About Bradley J. Bondi

Bradley J. Bondi is Senior Fellow of Legal Studies at the Center for Financial Stability, an adjunct law professor at Georgetown University Law Center and George Mason University Antonin Scalia Law School, and a partner with a national law firm where he is a leader of the securities enforcement and regulatory practices. He formerly served on the executive staff of the SEC as counsel to two commissioners and served as deputy general counsel of the Financial Crisis Inquiry Commission. His views here are solely his own.

A Questionable Delegation of Authority: Did the SEC Go Too Far When It Delegated Authority to the Division of Enforcement to Initiate an Investigation?

A seemingly innocuous decision by the Commission may have had a tremendous impact on the SEC’s Enforcement Program.  In 2009, under Chairman Mary Shapiro, the Commissioners of the Securities and Exchange Commission delegated authority to the Director of Enforcement to open formal orders of investigation of persons and entities.  The Director then sub-delegated authority to Regional Directors, Associate Directors, and Specialized Unit Chiefs.  A formal order of investigation is the precursor to the SEC Staff issuing subpoenas for documents and testimony.  Prior to the delegation of authority, the Division of Enforcement was required to present reasons to the Commission for the request for a formal order, and the Commission would vote, often in a summary fashion, to grant or deny the formal order.  The rationale for delegating formal order authority was that the Commission rarely declined to issue the formal order.  In fact, some statistics suggested that the Commission approved almost 99% of the requests by the Staff to issue a formal order of investigation.  Of course, whatever the approval rate, the fact that the Commission needed to approve a formal order provided an important internal check to prevent abuse.  In other words, the very fact that approval was required may have prevented the Staff from pursuing questionable investigations.

The delegation of formal authority has raised three concerns.

First, the fact that formal orders (and thus subpoenas) can be obtained now with relative ease – an SEC Enforcement Staff lawyer simply can request a formal order from his or her ultimate supervisor – has resulted in the Staff resorting to subpoenas earlier in the enforcement investigative process.  Under the prior system, the Enforcement Staff often would call the entity under investigation and engage in informal detective work prior to resorting to a request from the Commission for a formal order.  That informal detective work benefited the Staff by allowing the Staff to forgo a more elaborate investigation when the initial, informal steps gave assurances there was no wrongdoing.  Companies benefited by avoiding the costly production of thousands or millions of documents in response to an SEC subpoena by instead engaging in an initial conversation and voluntary production of key documents to demonstrate there was no violation.  Now, under delegated authority, the Staff does not need to exercise those informal investigative steps, resorting instead to the resource intensive subpoena for documents that often consumes Enforcement Staff resources for several months and, in some instances, unnecessarily.

The second concern with delegated authority is that it eliminated a process whereby the Commission can be involved in enforcement cases at the early stages.  Without the authority to issue formal orders, the Commission now rarely is briefed on any particular enforcement action until the late stages when the Staff seeks to bring charges.  The Commission does not have the visibility to provide guidance to the Enforcement Staff prior to the case unfolding.  The Staff is free to pursue any investigation no matter how resource-intensive to the SEC or costly to an individual or entity, without Commissioners even being aware.   Moreover, under the prior system, the Commissioners would know precisely the suspicions that prompted the initial formal order and could measure those suspicions against the final enforcement recommendation, which might differ substantially.  In order words, the Commissioners might find it informative whether a multi-year investigation into the initial issues yielded no enforcement action on those concerns but instead resulted in an enforcement action concerning entirely different issues.

The third concern with delegated authority is the balkanization of investigative authority.  Under the prior system, the fact of an investigation would be raised to the highest levels of the Commission – to both the Director and the Commission – and would be known to anyone in the Division of Enforcement who wished to attend the closed Commission meeting where the matter was discussed.  This centralization enabled a Staff member in a regional office to see areas that were being investigated by a different regional office.  Moreover, senior officers in the Division of Enforcement could offer assistance to others in the Division upon hearing about a new investigation.   The system enabled greater flow of communication and cooperation.  Under the new delegated authority, a formal order of investigation could be opened by one regional office without others in the Division even knowing at the time.

The Commission should re-evaluate whether it should continue with its delegation of authority to initiate formal investigations.  The authority to initiate an investigation is a power that might best reside with the five Commissioners.

