The Friday List: The 10 Consequences of Noncompliance and SEC Enforcement

 

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.  Today, we address the 10 implications for a firm that faces an enforcement action as a result of a failure to implement a competent compliance program (either intentionally or unintentionally).

 

Consequences of Noncompliance and SEC Enforcement

 

1. Financial penalties: The most obvious direct consequence of an enforcement action include the financial penalties that the SEC can impose.  These can include fines, interest, and restitution for “ill-gotten gains” going back several years.
2. Industry bars: Rarely does an SEC action not name one or more of the firm’s principals.  And, if successful, the penalties usually include fixed or permanent industry bars, thereby precluding you from making a living in your chosen field.  If the permanent bar includes a firm principal, it could mean the end of the firm itself.
3. Lost management time: Responding to, and defending, SEC enforcement actions consumes hundreds of hours of management time dealing with lawyers, assembling materials, meeting with employees, and testifying.  This is time lost to the productive activities required to run your business.
4. Defense Costs:  The costs of lawyers retained at high hourly rates to defend enforcement actions very often far exceed any fines or disgorgement that the SEC imposes.
5. Reputation – competitive (dis)advantage:  Don’t think your competitors won’t highlight a public enforcement action during every RFP and competitive client situation.   Additionally, many institutional investors automatically disqualify money managers with a regulatory record.
6. Impact on commercial value: A potential buyer will discount a firm’s equity value because of public regulatory issues that could impact its long-term competitiveness.
7. Criminal prosecution:  The SEC has the power to refer cases to the Department of Justice.  As a result of such referrals, especially when fraud or misuse of asset is alleged, the DoJ has prosecuted and imprisoned many financial executives.
8. Increased examination focus: Once the SEC has brought an action, expect the staff to appear for regulatory exams on an accelerated, if not continuous, cycle.  It’s the SEC’s job to weed out recidivists.
9. Insurance Costs:  Following an enforcement action, E&O and D&O rates will rise significantly, assuming you can even obtain such coverage.
10. Hiring: In the war for talent, a bad reputation will repel the best and brightest who have multiple opportunities.