Changes Announced at SEC to Strengthen Division of Enforcement
On Wednesday, August 5, 2009, the SEC's new enforcement director, Robert Khuzami, made his first major policy speech in New York City, in which, among other announcements, he outlined steps the agency is taking immediately to strengthen and improve its Division of Enforcement.
In his prepared remarks, Mr. Khuzami acknowledged the widespread criticism leveled at the agency in the wake of the Madoff scandal. Referring to various challenges to the agency's effectiveness existing before public disclosure of the Madoff scandal, Mr. Khuzami, a former federal prosecutor and general counsel of a global financial services firm, discussed steps the SEC is now taking to make it quicker and easier for its enforcement staff to issue subpoenas for documents and testimony. Mr. Khuzami also announced the creation of a new office of market intelligence at the SEC to monitor tips and referrals concerning potential violations and wrongdoing.
With respect to proposed changes concerning the issuance of subpoenas, Mr. Khuzami announced a new, streamlined process that would allow him to approve the issuance of formal orders for some investigations without getting advanced approval from the commissioners. Mr. Khuzami will also be able to delegate the authority to issue subpoenas to other senior SEC enforcement officers.
Easier to Issue a Subpoena
Earlier in February, the then-newly installed SEC Chairman Mary Schapiro had rescinded an existing and often criticized policy that required all five commissioners to grant permission before enforcement attorneys could issue a subpoena. To expedite the subpoena process and prevent growing case backlogs, Ms. Schapiro previously stated that she would allow SEC enforcement staff attorneys in routine matters to secure approval from only one commissioner, who would be deemed to be acting on the full commission's behalf.
In his Wednesday address, Mr. Khuzami stated that the change in subpoena process is an important one for the division: "This means that if defense counsel resist the voluntary production of documents or witnesses," a subpoena will most likely appear "on your desk the next morning," he remarked. Later, in a more informal discussions held after the speech, Mr. Khuzami expressed his hope that the increased subpoena power may induce companies to be more aggressive in addressing wrongdoing to avoid the "necessity" of an SEC subpoena; it is generally acknowledged that some companies do not publicly disclose SEC probes or investigations before formal subpoenas are issued and received.
It is now well documented that the SEC failed to uncover the Madoff fraud, despite receiving good tips. Partly as a result, Mr. Khuzami also announced on Wednesday the creation of a new office of market intelligence, which presumably will be charged with investigating both public and private leads regarding potential violations and wrongful conduct by individuals and entities.
In a separate, but related organizational restructuring, Mr. Khuzami used the New York City speech to announce new, specialized units within the division, which will include: asset management, market abuse, structured and new products (e.g., derivatives like CMOs and potentially credit default swaps), foreign corrupt practices act and municipal securities and public pensions.
Highlighting and reminding the audience of the new enforcement action focus of the SEC, Mr. Khuzami noted that since January, the division has opened 10 percent more investigations, compared with the same time last year, and granted 118 percent more formal orders.
More Immunity Requests Planned
Other noteworthy changes announced by Mr. Khuzami on Wednesday include plans to seek authority to submit more immunity requests to the Justice Department to encourage people to testify without fear of criminal prosecution. Further, he stated that enforcement staff will need his permission before entering into "tolling agreements" that effectively give the enforcement staff more time to conduct investigations. Mr. Khuzami observed that these have become far too common, and have caused either real or perceived delays, which reduces the SEC's accountability.
Mr. Khuzami's remarks reflect a recurring theme out of the agency since Ms. Shapiro's installment as its new chairman. In testimony given in May before the U.S. Senate Banking Committee, Mr. Khuzami foreshadowed his desire to strengthen and improve the agency's enforcement capabilities. Indeed, Mr. Khuzami's May congressional testimony signaled the SEC's heightened focus on reinvigorating its enforcement program. In that testimony, Mr. Khuzami summarized organizational and procedural changes that were then being contemplated, all of which are designed to maximize the division's effectiveness and address recommendations made by the Government Accountability Office in its report to improve the utilization of resources in the Division of Enforcement. Some of those proposed changes are now seeing the light of day.
Following Mr. Khuzami's prepared remarks on Wednesday, during the open question-and-answer session, Mr. Khuzami touched on the broader issue of enforcement with regard to upcoming potential action on dark pools and flash order types, each of which have been the subject of some considerable attention recently in the emerging debate concerning high-frequency trading and its potential for market disruption, unfairness and potential manipulation by a very select group of market participants.
Dark pools, an alternative trading system, are electronic trading venues where money managers trade large blocks of shares anonymously. Flash order types are a trading practice in which stock trades, after being checked against an exchange's order book, are sent to a select group of participants before being routed to other exchanges for filling.
Regulation for Dark Pools and Flash Orders?
In the past several weeks, some commission members have indicated that regulation may be in the works for these two types of trading, which are often used by sophisticated, high-frequency traders who utilize expensive technology. Critics of the commission have questioned whether the SEC has the technological expertise to tackle such sophisticated topics. Mr. Khuzami downplayed these not-so-veiled attacks on the SEC's capabilities, however, noting that technology had never been an inhibitor in the past and would not be an obstacle moving forward.
In response to further questioning regarding some high-profile enforcement cases in recent months, Mr. Khuzami indicated that the agency was not focused on, and would not over-emphasize higher-profile matters to the detriment of matters involving fewer investors and smaller amounts of money. He also disagreed with the suggestion that the division is feeling pressure to do more to aggressively pursue potential wrongdoers.
"I would take issue with the premise that I am under pressure to bring enforcement actions," he said in the question-and-answer session. "No one has told me to bring more cases. What they have told me is we need to be vigorous advocates for investors."
In separate remarks on Wednesday, SEC Chairman Schapiro told CNBC television that she would welcome definitive rules governing short-selling by the end of the year, which has been blamed for fueling runs on bank stocks. She also expressed her desire for the agency to work on many fraud cases with criminal authorities.
Ultimately, in this era of heightened enforcement coming to fruition, it is more important than ever that financial services firms and public companies make sure that their legal and compliance infrastructure is identifying and resolving potential issues of concern to regulators and positioning the company to respond effectively to future regulatory inquiries. Such efforts will increasingly require proactive responses to industry "hot-bed" issues and topics. The SEC is now more than ever demanding that firms and companies co-partner with the agency in ferreting out and stopping potential wrongdoing, putting in place remedial measures and putting policies and procedures in place to ensure that the problems never again resurface to harm investors.