Evidence from SEC Enforcement Against Broker-Dealers

My recent article “The SEC and the Financial Industry: Evidence from Enforcement Against Broker-Dealers,” just published at the Business Lawyer (Vol. 67, p. 679, May 2012), provides an empirical account of the agency’s enforcement record against investment banks and brokerage houses in the period right before the 2007-2008 crisis. At the time, the SEC was the target of severe criticism from diverse quarters, ranging from scholarly commentators to the popular press and Congress. This article provides a systematic examination of the SEC enforcement record up to April 2007 and finds that defendants associated with big firms fared better in SEC enforcement actions, as compared to defendants associated smaller firms.

As this data suggests, the SEC faces three key decisions when formulating an enforcement action. One decision concerns whether to focus on the violations of individual employees of financial institutions, pursue the corporate entity that employs them, or charge them both. In two well-publicized rulings, Judge Rakoff chastised the SEC’s decision to direct its action exclusively against the firm and avoid individual liability. The article reveals that actions against big broker-dealers were more likely to target solely the corporate entity, without any further action against either frontline employees or high-level supervisors. More specifically, 40 percent of all actions against broker-dealers involved exclusively corporate liability, compared to just 10 percent for smaller firms.

A second major decision for the SEC involves the choice between a civil action and an administrative proceeding. As to broker-dealer violations, both enforcement venues are open to the Commission. However, this article shows that courts are worse forum for finance professionals, since, when a violation occurs, a court injunction is more likely than an administrative action to result in a bank from the securities industry for defendants. The article finds that, for the same violation and comparable levels of harm to investors, big firms and their employees were more likely than smaller firms to avoid court and face administrative proceedings instead. These differences between courts and administrative proceedings might gain special importance if the SEC shows increased preference toward administrative proceedings in response to the recent setbacks it has faced in federal court.

Third, the article turns to administrative cases — in which the SEC’s claims arguably might carry more weight compared to court cases — to examine the type of sanctions the SEC pursues. Again, the article finds that, for the same violation and comparable levels of harm to investors, big firms and their employees were less likely to receive a ban from the securities industry, compared to small firms and their employees. The differential treatment of individual employees in large firms compared to individual employees in small firms is harder to justify from a public policy perspective.

This article’s detailed portrayal of SEC enforcement against this important segment of the financial industry has important implications for key theoretical debates. While corporate liability allows firm resources to complement payouts to harmed investors, it may be an imperfect deterrent when the firm cannot pass on the full impact of regulatory sanctions to employees who violate securities laws. For example, firms cannot ban finance professionals from the industry and prevent them from finding alternative employment or from starting their own ventures. Moreover, many are concerned that SEC officials who plan to leave the agency for a more lucrative position in the private industry might treat financial firms more favorably during their tenure. The article draws attention to the SEC’s policy of not including the names of SEC officials who negotiated administrative settlements in its public announcements. In contrast, names of agency officials who argued an SEC action in court are readily available in public records. Thus, the article concludes by calling for the SEC to disclose this information.

The full article is available for download here.