______________________________________________________________________The Center for Financial Stability (CFS) is a private, nonprofit institution focusing on global finance and markets. Its research is nonpartisan. This publication reflects the judgments and recommendations of the author(s). They do not necessarily represent the views of Members of the Advisory Board or Trustees, whose involvement in no way should be interpreted as an endorsement of the report by either themselves or the organizations with which they are affiliated.

An Evaluation of the SEC’s Admissions Policy

Since the establishment of the SEC’s Division of Enforcement in the 1972, the SEC has routinely allowed defendants to settle enforcement actions without admitting fault.  In the standard settlement language, a defendant neither admits nor denies wrongdoing, which means that the settlement cannot be used against the defendant in parallel proceedings, such as shareholder class action litigation and government contract debarment proceedings, but at the same time, the defendant may not publicly deny the SEC’s charges.  The neither-admit-nor-deny concept grew out of the practical reality that the SEC’s Enforcement Staff would be more likely to obtain a settlement and thus conserve SEC resources that could be used to protect other investors if the Enforcement Staff did not insist that defendants admit wrongdoing, which itself could have damaging collateral consequences, particularly with respect to public companies and their shareholders.

With the greater emphasis in the last five years on punishing wrongdoers, the SEC announced in 2012 that it would require defendants to admit liability in settlements where defendants also had pleaded guilty in related criminal actions.  The theory was that the defendant already had pleaded criminally guilty to essentially the same conduct at issue in the SEC’s civil action, and thus the defendant would have few, if any, additional concerns with admitting fault in the SEC’s settlement.

The SEC greatly expanded the admissions concept in 2013.  On June 18, 2013, SEC Chair Mary Jo White announced that the SEC would seek more often admissions of wrongdoing from individual and corporate defendants as a condition of settling enforcement cases.[1]  In a speech delivered on September 26, 2013, Chair White outlined the types of cases where the Commission, in its discretion, might seek an admission of wrongdoing, which include cases where:

  • A large number of investors have been harmed or the conduct was otherwise egregious.
  • The conduct posed a significant risk to the market or investors.
  • Admissions would aid investors deciding whether to deal with a particular party in the future.
  • Reciting unambiguous facts would send an important message to the market about a particular case.[2]

As this expanded admission policy was being implemented, the Director of Enforcement stated that the SEC would not consider the collateral consequences to an individual or entity when determining whether to seek an admission.  That means, for example, that the SEC would not consider the impact to shareholders of additional payouts in costly plaintiff litigation and would not consider the increased potential for debarment of government contractors after admitting wrongdoing to the SEC.  In contrast, the Department of Justice when seeking to impose corporate criminal liability must consider the collateral consequences to the company.

The SEC’s expanded admission policy has created three primary concerns.  First, the admissions policy marks a fundamental shift in emphasis from protecting investors to punishing wrongdoers.  While this distinction may appear at first glance to be academic in nature, it has very real consequences.  The SEC, as a regulatory agency, has as three-part mission:  Protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation.  The admission policy may be at odds with the concept of protecting investors and facilitating capital formation.  Indeed, protecting investors may mean that, under certain circumstances, alleged wrongdoers receive a lesser sanction from the SEC in an effort to ensure that shareholders and investors do not suffer additional, collateral consequences for alleged wrongdoing.  For a public company, greater exposure to shareholder litigation and potential loss of valuable government contracts through admitting wrongdoing in a settlement with the SEC harms shareholders, who ultimately shoulder SEC corporate penalties, settlements with plaintiffs, and loss of shareholder equity in the case of debarment from lucrative government contracts.  While those outcomes might be appropriate in some instances, would it be more appropriate for the Commission to consider those outcomes in determining whether to seek an admission?

The second concern with the SEC’s admission policy is the lack of clear guidance and the disproportionate impact on some defendants.  The admissions policy may allow for subjective application without considering the individualized conduct of the defendant.  Although the admission policy is rooted in punishing the wrongdoer, the stated standards are not focused on evaluating the circumstances of the alleged wrongdoer.  And while the SEC purports to be focused on protecting “investors” and the market as a whole, the collateral consequences to shareholders of the alleged wrongdoer company are not even considered.

