Efforts to rejuvenate the Enforcement program have focused in part on speed and efficiency. In view of this emphasis, the Commission delegated to the Director of the Division of Enforcement and his senior staff the authority to issue formal orders of investigation as discussed here. That delegation eliminated any Commission consideration of the circumstances under which a formal investigation is initiated. Some may argue that Commission consideration of such requests had become perfunctory. At a minimum however, it meant that the staff had to prepare a memorandum justifying the request and the Commission or the duty officer had to review it. Thus, there was some independent barrier between those advocating that an investigation be conducted and those who might become entwined in it.

The loss of that independent barrier has the potential to compromise efforts to rejuvenate the enforcement program and restore its battered reputation. This is well illustrated by a July 12, 2010 order entered in In the Matter of Morgan Asset Management, Inc., Admin. Proc. File No. 3-13847. That order, entered at the request of Respondents who discovered the Division was supplementing its evidence by using a parallel investigation, creates a wall between Division personnel conducting the proceeding and those conducting the parallel formal investigation.

The Order for proceedings in Morgan Asset Management, issued on April 7, 2010, centers on claimed misconduct by the directors of Morgan Keegan & Company’s Funds as discussed here. It was issued after a two year investigation, A-3042. The hearing in Morgan Asset Management is scheduled to begin on September 13, 2010.

Eight days after the Order for Proceedings was issued, the Division began conducting a parallel investigation under a formal order of investigation, A-3211, authorized by the Associate Regional Director of the Atlanta Office. That order permits the Division to investigate potential misconduct by the directors of Morgan Keegan & Company’s Funds. While the Division informed the ALJ and Respondents about the new formal order approximately a month after it was issued, no notice was provided that investigative subpoenas were being issued. Respondent’s counsel discovered that fact.

Respondents filed a motion arguing that Division personnel conducting the proceeding should be precluded from participating further based largely on Rule 230(g). That rule provides in part that “The Division of Enforcement shall promptly inform the hearing officer and each party if investigatory subpoenas are issued under the same investigation file number or pursuant to the same order directing private investigation (“formal order”) under which the investigation leading to the institution of proceedings was conducted.”

The Division argued that the motion should be denied, claiming that the rule is inapplicable since the current investigation is being conducted under a different formal order. It also claimed the subject matter differed, while admitting there was some overlap.

The ALJ rejected the claims of the Division. While the current inquiry is in fact being conducted under a different formal order, in substance the two investigations focus on the same conduct. Indeed, five days after the Order for Proceedings was issued an internal e-mail was captioned “Morgan Asset—Continuing investigation after institution of proceeding.” Although the Division did not take the testimony of the directors during A-3211 as it now intends to do or obtain certain evidence it now seeks for its experts, it chose to commence this proceeding, the ALJ noted. In essence the two investigations are the same ALJ Kelly concluded: “I agree with Respondents that A-3211 is the continuation of A-3042, the investigation leading to the institution of the present proceeding. I further find that the Division’s efforts to camouflage this fact are unpersuasive. Any other reading of the two formal orders would exalt form over substance.”

To remedy this situation, the hearing officer ordered that the Division personnel involved in the proceeding not participate in the new investigation. Likewise, the Division will be precluded from using any evidence gathered in the investigation at the hearing. The Division personnel conducting the new investigation are permitted to share documents and transcripts with the persons on the hearing team, but only if those materials are made available to the Respondents at the same time.

As ALJ Kelly concluded in his order, to sustain the position adopted by the Division would “require me to turn a blind eye to the Commission’s concern that ‘[e]ven the appearance of a lack of integrity could undermine the public confidence in the administrative process upon which our authority ultimately depends,’ quoting Clarke T. Blizzard, 77 SEC Docket 1515, 14518 (Apr. 24, 2002). Indeed, the appearance of fairness and integrity is critical not just to administrative hearings, but all of the Commission’s processes. If the Commission is going to rejuvenate the Enforcement Division and craft an effective program the bedrock on which it is built must be fairness and integrity. The risks from abolishing the barrier between the investigators and the investigated by delegating the authority to issue a formal orders can undercut that bedrock as this case well illustrates.