A new direction for enforcement? What the SFC's latest numbers show

In February 2017 the SFC published its quarterly report for the period October to December 2016.

The enforcement statistics in the quarterly report provide a snapshot of enforcement activity for the nine months to 31 December 2016 and therefore overlap significantly with Tom Atkinson's tenure as Executive Director of Enforcement beginning in May 2016. The figures suggest that there has been a clear change of approach under the SFC's new head of enforcement, including:

• reducing the number of enforcement investigations commenced and focusing on the efficient deployment of enforcement resources, with the goal of targeting a smaller group of "high impact" cases;

• clearing out the existing backlog of enforcement investigations (although the increased number of investigations completed may also represent the large number of investigations commenced in 2014 having come to their natural conclusion); and

• deploying independent reviews as an enforcement tool, both as an alternative means of concluding an investigation and as part of the remedial measures required of intermediaries in enforcement outcomes.

The reported enforcement statistics

A summary of the key enforcement statistics from the quarterly report is set out below, along with our observations on the trends arising from them.

The push towards prioritising enforcement actions

In his speech at the 7th Pan Asian Regulatory Summit on 9 November 2016, Atkinson stated that the number of enforcement investigations being commenced each year had increased rapidly, citing an approximately 20 percent increase each year, and that he wanted to move from a "try-to-do-everything approach" to a more targeted mode of enforcement focused on "high impact" issues. He referred to high impact issues as being the "cases that pose the greatest threats to the interests of the investing public and the integrity of our markets", with a large part of his speech summarising enforcement activities directed at corporate fraud and corporate governance failings in listed companies.

The figures suggest that Atkinson is seeking to make good on his intended approach. The number of directions to investigate being issued under section 182 and investigations commenced in the last nine months of 2016 have both fallen by almost 19 percent against the same period in the previous year.

In recent times, particularly over the past two to three years, the SFC has appeared to take a "zero tolerance" approach to all forms of non-compliance with regulatory obligations. In a number of instances those cases could be described as relating to technical breaches that have had no adverse impact on the operation of the markets or the clients of intermediaries. Responding to a formal enforcement investigation on those types of issues is a costly and time consuming exercise, particularly when efforts could instead be focused on remediating systems and control issues. A more judicious selection of the types of issues warranting formal investigation going forward is therefore likely to be welcomed by many intermediaries.

Clearing the enforcement backlog

The figures for the number of investigations completed also suggest that the SFC is trying to "clear the books" of its current investigations. For the last nine months of 2016, 457 investigations were completed, a significant increase of almost 40 percent on the same period in 2015. The number of NPDAs and notices of decision issued were also up 40 percent and 44 percent, respectively.

It will be interesting to see whether this trend of bringing open cases to their conclusion continues over the longer term. If one goes back to the earlier enforcement statistics issued by the SFC, it is noteworthy that 2014 was a peak year for the commencement of investigations, with 431 new investigations started in the last nine months of that year - up almost 70 percent on the 254 investigation files opened in the same period of 2013. It is therefore possible that the uptick in investigations completed in 2016 is simply the result of a number of the 2014 cases coming to their natural conclusion.

The challenge for the SFC moving forward in maintaining a more focused and efficient enforcement team will be to keep the number of enforcement files opened at a reasonable number while continuing to clear the current backlog of cases. At present, only 48 percent of investigations are being completed within seven months, a slight decrease on the 52 percent closure rate achieved in the last nine months of 2015.

A changing approach to resolving investigations

The number of individuals and entities charged with criminal offences, and the total number of charges laid, have both decreased significantly in the 2016 figures, down 67 percent and 74 percent respectively. Given the relatively small numbers involved on an annual basis, these statistics will naturally be subject to fluctuation. If the SFC maintains its enforcement focus on "high impact" issues that have market or investor impact, it is not expected that these figures will decline significantly over the longer term.

It is positive to see that the SFC is continuing to adopt the use of compliance advice letters as a means of resolving investigations where issues may have been identified, but which nonetheless are not serious enough to warrant formal sanction. However, while the 2016 number appears significantly higher than that for 2015 (up 41 percent), this does not indicate that the SFC is becoming any softer in its approach. The number of investigations completed during the period was also up almost 40 percent and the increase in compliance advice letters is therefore commensurate with that figure.

In our view, the key change of approach towards resolving enforcement actions under Atkinson has been the introduction of independent reviews. These reviews occur outside the scope of the enforcement provisions of the SFO and therefore require the voluntary participation of the licensed firm. While the SFC has not made public any policies or guidelines regarding the use of independent reviewers, they are becoming increasingly frequently mentioned in notices of enforcement outcome, whether the independent reviewer was appointed as part of the overall sanction imposed or was agreed to earlier on during the investigation process. The types of cases where they are being deployed appear to involve systems and control type issues rather than intentional misconduct.

There are clear advantages to the SFC in adopting an independent review process. Their use enables the SFC to free up its own investigation teams and resources to focus on other issues and also allows industry expertise to be brought to bear which the SFC may not itself possess within its own enforcement team (e.g. for issues related to complex IT systems or electronic trading). However, as they fall outside the statutory investigation processes provided for in the SFO, it is not clear whether and to what extent the usual statutory protections that apply during investigations are applicable to an independent review process. The appointment of an independent reviewer can also be an expensive exercise for intermediaries. There is a risk that the cost of an independent review may not be proportionate for all suspected underlying regulatory breaches. Despite these issues, it appears that the use of independent reviewers will remain a feature of the enforcement landscape for some time to come.