SEC Enforcement – Ethics and the New Tough Guy Approach

This is the new age of tough SEC enforcement. The Division will be omnipresent, spying every violation. Every infraction of the statutes will be prosecuted regardless of how small or large, the “broken windows” approach. Larger sanctions will be imposed to deter others – and Congress has been requested to increase penalty authority. Admissions will be demanded and made or the case will go to trial and, the theory goes, the SEC will win and get what it wants.

The tough guy approach has swagger. It generates headlines in a day when “put them in jail” is the demand from Capitol Hill to Main Street. But does it square with the statutory mission of the agency as a regulator? Does it fit with the idea that the agency has been tasked with policing violations to halt them and take remedial steps to ensure against a repetition and bring a new ethics to the market place?

Perhaps the “tough guy” mantra is about to be infused with some of the approach which has historically given the SEC one of the best enforcement programs in government. Addressing the Los Angeles County Bar Association, new SEC Commissioner and economist Michael S. Pinwowar used the Commission’s Code of Ethics, first adopted in 1958, to articulate a view of SEC enforcement that is consistent with the statutory obligations and historic mission of the agency. Remarks, SEC Commissioner Michael S. Pinwowar, Los Angeles County Bar Association Securities Regulation Seminar, Los Angeles, Calif. (Nov. 22, 2013)(here).

The Cannons of Ethics guide the mission of the agency. Specifically, they provide that the Commission is to “regulate in a manner designed ‘to insure that our private enterprise system serves the welfare of all citizens.’ The Cannons instruct the Commissioners to ‘carefully guard against any infringement of the constitutional rights, privileges, or immunities of those who are subject to regulation by th[e] Commission.’ And, importantly, the Cannons make clear that they apply to both the Commissioners and the staff alike. The core values expressed by the Cannons come into play every day at the Commission,” according to Commissioner Pinwowar.

Viewing the enforcement program as a “core part of our functions,” Commissioner Pinwowar detailed an overall approach to the work of the Division and then cited two specific examples of how the Cannons of Ethics apply. The SEC’s enforcement authority is broad, the Commissioner noted, because the agency has an obligation to protect investors, maintain fair and orderly markets, and facilitate capital formation. In exercising its broad enforcement powers the Cannons direct that the agency not “allow public outcry, agency morale, politics, or jurisdictional turf battles to become reason for pursing, or not pursuing, an enforcement action.” Rather, enforcement decisions should be guided by the facts, the law, due process and economic analysis.

These principles come into focus when a formal order of investigation is issued. Historically, those orders were issued by the Commission. While typically a staff request for a Formal Order was granted and rarely denied, the process had safeguards since it “brought forth a certain level of focus and review from not only the Division of Enforcement, but also staff in the Office of the General Counsel as well as the other divisions, such as Corporation finance, Trading and Markets, and Investment Management.”

With the delegation of the authority to issue Forman Orders first to the Division Director and later to the Associate Director level, the number of orders issued proliferated. From fiscal 2008 to 2012 the number of Forman Orders issued almost doubled, with a high of 578 in fiscal 2011. While the change was made in the name of efficiency, Commissioner Pinwowar stated “I question whether the processes currently in place are sufficient for the Commission to exercise the appropriate level of oversight of the formal order process.”

When the initial delegation was made, the Director of the Division of Enforcement indicated that in certain instances recommendations for a formal order might still be submitted to the Commission for review. However, “I am not aware of any criteria and procedures for determining when such a submission would be made. I believe a periodic review and evaluation of the formal order process using delegated authority is appropriate and necessary to effectuate Commission oversight,” the Commissioner noted. Indeed, while not required, it would be appropriate to make sure that the public is allowed to comment on the question in view of the “significant ramification for persons who are on the receiving end of a subpoena issued pursuant to a formal order . . .”

Another key area involves the question of retroactivity. In many situations where a case before the agency involves the question of applying changes in the law to conduct that previously occurred, the Commission applies the appropriate standards. On the question of collateral bars, however, “the Commission generally has taken a different approach . . .” In this area “[s]ome have contended [it] may be applied without being considered retroactive, because such a bar constitutes a prospective remedy.” The Commission adopted this approach in an opinion issued last year in a pro se case.

Yet the question here is “simply . . .an issue of fairness” the Commissioner declared. Citing the Supreme Court’s seminal decision on retroactivity in Landgraf v. USI Film Products, he noted that the High Court agrees. In the future hopefully the Commission will reconsider this question Commissioner Pinwowar declared.

The new “tough guy,” omnipresent approach, is clearly generating headlines for the Commission. Those headlines can be useful for an agency which is charged with monitoring a huge market place with very limited resources. At the same time care must be taken to ensure that the Commission remains faithful to its statutory obligations. Remembering that ethics is key as Commissioner Pinwowar notes, and that the agency is charged not with responding to the mood of the day but with brining a new ethics to the market place is critical if the SEC is to fulfill its mission.

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