I had wanted to attend a recent panel at Columbia Law School on securities law enforcement moderated by judge Jed Rakoff, but my lousy schedule got in the way. However, reader Adrian went and not only gave a favorable report, but called our attention to a post by one of the participants, Columbia’s professor John Coffee, who formalized his discussion at the conference into an article.
Coffee is a highly respected securities law professor as well as a frequent critic of regulators. In his post, he takes a hard look at the SEC’s claims that its performance has improved and finds them wanting. Now this conclusion is a lot like establishing that there is indeed gambling in Casablanca. However, Coffee’s analysis shows why the use of performance measures, particularly with government bodies, is a great way to lie to the public and yourself about how you are really doing. It’s also consistent with a recent VoxEU post that we flagged, that using performance metrics for government officials. And that is effectively what the SEC is doing, since it has touted figures like the one Coffee cites before Congress and in press releases. If a set of factors is important for external presentations, you can rest assured management and staff will do what they can to do well on those measures.
The real test of whether the SEC is doing well is not trend lines in various metrics, but whether it is feared on Wall Street and by investment managers. The answer is no. And that represents a considerable decline in the SEC’s standing. Stanley Sporkin, the SEC’s head of enforcement in the 1970s was feared all over Wall Street precisely because he was not afraid to go after questionable behavior, even if he might not prevail in court. Even a decade later, memories of the Sporkin era kept the securities industry on good behavior. And a reader provided some corroboration:
I was an SEC enforcement attrorney during the generally-regarded halcyon days of the Sporkin era, and I can tell you, we kicked ass and took names. I myself was involved in many cases involving some of the biggest names on Wall Street, and was instrumental in several cases that eventually resulted in the enactment of the Foreign Corrupt Practices Act. We had a trial unit back then that was quite busy actually trying, and, more often than not, winning cases. We referred many cases for criminal prosecution (including for perjury), not having prosecutorial authority ourselves.
Back then, the industry quaked in its boots when we came calling. The only partially apocryphal story about Stanley is that, during an investigation he was leading (before he became the head of enforcement), he had a group of witnesses waiting to give on-the-record testimony. When the witness he had been deposing had a heart attack during the deposition (a not-infrequent occurrence), the ambulance attendants wheeled the stricken witness out of Stan’s office on a gurney, with Stan close behind, announcing to the waiting group of witnesses, “alright, who’s next.”
Clinton and Congress were instrumental in reducing the SEC to a shadow of its former self. Clinton appointed Arthur Levitt, who was a former brokerage industry exec turned industry official, having recently headed the American Stock Exchange. Levitt was expected to be a pro-industry regulator, and was hands off as far as enforcement on the deep end of the pool, the institutional investors. But he was tougher as far as retail investors were concerned. That led to pushback from Congress led by the Senator from Hedgistan, Joe Lieberman, in the form of threat of budget cuts and inadequate resources.
Coffee stresses that the SEC’s inadequate staffing, by virtue of it being an easier target for Congresscritters who don’t like regulation than the DoJ) means it has to pick its spots. But that has turned out to be going after small potatoes retail abuses, for the most part, to justify its existence. Coffee tells us:
The SEC’s predicament is that, to justify a larger budget (which it clearly needs), the SEC must show a skeptical (and Republican) House of Representatives that it has done more. This need to improve on last year appears to have made the SEC very concerned with quantitative metrics (e.g., How many cases filed? How many settled in the fiscal year?) Much like a company approaching its IPO, the SEC has an incentive to inflate its numbers. At first glance, the SEC’s recent numbers do look much improved. In fiscal year 2012, the SEC brought 734 enforcement actions—a near record. Also in fiscal year 2012, the SEC entered into 714 settlements—up 6.6% from 2011 and the highest number since 2007.
But a closer look raises serious questions about whether these numbers have been padded. In an October, 2013 story, investigative reporters at the Wall Street Journal found that on the last day of its fiscal 2012 year, the SEC filed some 22 enforcement actions. Moreover, for the last month of that fiscal year (i.e., September 2012), the SEC initiated some 128 administrative actions—up 86% from the same month the preceding year. Many of these actions were simply “follow on” actions in which the SEC simply bars a broker or investment adviser from the industry based on a prior conviction or enforcement action.
