Part X: SEC Enforcement Trends, 2009 — Analysis And Conclusion

The SEC is at a cross roads. While it is clear that the market crisis is going to have a significant effect on the Commission, its precise impact is yet to be determined. Key events are still unfolding. The roots of the crisis are just beginning to be explored. Legislative proposals to reshape the regulatory landscape are still be proffered, shaped and debated. A new SEC chairwoman with a new team is just getting underway.

Despite the uncertainty, it appears that the SEC will survive as an independent agency, contrary to some early proposals for regulatory reform. The blueprint offered by Treasury Secretary Geithner, while still being shaped, appears to offer a broad outline for the future. Under that proposal, the SEC will have enhanced funding and authority. More funding will mean a larger enforcement staff which will complement the likely additions to the FBI and the Department of Justice. More authority should include, at a minimum, jurisdiction over hedge funds and a directive to address key concerns such as capital requirements for regulated entities and money market funds. While it seems likely that Congress will also craft legislation to regulate derivatives, credit default swaps and other key unregulated sectors of the economy such as mortgage backed securities, it is unclear if the SEC will be given that authority. At a minimum however, it seems likely that the SEC will have at least some role in these areas. In the end, the Commission’s place as a market regulator should be enhanced.

Reform is also taking place inside the agency. New Chairwoman Mary Schapiro was sworn in on promises to rejuvenate and reform. That process has already begun. Key senior staff positions, such as general counsel, director of enforcement and director of corporation finance have all new appointees. The chairwoman is touting a new tone at the top of enforcement, focused on a streamlined and more efficient program which is still in the process of reinventing itself. The new tone will be aided streamlined internal procedures for obtaining a formal order and resolve cases involving corporate penalties. In addition, a number of key rule making projects are underway focused on issues such as short selling, corporate governance and mutual funds. More are undoubtedly under consideration and will emerge shortly.

As these and other changes unfold, the enforcement division can be expected to work hard to restore its more than tarnished image. With multiple task forces working on over fifty investigations which, in probability are expanding, plus other inquiries in traditional areas, the division should have multiple opportunities to reestablish itself. The inventory of the current market crisis related investigations should spawn a series of financial fraud, insider trading and market manipulation cases involving a wide range of entities and individuals. As those cases move forward and expand, the division can also be expected to continue its emphasis on insider trading cases, as well as FCPA actions.

With a drive to restore lost luster to enforcement’s image, there may be a tendency to be over zealous with increasing penalties — a trend which is clearly evident in FCPA cases. Enhanced coordination with DOJ and an expanded FBI is will likely to increase the trend toward the criminalization of SEC enforcement. This is particularly true since it is far easier to plead an indictment which requires little more than basic statutory language than a civil enforcement complaint which requires not just plausibility, but facts specifying the role of the primary violator and compliance with the particularity requirements of Civil Rule 9(b).

Finally, while a return of Wall Street’s top cop is good for the capital markets issuers, directors, officers, general counsels and others within the jurisdiction of the agency should be prepared. Recent SEC settlements suggest that a key to avoiding or at least mitigating liability is strong compliance procedures. Good internal accounting and disclosure controls, insider trading prohibitions and mechanisms to contain the dissemination of material non-public information can help create a defense to enforcement investigations and actions. Likewise, strong procedures and employee educational policies are essential in the FCPA area to avoid or mitigate liability. Careful internal review and preparation now can bring significant benefits down the road — and may be essential to avoiding future liability as the SEC’s authority and resources are enhanced and its enforcement program rejuvenated.

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