By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as scribbles occasional travel pieces for The National.
Outgoing Securities and Exchange Commission (SEC) chair Mary Jo White last week touted A New Model for SEC Enforcement: Producing Bold and Unrelenting Results. Does this claim stand up?
Reflecting on her SEC tenure, White says:
We have brought many innovative and first-of-their-kind cases across the spectrum of the securities laws to protect investors, deter misconduct, cover the landscape of the marketplace, shape industry norms and practices, and send a strong message that the SEC is—and always must be—the tough cop on the financial beat. (Jerri-Lynn here: Note that I have removed all citations from my quotations from White’s speech. I refer interested readers to the full text of that speech, cited above.)
These accomplishments have been made possible by a new model for SEC enforcement. Indeed, we have essentially changed the way we do business in enforcement—from the way we identify misconduct, to our investigative processes and tougher settlement approaches, to the types of cases we bring, to our continued focus on individuals in every case, and to our trial work. These changes in the landscape of SEC enforcement have resulted in our renewed identity in the markets as an aggressive, nimble—and importantly— fair regulator. “Tough, but fair,” a label that has sometimes been applied to me, is what we strive for at the SEC, even as we have become bolder and more effective with our new approaches.
To give you a sense of how we at the SEC have changed the way we enforce the federal securities laws, I am going to first discuss Enforcement’s emphasis on the need to be trial-ready, reflective of our new “investigate to litigate” philosophy.
Jerri-Lynn here: Is that all? Isn’t the entire point of an SEC investigation to pursue litigation, if SEC investigators find federal securities laws have been violated? What has changed here? What, pray tell, was the SEC doing before it decided to “investigate to litigate”?
White further elaborated:
One important change in the way the SEC conducts enforcement that has allowed us to become bolder and more unrelenting is our emphasis on “investigating to litigate,” which, simply put, means that we have asked the staff to conduct all investigations with litigation in mind. During our investigations, we have enhanced our focus on acquiring admissible—and persuasive—evidence of the underlying elements that we will have to prove at trial, so that whenever possible, we produce a trial-ready record that can be used to prevail at trial or to secure a strong settlement. We also have enhanced our trial capacity, increasing our hiring of attorneys who have significant trial experience, often as criminal prosecutors.
Far from being merely amusing, the next point White discussed in her speech appeared to me to be downright problematic:
Using reverse proffers at key points in our investigations is one way enforcement leverages the “investigate to litigate” approach. When appropriate, we share with defense counsel significant documents and expected testimony, as well as any analyses we have done. We often do reverse proffers at an advanced stage of an investigation in order to attempt to bring the investigation swiftly to a close on strong settlement terms. But we also sometimes do them much earlier in order to demonstrate the benefits of cooperating with our ongoing investigation. This sort of blunt and bold transparency—a familiar tool for many prosecutors—drives home to parties in our crosshairs that we are ready, willing, and able to litigate the case— and win.
Litigation, after all, is an adversarial process, and I initially questioned the wisdom of the SEC sharing its case so completely with the other side. But one of my litigation contacts points out that from a tactical perspective, this SEC position isn’t necessarily ridiculous on its face. In the case of any SEC or DoJ investigation, a company’s interest may be at odds with those of various employees, managers, or members of the C-suite. In such an instance, sharing information with the company, for example, might help put pressure on them to settle.
Batting 1000%: Why Having a Perfect Winning Record at Trial May Suggest the SEC May Not Be Doing Its Job
Jerri-Lynn here: The SEC and the (Department of Justice) DoJ, for that matter, consistently pursue litigation strategies that emphasize not losing cases at trial. Some have suggested that not losing is necessary for the enforcement activities of these agencies to have the maximum deterrent effect. This cautious mindset has led Peet Bharara, the current US attorney for the southern district of New York, to focus– unduly, to my mind– on insider trading cases, rather than cases that may be more difficult to win but may have far more systemic significance. I have considered these issues at greater length in my past post entitled, The SEC Fiddles While the System Burns: Insider Trading Enforcement As Securities Law Theater, so I will not revisit the arguments I made there here.
White is certainly proud of the agency’s enforcement record:
Obviously, the true test of an investigate-to-litigate philosophy is how a case stands up in court. Enforcement programs cannot be strong unless we have the ability to prove it in court. While the SEC historically has had a strong trial record, we have enhanced that record over the last few years. Indeed, we have not lost a jury trial in federal district court in two and a half years, and the wins have been significant, including our victories in a case against two Texas billionaires accused of violating the laws governing ownership and trading of securities by corporate insiders, an insider trading case against two brokerage employees that we successfully tried after the Second Circuit’s decision in United States v. Newman, and a first-ever case against a recidivist municipality and one of its city officials.
