Winds of Change in the SEC’s Division of Enforcement

This post is based on a client memo by John F. Savarese and Wayne M. Carlin of Wachtell, Lipton, Rosen & Katz.

This is a period of significant change in the SEC’s enforcement program. A variety of new measures have already been implemented and numerous additional proposals are currently under consideration. The implications are likely to be significant for any company or financial institution that may be responding to SEC investigations in the months ahead. New policy decisions and their methods of implementation are likely to affect such matters as the SEC’s deployment of its resources, the pace and focus of investigations and opportunities for timely resolution of enforcement inquiries.

Chairman Mary Schapiro and Director of Enforcement Robert Khuzami have focused on speeding up the process of conducting investigations and bringing cases. One of Chairman Schapiro’s first acts was to terminate the agency’s “pilot program” regarding financial penalties, which had been widely viewed as slowing the enforcement process. We view this as a favorable development, given the practical concerns that our firm initially raised about this program. SeeImplications of the New SEC Penalty Policy” (May 15, 2007); “SEC Penalties Revisited” (June 8, 2007). Another early step was to streamline the procedure by which the staff obtains formal orders of investigation, which permit the staff then to issue investigative subpoenas as needed to obtain documents and testimony.

Congress appears poised to authorize the SEC to hire more staff and to increase its budget, and on May 7, 2009 the Obama Administration proposed a 6.8% funding increase for the agency in fiscal 2010. The key issue to watch is how the agency uses the new money, and who it hires to fill the new slots. Everyone’s interests will be best served if the SEC is able to recruit to its ranks new staff who will bring the agency the benefit of experience. In Congressional testimony on May 7, 2009, Mr. Khuzami stated that one of his goals is to increase the staffing of Enforcement’s trial unit. See here. This would be a positive development. Bringing more trial lawyers on board will enable the SEC to try more cases – but involving those seasoned trial lawyers in the pre-authorization case review process will also enhance the enforcement staff’s ability to identify the cases that should not be brought because they will be losers in court.

The GAO has also emphasized the theme of streamlining the SEC’s internal processes to allow investigations to be completed and cases filed more swiftly, in its report on the SEC’s enforcement program issued on May 7, 2009. See here. Streamlining is a laudable goal. At the same time, not all investigations should be pursued to completion, and not all investigations should lead to enforcement actions. The goal of bringing meritorious cases more rapidly should not compromise the staff’s ability to weed out the investigations that should be closed without action.

As the SEC’s new leadership contemplates reform, there are some additional ideas that should be considered. While these suggestions would in some ways be advantageous for companies involved in investigations, they would at the same time enhance the SEC’s own efficiency and effectiveness:

Early meetings with defense counsel – The willingness of enforcement staff to meet with defense counsel and engage in a dialogue early in an investigation varies greatly among SEC offices. An open-door policy and a willingness to listen is not only fair to the parties involved, but in the SEC’s own interest. These early discussions can bring factual information to the attention of the staff that will enable them to narrow or even close investigations at an early stage, so that their limited resources can be deployed on more promising matters. Prudent defense counsel will not abuse the opportunity to meet with the staff, and will use this approach only in inquiries that genuinely warrant being closed down early.

Better coordination among investigating authorities – It is commonplace for SEC investigations to be accompanied by parallel investigations of the same facts by one or more other regulatory or prosecutorial authorities. In some cases, parallel proceedings are appropriate. In many cases, however, little if any public interest is served by multiple simultaneous investigations of the same facts. The main result is an exponential increase in the cost of the investigation for the parties involved, as well as misallocation of regulatory resources. While this is a problem that the SEC does not have the unilateral ability to solve, senior officials should use their persuasive powers to discourage unnecessarily duplicative investigations.

Open the investigative files – The SEC’s enforcement manual, which was publicly released last year, recognizes that the staff has discretion to provide access to its evidentiary files to defense counsel at the conclusion of an investigation, as part of the Wells process, in which the staff engages in dialogue with counsel concerning possible enforcement action. In practice, the staff’s willingness to exercise this discretion varies greatly, and full open access is rare. In most cases at this stage, there is no compelling need to maintain secrecy about the testimony of witnesses or the contents of documentary evidence. Decision-making by the senior staff and by the Commission itself will be better-informed at the Wells stage if defense counsel are able to see the evidentiary record. This cuts both ways. Open access will help expose cases that have weak evidentiary support and should be closed or narrowed. At the same time, defense counsel will be better able to recognize cases where the staff’s evidence is strong and where a settlement should be pursued.

Additional proposals are bound to come under discussion as the agency’s new leadership continues to think creatively about improving the effectiveness of the enforcement program. This process should continue to include careful analysis of the likely practical effects of each new idea. For companies involved in investigations, it is essential to be mindful of the ongoing changes at the SEC, and the opportunities and challenges for effective advocacy that they present. Getting meritorious cases resolved sooner, while also weeding out marginal investigations faster, should be in everyone’s interests.

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