In the world of securities regulators, the U.S. Securities and Exchange Commission (SEC) stands tall. Its mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. In 2011, the SEC completed the most significant restructuring since its establishment roughly 40 years ago, and, if it must say so, had “A Record Performance” in enforcement. As these changes will continue in 2012 and potentially have a meaningful impact on global organizations, we thought it time to take a look at some of the key developments.
Change was Necessary
There had been well-publicized criticism and allegations of financial irregularities and weak internal controls at the regulator:
- “[The] SEC did not have effective internal control over financial reporting… we identified six significant deficiencies that collectively represent a material weakness in SEC’s internal control over financial reporting.”
- SEC’s Financial Information at Risk; Commission Hasn’t Been Consistent in Implementing Controls
These allegations carry heavy weight for an institution that in fiscal year 2011 had a budgetary authority of $1.673 billion, employs 3,844 full-time equivalents and carries the weight of the financial markets on its shoulders.
The Commission also faced tremendous external criticism for its role and lack of effective action in the Madoff matter when the $50B ten-year Ponzi scheme came to light. Eight of the SEC’s employees were eventually disciplined, the Commission itself was sued by investors and Congress questioned the legitimacy of the SEC in effectively policing the U.S. financial markets. Which put in question the very continued existence of the SEC.
In response to some of these criticisms, one change is that the Division of Enforcement, within the SEC has new specialized units designed to build expertise in complex, high-priority areas, including:
- asset management
- structured and new products
- complex trading strategies
- current market structure
To complement this, sophisticated analytic tools and data-based templates have been developed to identify suspicious patterns and activities, allowing Enforcement to more quickly identify and pursue illegal conduct.
Additionally, Enforcement has strengthened and improved coordination with the Office of Compliance Inspections and Examinations’ (OCIE’s) National Examination Program (NEP), hopefully resulting in targeted exam and investigation efforts to bring swift enforcement action.
The SEC also undertook corrective actions in FY 2011 to address information technology and security control weaknesses. But they are not fooling themselves that these are sufficient; new and residual deficiencies have been identified including dated security risk management procedures, inconsistent continuous monitoring processes, user account control gaps, and further improvements needed in the patch management process. These areas will be a priority for remediation in FY 2012.
Beefing Up Rules for Dodd-Frank
The Dodd-Frank Act is the most significant piece of securities legislation since the 1930s, and it imposes significant new investor protection and market stability responsibilities on the SEC. It also provides the Commission with new tools with which to meet those responsibilities (more about these below).
2011 was the busiest portion of the multi-year implementation agenda set out by Congress, and it requires the SEC—in collaboration with other regulatory bodies and in close communication with stakeholders representing different aspects of the financial marketplace – to make significant progress against that agenda.
Of the more than 90 mandatory rule-making provisions in Dodd-Frank, the SEC had proposed or adopted rules for three-quarters of them by the end of 2011, as well as a number of the rules stemming from the dozens of other provisions that give the SEC discretionary (as opposed to mandatory) rule-making authority. Quite the “teacher’s pet,” the SEC has also issued 12 of the more than 20 studies and reports that it is required to complete under the Act.
Enforcement Outcomes Break Records
Not to be distracted, in addition to rule-making and issuing studies while grappling with the weaknesses in its internal systems, the SEC brought a record-breaking 735 enforcement actions in FY 2011. Importantly, 85 of these actions are considered to be National Priority Cases—the Division’s most important and complex.
In addition to bringing cases, the SEC:
- obtained orders for $2.8B in penalties and disgorgement
- utilized enhanced Dodd-Frank remedies to bar wrongdoers from future work in the securities industry
- obtained relief intended to send a strong deterrent message, including asset freezes and trading suspension
Furthermore, in a “show me the money” move, over the last two fiscal years, the SEC distributed to investors over $3.6B in disgorgement and penalties.
And for those with global portfolios it may be important to note that the SEC reports that it recovered over $240M for wronged investors from overseas accounts through efforts by the Office of International Affairs, in collaboration with the Division of Enforcement and foreign regulatory and law enforcement bodies.
Some dramatic examples on the changing SEC tactics and strategies are identified by the Commission as “Enforcement Milestones” for its most recent fiscal year when it:
- Obtained disgorgement of illegal profits of roughly $1.878 billion and approximately $928 million in penalties as the result of judicial and administrative proceedings against securities violators.
- Sought orders barring 82 defendants and respondents from serving as officers or directors of public companies.
- Sought emergency relief from federal courts in the form of temporary restraining orders (TROs) to halt ongoing fraudulent conduct in 39 actions, and sought asset freezes in 42 actions.
- Filed 9 actions to enforce investigative subpoenas.
- Halted trading in securities of 276 issuers about which there was inadequate public disclosure.
- In SEC-related criminal cases, prosecutors filed 137 indictments, informations, or contempts in Fiscal 2011.
This last point, that the SEC’s enforcement actions have led to criminal cases, is an important one. The SEC itself does not have the authority to bring in criminal cases. So in 2011, it continued to work with criminal prosecutors to break up one of the largest insider trading schemes to date. Five separate Federal district court actions have been filed, involving charges against 22 individuals, including high-ranking corporate executives and hedge fund managers, and against seven entities involved in the scheme. Developments here are still unfolding.
Devotees of cop shows on American TV will be forgiven for not realizing that in the context of securities enforcement, until very recently, we were almost exclusively in the world of civil litigation. Adding the potential for criminal prosecutions makes for an even more volatile and expensive mix.