Securities and Exchange Commission: Additional Actions Needed to Ensure Planned Improvements Address Limitations in Enforcement Division Operations
Published: 2007-08-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Securities and Exchange Commission's (SEC) ability to conduct investigations and bring enforcement actions for violations of securities laws is critical to its mission to protect investors and maintain fair and orderly markets. SEC's Division of Enforcement (Enforcement) is charged with investigating securities law violations; recommending civil enforcement actions when appropriate, either in a federal court or before an administrative law judge; and negotiating settlements on behalf of the Commission. The types of sanctions that Enforcement can seek on behalf of the Commission include monetary penalties or fines and disgorgements of the profits that individuals or companies may derive by having committed securities violations. While SEC has only civil authority, it also works with various law enforcement agencies, including the United States Department of Justice (Justice), to bring criminal cases when appropriate. In addition, Enforcement is responsible for overseeing the Fair Fund program, which seeks to compensate investors who suffer losses resulting from fraud or other securities violations by individuals and companies. Under the Fair Fund program, SEC can combine the proceeds of monetary penalties and disgorgements into a single fund and then distribute the proceeds to harmed investors. In recent years, Enforcement has initiated high-profile actions that resulted in record civil fines against companies and senior officers and in some cases contributed to criminal convictions. However, the capacity of SEC in general and Enforcement in particular to appropriately plan and effectively manage their activities and fulfill their critical law enforcement and investor protection responsibilities on an ongoing basis has been criticized in the past. Although SEC received a substantial increase in its appropriations as a result of the Sarbanes-Oxley Act of 2002, questions have been raised in Congress and elsewhere on the extent to which the agency is using these resources to better fulfill its mission. Moreover, we have reported that aspects of Enforcement's information systems and management procedures could limit the efficiency and effectiveness of its operations. For example, we found in 2004 that Enforcement faced challenges in developing the advanced information technology necessary to facilitate the investigative process. In addition, we reported in 2005 that the distribution of funds to harmed investors under the Fair Fund program was limited and that Enforcement had not developed adequate systems and data to fulfill its oversight responsibilities. Because of congressional interest in ensuring that SEC effectively manages its resources and helps ensure compliance with securities laws and regulations, Congress requested that we review key Enforcement management processes and systems and follow up on our previous work where appropriate. Accordingly, this report evaluates Enforcement's (1) internal processes and information systems for planning, tracking, and closing investigations and planned changes to these processes and systems; (2) implementation of SEC's Fair Fund program responsibilities; and (3) efforts to coordinate investigative activities with other SEC divisions and federal and state law enforcement agencies.
section_title: What GAO Found
paragraphs: Enforcement's processes and systems for planning, tracking, and closing investigations have had some significant limitations that have hampered the division's capacity to effectively manage its operations and allocate limited resources. While Enforcement and SEC officials are aware of these deficiencies and have recently begun addressing them, additional actions are necessary to help ensure that the planned improvements fully address limitations in the division's operations. In March 2007, Enforcement said it would centrally review and approve all new investigations of potential securities law violations by individuals or companies. Under Enforcement's previous, largely decentralized approach, the division was not always able to ensure the efficient allocation of resources or maintain quality control in the investigative process. While the new centralized approach was designed to help address these issues, Enforcement has not yet established written procedures and criteria for reviewing and approving new investigations. Without such procedures and criteria, Enforcement may face challenges in consistently communicating the new approach to existing and new staff. The lack of written procedures and criteria could also limit the Commission's ability to evaluate the implementation of the new approach and help ensure that the division is managing its operations and resources efficiently. Recognizing that the division's current information system for tracking investigations and enforcement actions--Case Activity Tracking System (CATS)--is severely limited as a management tool, Enforcement plans to start using a new system (the Hub) by late 2007. The deficiencies of CATS include its inability to produce detailed reports on investigations of certain types or the status of such investigations. While the Hub is designed to address many of CATS's deficiencies the way that the system is being implemented may not address all existing limitations. More specifically, Enforcement has not established written controls to help ensure that staff enter investigative data in the Hub in a timely and consistent manner. Without such controls, management reports generated by the Hub may have limited usefulness, and the system's capacity to assist Enforcement in better managing ongoing investigations will not be fully realized. In May 2007, Enforcement implemented procedures to help ensure the prompt closure of investigations that are no longer being pursued and thereby better ensure the fair treatment of individuals and companies under review, but these procedures do not fully address the entire backlog of these investigations. One regional Enforcement official said that as of March 2007, nearly 300 of the office's 840 open investigations were 2 or more years old, were no longer being pursued, and had no pending enforcement actions. Enforcement officials said that the failure to close such investigations promptly could have negative consequences for individuals and companies no longer suspected of having committed securities violations. They attributed the failure to close many investigations to several factors, such as time-consuming administrative requirements for attorneys to prepare detailed investigation closing memorandums that then must be routed to senior division officials for review and approval. To address these issues, Enforcement plans to inform individuals and companies more promptly that they are no longer under review and expedite the review and closure of the existing backlog of investigations for which administrative tasks have been completed (as of March 2007, there were 464 such investigations). However, Enforcement's plans do not include clearing the potentially large backlog of investigations for which such administrative tasks have not been completed, which could be negatively impacting individuals and companies no longer actively under review.

section_title: Letter
paragraphs: The Securities and Exchange Commission’s (SEC) ability to conduct  investigations and bring enforcement actions for violations of securities  laws is critical to its mission to protect investors and maintain fair and  orderly markets. SEC’s Division of Enforcement (Enforcement) is charged  with investigating securities law violations; recommending civil  enforcement actions when appropriate, either in a federal court or before  an administrative law judge; and negotiating settlements on behalf of the  Commission. The types of sanctions that Enforcement can seek on behalf  of the Commission include monetary penalties or fines and disgorgements  of the profits that individuals or companies may derive by having  committed securities violations. While SEC has only civil authority, it also  works with various law enforcement agencies, including the United States  Department of Justice (Justice), to bring criminal cases when appropriate.  In addition, Enforcement is responsible for overseeing the Fair Fund  program, which seeks to compensate investors who suffer losses resulting  from fraud or other securities violations by individuals and companies.  Under the Fair Fund program, SEC can combine the proceeds of monetary  penalties and disgorgements into a single fund and then distribute the  proceeds to harmed investors.
In recent years, Enforcement has initiated high-profile actions that  resulted in record civil fines against companies and senior officers and in  some cases contributed to criminal convictions. However, the capacity of  SEC in general and Enforcement in particular to appropriately plan and  effectively manage their activities and fulfill their critical law enforcement  and investor protection responsibilities on an ongoing basis has been  criticized in the past. Although SEC received a substantial increase in its  appropriations as a result of the Sarbanes-Oxley Act of 2002, questions  have been raised in Congress and elsewhere on the extent to which the  agency is using these resources to better fulfill its mission. Moreover, we  have reported that aspects of Enforcement’s information systems and  management procedures could limit the efficiency and effectiveness of its  operations. For example, we found in 2004 that Enforcement faced  challenges in developing the advanced information technology necessary  to facilitate the investigative process. In addition, we reported in 2005 that  the distribution of funds to harmed investors under the Fair Fund program  was limited and that Enforcement had not developed adequate systems  and data to fulfill its oversight responsibilities.
