This is the second in a series of articles examining future trends in securities enforcement
The SEC’s authority will almost certainly be augmented by Congress later this year as discussed in the initial segment of this series. What has received little notice is the fact that the Supreme Court may also have a significant impact on the Commission and particularly its enforcement program. The securities cases on the Court’s docket arise in suits which do not deal directly with the SEC’s enforcement program. Rather the issues involves private suits challenging investment adviser fees, the statute of limitations in damage actions, the constitutionality of the PCAOB and honest services fraud, a statute used to prosecute many executives in criminal securities fraud cases. Those cases are discussed here.
The High Court recently agreed to hear Morrison v. National Bank of Australia, another private damage action based on Exchange Act Section 10(b). This is the Second circuit’s so-called “foreign cubed” decision. The resolution of this case may impact the SEC’s Enforcement program.
In Morrison, discussed here, the Second Circuit concluded that the district court did not have jurisdiction over the securities fraud claims, essentially because the nexus to U.S. investors and markets was far too attenuated. In its brief opposing certiorari, the Solicitor General, joined by the SEC, argued that while the Second Circuit decision is correct but that the circuit court and most others have incorrectly phrased the question. The issue is not jurisdictional, but whether the conduct falls within the ambit of Section 10(b). If the issue before the Court is resolved by defining the reach of Section 10(b), the decision could have a significant impact on the Enforcement program since that Section is the typically the weapon of choice in most enforcement actions.
Regardless of the Court’s decision in Morrison or whether Congress gives the SEC new authority, the critical question for the Commission going forward is the retooling of Enforcement. Beginning with her confirmation hearings, Chairman Mary L. Schapiro promised to rejuvenate SEC enforcement. To most observers, the need for a retooling of the program was clear. Scandals such as the Madoff debacle, with the senior Commission staff invoking executive privilege before Congress when asked to explain the obvious failure to discover the fraud, and the Pequot inquiry, with its suggestions of favoritism, have taken their toll. Ms. Schapiro promised a new tone at the top which would emphasize speed, efficiency and coordination with other regulators.
The new Chairman has moved quickly to implement her promises. Processes have been streamlined and revamped. The so-called “pilot program” of former Chairman Cox was jettisoned. That program, which in the view of many had undercut the authority of the enforcement staff and slowed an already far too drawn-out settlement process, required that any case potentially involving a corporate penalty be considered by the Commission prior to settlement negotiations to assess if a penalty was appropriate and, if so, the range. This should help speed the enforcement process.
Other changes will also speed the process, although not all agree for the best. The processes for issuing a formal order of investigation and instituting a subpoena enforcement proceeding were streamlined by delegating authority to the Director of the Division of Enforcement to issue an order or institute the action. Efforts were also initiated to revamp the processes for handling tips and incoming leads for possible cases to ensure more efficient scrutiny.
To facilitate her agenda, Ms. Schapiro brought in new senior staff members. Robert Khuzami, formerly an Assistant U.S. Attorney in the Southern District of New York, was appointed Director of the Division of Enforcement. Management expertise was added to Enforcement with the creation of the new position of Managing Executive. Adam Starch, formerly of Goldman Sachs & Co., was appointed to this position, which is taxed with managing the work flow and internal management systems of the Division including supervision of the office of Market Intelligence. That office is responsible for analyzing the large number of tips received by the agency.
Following Chairman Schapiro’s themes, Mr. Khuzami has emphasized speed, efficiency and coordination with other agencies. This began with a “more boots on the ground” approach, calling for less management and more people in the field. The Director implemented this policy by eliminating a number of first level management or branch chief positions, although the number second level or Assistant Director positions is being increased. Expertise is being added to the Division by creating five groups, each headed by a Unit Chief. The groups will specialize in the areas of Asset Management, Market Abuse, Structured and New Products, FCPA and Municipal Securities and Public Pensions. The approach also encourages cooperation by individuals, possibly through incentives such as those traditionally offered to business organizations.
The focus on coordination with other agencies will be implemented through the new interagency task force established in November of last year by executive order. That task force revamps and expands the one created in 2002 to focus on the investigation and prosecution of financial crimes.
Mr. Khuzami, in year end remarks to the AICPA, ticked off accomplishments of the SEC’s revamped Enforcement Division. There, he emphasized that compared to the prior year the dollar amount of orders for disgorgement increased about 170% and for penalties by about 35%. At the same time, the number of TROs and asset freezes obtained and the number of formal orders issued, all increased significantly. NERA reported however, that the number of cases settled by the Division declined by about 8%. That result is consistent with trends in private litigation where NERA reported a drop in the number of private securities cases filed last year compared to the prior year.
At trial, the SEC had mixed results. The Commission prevailed in SEC v. Conaway, discussed here, a financial fraud case arising out of the demise of Kmart. The agency also won in SEC v. Colonial Investment Management, discussed here, a short selling case and in SEC v. Tedder, discussed here, an insider trading case. However, the Commission lost in SEC v. Anton, discussed here, because it failed to prove that an alleged tipper obtained any personal benefit. The SEC also lost after trial in SEC v. Competitive Technologies, a market manipulation case, discussed here.
While the Commission has worked hard to move past the scandals from prior years which tarnished its reputation, a new one in the form of the Bank of America case looms. There, the court rejected a proposed settlement in an enforcement action, calling the investigation a sham (discussed here). The action, based on claims that the bank lied to its shareholders when soliciting proxies for the approval of its acquisition of Merrill Lynch, is currently heading for trial.
Next: Selected significant cases of 2009.