The Securities and Exchange Commission recently unveiled more details about its plan to invigorate enforcement, with the announcement of sweeping changes aimed at bringing and resolving cases more quickly.
The changes, detailed in an Aug. 5 speech by the agency’s top cop, Enforcement Division Director Robert Khuzami, include a flatter management structure, streamlined processes and procedures, and new specialized units to investigate bribery, fraud, and other types of wrongdoing.
For corporate compliance and legal departments already struggling with SEC enforcement, the message is unwanted but simple: Expect more.
Mixter
“The speech was largely directed at delivering the message that the SEC is streamlining itself and making changes directed at being able to investigate and bring cases more quickly,” says Christian Mixter, a partner in the law firm Morgan, Lewis & Bockius and a former Enforcement Division prosecutor.
The Enforcement Division does need the improved image, after heaps of criticism earlier this year over its failure to uncover Bernard Madoff’s $65 billion Ponzi scheme. The Government Accountability Office issued a scathing report in March that flagged numerous weaknesses in the Commission’s enforcement program.
One of the most significant changes is a one-year pilot program letting the director of the Enforcement Division (in this case, Khuzami) issue formal orders of investigation. Khuzami, in turn, says he plans to delegate that power to his senior officers. In most cases, that will ultimately mean SEC staff won’t need to obtain advance permission from SEC commissioners to issue subpoenas, but will simply need approval from their senior supervisor.
Landy
“The staff potentially has extraordinary power,” says Charles Landy, a partner in the law firm Pillsbury Shaw Pittman and another former SEC staff attorney. He warns issuers and management “should take these initiatives seriously.”
In a remark that seems to underscore that point, Khuzami himself noted in his Aug. 5 speech: “If defense counsel resist the voluntary production of documents or witnesses, or fail to be complete and timely in responses or engage in dilatory tactics, there will very likely be a subpoena on your desk the next morning.”
Senior staff members will also be able to approve all routine case decisions, which should further expedite investigations.
The bottom line, Mixter says, is that corporations under investigation “can expect less tolerance by the staff for taking extended time to comply with a request, because the staff will be under pressure to move the investigation along.”
Thomas Gorman, a partner at Porter Wright Morris & Arthur and former staff member in the SEC’s enforcement division, agrees that an accelerated pace is necessary, but also says the change raises a concern that the issuance of formal orders “might become routine.”
THE FOUR S’S
SEC Enforcement Director Robert Khuzami discusses four principles (aka “the four S’s”) needed to make the SEC Enforcement Division a stronger force:
First, to be as strategic as possible. This means a focus on cases involving the greatest and most immediate harm and on cases that send an outsized message of deterrence.
Second, to be as swift as possible. A sense of urgency is critical. Long gaps between conduct and atonement undermine the deterrent impact of our cases, and result in missed opportunities to achieve a permanent change in behavior and culture.
Third, to be as smart as possible. Our resources are finite and critically limited. We must better determine on an informed basis whether to continue an investigation, who to continue it against, how to shape it and how to charge it.
And last, to be as successful as possible. This means building strong cases so that defendants settle quickly on the Commission’s terms or face a trial unit armed with compelling evidence.
Source
SEC Enforcement Director Robert Khuzami’s Speech (Aug. 5, 2009).
“Rejuvenating enforcement is an important goal … while faster can be good in some sense, if it results in a lot more investigations quickly, but without thoughtful analysis, it can be detrimental,” he says.
Break It Down
Khuzami also plans to create five national, specialized units, to help SEC staff “get smart” about certain products, markets, regulatory regimes, practices, and transactions, to be more efficient in deciding where to focus investigations, and to “attack problems systemically” and on an industry-wide basis where appropriate.
A Foreign Corrupt Practices Act unit, for example, will focus on “new and proactive approaches” to identifying FCPA violations—an area where Khuzami said “more needs to be done, including being more proactive in investigations, working more closely with our foreign counterparts, and taking a more global approach” to violations.
Hunnius
By now, compliance executives should know what words like that mean. “That clearly signals that the ramp-up in FCPA prosecutions and investigations we’ve seen during the last few years is not going to abate any time soon,” says Patrick Hunnius, a partner at the law firm White & Case.
ENFORCEMENT INITIATIVES
Below is an excerpt of SEC Enforcement Director Robert Khuzami’s plans to enhance enforcement within the SEC:
A. Specialization
[W]e will be creating national specialized units dedicated to particular highly specialized and complex areas of securities law.
These specialized units will provide the structure and resources for staff to “get smart” about certain products, markets, regulatory regimes, practices and transactions. This will permit us to be better investigators, because we will be more efficient and less likely to be misled by those who use complexity to conceal their misconduct. Specialization will also permit us to be more proactive in deciding on an informed basis where to focus our investigations, as opposed to being more reactive to public information or the vast number of undifferentiated tips we receive. It will also enable us to attack problems systemically, swiftly and thoroughly and on an industry-wide basis where appropriate.