Because of your interest in ensuring that SEC effectively manages its  resources and helps ensure compliance with securities laws and  regulations, you requested that we review key Enforcement management  processes and systems and follow up on our previous work where  appropriate. Accordingly, this report evaluates Enforcement’s (1) internal  processes and information systems for planning, tracking, and closing  investigations and planned changes to these processes and systems; (2)  implementation of SEC’s Fair Fund program responsibilities; and (3)  efforts to coordinate investigative activities with other SEC divisions and  federal and state law enforcement agencies.
To address all three objectives, we obtained and reviewed relevant SEC  and Enforcement documentation and data. Specifically, we reviewed  documentation and data relating to Enforcement’s planning processes; its  automated system for tracking investigations and enforcement actions— the Case Activity Tracking System (CATS)—and a planned successor  system; the Fair Fund program; and internal and external coordination.  We also reviewed our relevant prior reports and federal standards for  internal controls. Further, we interviewed the SEC Chairman and two  commissioners, senior agency and Enforcement officials in Washington,  and officials in three SEC regional offices (Boston, New York, and  Philadelphia) that are responsible for a significant share of Enforcement’s  investigative activity. We also contacted Enforcement officials in other  SEC offices as appropriate. Additionally, we interviewed consultants that  assist Enforcement in developing plans to distribute funds to harmed  investors under the Fair Fund program.
We conducted our work in Washington, D.C., Boston, Massachusetts, New  York, New York, and Philadelphia, Pennsylvania, between November 2006  and July 2007 in accordance with generally accepted auditing standards.  Appendix I explains our scope and methodology in greater detail.
subsections: section_title: Background
paragraphs: SEC is an independent agency created in 1934 to protect investors;  maintain fair, honest, and efficient securities markets; and facilitate capital  formation. The agency has a five-member Commission that the President  appoints, with the advice and consent of the Senate, and that a Chairman  designated by the President leads. The Commission oversees SEC’s  operations and provides final approval of SEC’s interpretation of federal  securities laws, proposals for new or amended rules to govern securities  markets, and enforcement activities. Table 1 identifies several key SEC  units and summarizes their roles and responsibilities.
SEC’s current 2004-2009 strategic plan established four goals: (1) enforce  compliance with the federal securities laws, (2) promote healthy capital  markets through an effective and flexible regulatory environment, (3)  foster informed investment decision-making, and (4) maximize the use of  SEC resources. Enforcement and OCIE share joint responsibility for  implementing the agency’s first strategic goal. The Commission and the  Office of the Executive Director, which develops and implements all the  agency’s management policies, are updating the agency’s strategic plan,  which is to be issued in the summer of 2007.
Enforcement personnel are located in SEC’s home office in Washington,  D.C., as well as the agency’s 11 regional offices. Enforcement staff  located in the home office include the director and one of two deputy  directors, five investigative groups or Offices of Associate Directors, as  well as internal support groups, including its Offices of Chief Counsel and  Chief Accountant (see fig. 1). An associate director heads each Office of  Associate Director and has one or more assistant directors. Branch chiefs  report to assistant directors and supervise the work of investigative staff  attorneys assigned to individual investigations, with review and support  provided by division management. SEC regional office staff are typically  divided between Enforcement and OCIE personnel. Enforcement units in  the regional offices have Office of Associate Director structures similar to  those in the home office and report to the Director of Enforcement in  Washington, D.C.
The Sarbanes-Oxley Act of 2002 substantially increased SEC’s  appropriations, and Enforcement subsequently increased its staffing  levels. In 2002, Enforcement had 1,012 staff and, at the end of fiscal year  2006, 1,273 staff. As shown in figure 2, the number of investigative  attorneys in Enforcement increased substantially, from 596 in 2002 to 740  in 2005. However, the number of staff in Enforcement, in particular its  investigative attorneys, decreased from 2005 to 2006 because of a May  2005 hiring freeze (instituted across the agency in response to diminished  budgetary resources) and subsequent attrition. Since October 2006,  however, SEC has permitted Enforcement and other SEC divisions and  offices to replace staff that leave the agency. However, the agency does  not contemplate returning to early 2005 staffing levels. Appendix II  provides additional information on Enforcement’s staffing resources and  workload indicators.
Figure 3 provides a general overview Enforcement’s investigative process.  At the initial stage of the investigative process, attorneys evaluate  information that may indicate the existence of past or imminent securities  laws violations. The information can come from sources such as tips or  complaints from the public as well as referrals from other SEC divisions or  government agencies. If Enforcement staff decide to pursue the matter,  they will open either a Matter Under Inquiry (MUI) or an investigation.  Staff open a MUI when more information is required to determine the  merits of an investigation; otherwise, staff may open an investigation  immediately. Investigations can be conducted informally—without  Commission approval—or formally, in which case the Commission must  first approve a formal order if staff find it necessary to issue subpoenas for  testimony or documentation. Based on the analysis of collected evidence,  Enforcement will decide whether or not to recommend that the  Commission pursue enforcement actions, which can be administrative or  federal civil court actions (both of which must be authorized by the  Commission). Enforcement has established a variety of controls over the  enforcement action process, including reviews by senior division officials  in Washington, D.C., and, ultimately, review and approval by the  Commission. Enforcement has an information technology system— CATS—that tracks the progress of its MUIs, investigations, and  enforcement actions.
Enforcement also is responsible for implementing and overseeing the  Sarbanes-Oxley Act’s Fair Fund provision, which allows SEC to combine  civil monetary penalties and disgorgement amounts collected in  enforcement cases to establish funds for investors harmed by securities  laws violations. Fair Funds may be created through either SEC  administrative proceedings or litigation in U.S. District Court, and either  SEC or the courts may administer the funds. However, SEC is responsible  for general monitoring of all Fair Funds created. Typically, for SEC- ordered Fair Funds, the agency hires consultants to create Fair Fund  distribution plans (independent distribution consultants) and oversee  payments to harmed investors (fund administrators). However, in some  cases, SEC staff will take care of all of the distribution responsibilities  internally. The development of a Fair Fund plan can include estimating  losses suffered by harmed investors. For court-ordered funds, SEC  recommends a receiver or distributions agent, who creates a distribution  plan that is presented for court approval.
section_title: Enforcement Has Taken Steps to Better Manage the Investigative Process, but These Steps May Not Fully Address Existing Limitations
paragraphs: Enforcement’s approaches for planning, tracking, and closing  investigations have had some significant limitations that have hampered  its ability to effectively manage its operations, allocate limited staff  resources, and ensure the fair treatment of individuals and companies  under investigation. While SEC and Enforcement officials are aware of  these limitations and have begun addressing them, some of their actions  may not fully correct identified weaknesses. Specifically, Enforcement has  not (1) established written procedures and criteria for its newly  centralized review and approval process for new investigations, which  could limit its ability to ensure its consistent implementation and reduce  the Commission’s ability to oversee the division’s operations; (2)  established controls to help ensure the reliability of the investigative data  that division attorneys will be required to enter into a new information  system, which could limit the usefulness of management reports generated  by the system; and (3) established plans and procedures to ensure that all  investigations that are no longer being actively pursued are closed  promptly to reduce the negative impact on individuals and companies no  longer under review.
subsections: section_title: Enforcement Recently Centralized the Review and Approval of New Investigations, but the Lack of Written Procedures and Criteria Could Limit the Effectiveness of its Approach
paragraphs: To establish overall investigative priorities, Enforcement officials said that  they regularly communicate with senior SEC officials and their  counterparts in other agency units. For example, Enforcement officials  said that they hold weekly meetings with the SEC Chairman and other  commissioners as appropriate. During the Chairman’s tenure, he has  identified the pursuit of securities fraud against senior citizens as a key  investigative priority for Enforcement and other agency offices, including  OCIE. In addition to specific priorities, Enforcement officials said that  they seek to maintain a constant investigative presence across all areas of  potential securities violations (for example, insider trading abuses) and  that this “cover the waterfront” approach is designed to prosecute and  possibly deter securities law offenders. While an Enforcement official said  that the division has not established minimum quotas for different types of  investigations and enforcement actions, it will intervene if any one type  threatens to overwhelm the division’s operations. Based on internal  analysis of enforcement action data, Enforcement officials determined  that if the division’s pursuit of any type of securities enforcement action  exceeded 40 percent of total enforcement actions, an unacceptable  commitment of division resources would result.
