The Securities and Exchange Commission is undergoing a period of transition due to a series of recent changes in top leadership positions. On April 8, 2013, the U.S. Senate confirmed the nomination of Mary Jo White as the new Chairman of the SEC, and, on April 10, she was officially sworn in as the 31st Commission Chairman. White succeeds Elisse Walter, who replaced Mary Schapiro as Chairman in December 2012. Moreover, in February 2013, Enforcement Division Director Robert Khuzami stepped down, and Walter appointed George Canellos as Acting Director of the Enforcement Division; it is anticipated that White will name the permanent Enforcement Division Director shortly.
This post discusses recent public statements by top enforcement officials regarding the SEC’s enforcement priorities, trends, and strategies. In particular, this post discusses White’s confirmation hearing before the Senate Banking Committee on March 12, 2013, in which she outlined her vision for the SEC and promised continued aggressive enforcement. This post also discusses statements by top officials at the annual SEC Speaks conference on February 22 and 23, 2013, which reviewed recent enforcement efforts and previewed the Enforcement Division’s priorities in the year ahead.
These recent statements by White and other SEC officials, along with White’s reputation, suggest that there may be a strong enforcement effort in the coming years – and the Obama administration’s budget proposal for FY 2014, which was released on April 10, 2013, indicates that the SEC likely will have the resources it needs to support this effort.
Chairman White Comments on Enforcement
At her March 12 confirmation hearing, White pledged that one of her highest priorities as Commission Chairman would be “to further strengthen the enforcement function of the SEC” in a way that is “bold and unrelenting.” White stressed that, under her leadership, the Commission would aggressively pursue “all wrongdoers – individual and institutional, of whatever position or size” in order to deter wrongdoing and protect the integrity of financial markets.
In response to questions from several Committee members regarding whether the Commission should bring charges against corporations deemed “too big to fail,” White stated that, at the SEC, “there is no institution too big to charge.” In particular, White was asked for her views on whether some financial institutions are difficult to prosecute because of the potential negative impact on the national or world economy. White responded that, at the SEC, “collateral consequences are not taken into account before charging decisions are made.” White noted, however, that the SEC does consider collateral consequences, such as harm to innocent shareholders, in crafting remedies.
White also addressed questions about whether her representation of large corporations and financial institutions in private practice would impair her aggressiveness or otherwise require her recusal from particular enforcement matters. White reassured the Committee that, as SEC Chairman, she would function as the advocate of the investor, and she noted that she was “exceptionally aggressive” against large institutions and senior executives during her tenure as U.S. Attorney for the Southern District of New York. White acknowledged that she might encounter conflicts of interest that would preclude her participation in some enforcement matters, but she described the scope of such conflicts as “quite narrow” and as being similar to those encountered by former chairmen and other SEC commissioners.
SEC Speaks 2013 and Enforcement Trends
At the SEC Speaks conference, Enforcement Division officials discussed the Commission’s enforcement initiatives and priorities as well as its enforcement strategies. These discussions included reviewing the impact of recent and pending judicial decisions and recent enforcement activity. Key issues addressed at the conference are discussed below in light of enforcement trends.
A. Enforcement Initiatives and Priorities
Insider Trading and Market Abuses
Several Division officials expressed their expectation there would be a continued focus on insider trading, noting that, since 2009, the SEC has brought 175 enforcement actions alleging insider trading against 425 defendants involving approximately US$900 million in illicit profits. Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office, commented that, in the wake of the SEC’s investigation into the Galleon Group (which led to the highly publicized insider trading prosecution of its former head, Raj Rajaratnam), hedge fund insider trading and the use of “expert networks” will continue to be a high priority for the SEC.
Wadhwa also referenced the SEC’s recent emergency action asset freeze of a Swiss Goldman Sachs account in which unknown traders are suspected of insider trading in connection with the Heinz merger announcement, which is believed to have resulted in potential profits of US$1.5 million. Wadhwa said that the SEC will aggressively pursue matters in which suspicious trading is observed in offshore accounts.
As further discussed below, since the conference, the SEC announced and is awaiting court approval of what would be the largest-ever settlement in an insider trading case – a proposed US$602 million settlement with CR Intrinsic Investors, a subsidiary of hedge fund firm SAC Capital Advisors. The settlement would resolve Commission claims that SAC illegally made US$276 million from insider tips regarding the development of an Alzheimer’s drug.
In addition to insider trading, panelists discussed other market abuses that the SEC is targeting. Daniel Hawke, Chief of the Enforcement Division’s Market Abuse Unit, noted that his unit was focusing on the use of alternative trading systems, high-frequency trading, and dark pools.
Kara Brockmeyer, Chief of the Enforcement Division’s FCPA Unit, stressed that companies should not take a one-size-fits-all approach to compliance but, rather, should design compliance programs that address relevant, individualized risks and that evolve as those risks change over time. Brockmeyer advised that, to be most effective, compliance programs should be intertwined with a company’s financial controls. She directed the audience to the joint DOJ/SEC Resource Guide to the U.S. Foreign Corrupt Practices Act issued in November 2012, emphasizing that it was written in plain English and designed to be a reference for non-lawyers and lawyers alike.
