Photo credit: Tom Lianza
FROM: SEC
Denver, Colorado
April 13, 2012
Thanks George [Curtis], for your generous introduction and years of good counsel – to say nothing of your hospitality. And thank you too, Don [Hoerl], for a great visit to the SEC’s dynamic Denver office yesterday. It’s good to be here among friends this morning – and, as for the rest of you, I’m happy to share my Friday-the-thirteenth with you.
Before I begin, I must tell you that my remarks today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners. It is especially nice to be here with you in Denver because, in addition to enabling my participation in this important conference, it gave me a perfect opportunity to make my first official visit as an SEC Commissioner to a regional office. In meeting yesterday with the staff of our Denver office, I was quickly reminded of the excellent talent that the SEC is able to attract in our regional offices.
Having a regional presence is of key importance to the Commission. Thank heavens, American business and the entrepreneurial energy that drives it are not confined to our financial capitals. Sadly, neither are the misfeasance and outright fraud that we are charged with rooting out in order to promote the vitality of our capital markets and their attractiveness to investors of all sorts.
Our regional presence literally extends our physical reach across the country, making it far more efficient to have Enforcement and OCIE staffers on-site in far-flung places. And history has demonstrated that our well-placed regional offices and our expert staff in each of those locations are wise investments, significantly enhancing our ability to protect investors in a timely and effective manner.
***
In the five months that I’ve been back at the SEC, I have enjoyed the special vantage point afforded to Commissioners. Upon my return, I brought with me an awareness of how things were when I last served at the Commission as Deputy Director of the Division of Trading and Markets until early 2010. During my previous stint at the SEC, I had the opportunity to work directly with each of the SEC’s two most recent Chairmen. So I thought I would share with you some perspectives on where we are, in the context of where we’ve been, as an agency, with a special focus on the Division of Enforcement.
The financial crisis that took hold in 2008 had a major impact on the SEC. In fact, that’s a pretty big understatement. Not only did it call into question the role of the agency with respect to oversight of market participants, but it was the “low tide” that exposed the fraudulent schemes of many scoundrels, Madoff and Stanford in particular. It was into this firestorm that our Chairman, Mary Schapiro, arrived in 2009. Her willingness to return to the federal government at such a time is a terrific example of the strength of her commitment to public service.
One of the Chairman’s immediate tasks was to address perceived shortcomings in the agency’s Division of Enforcement. This task was assigned in large part to one man, Rob Khuzami, who came to us as Enforcement division director in 2009. Like the Chairman, Rob is a committed public servant, having been a federal prosecutor in New York who handled many of the most important cases of the day, including the trial and conviction of the infamous “blind sheik.” Rob has a long and exemplary record of public service – if you don’t believe me, just ask him, he’ll tell you!—and it was this commitment that brought him to the SEC.
I want, in particular, to commend Chairman Schapiro and Rob Khuzami for restructuring the Division into specialty groups and for eliminating what they found to be a redundant layer of management. The securities laws and many of their interconnected implementing rules are far too complex for us to have persisted in pretending that some degree of substantive specialization and knowledge-capture weren’t necessary. The Chairman and Rob [Khuzami] realized that and made the change, despite the reservations of many who preferred things as they had been. We move a bit slowly at times, but, as University of Maryland Terrapin fans back home insist, “fear the turtle!”
Don’t get me wrong; Enforcement already worked pretty well. I do not believe it was “broken,” in any ordinary sense, and so it did not need “fixing.” It didn’t need to be restructured in order to bring good cases, or to attract good lawyers. Many of you are living testaments to that incontrovertible fact. So, making full allowance for the ways of Washington, where a convenient bit of press coverage can be reason enough to do just about anything, the “whys” behind the restructuring are important. But it is hard to disagree with the idea that a change – a new way of approaching problems both old and new – was necessary, and in light of that I believe the restructuring was a success.
Many inside and outside the building asked “why restructure Enforcement?” The answer is, it seems to me, because we need to do more – faster – with the resources, both human and material, that we already have. You may, like me, have noticed over the past few years an SEC refrain that is very Washington – that we need more “resources.” That means money and, derivatively, people and neat, new technology – in that order.
The problem is that the “give me more and I will do more for you” argument is ultimately circular. In practice, it can be translated something like this – “I can’t do better until you give me more” – and in that form, particularly as applied to the Division of Enforcement, this should not be the case. We cando more with – and without overburdening – the very fine staff we have by increasing our efficiency, for example, by choosing our cases carefully, terminating unfruitful investigations quickly, and harnessing the full benefits of technology. Although my mind is still open as to whether we captured all of the appropriate areas with our selection of specialty groups, I find that the Division’s restructuring itself is a good example of positioning ourselves to do more, better, with the expertise and technology we already have.
I assume that, as markets, market participants, and market practices change, so too will the composition and focus of our specialty groups. Indeed, the recent restructuring builds on the successful records of earlier working groups like the “Hedge Fund Task Force” and the “Microcap Fraud Task Force.” In fact, back when I worked for Chairman Cox, I served as his liaison to an interdivisional “Subprime Working Group” he established. I am proud to see that many cases started in that working group are coming to fruition today.