While Enforcement has established planning processes for determining  overall priorities, the division has used a largely decentralized approach  for reviewing and approving individual new investigations, which may  have limited the division’s operational effectiveness, according to senior  SEC and Enforcement officials. Under this traditional approach, associate  directors in either SEC’s home or 11 regional offices approved the opening  of MUIs after staff came across a potential violation of federal securities  law. While Enforcement’s senior leadership in the home office reviewed  proposals for formal investigations and received weekly reports on MUIs  and new investigations that had been approved in each office (and  reviewed summaries of all investigations on a quarterly basis), it did not  have formal approval responsibility for such new MUIs and investigations.  According to Enforcement officials, staff in each office generally decided  to open MUIs and investigations based on considerations such as the  likelihood that they would be able to find and prove a violation of federal  securities laws, the potential amount of investor loss, the gravity of the  misconduct, and the potential message the case would deliver to the  industry and public. Typically, the staff attorney who opened the MUI was  responsible for conducting the investigation. According to Enforcement  officials, this decentralized approach was generally viewed as fostering  creativity in the investigative process and providing staff with incentives to  actively seek potential investigations.
However, without a centralized control mechanism for reviewing and  approving all new MUIs and investigations, Enforcement’s capacity to  ensure the efficient use of available resources, which is one of SEC’s four  strategic goals, was limited. For example, SEC’s Chairman, officials from  his office and the Office of the Executive Director, and Enforcement  officials said that the division has not always been able to prioritize or  ensure an efficient allocation of limited investigative staff resources.  Officials said that in some cases staff attorneys worked on investigations  that were outside of their geographic area (for example, San Francisco  staff conducting an investigation in the Atlanta region). Consequently, the  officials said that the division incurred travel and other related costs that  could have been minimized if a centralized process had been in place to  approve all new investigations. Further, one official from the Chairman’s  office said that without a formal quality check by senior Enforcement  officials, in some cases MUIs and investigations had been opened and  allowed to linger for years with little likelihood of resulting in enforcement  actions.
In March 2007, Enforcement began using a new, more centralized  approach to review and approve investigations. Under the new approach,  two deputy directors, who report directly to the Director of Enforcement,  are to review and approve all newly opened MUIs and investigations to  ensure the appropriateness of resource allocation considerations and  whether the MUI should be pursued. One deputy director is to review  MUIs opened in the division’s home office and another deputy director,  based in New York, is to review MUIs opened in regional offices. In  addition to the MUI review, after an investigation is open for 6 months,  staff will be required to prepare a memorandum with information on  evidence gathered to date, whether an enforcement action is likely,  resources, and estimated time frames for review by their deputy director.  According to Enforcement officials, the goal of this new approach is to  provide early assessments of whether an investigation ought to be pursued  further and resources reallocated. The deputy directors are also expected  to use this review to determine if the investigation is being conducted in a  timely manner, if it should be reprioritized based on Enforcement’s  current caseload, or if it should be closed.
While these are positive developments, Enforcement has not yet  established comprehensive written policies specifying how the new  approach will be carried out or the criteria that will be used to assess new  MUIs and ongoing investigations. According to our and Office of  Management and Budget (OMB) standards, documentation is one type of  control activity that will help ensure that management’s directives, such as  these new procedures, are carried out. In spring 2007, Enforcement  developed and distributed divisionwide a one-page planning document  that, among other items, identified the new centralized approach for  reviewing and approving MUIs and investigations. However, without the  establishment of agreed-upon and written procedures for carrying out the  new approach and relevant assessment criteria, the division may face  challenges in consistently communicating and explaining the new  approach to all current and new staff. Moreover, the Commission’s ability  to oversee how effectively Enforcement is implementing the new  approach and generally managing its operations may be limited. For  example, the lack of a transparent and documented standard could limit  the Commission’s capacity to identify inconsistencies in the  implementation of the new approach, determine whether any such  inconsistencies have affected Enforcement’s operations, and take  corrective action as warranted.
section_title: Planned Investigative Information System Has Significant Potential Benefits, but Enforcement Has Not Taken Sufficient Steps to Help Ensure Data Reliability
paragraphs: Enforcement officials have consistently stated that the division’s current  information system for tracking investigations and enforcement actions— CATS—is severely limited and virtually unusable as a management tool. In  particular, the officials have said that access to CATS is limited and the  system does not allow division management to generate summary reports,  which could be used to help manage operations on an ongoing basis.  Currently, the only summary reports CATS readily produces for  management review are lists of all open MUIs, investigations, and  enforcement actions by general violation types, such as violations  involving broker-dealers or investment advisers. CATS does not allow its  users to create timely reports on more specific topics, such as ongoing  investigations involving hedge funds, which do not exist as classification  fields in the system. As a result of the system’s limitations, several senior  Enforcement management officials said that they maintain their own  manual lists of certain types of investigations (such as those for hedge  funds) to assist in managing division activities.
Further, to obtain customized reports and statistics on Enforcement  operations, division officials said that they must submit requests to SEC’s  Office of Information Technology (OIT) and then wait for OIT staff to  create and run a computer program to respond to the request.  Enforcement officials said that OIT staff generally are responsive and  work very hard to address these requests; however, given their heavy  workload, one Enforcement official said that it generally takes 1-2 days to  receive the information, and more complex requests can take as long as a  week. Further, Enforcement officials said that obtaining technical support  for CATS can be difficult because the system is proprietary and the  company that created it is no longer in business. According to  Enforcement officials, CATS’s deficiencies result from the fact that the  system was hastily designed in preparation for expected year 2000  technical challenges.
Having recognized CATS’s limitations, SEC and Enforcement officials are  developing a new investigation information management system, called  the Hub, which is scheduled to be in use divisionwide by the end of fiscal  year 2007. According to Enforcement officials, division officials and staff  in SEC’s Boston office developed a prototype of the Hub in 2004 because  of their dissatisfaction with CATS. Subsequently, Enforcement, in  coordination with OIT, developed an enhanced version of the Hub, which  was then tested among home and regional office staff in late 2006 and  early 2007. Enforcement officials said that the Hub is an interim system  that will continue to interface with the CATS database until the second  phase of the Hub fully replaces CATS, which is expected to occur in fiscal  year 2009.
Although the Hub is an interim system, Enforcement officials said that it  will significantly enhance the division’s capacity to manage the  investigative process. In particular, the officials said that the Hub will  facilitate the creation of a variety of management reports on the division’s  investigative activities, including detailed reports on ongoing  investigations by certain types (for example, reports on the number of  hedge fund investigations). The Hub will also provide more detailed  information on the status of investigations so management can better  track their progress and timeliness. Further, the officials said that the Hub  is designed to be (1) generally accessible to all division staff, although  highly sensitive investigative information will be restricted on a need-to- know basis; (2) user-friendly, primarily employing drop-down menus for  data entry; (3) searchable so that staff can identify relevant information  associated with an investigative matter; and (4) flexible, because new data  fields can be added. We reviewed prototype screens for the Hub and found  that they were consistent with the descriptions of Enforcement officials,  and staff we contacted generally made favorable comments about the  system.
