Securities and Exchange Commission: Greater Attention Is Needed to Enhance Communication and Utilization of Resources in the Division of Enforcement
Published: 2009-05-07T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In recent years, questions have been raised about the capacity of the Securities and Exchange Commission's (SEC) Division of Enforcement (Enforcement) to manage its resources and fulfill its law enforcement and investor protection responsibilities. This testimony focuses on (1) the extent to which Enforcement has an appropriate mix of resources; (2) considerations affecting penalty determinations, and recent trends in penalties and disgorgements ordered; and (3) the adoption, implementation, and effects of recent penalty policies. The testimony is based on the GAO report, Securities and Exchange Commission: Greater Attention Needed to Enhance Communication and Utilization of Resources in the Division of Enforcement ( GAO-09-358 , March 31, 2009). For this work, GAO analyzed information on resources, enforcement actions, and penalties; and interviewed current and former SEC officials and staff, and others.
section_title: What GAO Found
paragraphs: Recent overall Enforcement resources and activities have been relatively level, but the number of investigative attorneys decreased 11.5 percent over fiscal years 2004 and 2008. Enforcement management said resource levels have allowed them to continue to bring cases across a range of violations, but both management and staff said resource challenges have delayed cases, reduced the number of cases that can be brought, and potentially undermined the quality of some cases. Specifically, investigative attorneys cited the low level of administrative, paralegal, and information technology support, and unavailability of specialized services and expertise, as challenges to bringing actions. Also, Enforcement staff said a burdensome system for internal case review has slowed cases and created a risk-averse culture. SEC's strategic plan calls for targeting resources strategically, examining whether positions are deployed effectively, and improving program design and organizational structure. Enforcement management has begun examining ways to streamline case review, but the focus is process-oriented and does not give consideration to assessing organizational culture issues. A number of factors can affect the amount of a penalty or disgorgement that Enforcement staff seek in any individual enforcement action, such as nature of the violation, egregiousness of conduct, cooperation by the defendant, remedial actions taken, and ability to pay. In 2006, the Commission adopted a policy that focuses on two factors for determining corporate penalties: the economic benefit derived from wrongdoing and the effect a penalty might have on shareholders. In 2007, the Commission adopted a policy, now discontinued, that required Commission approval of penalty ranges before settlement discussions. Setting aside the effect of any policies, total penalty and disgorgement amounts can vary on an annual basis based on the mix of cases concluded in a particular period. Overall, penalties and disgorgements ordered have declined significantly since the 2005-2006 period. Total annual penalties fell 84 percent, from a peak of $1.59 billion in fiscal year 2005 to $256 million in fiscal year 2008. Disgorgements fell 68 percent, from a peak of $2.4 billion in fiscal year 2006 to $774.2 million in fiscal year 2008. Enforcement management, investigative attorneys, and others agreed that the two recent corporate penalty polices--on factors for imposing penalties, and Commission pre-approval of a settlement range--have delayed cases and produced fewer, smaller penalties. GAO also identified other concerns, including the perception that SEC had "retreated" on penalties, and made it more difficult for investigative staff to obtain "formal orders of investigation," which allow issuance of subpoenas for testimony and records. Our review also showed that in adopting and implementing the penalty policies, the Commission did not act in concert with agency strategic goals calling for broad communication with, and involvement of, the staff. In particular, Enforcement had limited input into the policies the division would be responsible for implementing. As a result, Enforcement attorneys reported frustration and uncertainty in application of the penalty policies.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the results of our recent study of  the U.S. Securities and Exchange Commission (SEC) Division of  Enforcement (Enforcement). The division plays a key role in helping the  agency meet its mission of protecting investors and maintaining fair and  orderly markets. Current economic conditions and recent turmoil in  financial markets have underscored the importance of Enforcement’s role.  Each year, Enforcement brings hundreds of civil enforcement actions  against individuals and companies accused of violating securities laws.  However, we and others have criticized Enforcement’s capacity to  effectively manage its activities and fulfill its critical law enforcement and  investor protection responsibilities on an ongoing basis. As you know, the  alleged Madoff fraud—described as the largest Ponzi scheme in history— and the failure of Enforcement to detect the fraud during prior  investigation of the firm have increased concerns about the adequacy of  SEC’s enforcement efforts.