The agency’s trial record is impressive on any scale, but all the more so given the difficulty and complexity of the cases we try. Unlike our colleagues at the Department of Justice, we generally proceed without the benefit of cooperators, wiretaps, and many of the other tools prosecutors have. Our litigated cases, which are typically technically complex, also require us to heavily rely on circumstantial evidence, confront hostile witnesses, and refute testimony by the defendant—a much rarer occurrence in criminal cases.
But is this record all that it seems on its face? Another of my contacts who actively litigates cases reminded me that this perfect record should be placed in context. The government– whichever agency is involved– has such advantages, both in the content of the rules that it applies and the resources it can deploy when it brings a civil enforcement action– that it overwhelmingly wins such cases. So please consider the SEC’s perfect federal trial record in that context.
I want to close this section with this point. I forget who said this– and I encourage any reader who might know the source of this quotation to remind me in comments. But someone once said, if you don’t occasionally miss a flight, you’re probably spending too much time at airports. I think that warning might well apply to the SEC.
Why Has the SEC Failed to Pursue Corporate Wrongdoers?
In making the following argument, White seriously began to try my patience. Over to White:
If we are to be more effective in pursuing and deterring white collar wrongdoing, we must first be clear-eyed and knowledgeable about what conduct current law reaches—and doesn’t—and to be always mindful of relentlessly pursuing the evidence wherever it leads, but doing so fairly. We need to sort through the political rhetoric and decide whether (and how) we want to amend current laws—civil and criminal—to more frequently impose liability on executives and officers for offenses committed by employees “on the watch” of the executives and officers.
As our record in the financial crisis and financial reporting cases attests, the SEC prioritizes bringing charges against individuals, including senior executives, where the evidence supports charges we are authorized to bring. In certain areas, however, such as improper sales and disclosure practices of complex products at major financial institutions, it has been much more difficult to hold senior executives responsible, either because they do not have their fingerprints directly on the conduct or indeed are not involved in it. Most criminal offenses also require proof of scienter, the highest standard of culpability, which is often very hard to prove beyond a reasonable doubt even when it may be present. There is thus growing frustration that current law does not more broadly impose responsibility on senior executives, either for fostering a culture that led to the misconduct or for failing to ensure the existence or proper functioning of controls that could have prevented it.
It’s no secret to those of us who have been following this area closely that the SEC and the DoJ have failed to bring any cases against senior bankers (or other corporate officials, for that matter), for any activities that led to the financial crisis. This record stands in stark contrast to the DoJ’s record during the administration of President George W. Bush, when the DoJ successfully brought– and jailed- executives from Adelphi, Enron, and WorldCom, for example (even though that same DoJ, under the leadership of Attorney General Alberto Gonzales, was not without its own serious problems).
The Sarbanes-Oxley Act of 2002 was specifically designed to make it impossible for senior corporate executives to disclaim knowledge of problematic activity to avoid liability. Instead, as Yves has written on several occasions, the legislation required companies to put effective internal control procedures in place, and for the CEO and CFO to certify personally the accuracy of financial statements and the adequacy of internal controls.
Why has the SEC and the DoJ failed completely to use this authority to pursue CEOs and CFOs for signing off on the adequacy of a company’s internal controls? There are multiple situations I can think of where the see no evil defense doesn’t pass muster– and which are exactly what the Sarbanes-Oxley internal control certification procedures were intended to address.
In fact, I would be more inclined to believe White’s claim that existing makes it difficult to hold senior executives responsible if the SEC (in conjunction with the DoJ) had at least tried to bring Sarbanes-Oxley internal control or other claims– even if the agencies failed to secure winning judgments. The lack of any such significant record to my mind damages White’s credibility in claiming, essentially, that it’s the law that’s an ass.
One additional point: I also don’t wholly buy arguments that eschew pursuing actions against corporations on the grounds that the secondary effects– job losses, declines in shareholder value, etc.– unduly affect third parties not responsible for breaking the law in the first instance. But assume for the moment that I placed greater stock in such arguments than I do. Wouldn’t that mean that an agency that has limited enforcement means at its disposal such target actions against company executives that might have a significant deterrent effect– and thereby avoid the secondary consequences of targeting the company itself. But this the SEC has also signally failed to do.