However, due to significant planned changes to Enforcement’s traditional  approach for recording investigative data, there is a risk that data may not  be entered into the Hub on a timely and consistent basis, as required by  federal internal control standards. Enforcement has traditionally required  support personnel or case management specialists (rather than attorneys)  to enter investigative data into CATS because of the limited access to the  system and its lack of user friendliness. However, once the Hub is  implemented in late 2007, Enforcement officials said that they plan to  require division attorneys to enter relevant data into the system for all  investigations opened after that date. Further, Enforcement officials said  that attorneys will be responsible for entering relevant data into the Hub  for ongoing investigations that are being actively pursued but were  initiated prior to the system’s implementation. Enforcement officials  regard the entry of such data as critical; otherwise, management reports  generated by the Hub would only include information on investigations  begun after the system’s scheduled implementation in late 2007. One  Enforcement official said that the decision to require attorneys to enter  data into the Hub was based on the view that such attorneys have first- hand knowledge of ongoing investigations and thus would be able to  streamline the process. However, another Enforcement official said that  requiring attorneys to maintain timely, accurate, and consistent  investigative data in the Hub would require a cultural change on the  attorneys’ part because they have become accustomed to relying on case  management specialists to perform this task. Another Enforcement official  questioned whether division attorneys would enter investigative data into  the Hub on a timely and consistent basis because they may view doing so  as another administrative requirement diverting them from their primary  investigative responsibilities.
While Enforcement’s plans to require attorneys rather than case  management specialists to enter data into the Hub may be appropriate, the  division plans only a limited number of actions to ensure that data entered  into the system are timely, consistent, and reliable. For example,  Enforcement plans to train attorneys on the Hub as it is implemented and  is developing a system user manual. However, Enforcement is not  developing written guidance identifying data entry into the Hub as a  priority for division attorneys and specifying how and when such data  entry is to be done. Moreover, Enforcement has not yet established a  written process that would allow division officials to independently review  and determine the extent to which data entry for the Hub is performed on  a timely, consistent, and reliable basis in accordance with federal internal  control standards. Without doing so, the usefulness of management  reports generated by the Hub may be limited, and the system’s potential to  significantly enhance Enforcement’s capacity to better manage the  investigative process may not be fully realized.
section_title: Enforcement Has Planned Improvements to Its Investigation Closure Processes, but Plans May Not Fully Address Backlog of Cases
paragraphs: Enforcement may leave open for years many investigations that are not  being actively pursued with potentially negative consequences for  individuals and companies no longer under review. According to CATS  data, about two-thirds of Enforcement’s nearly 3,700 open investigations  as of the end of 2006 were started 2 or more years before, one-third of  investigations at least 5 years before, and 13 percent at least 10 years  before. According to an Enforcement official, technical limitations in  CATS make it difficult to readily determine how many of these  investigations resulted in enforcement actions and how many did not.  Nevertheless, other data suggest that the number of aged investigations  that did not result in an enforcement action may be substantial. For  example, Enforcement officials at one SEC regional office said that as of  March 2007, nearly 300 of 841 open investigations (about 35 percent) were  more than 2 years old, had not resulted in an enforcement action, and  were no longer being actively pursued.
Enforcement officials cited several reasons for division attorneys not  always closing investigations promptly. In particular, the officials said that  Enforcement attorneys may view pursing potential securities violations as  the division’s highest priority and lack sufficient time, administrative  support, and incentives to comply with established administrative  procedures for closing investigations. For example, Enforcement requires  attorneys to complete closing memoranda for each investigation that is to  be closed. These memoranda must identify why the investigation was  opened, describe the work performed, and detail the reasons for  recommending that the investigation be closed without an action. Staff  must also prepare draft termination letters, which inform individuals or  companies that they are no longer under review. A closing memorandum  is also required for investigations with associated enforcement actions. In  these cases, the staff attorney must account for all ordered relief before  the investigation is closed. One regional Enforcement official estimated  that it could take as long as a month for a staff attorney to complete this  process and submit the closing package to the home office, although  senior division officials noted that attorneys typically would not spend all  their time doing so. Once closing packages are received by the home  office, Enforcement’s Office of Chief Counsel must then approve the  closing of the investigation, at which point final termination letters are  sent to affected individuals and companies.
Enforcement officials in SEC’s home office said that a lack of resources in  their office also contributed to delays in closing investigations. They noted  that only one person in the division was assigned to processing closing  packages for investigations. Consequently, the officials said there was a  backlog of investigations for which the closing package had been  completed but not reviewed. As of March 1, 2007, the backlog consisted of  464 investigations, according to an Enforcement official.
However, Enforcement officials told us that in May 2007 they began  eliminating the backlog of investigations with completed—but  unreviewed—closing packages and had almost eliminated the backlog by  mid-June 2007. The division recently added one staff person to work on  administering closing procedures in the home office, and Enforcement  officials have set a goal of processing new closing documentation within 2  weeks of receipt.
Also in May 2007, Enforcement implemented revised procedures for  sending termination letters for investigations that will not result in an  enforcement action. Under the procedures, Enforcement will send the  letters to individuals and companies at the start of the closing process  rather than at the end. This particular effort will be emphasized on  Enforcement’s intranet—EnforceNet. Enforcement officials said they  changed this procedure out of concerns about fairness to those under  investigation and to reduce any negative impact an open investigation may  have on them. For example, a company may bar an individual from  performing certain duties until a pending SEC investigation is resolved.  Staff are generally encouraged to close investigations if they know they  will not be bringing any enforcement actions, even if all of their  investigative steps have not yet been completed.
While the above steps are a positive development, they do not address the  potentially large backlog of investigations that are not likely to result in  enforcement actions and for which closing packages have not been  completed. As a result, the subjects of many aged and inactive  investigations may continue to suffer adverse consequences until closing  actions are completed. We recognize that reviewing and resolving this  potentially large backlog of investigations and enforcement actions likely  would impose resource challenges for Enforcement. Nevertheless, the  failure to address this issue—potentially through expedited administrative  closing procedures for particularly aged investigations—would limit  Enforcement’s capacity to manage its operations and ensure the fair  treatment of individuals and companies under its review.
section_title: Enforcement’s Management of Fair Funds May Have Contributed to Distribution Delays, and the Division Lacks Data Necessary for Effective Program Oversight
paragraphs: According to available SEC data, the distribution of funds to harmed  investors under the Fair Fund program remains limited after 5 years of  operation. Enforcement officials, as well as consultants involved in Fair  Fund plans, have cited a variety of reasons for the slow distribution,  including challenges in identifying harmed investors, the complexity of  certain Fair Funds, and the need to resolve tax and other issues. However,  the largely decentralized approach that Enforcement and SEC have used  in managing the Fair Fund program may also have contributed to  distribution delays. SEC has announced plans to create a central Fair  Funds office, but it is too early to assess this proposal, as final  determinations about its staffing, roles and responsibilities, and  procedures have not yet been determined. Further, Enforcement does not  yet collect key data necessary to effectively monitor the Fair Fund  program (such as data on fund administrative expenses for ongoing plans)  because an information system designed to capture such data is not  expected to be implemented until 2008. In the meantime, Enforcement has  not ensured that reports intended to provide expense data for completed  Fair Fund plans contain consistent information or are analyzed. Until  Enforcement clearly defines the Fair Fund office’s oversight roles and  responsibilities and officials establish procedures to consistently collect  and analyze additional data, the division will not be in an optimal position  to help ensure the effective management of the Fair Fund program.
subsections: section_title: Fair Fund Distributions Have Been Limited
paragraphs: As of June 2007, Enforcement officials said that they were tracking 115  Fair Funds created since the program’s inception in 2002—up from the 75  identified in our 2005 report—largely because funds were created as part  of a series of enforcement actions against mutual fund companies. The  Fair Fund plans vary considerably in size and complexity, ranging from  plans for small broker-dealers with relatively few customers to large  corporate cases, according to SEC data. The smallest Fair Fund plan  established (measured by the amount of funds ordered returned to  investors) was $29,300 for alleged fraud at a hedge fund; the largest was  $800 million for alleged securities fraud at American International Group,  Inc. (AIG). Table 2 shows the 10 largest Fair Funds ordered through June  2007; 7 are court-created plans, and 3 have been established through SEC  administrative proceedings. SEC monitors all Fair Fund plans regardless  of their source.
