secured disgorgement payouts of $2.5 billion last year, and also levied $1.4 billion in penalties. The SEC reports that it returned $794 million to harmed investors last year.

In its annual enforcement report released on Friday, the commission touted its efforts to protect retail investors, "market participants who need and deserve the attention of the commission," enforcement co-directors Stephanie Avakian and Steven Peikin write.

Avakian and Peikin downplay the importance of those raw numbers, however, and argue for a more nuanced assessment of their division's performance that considers whether enforcement activity is deterring registrants from future harm, protecting investors and stamping out fraud.

"As we have often emphasized, quantitative metrics … cannot adequately measure the effectiveness of an enforcement program," they write.

But enforcement authorities acknowledge that several factors within and outside the commission are hampering their efforts. Since late 2016, the SEC has been on an agency-wide hiring freeze, making it difficult to replace departing staffers. Meanwhile, a tight budget has limited the extent to which the Division of Enforcement can contract for outside legal support.

Efforts to pay restitution to the victims of financial crimes also hit a setback last year when the Supreme Court held that the SEC can only force disgorgement for five years of illegal conduct. Setting that statute of limitations on payments means that many victims of long-running financial frauds will never get their money back -- the enforcement division estimates that the ruling in the Kokesh vs. SEC could put as much as $900 million in disgorgement payouts beyond its reach.

In a separate case, the high court invalidated the enforcement division's use of administrative judges, setting in motion a process or reopening old cases that "has required the division to divert substantial trial and other resources to older matters, many of which had been substantially resolved prior to the decision," Avakian and Peikin say.

Those cases will be competing with "a pipeline of hundreds of retail-focused investigations that were ongoing at the close of the fiscal year" that have come from the commission's concerted focus on Main Street investors, the enforcement division reports.

Since Jay Clayton began his tenure as chairman of the SEC, he has consistently championed a focus on the everyday, retail investors he has dubbed "Mr. and Mrs. 401(k)."

Advisors have been a major focus of two enforcement initiatives launched over the past year. Through the Retail Strategy Task Force, staff from other areas of the commission worked with enforcement to use more advanced data analysis to identify bad actors in the market who failed to make adequate disclosures about fees or conflicts of interest, market manipulations and other improper conduct.

And in the Share Class Selection Disclosure Initiative, also launched in fiscal 2018, the Division of Enforcement called on advisors to come forward and admit when they had sold clients high-cost shares of a fund when a cheaper share class was available that would have suited the investor's needs. In exchange for making that admission and returning the excess fees to their clients, advisors could receive standardized settlement terms that include a censure on their record, but would not impose additional monetary penalties or other disciplinary action. Without disclosing actual numbers, the commission reports that interest in the program was high.

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