This statement is based on our March 31, 2009 report, and focuses on:   (1) the extent to which Enforcement has an appropriate mix of resources  dedicated to achieving its objectives, including support staff, information  technology, and access to specialized services; (2) the factors that  influence the amount of penalties and disgorgements that are ordered and  the total amount of these remedies in recent years; and (3) the adoption,  implementation, and effects of two recent policies for determining  corporate penalties.
To address our objectives, we analyzed information on trends in SEC  resources, enforcement actions, and penalties, and reviewed relevant  documents on the corporate penalty policies. We also met with SEC  officials, former SEC commissioners, current and former Enforcement  staff, and outside parties knowledgeable about Enforcement practices,  such as securities defense attorneys and academics who study the  securities industry and SEC. We held 11 small group meetings with a total  of more than 80 front-line Enforcement staff—investigative attorneys, and  first-level supervisors, known as branch chiefs—in four SEC offices across  the country (Chicago, San Francisco, New York, and Washington, D.C.).  We undertook this performance audit in accordance with generally  accepted government auditing standards. These standards require that we  plan and perform the audit to obtain sufficient, appropriate evidence to  provide a reasonable basis for our findings and conclusions based on our  audit objectives. We believe that the evidence obtained provides a  reasonable basis for our findings and conclusions based on our audit  objectives.
subsections: section_title: Background
paragraphs: SEC is an independent agency created to protect investors; maintain fair,  honest, and efficient securities markets; and facilitate capital formation.  SEC’s five-member 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. Enforcement staff located in headquarters and 11 regional  offices conduct investigations through informal inquiries, interviews of  witnesses, examination of brokerage records, reviews of trading data, and  other methods. At the request of Enforcement staff, the Commission may  issue a formal order of investigation, which allows the division’s staff to  compel witnesses by subpoena to testify and produce books, records, and  other documents. Following an investigation, SEC staff present their  findings to the Commission for its review, recommending Commission  action either in a federal court or before an administrative law judge. On  finding that a defendant has violated securities laws, the court or the  administrative law judge can issue a judgment ordering remedies, such as  civil monetary penalties and disgorgement. In many cases, the  Commission and the party charged decide to settle a matter without trial.  In these instances, Enforcement staff negotiates settlements on behalf of  the Commission.
section_title: Investigative Staffing Has Fallen and Resource Challenges Undermine the Ability to Bring Enforcement Actions
paragraphs: Total Enforcement staffing has declined 4.4 percent, from a peak of 1,169  positions in fiscal year 2005 to 1,117 positions in fiscal year 2008. While  overall Enforcement resources and activities have remained relatively  level in recent years, the number of non-supervisory investigative  attorneys, who have primary responsibility for developing enforcement  cases, decreased by 11.5 percent, from a peak of 566 in fiscal year 2004 to  501 in fiscal year 2008. Enforcement management attributed this greater  decline to several factors: promotion of staff attorneys into management  during a hiring freeze, which left their former positions vacant; diversion  of investigative positions to other functions; and reduction of  opportunities for non-attorney support staff to move to positions outside  the agency.
At the same time, staff turnover has decreased and staff tenure increased.  The majority of Enforcement’s non-supervisory attorney workforce has 10  years of experience or less, but the distribution of experience in this  category has reversed in recent years. The portion with less than 3 years of  experience has declined by about 50 percent, and the portion with 3 to less  than 10 years of experience has increased by about 55 percent. The  portion with 10 to less than 15 years, while small overall, has grown by  about 14 percent. Enforcement management welcomed these trends, but  believed they resulted from a weaker private-sector job market for  attorneys. They felt that had market conditions been better recently,  departures would have been more numerous, which would have depressed  the experience level.
