Two Financial Cases: More Questions about the SEC’s Enforcement Program

Two settled books and records cases filed by the SEC on Tuesday raise significant questions about the Commission’s enforcement program. Both are based on years-old conduct, an issue discussed here. One raises significant questions about prosecutorial discretion and why the case was brought at all.

SEC v. Prudential Financial, Inc., Civil Action No. 08 Civ. 3916 (D.N.J. Aug. 6, 2008) is a settled books and records case based on what is alleged to be a blatant scheme to falsify revenue. Specifically, the SEC’s complaint claims that a subsidiary of Prudential entered into round-trip transactions with reinsurance giant General Re. Under the scheme, the Prudential subsidiary entered into a series of so-called finite reinsurance contracts with General Re that had no economic substance or purpose other than to build up and then draw down off-balance sheet sums as though General Re were a “bank” for Prudential. According to a chart in the complaint, for three years Prudential understated revenue as the “bank” was funded. For three subsequent years, Prudential’s revenue was overstated as the “bank” was drawn down. The scheme is a blatant fraud that had a material impact on the financial statements of the company and filings made with the Commission.

The SEC however, did not charge Prudential with fraud. Rather, the complaint alleges only books and records charges. The complaint does not allege material impact in any current period since the scheme began in 1997 and ended in 2002. It does not allege that there was any restatement, perhaps because there is no current period impact from conduct that ended six years ago. And, there seems little if any likelihood of a reoccurrence since the subsidiary involved was sold five years ago. Nevertheless, the Commission secured a books and records injunction to settle this case. The necessity for, and purpose of, this injunction, like the reason that this years-old case is being brought now, after all these years, is at best unclear

The second case raises a different question. SEC v. Hozhabri, Civil Action No. 08-CV 1359 (D.D.C. Filed Aug. 6, 2008) presents a significant question regarding prosecutorial discretion in selecting and bringing cases. Here, Defendant Ali Hozhabri, a former project manager for ABB Network Management, fraudulently submitted $468,714 in cash and check disbursements requests to his employer between 2002 and 2004. This conduct is not alleged to have had any impact on the financial statements of the company. And, the SEC did not charge Defendant Hozhabri with fraud, only books and records violations to which it obtained a consent injunction as a settlement.

The reason the SEC decided to bring this case is puzzling. As the complaint says, Mr. Hozhabri engaged in an “embezzlement scheme.” Indeed, Mr. Hozhabri previously pled guilty to conspiracy to commit wire fraud and the SEC deferred any disgorgement to that criminal case. Embezzlement and theft is the focus of this case, not a securities transaction.

To be sure, the Commission can charge the defendant here with the violations alleged. That is not the point, however. If, for example, the theft here was tied to bribery in violation of the FCPA it would be different. But it is not. At its core this is not a securities case – it is simple theft, differing little from dozens of street crimes chargeable under state or federal criminal statutes. As the Supreme Court made clear in another context earlier this year in Stoneridge Investment Partners (discussed here), the securities laws focus on protecting investors involved in securities transactions, not ordinary business deals or, as in this case, simple theft. The SEC would do well to focus its efforts on obtaining injunctions in cases where they are needed and matter to investors and the markets and to focus its investigative efforts on policing the securities markets, not street corners.