Brockmeyer also discussed two recent district court rulings addressing jurisdictional challenges in FCPA actions. Although the SEC successfully defended the challenge in only one of these cases, Brockmeyer noted that both illustrate the SEC’s aggressive approach to the FCPA’s extraterritorial reach.
Increased Emphasis on Auditor and Gatekeeper Accountability
Acting Director Canellos described the Enforcement Division as reaching an “inflection point” in its investigation into the financial crisis. Canellos said that the Division is redefining priorities to emphasize a heightened enforcement focus on gatekeepers, including boards of directors, supervisors, and outside auditors. Other Enforcement Division officials reiterated this theme, emphasizing the critical role played by corporate gatekeepers in safeguarding market integrity.
Panelists noted, for example, that the Commission instituted administrative proceedings earlier this year against two auditors from a Big Four accounting firm based on their roles in the 2008 audit of a failed bank (TierOne Bank). The Commission alleged that the auditors failed to appropriately scrutinize management’s estimates of TierOne’s allowance for loan and lease losses and instead relied on stale information and management’s representations, even though this was one of the highest-risk areas of the audit due to the financial crisis and the troubled real estate market. In an SEC release announcing the proceedings, Khuzami noted that “[a]uditors must adhere to professional auditing standards and exercise due diligence rather than merely relying on management’s representations.” In another recent action, the SEC instituted administrative proceedings against an auditor based on his failure to adequately scrutinize an audit client’s improper revenue recognition practices which led to material misstatements of revenue over multiple years.
Charles Wright, Counsel to the Chief Accountant for the Division of Enforcement, noted that the focus on gatekeepers extends to auditors of foreign companies or subsidiaries trading on U.S. markets. Howard Scheck, Chief Accountant for the Division of Enforcement, also noted that the SEC has seen increased activity under Section 10A of the Securities Exchange Act of 1934, which prescribes procedures (including a series of reporting obligations) when an auditor detects or otherwise becomes aware of information indicating that an illegal act has or may have occurred. Scheck noted that, since 2007 the SEC has received 31 Section 10A letters from auditors, with a sharp increase in 2011 when the Commission received nineteen such letters. Scheck indicated that the Division of Enforcement would continue to look at auditor conduct in this area.
Secondary Actor Liability
Several Division officials, including Enforcement Division Chief Counsel Joseph Brenner, discussed the impact of the Supreme Court’s 2011 decision in Janus Capital Group Inc. v. First Derivative Traders. The Janus decision restricted liability in private securities fraud actions under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b) to those persons with “ultimate authority” over the alleged false or misleading statements. In practice, the Janus decision has narrowed the scope of private securities fraud actions against secondary actors, such as outside lawyers and auditors.
Brenner explained, however, that Janus had resulted in only a modest impact on the SEC’s enforcement work, because the SEC retains statutory authority to bring aiding- and-abetting or control-person charges against secondary actors. Brenner also noted the Second Circuit’s decision in SEC v. Apuzzo, where the court held that the Commission need not prove that a defendant proximately caused a securities violation in order to establish aider-and-abettor liability. Accordingly, the Janus decision is unlikely to undermine the Commission’s enforcement focus on so- called “gatekeepers.”
Financial Crisis and Bank Loan Loss Reserves
Scheck noted that the Division has recently brought a number of actions where the value of loan collateral was overstated due to improper valuation techniques, including the use of outdated appraisals. Scheck cited three examples of recent SEC enforcement actions. The first example is the aforementioned TierOne Bank matter, where, in addition to charging the bank’s outside auditors, the SEC charged the bank’s executives. The Commission alleged that management relied primarily on stale appraisals and used the appraisals to avoid reporting losses that would have resulted in the bank not meeting its required regulatory capital ratios. Scheck also cited two other cases – one where bank executives were charged with using loan modifications to disguise non-performing loans, and another where the bank understated its loan loss reserve and underreported the amount of its underperforming loans and its other real estate owned.
B. Enforcement Strategies
Preview of Novel Enforcement Strategies
Representatives of the Enforcement Division emphasized that, in addition to using enforcement remedies in a traditional manner, the Division intends to use such tools in creative new ways. In particular, Acting Director Canellos emphasized the following:
- In addition to the traditional approach of relying on general “obey the law” injunctions, the SEC is utilizing more specific conduct injunctions to prevent ongoing fraud;
- The SEC is seeking ways it can invoke a court’s broad equitable authority to prevent future frauds and market manipulation; and
- The SEC is examining its practices in relation to Exchange Act Section 21(a), which allows the Commission to issue public reports of its investigations even if it chooses not to file an enforcement action.