According to SEC data, from 2002 to 2007, federal courts and SEC  administrative proceedings ordered individuals and entities subject to SEC  enforcement actions to pay a total of $8.4 billion into Fair Fund plans, an  increase of about 75 percent from the $4.8 billion total Fair Funds we  identified in our 2005 report. As of June 2007, $1.8 billion of the $8.4 billion  (about 21 percent) had been distributed to harmed investors, according to  SEC data. As shown in table 3, the amount distributed from court-overseen  plans exceeded that distributed from SEC-overseen plans. According to  Enforcement officials, the funds were distributed more slowly from SEC- overseen plans largely because much of the money ordered through SEC  proceedings involves mutual fund market timing matters, which, as  discussed later, are among the most complex Fair Fund plans.
section_title: Fair Fund Distribution Delays Have Been Attributed to Difficulties in Identification of Harmed Investors, the Complexity of Certain Cases, and Tax Issues
paragraphs: According to Enforcement officials and consultants who work on Fair  Funds, a key reason for the slow distribution of Fair Funds has been the  difficulty of identifying harmed investors in certain cases. Unlike typical  securities class action lawsuits, Fair Funds may not rely on a claims-based  process in which injured parties identify themselves by filing claims with  trustees or other administrators. For example, in Fair Fund cases involving  mutual fund market timing abuses, which account for many funds ordered  into Fair Fund plans, Enforcement attorneys and plan administrators have  assumed responsibility for identifying harmed investors. This step was  taken because with the large number of affected investors and the nature  of market timing violations, many such investors may not even have been  aware that their accounts experienced losses. One Fair Fund plan  consultant said that many harmed investors already had redeemed their  shares in the affected mutual fund companies in prior years. Tracking  down such former customers can be challenging because they may have  changed their addresses several times, the consultant said. Several  consultants and Enforcement officials also said that tracking down  customers can be hard because securities brokers, through whom  individuals may purchase mutual funds, may maintain customer account  information rather than the mutual fund company itself. As a result, a  Fair Fund administrator might need to contact and obtain the cooperation  of relevant broker-dealers to obtain customer account information and  make related distributions.
The complexity of some cases can also impede the timely distribution of  Fair Funds. For example, in mutual fund market timing cases,  sophisticated analysis might be required to first identify trades that  benefited from improper activity and then to calculate profits earned from  those transactions and associated losses to investors, which may be  spread across many such customers. According to a Fair Fund plan  consultant and Enforcement officials, another significant challenge to the  Fair Fund distribution involves retirement plans and the Employee  Retirement Income Security Act of 1974 (ERISA), the federal law setting  minimum standards for pension plans in private industry. Retirement  plans hold assets on behalf of their beneficiaries, and it is not unusual for  those assets to be invested with entities that become subject to Fair Fund  enforcement actions. Thus, ERISA-covered retirement plans will be  entitled to Fair Fund proceeds by virtue of such investments. But  depending on circumstances, a Fair Fund distribution consultant may  need to make determinations on a variety of complex issues before funds  can be distributed, such as determining when such distributions become  plan assets under ERISA. One Fair Fund consultant told us he spent a  year waiting for Department of Labor clarification of relevant ERISA  issues.
Finally, determining the tax treatment of funds may also slow the  distribution process. According to Fair Fund consultants, tax information  must accompany Fair Fund distributions to investors so that recipients  have some idea of how to treat their payments for tax purposes.  Consultants and Enforcement officials told us that determining  appropriate tax treatment has been time-consuming as they had no  precedents upon which to draw. Depending on circumstances, an  investor’s recovery of disgorged profits can constitute ordinary income or  a capital gain—which can be taxed at different rates—or not represent  taxable income at all. SEC ultimately hired a consulting firm to handle tax  issues. One Fair Fund consultant told us that obtaining tax guidance from  the Internal Revenue Service delayed the plan’s distribution by about 1  year.
section_title: Enforcement’s Approach to Managing Fair Funds May Also Have Slowed Distributions, and SEC Has Not Defined Responsibilities of a New Office to Administer the Program
paragraphs: In addition to the factors discussed above, Enforcement’s largely  decentralized approach to managing the process may also have  contributed to delays in the distribution of Fair Funds. Currently,  Enforcement staff attorneys in either SEC’s home office or 1 of its 11  regional offices who are pursuing individual enforcement cases take a lead  role in the Fair Funds process, overseeing much of the work necessary to  establish and maintain a fund. This includes supervising cases directly,  overseeing consultants who design or administer distribution plans, and  advising or petitioning courts presiding over Fair Fund plans. Enforcement  officials said that the approach made sense from a Fair Fund  administration standpoint because division attorneys have substantial  knowledge of the regulated entity involved and the relevant enforcement  action. Enforcement officials also said that senior officials in the home  office have always played an important role in the oversight of the  program. Their responsibilities have included providing guidance on  selecting consultants, leading information-sharing and problem-solving  efforts (for example, leading regular conference calls among fund  consultants, parties involved in Fair Fund enforcement actions, their legal  counsel, and SEC staff in Enforcement and elsewhere), and reviewing  proposed Fair Fund distribution plans and recommending modifications  as necessary.
Outside consultants hired to design and implement Fair Fund plans told us  that Enforcement staff attorneys assigned to their cases were dedicated  and responsive and that the agency appears to be making a good faith  effort to implement and oversee the Fair Funds provision. However, they  also said that Enforcement’s delegated approach has resulted in delays,  higher costs, and unnecessary repetition of effort. With different  Enforcement staff handling different Fair Fund cases, the consultants said  that Enforcement forgoes the opportunity to build institutional expertise  and efficiencies. For example, one consultant said that Enforcement’s  delegated management of the Fair Fund program has resulted in  inefficiencies in key administrative aspects of the program, such as the  development of standardized means of communicating with investors (for  example, form letters) and the mechanics for distributing funds to them.  Consequently, the consultant said that the Fair Fund program incurs a  substantial amount of unnecessary administrative costs. Further, the  consultants generally agreed that it would make sense for SEC to consider  centralizing at least some aspects of the administration of Fair Fund plans  to improve the efficiency of the distribution process.
