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

Letter

Background

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.

Investigative Staffing Has Fallen and Resource Challenges Undermine the Ability to Bring Enforcement Actions

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.

Various Factors Affect the Amount of Penalties and Disgorgements Ordered, While Overall, Total Amounts Have Declined in Recent Years

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.

Recent Corporate Penalty Policies— Adopted and Implemented with Only Limited Communication— Have Delayed Cases and Discouraged Penalties

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.

Contacts

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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