David Bergers, the Acting Deputy Director of the Enforcement Division, discussed the creation of a new Enforcement Advisory Committee to evaluate and improve the Division’s investigation and litigation capabilities. Bergers stated that, because the Enforcement Division’s resources are limited, it is focusing on technological tools that will enable it to monitor activity and organize data in ways that will empower the enforcement staff and make investigations more efficient. One such tool cited by Bergers is a “forensic lab” that mines data to detect outliers in trading activity for potential investigation.
Bergers noted that the Enforcement Division intends to pursue subpoena enforcement actions more aggressively to address the problem of companies failing to produce documents in a timely manner or in the requested electronic format. One recent example with respect to subpoena enforcement is that, on March 13, 2013, a federal magistrate judge heard arguments regarding the enforceability of an SEC administrative subpoena seeking audit documents from the Chinese affiliate of a major U.S. accounting firm, Deloitte Touche Tohmatsu CPA Ltd. The Commission originally filed the subpoena enforcement action in September 2011, seeking documents related to the investigation of accounting fraud by a Chinese company (and Deloitte audit client), Longtop Financial Technologies Limited. Deloitte has argued that compliance with the subpoena would require the company to violate Chinese secrecy laws, exposing the company to potential criminal liability. Earlier, on March 4, the magistrate lifted a stay in the matter following unsuccessful attempts by the SEC to negotiate an agreement with the China Securities Regulatory Commission regarding access to the documents of Chinese companies.
SOX 304 Clawbacks
Brenner discussed clawback actions pursued under Section 304 of the Sarbanes-Oxley Act. In the event a company “is required to prepare an accounting restatement” that results from “misconduct,” Section 304 authorizes the SEC to recover certain compensation and profits from the company’s CEO and/or CFO. The SEC has brought approximately fifty Section 304 cases, and Brenner reported that, in approximately fifteen percent of such cases, the targeted officer was not accused of any misconduct. Brenner also touted a recent favorable district court decision, upholding Section 304 against constitutional and other challenges.
Updates on Whistleblower and Cooperation Initiatives
Several panelists provided updates regarding the Enforcement Division’s high-profile whistleblower and cooperation initiatives. The Panel noted the following:
- In 2012, the SEC received 3,001 whistleblower tips, including tips from whistleblowers in 49 foreign countries;
- The Whistleblower office is evaluating whether the practice of requiring employees to sign confidentiality notices that would effectively bar them from being whistleblowers might violate provisions of the Dodd-Frank Act that prohibit companies from punishing whistleblower complaints; and
- Since the inception of the Division’s cooperation program in 2010, 51 cooperation agreements have been executed and the SEC has filed more than 40 enforcement actions in which there were formal cooperation agreements.
Citigroup and Ramifications for SEC Settlements
Several speakers noted that the Enforcement Division is awaiting the Second Circuit’s decision in SEC v. Citigroup Global Markets, Inc., a case that may have broad ramifications for the SEC’s common practice of reaching settlements in which companies neither admit nor deny wrongdoing. The case involves a 2011 decision in which Judge Jed Rakoff rejected a proposed US$285 million settlement stemming from Citigroup’s allegedly fraudulent marketing of collateralized debt obligation instruments. Judge Rakoff concluded that the proposed settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest,” primarily because Citigroup neither admitted nor denied the allegations of misconduct in the proposed consent decree. Judge Rakoff criticized such “neither admit nor deny” settlements as serving the narrow interests of the parties, but not the public interest.
The Citigroup case was not the first time Judge Rakoff had taken issue with a “neither admit nor deny” settlement, nor is he alone among federal judges in this regard. In 2009, Judge Rakoff denied approval of a proposed settlement in SEC v. Bank of America Corp., later approving a revised settlement that contained a detailed factual recitation, an undertaking by the bank to take prophylactic measures, and a penalty more than four times the size of the penalty that was initially proposed. A year later, Judge Rakoff expressed skepticism about another proposed settlement, ultimately approving the deal but criticizing it for lacking any admission of liability. Other federal judges have expressed similar concerns in blocking proposed settlements.
Most recently, Judge Victor Marrero deferred approval of a proposed US$602 million settlement between the SEC and a unit of hedge fund firm SAC Capital Advisors, which would be the largest-ever settlement in an insider trading case, based on the absence of an admission of wrongdoing by the defendant. At a March 28, 2013 hearing, he stated that he was considering conditioning his approval of the proposed settlement on the outcome of the Citigroup appeal.
At the conference, while Enforcement Division officials stated that a reversal of Judge Rakoff’s Citigroup decision would be important because it would provide the Division with greater flexibility in future settlements, they also emphasized that the SEC has a high success rate against defendants at trial and the Commission would continue to pursue litigation where appropriate.
Chairman White joins the Commission with a reputation as a tough prosecutor from her tenure as U.S. Attorney for the Southern District of New York – and her recent confirmation-hearing comments, along with the recent comments of Enforcement Division officials at the SEC Speaks conference, suggest that the Commission will continue on a path of aggressive enforcement. In addition, the SEC’s efforts to adopt new enforcement tools and maximize the potential of its pre-existing capabilities, along with the budget increase recently proposed for the agency, indicate that there may be proactive enforcement activity in the coming years.