Alone, this padding might not mean much. But there are other, more significant problems with many of the cases that the SEC brings. According to NERA Economic Consulting, from 2003 to 2010, slightly over 40% of SEC settlements included no monetary payment. In fiscal 2012, this percentage of “zero dollar” settlements fell to approximately 34% of individual settlements and roughly 24% of company settlements. Improved as that is, such bloodless settlements (particularly in the case of corporate defendants that are seldom impecunious) raise a puzzling question: Why does the SEC regularly sue defendants when it is willing to settle for nothing? Arguably, this looks like illusory enforcement.
And there has been a clear decline in quality:
Moreover, in FY 2012, NERA found that the median company settlement (in those cases where cash was paid) fell some 28% to $1 million, down from $1.4 million in FY 2011. In addition, there were 20 fewer settlements with companies in FY 2012 in comparison with FY 2011. Even the way these median values are computed seems dubious. Computing the median value by considering only those settlements in which some cash was paid (and ignoring the numerous settlements in which none was paid) is much like my computing my batting average by counting only the plate appearances in which I did not strike out. (By the way, on that basis, I look much better).
Perhaps more important than the declining number and median size of corporate settlements in FY 2012 is the fact that the number of “high value” corporate settlements has fallen way below where it was in the period from 2003 to 2005. “High value” settlements are best measured by looking to the 90th percentile of all SEC company settlements. The 90th percentile figure was $80 million in FY 2003, $50 million in FY 2004, and $72.5 million in FY 2005. Yet, by FY 2011, it had fallen to $16.4 million, while in FY 2012, it rose modestly to $18.9 million—still less than one quarter of the level in FY 2003. This fall in the size of the “high value” settlement means fewer “big” cases are being brought and likely measures the impact of resource constraints on the SEC. Unable credibly to threaten to go to trial, the SEC’s staff may have to settle at reduced amounts, as defense counsel (who usually are alumni of the agency) are well aware of the SEC’s logistical constraints.
This is consistent with the result of the SEC’s whisteblower program, which awarded $15 million last year, when it has $439 million remaining in its pool.
Coffee shreds bigger figures for SEC enforcement actions released by Morvillo, Abramowitz, Grand, Iason & Anello. He points out that most of these aren’t what the layperson considers to be enforcement. 30% were mere follow-on orders and another 21% was for late report filings. Of the balance, only a bit more than half both alleged fraud and went to Federal court.
And Coffee confirms that the SEC has a glass jaw:
….avoiding the large, highly public case may be a product of risk aversion, because with greater publicity comes a greater risk of an embarrassing failure that the post-Madoff SEC can ill afford. The SEC’s reputation was at risk in the Tourre case, and the SEC suffered a prestige-damaging defeat in the Mark Cuban insider trading case. Neither case will incline it to take the high risk in going to trial in a much publicized matter. This suggestion that the SEC has become highly risk averse is more than an intuitive speculation on my part. A July 2013 study by the Government Accountability Office (“GAO”) asked SEC staffers if they agreed or disagreed with the statement that “fear of public scandals has made the SEC overly cautious and risk averse.” 62.8% of the SEC senior officials, 57.4% of its supervisory officials, and 54.7% of its non-supervisory staff either “agreed” or strongly agreed with this statement. To the extent that the SEC is risk averse, it might be reluctant to pursue senior executives (who would predictably not settle, at least in a scienter-based case because the reputational damage could be career-ending). A risk averse SEC might still be prepared to sue large banks (who would generally prefer to settle than engage in a trial that would subject them to unfavorable publicity day after day in the national media).
Mary Jo White has said she intends to turn the SEc around, and she has both the prosecution skills and the drawing power to at least make a dent. Given the SEC’s obsession with data-driven reporting, we will able to see the results of her efforts in due course.