by T. GormanPosted on Posted in SECActions

The SEC Speaks conference has traditionally been a forum in which the agency reviewed significant recent undertakings and indicated its future direction. This year was no different. Four of the five Commissioners addressed conference participants, discussing recent significant undertakings and sketching the future direction of the SEC. This article reviews the comments of Chair Mary Jo White and Commissioner Stein. An article tomorrow will review the remarks of Commissioners Piwowar and Gallagher.

Chair Mary Jo White: Ms. White reviewed recent significant rule making initiatives by the agency before turning to a discussion of the enforcement efforts last year and future undertakings. Last year the Commission focused on three key rule making initiatives tied to the risks exposed by the financial crisis. First, the SEC reformed money market funds. New rules were promulgated regarding institutional prime money markets funds. Those funds will be required to maintain a floating net asset value, for the first time. At the same time non-government money market funds will have new tools to address runs on the fund while all money market funds will be subject to enhanced diversification, disclosure, reporting and stress testing requirements.

Second, the agency moved forward with its mandate under Title VII of Dodd-Frank regarding the swaps market. The SEC has now proposed all of the required rules. Last June it adopted the threshold rules that create the foundation for the regulatory regime for these products. Early this year the SEC adopted two sets of rules which will add transparency to these markets.

Finally, last year the Commission adopted what Chair White called a “strong, comprehensive package of reforms for the regulation and oversight of credit rating agencies, implementing over a dozen rulemaking requirements under the Dodd-Frank Act. The SEC also proposed additional rules to enhance oversight of clearing agencies and requiring companies to disclose their hedging policies.

Enforcement set records last year, bringing 755 actions and obtaining over $4.1 billion in monetary relief, accord to Ms. White. She then reviewed a series of “first of a kind” cases, summarizing the SEC’s earlier press release on enforcement. OCIE complemented these efforts by conducting over 1,850 examinations, an increase of 15% compared to the prior year.

For 2015 Ms. White highlighted three core initiatives. First, the “staff is developing recommendations to enhance the transparency of alternative trading system operations, expand investor understanding of broker routing decisions, address the regulatory status of active proprietary traders, and mitigate market stability concerns through a targeted anti-disruptive trading rule.” Those efforts will be aided by the formation of the new Market Structure Advisory Committee.

Second, the staff is developing three sets of initial recommendations to address the increasing complexity of portfolio composition and the operations of the asset management industry. Those initiatives center on improving data reporting, requiring funds to have controls in place to more effectively identify and manage risks and on planning for market stress events.

Finally, in 2015 the Commission will focus on capital formation for smaller issuers. The final two major mandates of the JOBS Act will be a key focus as well as the pilot program to widen tick sizes for the stocks of smaller companies.

Commissioner Kara Stein delivered remarks which centered on three key topics. First, the Commissioner noted that the agency should “be reimagining disclosure and [the use of] data to keep pace with the digitized and data-centric market.” Now is the time to consider a “fundamental shift in disclosure.” Commissioner Stein mentioned two potential initiatives. One would involve updating EDGAR. A second would focus on making data “available more quickly and in a format that is more usable . . .” In this regard data could be made available so that investors could “click” their way through to “deeper and more extensive information.”

Ms. Stein then turned to the question of over complexity in financial products. Once of the lessons of the great crash of 1929 was the pyramiding of leverage and complexity that ultimately played a role in the crash of the market. That lesson was reiterated in the last financial crisis when innovation created very complex financial instruments that ultimately imploded. It is imperative that everyone learn the lesson that innovation in financial products can lead to a level of over-complexity.

Finally, turning to enforcement, Commissioner Stein focused on what she called “bad actor bars,” a topic which is becoming of increasing concern. Here Ms. Stein began by stating “Let me be clear, bad actor bars, including partial bars or conditional waivers, are not intended to be used as ‘punishment.’” The critical question is whether these tools are being properly and effectively applied.

The building blocks for the application of these provisions are recidivism and deterrence. This begins with tone at the top of the organization: “The degree to which those at the top knew or should have known about a violation or a failed culture of compliance is an important factor in analyzing whether an automatic bad actor bar should occur. I have been urging the Commission to adopt and use this factor in the context of evaluating these bars. And if a firm is so sprawling and large that the top simply cannot manage it at all isn’t that a problem in and of itself . . .” Commissioner Stein noted.

The critical question in applying these provisions is not whether the reason for the automatic disqualification is “unrelated” to the waiver. Rather, “If you manipulate LIBOR, enable offshore tax evasion, or launder drug money, should we wait for you to defraud a pension fund before barring you from raising money outside of strict Commission oversight?” the Commissioner asked. The point here should be to continue developing a consistent and transparent process for the application of bad actor bars.

