After all the PubCo posts on the avalanche of SEC enforcement cases muscled into the last couple of days before the SEC’s fiscal year end, I thought this column in Bloomberg from Matt Levine might be of particular interest. The relevant portion of the column, called the “SEC silly season,” discusses the apparent scramble by the SEC at the end of its fiscal year to bring as many enforcement actions as possible in response to “performance-reporting pressures,” that is, the pressures to make its stats to achieve optimal Congressional funding. According to academic research cited in the column, that scramble is not just “apparent,” it’s real, and it has practical implications for enforcement behavior. The research showed that the average number of cases filed in September “is almost double the average in other months,” and that the “spike is larger when case totals are behind pace to meet last year’s case total, which likely serves as a de facto performance benchmark.” The SEC achieves this fiscal-year-end increase, according to the research, “by changing its enforcement behavior related to substantive cases,” that is, through prioritization of less complex cases and imposition of more lenient penalties, including financial discounts, relative to other periods. For example, the September cases are “significantly more likely to reference defendant cooperation and to only name companies as defendants, and are less likely to include a fraud allegation and to reference parallel criminal proceedings.” Accordingly, the authors found that the “evidence is consistent with the SEC agreeing to more lenient settlement terms to increase case volume at fiscal year-end—an unintended consequence of performance reporting that undermines the SEC’s core values.” As the authors of the research suggest, might defendants familiar with this “regulatory inconsistency” be able to use it to their advantage?
In his column, Matt Levine writes that he “made some dumb jokes yesterday” about tendency of the SEC to bring more enforcement actions just before the end of its fiscal year on September 30 “to pad its numbers for the year. I compared this to ‘earnings management’ and ‘window dressing’ for public companies, which are frowned upon, by the SEC, when companies do them.” He then refers to an academic paper by Dain C. Donelson, Matthew Kubic and Sara Toynbee, “The SEC’s September Spike: Regulatory Inconsistency within the Fiscal Year,” quoting and commenting:
“‘We examine whether performance reporting leads to inconsistent enforcement at the Securities and Exchange Commission (SEC). In a sample of over 13,000 SEC enforcement actions, we show that SEC staff respond to performance-reporting pressures and file more enforcement actions in September, the final month of the SEC’s fiscal year, than in any other month. The increase in case volume in September is not fully explained by staff filing more procedural cases or accelerating case filings. Instead, SEC staff pursue less complex cases and agree to more lenient financial and non-financial sanctions to increase case volume in September. We attempt to rule out alternative explanations for our results, including natural SEC workflow and resource constraints. Overall, our findings suggest that performance reporting creates agency conflicts that lead to regulatory inconsistency within the fiscal year.’
The idea is that the SEC’s performance is measured, and its budget set, based on the number of cases filed in the previous fiscal year:
‘The SEC receives its funding from Congress and must submit a budget justification report as part of the appropriations process (see, e.g., SEC, 2020b). Consistent with the Government Performance and Results Act of 1993’s objective of ensuring regulatory effectiveness, the budget justification report outlines the SEC’s proposed allocations of requested funds, actual outlays from the prior year, and a summary of performance for the most recent fiscal year. The most prominent performance metric in both the SEC’s annual reports and the budget justification reports is the number of cases filed (see SEC, 2018, 2019, 2020a). The number of case filings also receives attention in congressional testimony and from the press.’
And so the SEC has incentives to maximize that number, and to cram cases into the end of the fiscal year. One way to cram in cases is by settling. Defendants know this, though, and they can use it to their advantage: They can drag their feet on cases early in the year, and then drive a hard bargain in September because they know the SEC is desperate to settle.
‘We find that defendants receive lower financial sanctions—both disgorgement and civil penalties—when they settle in September. On average, our results suggest the SEC discounts financial sanctions for cases filed as settled charges in September by approximately $132,000—an economically meaningful discount, given that the average financial sanction is $270,000. We also find an 11% lower likelihood of a large financial sanction in September.
Our evidence suggests that SEC staff compromise in settlement negotiations in order to file cases before the fiscal year-end. This predictable leniency has important practical implications. The revolving door between SEC enforcement and industry likely increases defendants’ awareness of the pressure on the SEC at the fiscal year-end (deHaan et al. 2015), and such awareness may incentivize them to delay settlement negotiations to obtain more favorable outcomes.’”