Reviewing the sec, reinvigorating the sec

University of Pittsburgh Law Review

Volumn 71, Issue 3, 2010, Pages 489-516

  Katz, Jonathan G ^a  

^a NONE

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EID: 77953276539     PISSN: 00419915     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (64)

1. JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET 285-286 (Houghton Mifflin Company 1982).
2. Id. at 286.
3. Id. at 288.
4. Carol J. Loomis, Where Manny Cohen Is Leading the SEC, FORTUNE MAG., Dec. 1966, at 163.
5. In re Cady, Roberts & Co., 40 S.E.C. 907 (1961).
6. H.R. Doc. No.88-95, pt. 1-5 (1963).
7. H.R. Doc. No.92-64 (1971).
8. See Dirks v. U.S. Sec. and Exch. Comm'n, 463 U.S. 646 (1983).
9. Id. at 649.
10. Id.
11. Id. at 649-650
12. Id.
13. Id.
14. Id. at 650.
15. Id.
16. Id. at 650 n.3.
17. Id.
18. Id. at 650-652 In recognition of Dirks' role in exposing the Equity Funding scandal, the SEC imposed its least severe sanction: a public censure. The purpose of the SEC action appears primarily to have been to articulate the breadth of its theory of illegal insider trading.
19. Id. at 667.
20. In 1967, the SEC had brought an action against IOS for operating as an unregistered investment company. This of course is another ironic parallel to Madoff, who the SEC pressured to register a few years before the fraud was exposed.
21. Brian Trumbore, The Fund Indiutry's Black Eye,available at http://www.buyandhold.com/bh/en/education/history/2002/fund.html.
22. Wikipedia, http:/en.wikipedia.org/wiki/Investors-Overseas-Service.
23. Vesco fled the U.S. after the indictment in 1972 and was a fugitive until his apparent (but unconfirmed) death in Cuba in 2008. "How much Robert Vesco stole no one knew for certain. America's Securities and Exchange Commission (SEC) was after him for more than $224 million, or more than $1 billion in today's money, which was then the biggest financial fraud in history. But oddly, once the crack teams of lawyers and accountants were on the case, they recovered almost twice as much." Obituary: Robert Vesco, ECONOMIST, May 31, 2008, at 91.
24. In its obituary for Mr. Cornfeld, The New York Times included this description: "Shuttling around the world from his ancient French castle with a coterie of celebrity jet-setters, Mr. Cornfeld built his company, Investors Overseas Services, into a $2.5 billion financial empire that fascinated the news media, attracted small investors and plagued market regulators around the world." Diana B. Henriques, Bernard Cornfeld, 67. Dies; Led Flamboyant Mutual Fund, N.Y. TIMES, Mar. 2, 1995, at B10.
25. See Sec. and Exch.Comm'nv. Thayer, 1984 U.S. Dist. LEXIS 18562 (S.D.N. Y. Mar. 16, 1984);
26. Sec. and Exch. Comm'n v. E.F. Hutton Group, 1985 U.S. Dist LEXIS 14450 (D.D.C. Oct 29, 1985);
27. Sec. and Exch. Comm'n v. Levine, 1986 U.S. Dist. LEXIS 23353 (S.D.N.Y. Jury 3,1986);
28. Sec. and Exch. Comm'n v. Boesky, 1986 U.S. Dist LEXIS 17703 (S.D.N.Y. Nov. 14, 1986);
29. Sec. and Exch. Comm'n v. Drexel Burnham Lambert, 837 F. Supp. 587 (S.D.N.Y. 1993);
30. Sec. and Exch. Comm'n v. First Jersey Sec., 2001 U.S. Dist. LEXIS 6887 (S.D.N.Y. May 25, 2001). At the time that the Hutton case was brought in conjunction with a parallel criminal proceeding, John Shad was the Chairman of the SEC. Mr. Shad previously served as Vice Chairman of Hutton. While Shad played no role in the misconduct at Hutton, the fact that the SEC - under Shad - could take action against Hutton demonstrated the independence of the agency. Similarly, the action against Thayer, a prominent member of the Reagan administration, demonstrated that the agency was not subject to political influence.
31. Ellis Is Ordered to Yield Data, N.Y. TIMES, Apr. 16, 1987,at D15.
32. That investigation was related to the overall Boesky investigation. Keating had invested more than $100 million of government-insured Lincoln deposits in one of Boesky's unregistered investment vehicles. See MARTIN MAYER, THE GREATEST-EVER BANK ROBBERY - THE COLLAPSE OF THE SAVINGS AND LOAN INDUSTRY 165 (Collier Books 1990), for a comprehensive and highly entertaining description of Mr. Keating and the Lincoln S&L fraud.
33. William Christie & Paul Schultze, Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?, J. FIN., Dec. 1994, at 1813.
34. Erik Lie, On the Timing of CEO Stock Option Awards, 51 MGMT. SCI. 802, 803 (2005).
35. One SEC Chairman attempted to solve the problem by instructing the Division to refer all investigations involving a single person at a broker-dealer to the appropriate SRO for action. When that Chairman resigned, the referral program ended.
36. I am personally aware of four different Chairmen who directed the Division to actively review old open cases. The fact that four out of seven successive Chairmen would direct such a review suggests that case management has never been a high priority or a rigorous and disciplined process. It is my understanding that case management is again a priority for the Division.