While Enforcement officials have cited benefits associated with the  current management of the program, both SEC and division officials also  acknowledged that it has created challenges. An official within the  Chairman’s office said that the slow distribution of funds to harmed  investors is of significant concern to the agency and that the lack of a  centralized management approach has limited the development of  standardized policies and controls necessary to facilitate disbursements.  Further, Enforcement officials said that while Fair Fund work is  important, it can divert investigative attorneys from pursuing other cases.  The officials said that the Fair Fund workload on any particular case  varies over time, but during peak periods it can consume about 50 to 75  percent of a staff attorney’s time. At one SEC regional office, Enforcement  officials said that administering the Fair Fund program has resulted in a  significant commitment of attorneys’ time, especially because the office  lost almost 25 percent of its investigative staff due to attrition in the past  year or so.
In response to concerns about the slow distribution of Fair Fund proceeds  to harmed investors, SEC’s Chairman took two actions in 2007. First, he  established an internal agency committee to examine the program’s  operation. The committee—which includes representatives from  Enforcement, General Counsel, the Office of the Secretary, and the Office  of the Executive Director—is assessing lessons learned in program  implementation, the agency’s selection of consultants to administer the  plans, and SEC’s policies and procedures for managing the program. An  Enforcement official said that the committee is expected to complete its  analysis by September 30, 2007. Second, in March 2007, the Chairman  announced plans to create a centralized Fair Fund office. The Chairman  stated that the purpose of the new office is to develop consistent fund  distribution policies and dedicate full-time trained staff to ensure the  prompt return of funds to harmed investors.
While creating a central office within SEC could facilitate the distribution  of Fair Funds, it was not yet possible to assess the planned office’s  potential impact at the time of our review. For example, SEC had not  announced which SEC unit the office would report to, although one  official said that the office probably would be located within Enforcement.  Further, SEC had not staffed the new Fair Fund office and had not  established the roles and responsibilities of the new office or written  relevant policies and procedures. For example, SEC had not determined  the extent to which the new office might assume complete responsibility  for managing at least some Fair Fund plans, although it is expected the  office will continue to provide support to division attorneys who currently  manage such plans. Until such issues are resolved, the new office’s  potential efficiency in more quickly distributing Fair Fund proceeds to  harmed investors will not be realized.
section_title: Enforcement Does Not Yet Collect Key Data Necessary to Effectively Oversee the Fair Funds Program
paragraphs: Enforcement does not collect key data, as we recommended in 2005, to aid  in division oversight of the Fair Fund program. In particular,  Enforcement does not systematically collect data on administrative  expenses for all ongoing Fair Fund plans. These costs range from fees and  expenses that Fair Fund administrators and consultants charged to the  costs of identifying harmed investors and sending checks to them.  Approximately two-thirds of individual Fair Funds pay for administrative  costs from fund proceeds, so that the greater the administrative expenses,  the less money is available for distribution to harmed investors, according  to our analysis of SEC Fair Fund information. However, without data on  administrative expenses charged, Enforcement cannot judge the  reasonableness of such fees and take actions as necessary to minimize  them.
Enforcement officials generally attributed SEC’s inability to implement  our 2005 recommendation to changes in priorities for the development of  the agency’s information systems. After we issued our 2005 report,  Enforcement officials said they began working to modify the CATS system  so that it could better track Fair Fund administrative expenses and other  data. However, SEC ultimately decided to accelerate the development of a  new financial management system for the division, called Phoenix. SEC  and Enforcement officials said that the agency implemented the first phase  of Phoenix in February 2007. The first phase includes limited information  relevant to the Fair Fund program (the amount of money ordered in  penalties and disgorgement and the amount paid to the agency), but it  does not include data on such items as fund administrative expenses.  Enforcement officials told us that a second phase of the Phoenix system  will contain additional features for more complete management and  monitoring of Fair Fund activity, consistent with our 2005  recommendation. According to Enforcement officials, Phoenix II has been  funded and is expected to be in place in 2008. Until Phoenix II is  implemented and tested, Enforcement officials will continue to lack  information necessary for effective Fair Fund management and oversight.
We also note that in the meantime, Enforcement has not leveraged reports  that could enhance the division’s understanding of Fair Fund expenses,  including administrative expenses. SEC rules generally require that final  accounting reports be prepared when SEC-overseen Fair Funds are fully  distributed and officially closed. We reviewed four such reports and  found that three of them were inconsistent in data reported and did not  include comprehensive accounting information. For example, two of the  accounting reports did not include complete data on the expenses  incurred to administer the Fair Fund plan. Further, senior Enforcement  officials said that the division could improve its analysis of information  contained in the reports. As a result, Enforcement cannot evaluate the  reasonableness of administrative expenses for individual Fair Fund plans  or potentially gain a broader understanding of the reasonableness of such  expenses among a variety of plans.
section_title: Enforcement Coordinates Its Investigative Activities Internally and with Other Agencies and Is in the Process of Documenting Criminal Referrals
paragraphs: Enforcement has established a variety of processes to coordinate its  investigative and law enforcement activities with other SEC offices.  Further, Enforcement has established processes to coordinate its  investigative activities with other law enforcement agencies, including  Justice. However, Enforcement and SEC have not yet implemented our  2005 recommendation that they document referrals of potential criminal  activity to other agencies, although plans to do so have been established as  part of the division’s new investigation management information system  (the Hub). Until Enforcement completes this process, its capacity to  effectively manage the referral process is limited.
subsections: section_title: Enforcement Coordinates with Other SEC Units through Regular Meetings and a Referral Process
paragraphs: Enforcement officials said that they hold a variety of meetings periodically  to coordinate investigative and other activities within SEC. As discussed  previously, senior Enforcement officials said they meet regularly with the  SEC Chairman and commissioners to establish investigative priorities.  According to the Director of Enforcement, she meets weekly with the  heads of other SEC divisions, and other senior division officials said that  they meet periodically with their counterparts in other agency units.  Enforcement officials cited their coordination with other SEC units on  investigations of the backdating of stock options as an example of the  agency’s successful collaborative efforts. One Enforcement official said  that division staff worked closely with the Office of Economic Analysis to  analyze financial data and trends related to options backdating, which  allowed them to identify patterns used to target companies for further  investigation. This official said that Enforcement also collaborated with  the Office of the Chief Accountant, the Division of Corporation Finance,  and the Office of the General Counsel throughout this effort.
Enforcement officials also said that coordinating their activities with OCIE  is particularly important and that the division places a high value on  referrals it receives from OCIE regarding potentially illegal conduct.  Enforcement officials said that because OCIE staff regularly examine  broker-dealers, investment advisers, and other registered entities, they  have a broad perspective on compliance with securities laws and  regulations. Enforcement officials in SEC’s Philadelphia regional office  estimated that about 30 or 35 percent of the enforcement actions the  Philadelphia office initiates are based on referrals from OCIE staff. They  cited one notable recent insider trading case—involving broker-dealer  Friedman, Billings, Ramsey & Co., Inc., and which was among the first  cases of its kind since the 1980s—as stemming from a referral from an  OCIE examination.
However, other Enforcement officials said that historically they have had  some concerns about limitations in information contained in OCIE  referrals. These concerns centered on how clearly OCIE identifies  potentially improper conduct in its referrals and how much evidence it  provides in support of such matters. As a result, in November 2006, OCIE  and Enforcement instituted a process that would provide a more formal  review of the nature and quality of OCIE referrals. According to OCIE and  Enforcement officials, the new procedures expand and formalize a  preexisting committee process for reviewing OCIE referrals to  Enforcement and communicating the ultimate outcome of those referrals  to OCIE. The officials said the revised procedures were instituted to (1)  help identify the types of OCIE referrals that were likely (or not) to result  in enforcement actions and (2) provide better information to OCIE on the  ultimate disposition of its referrals.
