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SEC Sets New Enforcement Course

Bruce Carton | November 12, 2013

During her confirmation hearings in March, incoming Securities and Exchange Commission Chairman Mary Jo White pledged that on her watch the SEC's enforcement program would pursue securities lawbreakers with “bold and unrelenting” actions.

Given White's background as a successful former U.S. attorney for the Southern District of New York, the promise of a strong focus on enforcement came as no surprise to many as she took the reins from outgoing chairman Mary Schapiro. Now, just six months into her term as chairman, the agency's renewed commitment to a vigorous enforcement program under White is indeed unmistakable.

Since September, senior SEC officials including White, Commissioner Luis Aguilar, and co-Enforcement Director Andrew Ceresney have delivered several substantive speeches addressing the agency's plans and current actions in the enforcement area. White herself laid out a detailed vision for the Enforcement Division in two important speeches on September 26 and October 9. Her message is that the SEC must use every weapon in its enforcement arsenal, including some new tactics and policies introduced in the last few months, to create an environment where the SEC's enforcement presence is felt “everywhere”—covering the entire market and pursuing every level of violation.

In her most recent speech on enforcement issues, White added that it was important for the SEC to pursue even minor violations, as “even the smallest infractions have victims, and the smallest infractions are very often just the first step toward bigger ones down the road.” She compared her enforcement philosophy to the “Broken Windows” strategy employed in the 1990s by New York City Mayor Rudy Giuliani and Police Commissioner Bill Bratton. Under the Broken Windows theory, she explained, “When a window is broken and someone fixes it, it is a sign that disorder will not be tolerated. But, when a broken window is not fixed, it is a signal that no one cares, and so breaking more windows costs nothing.”

It is White's view that by pursuing violations large and small, the SEC can avoid an environment of disorder and send a message of law and order the same way that the New York Police Department did in the 1990s. White specifically mentioned control failures, negligence-based offenses, and short-selling ahead of securities offerings as the type of minor violations the SEC would now be pursuing with greater vigor.

“I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in. It is a subtle shift, but one that could bring more individuals into enforcement cases.”


—Mary Jo White,
Chairman,
Securities & Exchange Commission

Greater pursuit of minor violations does not mean, however, that White plans to pay less attention to larger cases. To the contrary, White has already reallocated enforcement resources to create the Financial Reporting and Auditing Task Force, with the mission of generating cases in one of the most complex and resource-demanding areas: financial and accounting fraud. Ceresney stated in September that the task force is specifically looking at high-priority areas including setting reserves, revenue recognition, auditor independence, and auditor conduct.

White acknowledges that with the persistent and significant limitations on the SEC's enforcement resources, the goal of being everywhere is as much about public perception as it is reality. The Broken Windows strategy of making sure that small violations are not ignored is one part of the SEC's campaign to create this perception, but White points to several other “force multipliers” that the agency is employing to expand its reach and presence beyond its physical footprint. These include:

  • Leveraging the SEC's existing National Exam Program. The SEC already has boots on the ground at registered entities such as broker-dealers, investment advisers, and exchanges. White says the exam program gives the agency a “real-time look into developing industry practices that may sometimes constitute violations that warrant further investigation and enforcement action” and that the exam and enforcement teams are coordinating more than ever before to pursue suspected violations.
  • Whistleblowers. White has emphasized the power of the SEC's fledgling whistleblower program, which allows the agency to award potentially large sums of money in exchange for valuable information about securities law violations. Indeed, in October the SEC announced an award of more than $14 million to a single whistleblower whose information led directly to an SEC enforcement action that resulted in the return of tens of millions of dollars to investors. White says that in addition to helping the SEC better identify fraudulent conduct, the whistleblower program also helps “deter wrongdoing by making would-be violators ask themselves—who else is watching me?”
  • Collaboration with other law enforcement agencies and regulators. The SEC collaborates “continuously and effectively” with the Department of Justice, the Financial Industry Regulatory Authority, and state securities regulators. In September, for example, the SEC announced a crackdown in which it charged 23 firms under Rule 105 with short-selling violations in advance of stock offerings. White credits coordination between the SEC and FINRA's market surveillance team as a vital part of securing the charges.
  • Technology. White says the SEC is doing a better job of using technology to identify fraud, as well. In insider-trading cases, for example, the SEC is now using the Advanced Bluesheet Analysis Program that allows computers to analyze data on specific securities transactions. ABAP identifies suspicious trading before market-moving events and also flags relationships between different traders—relationships that might have gone unnoticed in the past in a manual review of documents and data by SEC investigators. Other “force multiplying” technologies are now being rolled out or are already being employed in the financial fraud area. These include the Aberrational Performance Inquiry, which seeks out suspicious performance returns posted by hedge fund advisers to identify candidates for examination or investigation; and the Accounting Quality Model, which seeks out anomalies in financial statements to identify potential financial fraud.
  • Keeping Gatekeepers Honest. In September the SEC announced charges against three auditors for violating federal securities laws or failing to comply with U.S. auditing standards during certain audits and reviews. The SEC stated that the actions were part of its “Operation Broken Gate,” an effort to hold “gatekeepers” such as auditors accountable for the important roles they play in protecting investors from fraud or other financial mis-statements. Although these actions were limited to auditors, it is quite possible that the SEC will similarly seek to hold other types of gatekeepers—counsel to public companies, for example—more accountable for their roles, as well.

Beyond emphasizing the SEC's efforts to use its entire enforcement arsenal to cast a shadow everywhere, White has also laid out several overarching principles that the enforcement program will follow under her leadership. The most high-profile of these principles is the concept of accountability in settlements.

Breaking with nearly 40 years of practice, the SEC announced in June that it would begin to require admissions of wrongdoing from defendants to settle enforcement actions in certain instances. In August, billionaire hedge fund manager Philip Falcone and his firm Harbinger Capital Partners became the first settling defendants that the SEC required to admit to misconduct.  The SEC also required JPMorgan Chase to admit to the facts underlying the charges against it when it settled an administrative proceeding in September. In both cases, the SEC justified the need for such admissions by pointing out the defendants' particularly egregious misconduct.

White has promised that another core principle of her enforcement program will be to pursue the individuals responsible for securities law violations wherever possible. In numerous cases in recent years, the SEC has been harshly criticized for bringing an action against the company only, and letting the executives responsible off the hook. In reviewing the proposed Citigroup settlement in 2011, for example, Judge Jed Rakoff demanded that the SEC explain why it chose to pin responsibility only on the company and did not pursue the “culpable individual offenders acting for the corporation.” He later rejected that settlement.

White stated in September that she has now made it clear to her enforcement staff that they should look hard to see whether a case against individuals can be brought. “I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in. It is a subtle shift, but one that could bring more individuals into enforcement cases,” she said at the time.

A truly enforcement-focused chairman is now calling the shots at the SEC for the first time in many years. The question now is whether the SEC has the resources, the ability, and the will to carry out her ambitious plan to expand the agency's enforcement reach and hold companies and individuals more accountable than ever before.