B. Streamlining Management & Internal Processes
The second initiative stemming from our self-assessment is to streamline our management structure. We will reduce the number of managers by redeploying our branch chiefs—some of whom are our best and brightest performers—to the heart-and-soul function of the SEC—conducting investigations. This flattening of our management structure will increase the resources dedicated to our investigative efforts, and will operate as a check on the extra process, duplication, unnecessary internal review and the inevitable drag on decision-making that happens in any overly-managed organization. This flattening will also encourage autonomy and accountability throughout the organization by pushing more decision-making to the front-line staff.
C. Office of Market Intelligence
A third initiative I am pleased to announce is the creation of an Office of Market Intelligence. It is this Office that will be responsible for the collection, analysis, risk-weighing, triage, referral and monitoring of the hundreds of thousands of tips, complaints and referrals that the Agency receives each year. By analyzing each tip according to our internally-developed risk criteria, as well as our priorities, and by making connections between and among tips from different sources, we will be better able to focus our resources on those tips with the greatest potential for uncovering wrongdoing. This Office of Market Intelligence will also utilize the expertise of the Agency’s other Divisions and of our Specialized Units to help analyze the tips and identify wrongdoing.
D. Fostering Cooperation By Individuals
I consider it critical that we increase our incentives to individuals to cooperate in SEC investigations. We have an enormous task—the SEC has anti-fraud jurisdiction over 30,000 issuers, advisors, broker-dealers, transfer agents and issuers, as well as anyone who commits securities fraud—and yet we have only 1,100 Enforcement staff nationwide. It is thus critical that we leverage our limited resources by incentivizing cooperation by individuals, which is often the source of some of the most credible and valuable evidence.
E. Commitment to Strategic Use of New Resources
These initiatives reflect in part our obligation to use the resources we have now in the most efficient manner possible. That is our obligation and our commitment to taxpayers. Having said that, we are also hopeful that Congress will increase our resources. We have had an approximately 11 percent reduction in force since 2005. With greater resources we can do even more.
Congress already has given us some targeted relief. We have employed those resources where they will do the most good. We have committed to more than triple the current number of fulltime paralegals and support personnel in the Division. We are determined to free up our investigators for critical front-line work and to relieve them of the burdens of routine administrative tasks. We have committed significantly greater resources to a number of ongoing technology initiatives, including revamping how tips, complaints, and referrals are handled and to improve and expand the Division’s document management, reporting and case management capabilities.
Source
SEC Enforcement Director Robert Khuzami’s Speech (Aug. 5, 2009).
The other specialized units Khuzami wants:
An asset management unit, to focus on investment advisers and companies, hedge funds, and private equity funds.
A market abuse unit to ferret out suspicious trading activity.
A “structured and new products unit” to focus on complex derivatives and financial products, including credit default swaps and securitized products.
A “municipal securities and public pensions unit,” to scrutinize offering and disclosure issues, tax and arbitrage-driven activity, unfunded or underfunded liabilities, and “pay-to-play” schemes where money managers and advisers pay kickbacks in return for the right to advise funds.
Khuzami also wants to streamline the Enforcement Division’s management structure by redeploying branch chiefs to conducting investigations. That change would free up seasoned people to lead or staff the new specialized units, Hunnius says.
Going forward, director approval will be required for “tolling agreements,” which give the SEC more time to investigate suspected misconduct than typically allowed under statutes of limitations. Khuzami said he’ll grant such agreements “as an exception, not the rule.”
That should also speed up investigations, Mixter says, since making tolling agreements harder to get will “leave the staff exposed to the pressures that statutes of limitations are intended to create.”
Ramp It Up
Khuzami also noted that his division has committed to more than triple its number of paralegals and support staff, so investigators can be free for front-line work. The division will also hire more trial lawyers, signaling its preparedness to go to trial against corporations with their usually high-powered outside counsel teams.
The SEC will also create an Office of Market Intelligence handling the myriad tips and complaints the Commission gets from the public—tips that, in the Madoff case, went unaddressed for years. New SEC Chairman Mary Schapiro has promised numerous times to handle such information more effectively.
Khuzami also detailed efforts to increase incentives for individuals to cooperate in SEC investigations, including the creation of a so-called “Seaboard” standard for individuals, named after the 2001 Seaboard Report that set forth SEC standards to evaluate cooperation by companies.
Landy says a standard of cooperation for individuals, “while on its face, sounds as though it might be helpful to certain individuals, also has the potential for increasing the ‘culture of compliance’ where the absence of cooperation will, explicitly or implicitly, be treated as an aggravating factor in making a prosecutorial judgment on that person.”
The Enforcement Division is also preparing to recommend that the SEC enter into its own version of deferred-prosecution agreements, where the agency will forego enforcement action against a company subject to certain terms, including full cooperation, waiver of statutes of limitations, and compliance undertakings.
DPAs and their close cousin, the non-prosecution agreement, have become a standard settlement tool for the Justice Department in the last several years. While the SEC can issue a Section 21(a) report without an enforcement action, it has done so only a handful of times.
Gorman
Gorman says the use of DPAs and NPAs “could be a significant change for companies, and could foster additional cooperation depending on the standards that have to be met.”
“By cooperating with the SEC, a company might get a smaller fine or lesser sanction, but there’s usually still some enforcement action brought and the Commission’s complaint lays out a view of the facts that’s not very kind to the company,” Gorman says. “An NPA would avoid the adverse publicity that comes even with a lesser sanction.”
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