Measured by the number of enforcement cases opened and number of  enforcement actions brought annually, Enforcement activity has been  relatively level in recent years. Case backlog has declined somewhat as the  division has made case closings a greater priority. Nevertheless,  Enforcement management and investigative attorneys agreed that  resource challenges have affected their ability to bring enforcement  actions effectively and efficiently. Enforcement management told us that  the current level of resources has not prevented the division from  continuing to bring cases across a range of violations. But management  and staff acknowledged that current staffing levels mean some worthwhile  leads cannot be pursued, and some cases are closed without action earlier  than they otherwise would have been. More specifically, investigative  attorneys cited the low level of administrative, paralegal, and information  technology support, unavailability of specialized services and expertise,  and a burdensome system for internal case review as causing significant  delays in bringing cases, reducing the number of cases that can be  brought, and potentially undermining the quality of cases. Enforcement  management concurred with the staff’s observations that resource  challenges undercut enforcement efforts. Effective and efficient use of  resources is important to accomplishing Enforcement’s mission. SEC’s  strategic plan calls for targeting resources strategically, examining  whether positions are deployed effectively, and exploring how to improve  program design and organizational structure. Some attorneys with whom  we spoke estimated that they spend as much as a third to 40 percent of  their time on the internal review process. Recently, Enforcement  management has begun efforts that seek to streamline the case review  process. The initiative focuses on process, but our review suggests that  organizational culture issues, such as risk aversion and incentives to drop  cases or narrow their scope, are also present. If the division does not  consider such issues in its initiative, it may not be as successful as it  otherwise could be.
section_title: Various Factors Affect the Amount of Penalties and Disgorgements Ordered, While Overall, Total Amounts Have Declined in Recent Years
paragraphs: Enforcement staff consider a number of factors when determining the  dollar amounts of penalties and disgorgements, which in total have  declined in recent years. To determine a penalty in an individual case,  Enforcement staff consider factors such as the nature of the violation,  egregiousness of conduct, cooperation by the defendant, remedial actions  taken, and ability to pay. Disgorgement is intended to recover ill-gotten  gains made, or losses avoided, through a defendant’s actions. In 2006 and  2007, the Commission articulated certain policies for determining the  appropriateness and size of corporate penalties. The 2006 policy—which  the Commission said was based in part on the legislative history of a 1990  act that provided SEC with civil penalty authority—established nine  factors for evaluating imposition of corporate penalties, but said two were  of primary importance: (1) direct benefit to the corporation and   (2) additional harm to shareholders.
The 2007 policy, now discontinued, required Enforcement staff, when  contemplating a corporate penalty, to obtain Commission approval of a  penalty range before settlement discussions could begin. Cases that  subsequently were settled within the range specified by the Commission  were eligible for approval on an expedited basis. At the same time the  Commission provided the settlement range, it also granted Enforcement  staff authority to sue. According to Enforcement staff and former  commissioners with whom we spoke, and as stated by the then-Chairman,  the purpose of the policy, also known as the “pilot program,” was to:    provide earlier Commission involvement in the penalty process;    strengthen Enforcement staff’s negotiating position; and    maintain consistency, accountability, and due process.
Setting aside the effect of the implementation of any policy, the total  amount of penalties and disgorgement ordered on an annual basis can vary  according to the type and magnitude of cases concluded in a given period.  As shown in figure 1, since reaching peaks in fiscal years 2005 and 2006,  total annual penalty and disgorgement amounts have declined. While both  penalties and disgorgements fell in recent years, penalties have been  declining at an accelerating rate, falling 39 percent in fiscal year 2006,  another 48 percent in fiscal year 2007, and then 49 percent in fiscal year  2008. Also, penalties declined in the aggregate by a greater amount than  disgorgements. In particular, penalties fell 84 percent, from a peak of   $1.59 billion in fiscal year 2005 to $256 million in fiscal year 2008.  Disgorgements fell 68 percent, from a peak of $2.4 billion in fiscal year  2006 to $774.2 million in fiscal year 2008.