37. In 2008, the SEC Inspector General concluded that the head of an SEC regional office had improperly closed a case despite having received a signed offer of settlement from a person more than twelve months before the closing. Chairman Cox assigned the Chief Administrative Law Judge of the SEC to conduct an inquiry into the finding and make a recommendation on whether to discipline the individual. In an unpublished opinion, the ALJ concluded that the decision to close the investigation was not based upon malfeasance but rather reflected an appropriate decision to close an investigation that was too old and had been delayed by staff departures and the need to investigate other persons and actions. The findings of the Inspector General are described in his 2008 semiannual report to Congress. OFFICE OF INSPECTOR GENERAL, U.S. SECURITIES AND EXCHANGE COMMISSION, SEMIANNUAL REPORT TO CONGRESS 43 (Apr. 1, 2008-SepL 30,2008), available at http://ww.sec-oig.gov/Reports/Semiannual/2008/seminov08. pdf.
38. In 2006, Chairman Cox disclosed that the SEC had more than 100 open investigations of option backdating. Stock Options Backdating: Hearing Before the Comm. on Banking, Housing, and Urban Affairs, 109th Cong. 12 (2006) (statement of SEC Chaiman Christopher Cox). Other public comments put the number of open investigations up to 170.
39. The Special Study Report and the Institutional Investor Study both identified this failure and recommended that the SEC develop this internal capability: "If the Commission is to be fully cognizant of the economic implications of developments in the securities markets under its jurisdiction, including those that result from its own actions, a substantially larger internal economic research capability, fully staffed and supported, is required." H.R. Doc. No.92-64, at XI (1971).
40. The dominance of the lawyer's perspective at the SEC was described by former SEC Chairman Harvey Pitt in an op-ed column in the Wall Street Journal aptly titled "Over-Lawyered at the SEC." Harvey L. Pitt, Editorial, Over-Lawyered at the SEC, WALL ST. J., July 26, 2006, at A15.
41. On rare occasions, regulatory divisions have obtained formal orders from the Commission to conduct investigations for regulatory purposes. A "recent" instance of one such investigation, by the Division of Investment Management resulted in the 2003 publication of its report and recommendations on the regulations of hedge funds. U.S. SEC. AND EXCH. COMM'N, IMPLICATIONS OF THE GROWTH OF HEDGE FUNDS (2003), http://www.sec.gov/news/ studies/hedgefunds0903.pdf. This report was primarily a legal analysis rather than a quantitative analysis.
42. There is no single answer to explain the limited number of economists, industry professionals, mathematicians, or other specialists at the SEC. Certainly the lawyer's bias toward hiring more lawyers is a key factor. Also influencing this pattern is the relative ease with which lawyers may be hired under Federal personnel rules compared to the rigid and time-consuming rules that apply to hiring other professions. Limited Congressional appropriations also played a role. Finally, an often-overlooked problem is the comparative reputational appeal of the SEC. Lawyers and accountants see a job at the SEC as career enhancing. More than one SEC Chief Economist who had difficulty recruiting top-flight economists has explained to me that the SEC is viewed as a professional backwater, and that the SEC is not comparable to other high profile government agencies.
43. See Christie & Schultze, supra note 28.
44. See Lie, supra note 29.
45. One must be careful in generalizing about the regional office operations. Because they function with minimal direct oversight, there is no one organizational structure. For example, in New York, the largest regional office, there is an enforcement office but the office responsible for broker-dealer examinations also has its own enforcement group. As in the home office, both units operate independently and occasionally overlap. Another interesting operating difference between the home office and the regions is the separation of investigation and litigation responsibility. In the home office, if an investigation results in litigation, the matter is transferred to a trial attorney, who must learn the case from scratch. Conversely in most of the regional offices, the attorney who investigated the case tries the case. Of course, this means that any other open investigations assigned to that attorney are put on hold during litigation.