Tomorrow: Commissioners Piwowar and Gallagher

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by T. GormanPosted on Posted in SECActions

Waivers from the automatic disqualifications of the “bad boy” provisions which can come into play following the resolution of a Commission enforcement action is a topic of increasing concern. Consider the recent decision regarding Oppenheimer for example. There the Commission agreed to waivers based on certain conditions for a firm with a long history of violations and with what some view as a huge tone at the top problem over the dissent of two Commissioners.

Now Commissioner Gallagher is proposing a new approach to the use of these provisions. Under his approach the SEC consider the issue in conjunction with the resolution of the underlying enforcement action, not as a separate matter which is the current practice.

The bad boy provisions

The bad boy provisions generally refers to a collection of various provisions in the securities laws which are triggered by the resolution of a Commission enforcement action. Typically those provisions preclude the settling party from relying on exemptions that otherwise would be available to them. The first was created in the 1930s along with the Regulation A exemption. It contains an automatic disqualification for anyone subject to an injunction. In 1940 the Investment Company Act added Section 9(a). It contains an automatic disqualification from acting as an adviser to a registered investment company upon entry of an injunction.

In 1982 a Reg. A type provision was written into Regulation D. Rule 405, adopted in 2005, specified that issuers who have violated the anti-fraud provisions of the Federal securities laws are not eligible to be considered as well-known seasoned issuers. Similarly, Section 926 of Dodd-Frank directed the SEC to issue Rule 506(d), the provision of Regulation D, which precludes felons and other bad actors who have violated Federal and State securities laws from continuing to use the Rule 506 private placement process.

Purpose of the provisions

A critical question regarding these provisions, according to Commissioner Gallagher, is their purpose. Some may consider them backward looking sanctions for misconduct. Others may argue that they were meant to be forward looking and prophylactic. Since there is little legislative history for any of the provisions, guidance is sparse.

At the same time, a “common thread runs through the legislative and SEC records underlying each of these disqualification provisions: Congress and the SEC may be willing to allow for exemptions from otherwise applicable restrictions or burdens, but only to those persons who are unlikely to abuse that relief through fraudulent or other improper conduct. They recognize that the disqualifications were intentionally over-broad and thus necessitated an exceptive process to be employed when the facts and circumstances warranted a less heavy-handed approach . . .” according to the Commissioner.

The SEC’s historical approach followed this path. Traditionally, the staff approached disqualifications and waivers against a backdrop of reducing a repetition of wrongful conduct. Waiver requests were handled by the policy division staff on the merits pursuant to delegated authority separate and apart from the underlying enforcement action. At the same time the Commission remained free to take up any action it deemed appropriate.

Recently, according to the Commissioner, some have come to view these provisions as sanction enhancement. The SEC should resist this approach and not “conflate” disqualifications and enforcement sanctions he argues. This process is “exacerbated by the informal, non-Commission-approved, practice recently followed by the Enforcement Division of not allowing respondents to condition settlements on the granting of waivers. This makes no sense to me. If a disqualification is now a sanction, then the waivers must be part of the settlement process .. .” Commissioner Gallagher noted. This is because “I cannot fulfill my duty as a Commissioner to cast a vote in favor of a recommendation without the ability to accurately assess what punishments will be meted out . . . and whether those punishments are just given the nature of the violation . . .” the Commissioner stated.

The path forward

The “ideal” solution to the current cross-roads at which the Commission finds itself would be to return to the historical practice, according to Commissioner Gallagher. At this point, however, that does not appear possible. Accordingly, Commissioner Gallagher is calling for the SEC to amend its practice and consider the question of waivers in conjunction with the underlying enforcement action. If the Commission is unable to adopt this approach, then Congress should step in and mandate it.

Comment

The question of remedies is a critical question for the agency. Historically its equitable remedies served the purposes on which the federal securities laws are based. The injunction, equitable relief, and fashioning provisions which at once reformed a violating issuer and prevented a reoccurrence in the future were the approach of choice. Reforming corporate governance for the good of the shareholders was key.

The Remedies Act and the advent of monetary penalties changed the focus. Regardless of its intent, today large dollar penalties that generate headlines are the name of the game. More dollars, more headlines. Whether those headlines serve their preventative purpose is debatable. Nonetheless, they are a key part of the omnipresent, broken windows approach of the agency today.

Commissioner Gallagher’s comments on the use of the bad boy provisions only serves to highlight this trend. Provisions he describes as intentionally over broad and a blunt instrument are being administered as additional punishment after the settlement is done. That turns settlement into a game of roulette – maybe there is more punishment and maybe not. If fundamental fairness is to be the hallmark of an effective enforcement program, it is surely lacking from this approach.

What all of this points out, however, is not just that the approach to, and the application of, the bad boy provisions requires reconsideration, but all enforcement remedies. It is time for the agency to reconsider the purpose of its enforcement remedies as well as their application in an open and transparent way that allows for discussion and comment before any steps are taken. Initiating this process, and doing it in this manner, could do much to restore the image which has in recent years eluded the agency – that of a tough but fair enforcement authority.

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