Enforcement officials noted that the division receives many more referrals  from OCIE than from any other SEC division or office; therefore,  developing a formal committee and tracking process for other internal  referrals has not been viewed as warranted. SEC also receives referrals  from self-regulatory organizations (SRO)—such as what is now the  Financial Industry Regulatory Authority (FINRA)—often involving  allegations of insider trading, which are received by Enforcement’s Office  of Market Surveillance (OMS). In a forthcoming report, we assess OMS’s  and Enforcement’s processes for reviewing and prioritizing these SRO  referrals.
section_title: Enforcement Coordinates with Law Enforcement and Other Regulators and Plans to Document Criminal Referrals in New Information Management System
paragraphs: Enforcement officials also said that division staff have established  processes to coordinate their investigative activities and working  relationships with other law enforcement and regulatory agencies. For  example, Enforcement officials in SEC’s regional offices said they have  established effective working relationships with U.S. attorney offices to  prosecute alleged criminal violations of the securities laws. In our 2005  report, we discussed how Enforcement worked with Justice and state  attorneys general to prosecute investment advisers that allegedly violated  criminal statutes related to market timing and late trading. In some cases,  Enforcement details investigative attorneys to Justice to assist in the  criminal prosecution of alleged securities law violators. Other outside  organizations with which SEC and Enforcement coordinate investigative  activities include the Federal Bureau of Investigation, federal banking  regulators, the Commodity Futures Trading Commission, state securities  regulators, and local police. Enforcement also participates in interagency  investigative task forces, such as the Corporate Fraud Task Force, the  Bank Fraud Enforcement Working Group, and the Securities and  Commodities Fraud Working Group.
Additionally, in March 2007, Enforcement held its annual conference at  SEC’s Washington headquarters on securities law enforcement, which  federal and state regulators and law enforcement personnel attended.  Topics covered included coordination of SEC investigations with criminal  law enforcement agencies and advice on trying a securities case. SEC also  conducted sessions on market manipulation, insider trading, financial  fraud, stock options backdating, and executive compensation. In  September 2007, Enforcement will join other SEC units in hosting the  Commission’s second Seniors Summit, at which SEC, other regulators, and  law enforcement agencies will discuss how to work together to address  the growing problem of fraud targeting the nation’s senior citizens.
Although Enforcement officials say they are planning to do so, they have  not yet fully implemented our 2005 recommendation to document  Enforcement’s referrals of potential criminal matters—and the reasons for  making them—to other law enforcement agencies. As discussed in that  report, SEC has established a policy under which Enforcement attorneys  may make referrals on an informal basis to Justice and other agencies with  authority to prosecute criminal violations. That is, Enforcement attorneys  may alert other agencies to potential criminal activity through phone calls  or meetings, and such referrals need not be formally approved by the  division or the Commission. We noted that such an informal referral  process may have benefits, such as fostering effective working  relationships between SEC and other agencies, but also found that  Enforcement did not require staff to document such referrals. Appropriate  documentation of decision-making is an important management tool.  Without such documentation, Enforcement and the Commission cannot  readily determine whether staff make appropriate and prompt referrals.  Also, the division does not have an institutional record of the types of  cases that have been referred over the years. However, Enforcement  officials told us that the forthcoming Hub system will include data fields  that indicate when informal referrals of potential criminal activity have  been made.
section_title: Conclusions
paragraphs: In recent years, SEC’s Enforcement division and investigative attorneys  have initiated a variety of high-profile enforcement actions that resulted in  record fines and other civil penalties for alleged serious securities  violations and contributed to criminal convictions for the most egregious  offenses. While Enforcement has demonstrated considerable success in  carrying out its law enforcement mission, some significant limitations in  the division’s management processes and information systems have  hampered its capacity to operate at maximum effectiveness and use  limited resources efficiently. One key reason for these limitations appears  to have been Enforcement’s management approach, which emphasized a  broad delegation of key functions with limited centralized management  review and oversight, particularly in the approval and review of new  investigations and the administration of the Fair Fund program.  Delegation of authority is an important management principle that can  foster creativity at the local level and, in the case of Enforcement, likely  had some benefits for the investigative process and the administration of  the Fair Fund program. However, without well-defined management  processes to exercise some control over delegated functions, inefficient  program implementation and resource allocation can also occur.
Officials from Enforcement and the Offices of the Chairman and Executive  Director have recognized limitations in the division’s operations and taken  important steps to establish more centralized oversight procedures. In  particular, they have centralized the review and approval of new  investigations, moved forward to upgrade or replace information systems  key to division operations and management, and announced the creation  of a new Fair Fund office. However, as described below, these plans  require additional actions to fully address identified limitations and  maximize the division’s operational effectiveness.
Enforcement has not developed written procedures and criteria for  reviewing and approving new investigations. Establishing such guidance  would help focus the review of investigations and reinforce the  consistency of reviews, as intended by the centralization of this function,  and assist in communicating the new policies to all current and new staff.  Further, developing written procedures and criteria would establish a  transparent and agreed-upon standard for the review and approval of new  investigations and thereby facilitate the Commission’s ability to oversee  and evaluate the division’s operations and resource allocation.
Enforcement has not developed written controls to help ensure the timely  and consistent entry of investigative data in the Hub information system,  which could increase the risk of misleading or inaccurate management  reports being generated by the system. Without written guidance and the  establishment of independent and regular reviews of the accuracy of Hub  data by division officials, Enforcement is not well positioned to help  ensure that it is receiving reliable program information. Further, the lack of guidance and controls may limit the new system’s capacity to better  manage the investigation process.
Enforcement’s potentially large backlog of investigations for which closing  memoranda and other required administrative procedures have not been  completed requires division management’s attention. We recognize that  clearing this potentially large backlog could pose challenges to  Enforcement given the resource commitment that would be required to do  so. Nevertheless, leaving such investigations open indefinitely continues to  compromise management’s ability to effectively manage its ongoing  portfolio of cases. Moreover, it has potentially negative consequences for  individuals and companies that are no longer under investigation.
SEC has not yet staffed or defined the roles and responsibilities of the new  office that is being established to administer the Fair Fund program.  Therefore, it is not possible to determine the extent to which the office  may better facilitate the distribution of funds to investors harmed by  securities frauds and other violations. While Enforcement awaits the  development and implementation of a new information system that would  collect comprehensive information on Fair Fund expenses for ongoing  plans (for example, administrative expenses), the division has not taken  other steps that would, in the meantime, allow it to develop a better  perspective on the reasonableness of such expenses. That is, Enforcement  has not ensured the consistency of information contained in reports on  completed Fair Fund plans or sufficiently analyzed such reports,  compromising its capacity to monitor the program.