All of these were creative responses to the need to foster, in the SEC’s Division of Enforcement and throughout the SEC, not only greater expertise, but also efficiency. The positive results of these earlier experiments in interdisciplinary analysis were a solid foundation on which to build the recent full-blown specialty group restructuring in Enforcement. The need to increase our efficiency is a way to make our requests for additional resources more credible. The familiar plea for more “boots on the ground” is a good deal more persuasive amidst the competing demands and vagaries of the budget process when we can show that we are using our staff expertise and technology as effectively as possible – even when that may require us to change our longstanding work habits.
Ultimately, of course, our financial condition is out of our control. So, we should focus on what is under our control -- enhancing our Enforcement staff’s expertise and efficiency. Again, organizing the Division into specialist groups is an important step in the direction of enhancing both expertise and efficiency, for obvious reasons.
On the technological side, I want to commend another very worthwhile innovation, creation of a computer-based “tips, complaints, and referrals” system, inevitably nicknamed “TCR.” The primary idea was to get tips and complaints to the desks of those who might need and could evaluate them, quickly and across all internal frontiers. I gather that we’re almost there, with the significant caveat that having a large volume of unevaluated tips hit your electronic desk every day is not a gift in any ordinary sense – especially when, from experience, we know that many of them, for various reasons, will not yield fruit. However, that one tip, that proverbial needle in the haystack, might just lead you to the next major Ponzi scheme.
A secondary purpose of the TCR system is, frankly, not yet realized. TCR has not yielded any useful dataset for analysis. It remains, for us, the ultimate unstructured database. What we hope will someday be a stream of timely information on suspected market misfeasance, prompting not only fruitful investigations, but also guiding our market inspection and market surveillance efforts cannot now be mined. For an apt analogy, that is the difference between a few million sticky-notes and Google. So as to TCR, well begun, but not yet done. I look forward to the day when our experts in the Division of Risk, Strategy, and Financial Innovation will have brought that system up to its full potential as an interdivisional analytic resource.
* * *
As many of you know, the Division of Enforcement turns 40 this year. Although today’s Division is very different from the group that former Commissioner Irv Pollack led in 1972, some things remain exactly the same. One of those things is the Division’s role in giving effect to the Commission’s commitment to due process.
It was, in fact, just before Chairman Casey established the Division of Enforcement that the “Wells Committee” issued its report – one of whose 43 recommendations endorsed what we now refer to as “Wells notices” and “Wells submissions,” the pre-litigation procedural hallmark of SEC practice. And, although the Wells Committee’s endorsement was the news, what the Wells Committee really did was to underscore the importance of a procedural norm that Chairman Hamer Budge had announced in a memorandum to division and office heads two years earlier – two years before a stand-alone Division of Enforcement came into existence.
Chairman Budge, and later the Wells Committee, simply said that a prospective respondent should be given advance notice of the likely charges and have an opportunity to respond to them in a writing that would accompany any recommendation the staff might make for Commission action. Our “Wells process” is, in other words, a matter of procedural decency and fairness – of “due process” – and, for us, a very good last minute check on investigative enthusiasm. Wells submissions help us decide whether to go forward as recommended, and so assist us in deploying our always scarce staff resources in productive directions.
Now – full disclosure, here – I play for the SEC. That’s my team, and I want us to win. None of us has any other objective when we take the field. But, to extend the metaphor, the game isn’t solitaire and you can’t win it by yourself. There’s no game without, rules, a referee, and – not least – an opponent. And the rules I’m talking about are not SEC rules implementing the Securities, Exchange, and Investment Company Acts – or even Dodd-Frank and, soon, the JOBS Act. I’m talking about the procedural rules that guide and constrain our conduct in the enforcement arena.
The most important of those are administered by the courts; we did not create them and we are not the arbiters of whether we – or others – have met their requirements. The constitutionally assured right to due process is preeminent among such procedural norms. Now, no one would begin to pretend that the Wells Committee invented either due process, or our adversarial legal system. Still, lurking within that obvious point lies, it seems to me, a more subtle point, one that sometimes goes unacknowledged. Procedural due process was already an explicit part of the Commission’s enforcement practices when the Division of Enforcement was brought into being. It is, in a sense, the mark of legitimacy of our enforcement system. Our commitment to it in all we do must be unequivocal. But, we must also recognize that, for most of those who find themselves defendants in SEC proceedings, the assurance of due process would mean very little if it were only observed in the courts, or if they were left to themselves to try to respond effectively to our Wells notices.
I am, of course, alluding to the indispensable role of defense counsel in SEC enforcement proceedings. Without their expert and active assistance to their clients, the SEC’s longstanding commitment to due process for those involved in our proceedings would ring hollow. We expect and encourage defense counsel to act zealously on behalf of their clients – during our investigations, no less than in court. Expert opposition, moreover, contributes indirectly to our own efficiency, encouraging, for example, a client’s cooperation to engender a mutually advantageous settlement and by knowing, in the context of the facts, what would be productive to contest in furtherance of the client’s interests, while avoiding time consuming skirmishes over the tangential and non-germane.
