How SEC Enforcement is Getting Back to Basics

by Russell G. Ryan

Since leaving the Securities and Exchange Commission in 2004, I’ve done my share of critiquing SEC enforcement policy. So it’s only fair, nearly two years into the tenure of current SEC leadership, to give credit where it’s due.

And as it happens, plenty of credit is due in at least six areas of SEC enforcement policy:

Better Accountability

About ten years ago, the SEC departed from historical practice by delegating to senior enforcement staff the commissioners’ legal responsibility for launching formal investigations and unleashing the power to issue subpoenas. Some of us publicly expressed concerns at the time about this dilution of political accountability, given the severe reputational harm and financial expense that can result from investigations, even if no wrongdoing is ever uncovered. 

Happily, in February 2017 the SEC’s then-acting chairman partially reversed this delegation to ensure that formal investigations with subpoena power now can be launched only after approval by the politically-appointed SEC commissioners or the agency’s top enforcement official. Thus, current policy at least partially restores the commissioners’ historical accountability for initiating formal investigations. But a return to personal sign-off by the appointed commissioners in all cases would be even better.

Less Home-Court Advantage

About five years ago, the SEC again departed from historical norms by steering more enforcement cases away from federal courts with jury trials and into the agency’s own non-jury administrative tribunals, which created a perception that SEC prosecutors were seeking unfair home-court advantage. Many of us raised due-process concerns about this forum-shifting gambit, which ultimately backfired when the Supreme Court ruled last summer in Lucia v. SEC (PDF: 226 KB) that the agency’s administrative law judges (ALJs) were appointed unconstitutionally – a decision that effectively required the commission to re-litigate or settle dozens of cases then pending on its administrative docket. 

Yet even before Lucia was decided, current SEC leadership appeared to foresee the impending havoc and, to its credit, preemptively reappointed its ALJs and quietly began reverting to the historical norm of litigating most contested enforcement cases in federal courts – especially those seeking harsh sanctions based on disputed allegations of fraud.

Still, numerous concerns linger with in-house agency adjudication of law-enforcement cases (and not just at the SEC). The SEC now faces challenges (PDF: 426 KB) to the layers of removal protection those ALJs enjoy. And although the agency amended its procedural rules in 2016 to reduce some of the disadvantages faced by the accused in administrative proceedings, the SEC can never really solve the most basic concern of all: the untenable concentration of legislative, executive, and judicial power that exists when the commission simultaneously (i) writes the rules, (ii) authorizes and supervises its prosecutors when they enforce those rules, and (iii) ultimately decides guilt or innocence (and the severity of any punishment) when its prosecutors accuse someone of breaking the rules.

Fewer Forced Admissions

 In yet another departure from historical practice, the SEC in 2013 began requiring some accused wrongdoers to publicly admit their sins if they wanted to settle with the agency and avoid costly litigation. The concerns some of us expressed at the time went unheeded, and the SEC has secured admissions of wrongdoing in dozens of settlements over the ensuing years. Northern Illinois University law professor David Rosenfeld recently published a comprehensive analysis of the affected cases through early 2017, from which he concluded that the policy requiring admissions was applied “inconsistently and haphazardly” with “a complete lack of transparency in the process.” 

Recent SEC settlements suggest the agency has reconsidered its 2013 policy shift and largely stopped demanding admissions, effectively reverting to the historical norm of allowing parties to settle while neither admitting nor denying wrongdoing. This return to normalcy has the added virtue of bringing SEC enforcement practice back into alignment with section 202.5(e) of the agency’s informal procedural rules (PDF: 120 KB), which has explicitly allowed no-admit settlements since 1972. Although the SEC continued to demand a diminishing trickle of forced admissions during 2018, the agency’s experiment with that practice appears to have largely run its course.

Here too, however, the SEC faces lingering challenges. Among other things, a recent lawsuit by the Cato Institute (PDF: 65.4 KB)  is challenging the SEC’s ability even to prohibit settling parties from publicly denying the agency’s allegations of wrongdoing.

De-emphasis on Statistics

In recent months senior SEC leaders have publicly underplayed the importance of statistical metrics in evaluating the success of the agency’s enforcement program. This refreshing perspective reverses decades of SEC and media obsession over the number of cases filed each year and the aggregate monetary sanctions imposed. That obsession rested on (and reinforced) the toxic premise that effective enforcement is synonymous with ever-increasing case filings and eye-popping penalties. It also invited speculation that agency staff were incentivized to pursue quick and easy cases over more difficult ones, even when the latter had broader importance to investors and markets, and to demand arbitrarily large penalties in settlements with deep-pocketed companies desperate to avoid litigation. Even if that speculation was unfounded, an end to the obsession with numbers was long overdue.

Better PR Hygiene

My Wall Street Journal op-ed in late 2014 pointed out how SEC press releases announcing enforcement charges had become unfairly prejudicial and otherwise inconsistent with legal precedent governing due process, particularly in administrative cases where the commissioners would eventually play the role of final adjudicators. Among other things, these pre-hearing press releases were blurring the crucial distinction between proven fact and mere allegation. They were also routinely including unofficial quotations from the SEC prosecution team without affording the same courtesy to the accused, and they rarely mentioned that the allegations had yet to be proved at a hearing. To its credit, the SEC has since improved the balance and fairness of its enforcement-related press releases, although the unfair practice of allowing its prosecution team to insert gratuitous, one-sided quotations into official press releases unfortunately persists.

Return to Core Mission

Over the past two years the SEC has noticeably pulled back from its brief foray into “broken windows” policing, whereby even unintentional, technical violations were penalized regardless of whether ordinary investors suffered any harm. The agency appears to have returned to its core enforcement mission, prioritizing cases where fraud or other intentional misconduct caused widespread harm to retail investors – such as deceptive securities offerings, dishonest or conflicted investment advice, and misleading accounting or disclosures by publicly-traded companies. And in a subtle but telling gesture, the SEC website recently erased the agency’s debatable claim – originally coined in the 1990s – that it is “first and foremost” a law-enforcement agency.

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The SEC deserves great credit for accomplishing all of the foregoing in relatively short time, with little fanfare, and despite a shrinking enforcement staff. Here’s hoping the agency will continue along this road back to basics through 2019 and into the next decade.

Russell G. Ryan, a partner with King & Spalding LLP, previously served as assistant director of enforcement at the SEC and deputy director of enforcement at the Financial Industry Regulatory Authority (FINRA).


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