The Securities and Exchange Commission must improve shortcomings in the operations of its enforcement division, according to a government watchdog report.
The recently released report from the Government Accountability Office found that the division’s systems for planning, tracking, and closing investigations had “significant limitations that hampered its ability to effectively manage operations and allocate resources.” While the SEC has begun addressing the problems, the GAO said more action is needed to ensure they are fully corrected. In particular, the report criticized the division for not doing enough to eliminate a backlog of open cases.
Sen. Charles Grassley, R-Iowa and ranking member of the Senate Finance Committee, ordered the GAO last year to conduct the study. In a letter to Grassley summarizing the findings, Orice Williams, the GAO’s director of financial markets and community investment, wrote that despite hefty SEC budget increases in the early 2000s, “Questions have been raised in Congress and elsewhere on the extent to which the agency is using these resources to better fulfill its mission.”
Gorman
“It’s a significant issue that has been a long-simmering problem with enforcement,” says Thomas Gorman, a former senior counsel in the enforcement division and now with the law firm Porter, Wright, Morris & Arthur.
Since lingering investigations can be a significant strain on the companies and individuals involved, companies often try to “quickly resolve cases that they might want to litigate but can’t, because having an open investigation is very detrimental,” Gorman says. For individuals, he says, “It can be even worse. It can preclude people from getting jobs.”
According to the GAO report, of nearly 3,700 open investigations at the end of 2006, two-thirds were at least two years old, and one-third were at least five years old. Nearly 500 had been dragging on for more than 10 years.
FINDINGS
Below are some of the key findings of the GAO audit of SEC enforcement efforts.
In March 2007, Enforcement said it would centrally review and approve all new investigations of potential securities law violations by individuals or companies. Under Enforcement’s previous, largely decentralized approach (senior Enforcement attorneys in the agency’s home and 11 regional offices could approve new investigations), the division was not always able to ensure the efficient allocation of resources or maintain quality control in the investigative process. While the new centralized approach was designed to help address these issues, Enforcement has not yet
established written procedures and criteria for reviewing and approving
new investigations. Without such procedures and criteria, Enforcement
may face challenges in consistently communicating the new approach to
existing and new staff. The lack of written procedures and criteria could
also limit the Commission’s ability to evaluate the implementation of the
new approach and help ensure that the division is managing its operations
and resources efficiently.
Recognizing that the division’s current information system for tracking investigations and enforcement actions—CATS—is severely limited as a management tool, Enforcement plans to start using a new system (the
Hub) by late 2007. The deficiencies of CATS include its inability to
produce detailed reports on investigations of certain types (for example,
those for hedge funds) or the status of such investigations.9 While the Hub
is designed to address many of CATS’s deficiencies—it will, for example,
be able to produce detailed management reports on ongoing
investigations—the way that the system is being implemented may not
address all existing limitations. More specifically, Enforcement has not
established written controls to help ensure that staff enter investigative
data in the Hub in a timely and consistent manner. Without such controls,
management reports generated by the Hub may have limited usefulness,
and the system’s capacity to assist Enforcement in better managing
ongoing investigations will not be fully realized.
In May 2007, Enforcement implemented procedures to help ensure the
prompt closure of investigations that are no longer being pursued and
thereby better ensure the fair treatment of individuals and companies
under review, but these procedures do not fully address the entire backlog of these investigations ... Enforcement officials said that
the failure to close such investigations promptly could have negative
consequences for individuals and companies no longer suspected of
having committed securities violations. They attributed the failure to close many investigations to several factors, such as time-consuming
administrative requirements for attorneys to prepare detailed investigation
closing memorandums that then must be routed to senior division officials
for review and approval. To address these issues, Enforcement plans to
inform individuals and companies more promptly that they are no longer
under review and expedite the review and closure of the existing backlog
of investigations for which administrative tasks have been completed (as
of March 2007, there were 464 such investigations). However,
Enforcement’s plans do not include clearing the potentially large backlog
of investigations for which such administrative tasks have not been
completed, which could be negatively impacting individuals and
companies no longer actively under review.
Source
Government Accountability Office (August 2007)
The failure to close many investigations was blamed on several factors, including a time-consuming administrative requirement for lawyers to prepare detailed investigation-closing memos that had to be approved by senior division officials.
While he was “a bit surprised” that nearly 500 investigations are more than a decade old, Russell Ryan, a former assistant director in the enforcement division and now a partner in the law firm King & Spalding, says he suspects “very, very few” of the cases “are really still active in any way.”
Ryan says he’s “very encouraged” to hear that the SEC staff is being more prompt in notifying investigative subjects when a probe is closed.
Ryan
“That has been a long-standing concern for investigative subjects and their counsel: when they think an investigation is over, but don’t dare to call the staff for fear of prompting renewed interest in the case,” he notes. “It’s a particular concern for public companies who have already disclosed that they are under investigation and would like to inform the market that the investigation is no longer a potential issue.”
Still, the GAO said, previously announced plans to improve the prompt closure of inactive investigations won’t fully resolve the large backlog. The significant number of probes that still need memoranda and other required administrative procedures “requires division management’s attention,” the report said. “Leaving such investigations open indefinitely continues to compromise management’s ability to effectively manage its ongoing portfolio of cases,” and could harm individuals and companies no longer under scrutiny.
In a letter responding to the report, Enforcement Division Director Linda Chatman Thomsen said the division has eliminated the backlog of investigations with completed but unreviewed closing packages, and has developed new procedures to prevent another backlog in the future. Further, she said the division plans to review “aged” pending investigations that aren’t actively being pursued, to determine which should be closed.
The report also criticized the SEC’s previous decentralized approach to managing the Fair Fund program, which the Commission uses to disburse monies to aggrieved investors. Only about $1.8 billion, or 21 percent, of the $8.4 billion ordered since the program’s inception in 2002 had been distributed to harmed investors as of June 2007, according to SEC data. The SEC announced plans earlier this year to centralize Fair Fund management within a new office, the Office of Distributions, Collections and Financial Management, located within the Division of Enforcement.
While the division moved to a new centralized process for reviewing and approving new investigations, the GAO noted that it hasn’t yet established needed written procedures and assessment criteria for reviewing and approving new investigations. Further, while the division’s IT system for managing investigations is being updated this year, the SEC hasn’t taken sufficient steps to help ensure that data are entered into the new system on a timely and consistent basis, the GAO said.
The report included several recommendations to strengthen management of the investigation process and the Fair Fund program. Among them:
The SEC chairman should direct enforcement and other agency offices, as appropriate, to establish written policies and assessment criteria for reviewing and approving new investigations;
Establish controls to better ensure the reliability of investigative data entered into the hub information system;
Consider developing expedited procedures for closing investigations, and establish a comprehensive plan to staff and identify the roles and responsibilities of the new Fair Fund program office and collect and analyze reports on completed Fair Fund plans.
A letter from SEC Chairman Christopher Cox responding to the report said the SEC would implement all of the recommendations.
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