Make no mistake, there is a limit, and last year Rob Khuzami reminded everyone publicly of how counsel have occasionally crossed that line. But in the majority of our investigations, that’s not what we see. Time and again, the careful and creative analyses of defense counsel compel us to examine both how we apply our rules and the limits of their elasticity. Put another way, there is a point beyond which our rules must not be stretched in our effort to enforce the securities laws. The upshot is that we should have to consider and adopt new, closer-fitting rules for truly novel situations. That seems to me implicit, at least, in the SEC’s commitment to procedural fairness.
Let me take a simple, but currently very common example. The Commission is regularly asked to approve sanctions based on the Dodd-Frank Act that would preclude defendants from future participation, temporary or permanent, in the financial services industry – the collateral bars authorized in section 925 of Dodd-Frank. Many cases that are brought to our attention for Commission action still relate to conduct that occurred before Dodd-Frank’s enactment. Where the new sanctions would apply to pre-enactment conduct, we face a question of basic fairness. With that in mind, I believe we should reject as inappropriate a reading of section 925 that would permit us to apply these collateral bars to pre-enactment conduct. In showing such restraint, we would demonstrate that our purpose is not only to deter bad conduct and to safeguard markets and investors, but to afford procedural fairness to those whose conduct subjects them to legitimate SEC enforcement action.
Let’s stipulate, in other words, that a great many of the defendants against whom the Commission authorizes enforcement action richly deserve whatever sanction we can levy on them. Even so, there is a limit. Their due process interests and our commitment to procedural fairness should be vindicated in our imposition of sanctions. Just as defendants should not be held accountable by reference to a standard that makes unlawful conduct that was lawful when it occurred, defendants should not be subjected to sanctions that didn’t exist at the time of their conduct. I want my team to win, and most days I’m pretty sure my team deserves to win, but I want my team to win fair-and-square.
***
Let me close with a somewhat more general thought. It is critically important that our enforcement program be extremely efficient. Each time the Division opens an investigation, which it is free to do without Commission approval, it has made at least a tacit decision to devote scarce resources to it, rather than some other investigation or case. So, recognizing that it is unrealistic to imagine we will ever achieve a one-to-one correspondence between incidents of misfeasance and SEC Enforcement staff, we’d better plan to do everything we can to increase our hit-rate per investigation opened, and should commit our staff resources carefully, which is to say, consciously.
That’s not a question merely of shunning low-percentage investigations, much less low-gain cases. Experience teaches us, for example, that fraud tends to proliferate in smaller entities that may lack highly developed compliance programs. It also means thinking carefully about what we might, borrowing again from the world of sports, call “shot selection.” It can be tempting to tangle with prominent institutions. But chasing headlines and solving problems are two different things. The question is what will do most good – where our focus should be. And the record seems to suggest that we can do most to protect smaller, unsophisticated investors by focusing more attention on smaller entities, where Ponzi schemes and microcap fraud have seemed to flourish unimpeded.
With that in mind, the SEC’s Microcap Fraud Working Group is a promising initiative. It is a creative effort to focus expertise from across the agency to pool knowledge and resources in an effort to detect, investigate, and deter fraud in the microcap market. That’s a practical way to leverage what we have in the fight against fraud in the service of markets and investors alike. I applaud the work of the group, and I am encouraged that such a talented team is on the front lines fighting for investors.
And, finally, while we’re talking about putting more heft in key areas, it is important to note the role played by the Division’s trial unit. Our trial unit has developed into one of the top groups of litigators in the country, and –in addition to their courtroom duties – they are key advisors to the Commission as we consider litigation risk and related strategy issues in our enforcement proceedings. As such, I am glad to see that their ranks have grown in number and expertise over the years, and I hope that trend continues. I will note that we just announced last night the addition of Matt Solomon as the Deputy Chief Litigation Counsel in Enforcement. Matt will report to another Matt – Matt Martens. Go look up their resumes and tell me I am wrong about our expertise in that group!
Our willingness to negotiate settlements must be matched by an explicit willingness to take our cases to trial in order to maximize results for investors. The extreme form of that argument, is that the Commission should not approve any settlement recommendation if the staff would not also be able and willing to proceed to trial. On the contrary, a trial-ready posture would alter defendants’ operating assumptions and actually increase the likelihood of prompt and advantageous settlements.
***
I want, in closing, to return to first things – our heritage of procedural fairness and the need to vindicate it in all that we do. What the vision of Chairman Budge and the Wells Committee began forty years ago, our expert Enforcement staff has since fostered. We, on the Commission, derive great benefit from the Wells submissions so carefully prepared by so many defendants’ counsels. They enhance significantly our ability to evaluate facts and the complexities of the law applicable to them in the fair and balanced manner the public has a right to expect, by virtue of both our oath and inclination. We all have complementary roles to play in promoting strong, fair, and effective enforcement to help keep our markets strong and our investors confident in participating in them.
Once again, thank you for this opportunity to share my thoughts with you – and I wish you an interesting and enjoyable conference.
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