May 7, 2009

SEC Enforcement: Past, Present and Future

Before we all move on with the next phase of the SEC’s revived enforcement efforts, we still have occasion to review what may have helped get use into this mess. As reported in this Bloomberg story from yesterday, the GAO released a report at the end of March outlining the headwinds faced by the Enforcement Staff over the past several years. (Broc mentioned the report in the blog last month.) Today, the Senate Subcommittee on Securities, Insurance, and Investment of the Committee on Banking, Housing, and Urban Affairs will hold a hearing on strengthening the SEC’s enforcement responsibilities.

The Bloomberg story points out how the GAO found that the SEC instituted policies that “slowed cases and led enforcement-unit lawyers to conclude commissioners opposed fining companies.” As one unidentified Staffer put it, there was a feeling that the Commissioners prevented Enforcement from “doing its job.” The findings of the GAO’s report bear out my own experience during those years, not only with respect to Enforcement but also with respect to all other regulatory matters – hostility toward the Staff and its recommendations became institutionalized, which served to not only demoralize the Staff but also to result bad decisions being made at all levels.

The report also notes the use of executive sessions during former Chairman Cox’s tenure, where some Enforcement Staff were barred from participating. The report indicates that executive sessions occurred on 40% of the days when the SEC met to vote in closed Commission meetings in 2008, more than three times the rate in 2005 when Cox was appointed Chairman (but equal to the rate from 2003 and 2004).

As for the future of Enforcement, Chairman Schapiro reiterated her agenda for the Division of Enforcement in an address last week to the Society of American Business Editors and Writers. She noted that she has streamlined SEC enforcement procedures by no longer requiring full Commission approval to launch an investigation, and eliminating the need for approval by the full Commission before negotiating a settlement. She stated “before these directives, enforcement attorneys will tell you that they worried about red lights at every turn — now they see green.” This is sure to mean many more inquiries and, in all likelihood, much speedier cases as the Enforcement Division ramps up again.

SEC Brings First Credit Default Swap Insider Trading Case

Earlier this week the SEC filed a complaint alleging insider trading in credit default swaps. The SEC noted in its Litigation Release that this case is the first of its kind – and I suspect that it is certainly not the last case we will see regarding the much-maligned credit default swap market. Not only is the case novel in the sense that the alleged insider trading and tipping occurred with respect to credit default swaps, but it is also another notable case of the SEC alleging insider trading in fixed income markets. The SEC’s interest in this area was highlighted two years ago in the settled case of SEC v. Barclays Bank PLC, Litigation Release No. 20132 (May 30, 2007). (For more on the implications of that case, check out our “Insider Trading” Practice Area.)

In terms of the SEC’s jurisdiction over the trading in the OTC derivatives, the SEC noted in the complaint that “[t]he CDSs at issue in this matter qualify as security-based swap agreements under the Gramm-Leach-Bliley Act of 2002 and are therefore subject to the antifraud provisions set forth in Section 10(b) of the Exchange Act and the rules promulgated thereunder.”

Cracking Down on an Opinion Mill

While on an Enforcement theme here, I note that the SEC brought an action earlier this week against the operators of what the SEC called a Rule 144 “opinion mill.” In its Litigation Release, the SEC notes that it has filed a complaint against the operators of 144 Opinions, Inc., which runs the website They are alleged to have “issued fraudulent legal opinions used by promoters in a pump-and-dump scheme, and others, to sell securities in violation of the registration provisions of the federal securities laws.” Rule 144 opinions over the Internet – what will they think of next? Maybe we will have to start twittering Rule 144 opinions some day…

– Dave Lynn