Given SEC and Enforcement’s critical law enforcement mission, it is  important that senior officials ensure that weaknesses in their planned  improvements be addressed and implementation monitored. Without a full  resolution of existing limitations, a significant opportunity to further  enhance the division’s effectiveness may be missed.
section_title: Recommendations for Executive Action
paragraphs: To strengthen Enforcement’s management processes and systems and  help ensure compliance with securities laws, we recommend that the  Chairman of the Securities and Exchange Commission direct the Division  of Enforcement and other agency offices, such as the Office of Information  Technology or Office of the Executive Director, as appropriate, to take the  following four actions:    establish written procedures and criteria on which to base the review and  approval of new investigations;   establish written procedures that reinforce the importance of attorneys  entering investigative data into the Hub, provide guidance on how to do so  in a timely and consistent way, and establish a control process by which  other division officials can independently assess the reliability of  investigative data maintained in the system;   consider developing expedited administrative and review procedures for  closing investigations that have not resulted in enforcement actions and  are no longer being actively pursued; and    establish and implement a comprehensive plan for improving the  management of the Fair Fund program, to include (1) staffing the new  central Fair Fund office, defining its roles and responsibilities, and  establishing relevant written procedures and (2) ensuring the consistency  of and analyzing final accounting reports on completed Fair Fund plans.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Chairman of SEC for comment,  and he and the Director of the Division of Enforcement provided written  comments that are reprinted in appendix III. In its written comments, SEC  agreed with our conclusions and stated it would implement all of our  recommendations. Moreover, SEC officials noted that the agency has since  established that the new Fair Fund office—referred to as the Office of  Distributions, Collections and Financial Management—will be located  within the Division of Enforcement. SEC officials said that a senior officer  and two assistant directors will lead the operations of the office and the  agency is developing the office’s responsibilities. SEC also provided  technical comments, which we have incorporated as appropriate.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution of this report until 30  days from the report date. At that time, we will provide copies to the  Chairman of the Senate Committee on Finance; the Chairman and Ranking  Member of the Senate Committee on Banking, Housing, and Urban Affairs;  the Chairman and Ranking Member of the House Committee on Financial  Services; and other interested committees. We are also sending a copy of  this report to the Chairman of the Securities and Exchange Commission.  We will make copies available to others upon request. In addition, the  report will be available at no charge on our Web site at  http://www.gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report. If  you or your staff have any questions about this report, please contact me  at (202) 512-8678 or williamso@gao.gov. Key contributors are  acknowledged in appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: To address our first objective—evaluating the Securities and Exchange  Commission (SEC) Division of Enforcement’s (Enforcement) internal  processes and information systems for planning, tracking, and closing  investigations and planned changes to these processes and systems—we  reviewed relevant SEC and Enforcement documentation and data,  including the agency’s strategic plan, annual performance reports,  performance measurement data, investigation and enforcement action  data from the Case Activity Tracking System (CATS), and Enforcement  personnel data. We also reviewed guidance on Enforcement’s intranet— EnforceNet—to determine internal procedures for conducting and  managing the investigation process and obtained documentation and  attended demonstrations for the first phase of Enforcement’s new planned  successor system for CATS (the Hub) and for the base model system for  the Hub (M&M). We also reviewed prior GAO reports on SEC and  Enforcement processes and information technology systems, as well as  federal internal control standards. Further, we interviewed the SEC  Chairman, two commissioners, officials from SEC’s Offices of the  Executive Director and General Counsel, and Enforcement officials in  Washington and the agency’s New York, Boston, and Philadelphia regional  offices.
To address our second objective—evaluating the implementation of SEC’s  Fair Fund responsibilities—we reviewed a 2005 GAO report that discussed  SEC’s Fair Fund process, as well as relevant legislation. We also obtained  and analyzed summary Fair Fund statistics and documentation and data   on individual funds, as provided by Enforcement. However, Enforcement  did not provide data on 24 Fair Fund plans that were identified in our 2005  report. Among the reasons Enforcement officials cited for the omissions  were that some of the 24 funds had been fully distributed and thus were  not included in an information system established in 2006 that was  designed to track only ongoing plans. However, these 24 Fair Fund plans  are generally smaller (accounting for about $118 million or 1 percent of  total Fair Funds), and their exclusion does not change our overall  conclusion that distributions have been limited.
In addition to Fair Fund data, we reviewed SEC guidance on Fair Funds,  including rules on distribution plans, tax treatment, selection of  consultants, and distribution procedures. We also reviewed Fair Fund  guidance from the U.S. Department of Labor. In addition to discussing the  Fair Fund program with relevant SEC and Enforcement officials, we  interviewed six consultants hired to design and implement Fair Fund  plans, attorneys, consumer advocates, an academic expert, and a  representative of a trade group for a retirement plan service provider trade  group.
To address the third objective—evaluating Enforcement’s efforts to  coordinate investigative activities with other SEC divisions and federal  and state law enforcement agencies—we reviewed previous GAO reports  on mutual fund trading abuses and Enforcement’s coordination efforts  with law enforcement. We also reviewed relevant SEC documentation,  including internal referral policies, and guidance regarding coordination  between Enforcement and outside law enforcement authorities. We also  attended SEC’s annual securities coordination conference held in  Washington in March 2007, which was attended primarily by federal and  state regulators and law enforcement personnel. Further, we discussed  Enforcement’s coordination efforts with relevant SEC and division  officials.
We conducted our work in Washington, D.C.; Boston, Massachusetts;  Philadelphia, Pennsylvania; and New York, New York, between November  2006 and July 2007 in accordance with generally accepted government  auditing standards.
section_title: Appendix II: Selected Division of Enforcement Investigation and Personnel Data
paragraphs: We collected data from the Securities and Exchange Commission (SEC)  on the Division of Enforcement’s (Enforcement) investigative caseload  and other personnel information (see tables 4-6 below). As shown in table  4, the ratio of ongoing Enforcement investigations to staff attorneys  increased substantially from about five investigations per attorney in 2002  to eight per attorney in 2006, according to SEC data. However, these SEC  data should be interpreted with caution and may significantly overestimate  the number of investigations per Enforcement attorney. The reported  number of investigations includes all open investigations at the end of  each year, even investigations that have been open for many years. As  discussed in this report, Enforcement has not promptly closed many  investigations that have not resulted in enforcement actions and are likely  no longer being actively pursued. Accordingly, we requested that SEC  provide data on the number of ongoing investigations in Enforcement that  as of year-end 2006 had been initiated within the previous 2 years. When  pending investigations that were more than 2 years old are excluded, the  investigation-to-staff-attorney ratio drops to 2.54. While this ratio may  provide a more accurate assessment of Enforcement attorneys’ active  workloads, individual investigations more than 2 years old could continue  to be actively pursued while some individual investigations less than 2  years old may no longer be actively pursued. Enforcement officials  estimated that staff attorneys generally can be working on from 3 to 5  investigations at one time, including administering individual Fair Fund  plans.
Table 5 shows that the ratio of Enforcement investigative attorneys to  paralegals, who provide support to the investigative process, generally  declined from 2003 to 2006. Our review of SEC data indicates that the  number of Enforcement paralegals increased substantially from 2003 to  2005 (from 58 to 98, or 69 percent) and remained stable in 2006 at 94 (a  decline of just over 4 percent). While the number of Enforcement staff and  supervisory attorneys also increased from 2003 to 2005 (from 596 to 740,  or 24 percent), the rate of increase was not nearly as high as for paralegals.  In addition, the number of Enforcement investigative attorneys declined  from 740 in 2005 to 684 in 2006, or 8 percent. The relatively slower pace of  attorney hiring from 2003 to 2005 and relatively higher rate of attrition in  2006 helps explain why the ratio of attorneys to paralegals has declined in  recent years. Other SEC data that we reviewed also indicated a decline in  the ratio of investigative attorneys to various types of administrative  support staff, such as research specialists, during this period.
Table 6 shows that the ratio of investigative staff attorneys to supervisory  attorneys has remained relatively constant. Supervisory attorneys are  branch chiefs and assistant directors and do not include attorneys at the  associate director level and above.
section_title: Appendix III: Comments from the Securities and Exchange Commission
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Wesley M. Phillips, Assistant  Director; Allison Abrams; Christopher Forys; Marc Molino; Carl Ramirez;  Linda Rego; Barbara Roesmann; and Christopher Schmitt made significant  contributions to this report.