46. To illustrate, imagine a national real estate agency in which each local office is a separately owned franchise with each agent in that franchise competing with the other agents in the office to sell or find buyers for the best houses in the community.
47. In its 2008 Annual Performance and Accountability Report, Chairman Cox disclosed that there were fifty open investigations concerning sub-prime securities offerings. In addition, there is ongoing private litigation that alleges that the originators, underwriters and credit rating agencies made materially false and misleading statements in the offer and sale of CDOs.
48. See, e.g., Abu Dhabi Commercial Bank and King County, Wash. v. Morgan Stanley & Co. Int'l Ltd. et al., No. 08 Civ. 7508 (S.D.N.Y. 2009).
49. The Secretary of the Commission must sign and issue every administrative proceeding order from the Division of Enforcement. The Secretary also reviews prior to publication all SEC litigation releases announcing the filing of an injunctive action. Because of this responsibility, the author routinely stayed at his desk working late into the night every year on September 30, the last day of the SEC fiscal year. On one such occasion a senior officer of the SEC who did not work in the Division of Enforcement once commented to the author, "You know we sue companies that keep their books open after the fiscal year ends."
50. In fact, the routine practice of ordering disgorgement but waiving payment began inadvertently in a single case to explain why the person was not actually paying back the money illegally obtained.
51. Warren Buffet once wrote, "You only leam who has been swimming naked when the tide goes out." Letter to Berkshire Hathaway Shareholders, Feb. 2008, at 2.
52. The U.S. Chamber of Commerce Report examined three discrete regulatory programs and a series of related agency-wide issues. That report is 85 pages in length and contains 23 recommendations. Several of the recommendations in that Report are included in this paper.
53. U.S. SEC. AND EXCH. COMM'N, PERFORMANCE AND ACCOUNTABILITY REPORT (2006), http://www.sec.gov/about/secpar/secpar2006.pdf, at 2.
54. Prior to 1990, the SEC could obtain a money penalty only in insider trading cases, authority that it first obtained in 1983.
55. For a detailed discussion and analysis of the Twin Peaks model, see GROUP OF THIRTY, THE STRUCTURE OF FINANCIAL SUPERVISION: APPROACHES AND CHALLENGES IN A GLOBAL MARKETPLACE (2008), https:/www.deloitte.com/assets/Dcom-UnitedStates/ Local%20Assets/Document/us-fsi-bankings-G30%20Final%20Report%2010-3-08.pdf.
56. SEC Director of Enforcement Robert Khuzami has publicly announced an intention to increase specialization within the Division by creating a series of specialized units with clear but broad functions, such as hedge funds, market trading and municipal. This appears to be a promising step, provided that the responsibilities of these units is sufficiently broad to provide responsibility for emerging problems and not merely the problems of the immediate past. This latter approach has been used, with limited success, repeatedly in the Divisions. The problem with it is that it reflects the "flavor of the month'' mentality of searching for specific frauds after one such fraud has been exposed This fraud-specific approach is too narrow and backward, not forward-looking.
57. Press Release, U.S. Sec. and Exch. Comm'n, SEC Announces New Initiative to Identify and Assess Risks in Financial Markets (Apr. 30, 2009) (The Securities and Exchange Commission today announced a new effort to identify and assess risks in the financial markets by attracting seasoned industry professionals to the agency's Office of Risk Assessment. The new Industry and Markets Fellows Program will help the agency expand its ability to oversee complex industry practices and products in today's markets.").
58. For a more detailed discussion of this function, see Chamber of Commerce Report, supra note 46, at 18-22.
59. There is one notable exception. In 2002, following Enron and WorldCom, Corporation Finance received a substantial increase in its accounting staff.
60. This subject is fully discussed in the Chamber of Commerce Report.
61. Jonathan O. Katz, Letter to the Editor, WALL ST. J., Aug. 8, 2006.
62. The need for better initial and periodic disclosure in structured finance offerings is fully described in Chapter 3 of the report of the Committee on Capital Market Regulation. Comm. on Capital Markets Regulation, The Global Financial Crisis: A Plan for Regulatory Reform (2009), htq)://www.capmktsreg. org/pdfs/TGFC-CCMR-Report-(5-26-09).pdf. Two years earlier, Allan Sloan described the inadequacies of structured finance disclosure in an article in Fortune Magazine.
63. Allan Sloan, Junk Mortgages Under the Microscope, FORTUNE MAO., Oct 16, 2007, http://money.cnn.com/2007/10/15/markets/junk-mortgages.fortune/index.htm.
64. House of Commons speech, Nov. 11, 1947.