Compared to fiscal year 2006, SEC brought more corporate penalty cases  in fiscal 2007, but for smaller amounts. In 2007, SEC brought 10 cases,  compared to 6 in 2006. Four of the six cases in 2006 resulted in penalties of  $50 million or more, with the two largest, American International Group,  Inc. and Fannie Mae, totaling $100 million and $400 million, respectively.  In contrast, in the fiscal year 2007 cases, only two issuers, MBIA, Inc., and  Freddie Mac, were assessed penalties of at least $50 million.
The distribution of enforcement actions by type of case generally has been  consistent in recent years. Enforcement management said that the division  has met its goal that a single category of cases not account for more than  40 percent of all actions.
section_title: Recent Corporate Penalty Policies— Adopted and Implemented with Only Limited Communication— Have Delayed Cases and Discouraged Penalties
paragraphs: We found that Enforcement management, investigative attorneys, and  others concurred that the 2006 and 2007 penalty policies, as applied, have  delayed cases and produced fewer and smaller corporate penalties. On  their face, the penalty policies are neutral, in that they neither encourage  nor discourage corporate penalties. However, Enforcement management  and many investigative attorneys and others said that Commission  handling of cases under the policies both transmitted a message that  corporate penalties were highly disfavored and caused there to be fewer  and smaller corporate penalties.
According to a number of Enforcement attorneys and division managers,  investigative attorneys began avoiding recommendations for corporate  penalties. For example, when the question of whether to seek a corporate  penalty is a close one, the staff will default to avoiding the penalty. Or, if  investigative staff decides to seek a penalty, they will change their focus  from pursuing what they otherwise would recommend as most  appropriate to tailoring recommendations to what they believe the  Commission will find acceptable. According to many investigative  attorneys, the penalty policies contributed to an adversarial relationship  between Enforcement and the Commission, where some investigative  attorneys came to see the Commission less as an ally and instead more as  a barrier to bringing enforcement actions.
Enforcement management told us they concurred with these observations  about the effect of the application of the penalty policies. Although the  Commission never directed there be fewer or smaller penalties, the  officials said this has been the practical effect because Commission  handling of cases made obtaining corporate penalties more difficult. Over  time, the officials said they struggled with implementation and were  unable to provide guidance to the staff, because they saw the  Commission’s application of the penalty factors as inconsistent.  Furthermore, the widely held view in Enforcement was that the unstated  purpose of the 2006 policy was to scale back corporate penalties.
Our review identified several other concerns voiced by Enforcement staff  and others:    That the policies have had the effect of making penalties less punitive in  nature—by conditioning corporate penalties in large part on whether a  corporation benefited from improper practices, penalties effectively  become more like disgorgement.
That the 2007 policy (Commission pre-approval of a settlement range)  could have led to less-informed decisions about corporate penalties. That  is, the Commission would decide on a penalty range in advance of  settlement discussions, when settlement discussions themselves can  reveal relevant information about the conduct of the wrongdoer.
That the policies have reduced incentives for subjects of enforcement  actions to cooperate with the agency, because of the perception that SEC  has retreated on penalties.
That it became more difficult to obtain formal orders of investigation,  which allow issuance of subpoenas to compel testimony and produce  books. Since fiscal year 2005, the number of formal orders approved by  the Commission has decreased 14 percent.
Our review also showed that in adopting and implementing the 2006 and  2007 corporate penalty policies, the Commission did not act in concert  with agency strategic goals calling for broad communication with, and  involvement of, the staff. In particular, Enforcement, which is responsible  for implementing the policies, had only limited input into their  development. According to Enforcement management, the broad  Enforcement staff had no input into either policy. Senior division  management did have input into the 2006 policy, but none into the 2007  policy. As a result, Enforcement attorneys say there has been frustration  and uncertainty about application of the penalty policies.
Mr. Chairman, this concludes my prepared statement. I would be happy to  respond to any questions that you or other members of the subcommittee  might have.
section_title: Contacts
paragraphs: For further information on this testimony, please contact Orice M.  Williams at (202) 512-8678 or williamso@gao.gov, or Richard J. Hillman at  (202) 512-8678 or hillmanr@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. Individuals making key contributions to this testimony  include Karen Tremba, Assistant Director and Christopher Schmitt.
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