Finally, the admissions policy is susceptible to being used directly or indirectly as a negotiating tool for greater penalties.  This form of leverage could take the form of the SEC Enforcement Staff making overtures that, if a defendant were to agree to a higher penalty, the Enforcement Staff would not push for an admission.  Or the Enforcement Staff might be less direct and instead say that they are still considering whether to seek an admission but would be open to a settlement offer.  Regardless of the form it takes, leaving any discretion to the Enforcement Staff to seek an admission directly or indirectly increases the Enforcement Staff’s leverage for higher penalties.  The mere threat that the Enforcement Staff might seek the dreaded admission may result in defendants offering to settle for greater penalties than without that threat.

One possible solution may be to remove any discretion from the Enforcement Staff and place that discretion into the hands of the Trial Unit to evaluate whether the evidence is so strong that they would risk taking the matter to trial.  Another possible solution may be for the Enforcement Staff to determine from the Commission at the start of settlement negotiations whether the Commission would insist on an admission of wrongdoing.  That course would enable to the parties to negotiate under the same understanding of whether an admission is, in fact, likely to be sought.

One thing is clear.  The SEC’s admission policy requires some rethinking.

The Center for Financial Stability (CFS) is a private, nonprofit institution focusing on global finance and markets. Its research is nonpartisan. This publication reflects the judgments and recommendations of the author(s). They do not necessarily represent the views of Members of the Advisory Board or Trustees, whose involvement in no way should be interpreted as an endorsement of the report by either themselves or the organizations with which they are affiliated.

[1] http://www.bloomberg.com/news/articles/2013-06-18/sec-to-seek-guilt-admissions-in-more-cases-chairman-white-says

[2] http://www.sec.gov/News/Speech/Detail/Speech/1370539841202#.VOoCDkpOmtU

SEC Chair White Highlights High-Frequency Trading in 2015 Budget Request

In testimony before the House Committee on Appropriations regarding the SEC’s fiscal year 2015 budget, Chair Mary Jo White addressed the $1.7 billion budget request, stating that the funds would enable the SEC to accomplish several key and pressing priorities. Among these priorities, Chair White focused on the following:

  • Bolstering examination coverage for investment advisers and other key areas within the agency’s jurisdiction;
  • Strengthening the agency’s enforcement program’s efforts to detect, investigate and prosecute wrongdoing;
  • Continuing the agency’s investments in the technologies needed to keep pace with today’s high-tech, high-speed markets; and
  • Enhancing the agency’s oversight of rapidly changing markets and its ability to carry out increased regulatory responsibilities.

Chair White further covered the development of the SEC’s new tool, MIDAS (“Market Information Data Analytics System”), which she stated is being used to facilitate the analysis of trade and order data that reflects, among other things, “high-frequency trading and trading on off-exchange venues where pre-trade prices are not typically available to the public.” White went on to note that the SEC has several ongoing investigations into trading practices by high-frequency trading firms.

Chair White’s remarks were made on the day after it was revealed that the FBI is conducting insider-trading probes into high-speed trading firms.

Bondi Comment: In general, very little of Chair White’s testimony differs from that of the prior Chair before the appropriation committee. Chair White reiterated the importance of aggressive enforcement, examinations, technology and training – all areas that were emphasized in the past. What is notable about the context of Chair White’s testimony is this: (1) the SEC seeks from Congress a record high budget of $1.7 billion, which represents over a 50% increase from the SEC’s budget prior to the financial crisis; (2) the SEC clearly anticipates pressing for more “admissions” in enforcement matters, which likely will result in more litigation costs to the SEC, a cost not discussed in the testimony; (3) the SEC clearly intends to increase the number and frequency of examinations of registered entities; Chair White observed that the SEC examined “only about 9%” of the registered investment advisors, “comprising approximately 25% of the assets under management”; and (4) in order to keep up with evolving technology in the marketplace (including with respect to high-frequency traders), the SEC seeks to employ new technology, such as MIDAS, and to continue to encourage tips from whistleblowers.

See: Chair White’s Written Testimony; Webcast of Chair White’s Testimony.
See also: Subcommittee Chairman Ander Crenshaw’s Written Opening Statement.