The SEC’s Regulatory Approach
Part of the problem I think, is that the SEC has largely abandoned the adversarial approach to enforcement that previously characterized its efforts when the agency was not only respected, but feared. The SEC has rejected a basic principle: regulators regulate, and when the regulated fail to conform, the SEC (and the DoJ, when appropriate), should chase wrongdoers. To do otherwise creates considerable risks.
This is far from a trivial point, and allow me to quote from another post I wrote earlier this month, The Obamamometer’s Toxic Legacy: The Rule of Lawlessness, in which I discuss why this approach is so deeply problematic. Although that earlier post discussed the DoJ’s enforcement capability, rather than that of the SEC, the general point I made there applies equally to the present discussion:
First, to quote my contact the white collar defense specialist again. The lack of an effective DoJ deterrent has enormously complicated his practice and his ability to get his clients to understand and act on prudent legal advice. “What I’ve seen happening more and more in the last couple of years is the chairs of audit committees of major companies openly mocking the DoJ’s enforcement capability.” This leads the companies to pursue courses of action that they wouldn’t dare to undertake if they worried that the DoJ would aggressively pursue securities law violations.
Where does this leave their lawyers? Well, it often means that they must either moderate their advice, or risk losing their clients. Clients who want to do something will resist their impulses and continue to listen to what they hear as their lawyers crying wolf only for so long. Eventually, the less scrupulous among them are going to ignore the contrary advice, or get another lawyer. The lack of effective enforcement at the DoJ hinders the efforts of the best, most prudent, and most ethical members of the legal profession to practice law as we would want them to.
Where Things Stand: Republicans Keep Their Eye on The Ball
I should remind readers at this point that the SEC is charged with two tasks, regulation and enforcement. The mainstream of the Republican Party consistently espouses an anti-regulatory agenda. And in this area, President-elect Donald Trump and his party are in accord, and have pledged to roll back the 2010 Dodd-Frank Wall Street Reform and Competitiveness Act, one of the signature achievements of the Obamamometer’s administration.
Here, the failure of the SEC to complete necessary implementing steps– in the form of rule-making procedures– according to statutory deadlines, has restricted the reach and scope of this legislation. Why is this important? Well, as I wrote last week in Mary Jo White Leaves Behind a Weakened SEC for Trump to Weaken Further:
[Trump’s] ability to unravel the entire multi-faceted Dodd-Frank regulatory program would be seriously complicated if the SEC had managed to complete rule-making procedures mandated previously by Congress, according to statutory deadlines, and had firm regulations now in place.
Instead, White leaves the SEC with serious rule-making tasks still incomplete.
Contrast this state of play with the aggressive approach Trump’s transition team is taking to the task of regulatory rollback in the securities and financial regulatory realm. Again, allow me to quote from my post from last week:
During the administration of President George W. Bush, state attorneys general used state authority to prosecute securities and financial transgressions. Notably, former New York state Attorney General Eliot Spitzer relied on authority provided by the state’s 1910 Martin Act, which predates the federal securities law, to take legal action actions against insurance firms for brokerage practices, hedge funds for improper trading practices in mutual fund shares, and investment banks for conflicts of interest that distorted the investment research they provided, to name some of the most significant initiatives.
But crucially, the Republicans do not confine themselves to contesting regulatory terrain as defined by Democrats. Instead, they seek to shift the entire debate aggressively in a new anti-regulatory direction. As reported by Fox Business:
The state’s Martin Act has been the bane of Wall Street banks in recent years, particularly as a group of ambitious New York state attorneys general, beginning with Eliot Spitzer nearly 15 years ago, began using the law to crack down on alleged financial improprieties that had previously been the territory of federal regulators such as the Securities and Exchange Commission.
But there is a movement afoot inside the Trump transition team to target the Martin Act—and other similar state regulations known as “blue-sky laws” – for extinction, by crafting legislation that would supersede them with existing federal statutes, according to people with direct knowledge of the matter.
The point man of this effort, former SEC commissioner and Trump transition team member Paul Atkins, has been discussing ways to ensure that federal securities laws preempt state laws by enacting new legislation that could pass considering the GOP now controls both the legislative and executive branches.
Now, eliminating the Martin Act would be far from a trivial task, as it would require Congress to pass legislation to preempt the existing New York state statute (and there’s reason to believe that even Republicans would not want to push this agenda). My point, however, is that the anti-regulation party isn’t confining itself to contesting securities law issues on the ground defined by Democrats. By seriously raising the issue of gutting the Martin Act, Republicans would force Democrats to contest new terrain, and shift discussion of financial regulation further toward the anti-regulatory pole.
Mary Jo White claims she leaves an SEC whose enforcement agenda produces bold and unrelenting results. Sadly, I don’t think so.