SEC’s Enforcement Director Robert Khuzami Emphasizes Changes and Accomplishments in First 100 Days

August 6, 2009

In his first speech as Director of the SEC’s Division of Enforcement, on August 5, 2009, Robert Khuzami announced changes underway in the Division’s procedures and organization that are intended to strengthen the agency’s enforcement program.  Mr. Khuzami also discussed a number of cases filed in the last several months which have demonstrated the Enforcement Division’s increased level of activity and focus on the financial crisis.  Of greatest significance, the changes are intended to delegate greater discretion to the staff in the initiation of formal investigations, Wells notices and settlement demands, and to incentivize individuals to cooperate in investigations.

I.  Increased Enforcement Activity

Mr. Khuzami began by noting the marked increase in enforcement activity under the new Administration.  Comparing the period from the end of January to the present with the same period last year, the Division has opened 10% more investigations, has filed nearly 30% more actions, has been granted 118% more formal orders of investigation, and has filed 147% more temporary restraining orders.  The Division has directed much of this increased activity at several priority areas identified by Mr. Khuzami, including the mortgage and credit crisis, Ponzi schemes, and cross-market misconduct.  Later in his speech, Mr. Khuzami highlighted many of the recent significant cases in these priority areas.

As we have discussed previously, we have observed another noteworthy trend during the first six months of this year.  While the number of cases filed and defendants charged is up, the percentage of defendants whose charges were settled at the time of filing is down significantly year over year, from 32% last year to 20% this year (see Gibson Dunn’s Mid-Year Review of SEC Enforcement).  This reflects not only increased enforcement activity, but particularly a willingness by the SEC to file cases against defendants in the absence of settlements.  This may be partly a result of the recent number of Ponzi scheme cases, which are typically filed on an emergency basis.  But, it also likely reflects a priority on bringing cases against individuals more quickly, without settlements and without awaiting the result of possible parallel criminal investigations.

II.  New Initiatives

Mr. Khuzami outlined five new initiatives to reorganize the Enforcement Division and modify the process for investigations.

A.  Specialized Units

The Division is creating five specialized units dedicated to particular areas of the securities industry and securities law.  Each unit will be headed by a "unit chief" and comprised of staff from offices around the country.  The staff in the units will receive specialized training, and the Division will also hire individuals with market experience or other expertise.  At the outset, the five units will be as follows:

• The Asset Management Unit will focus on investment advisers, investment companies, hedge funds and private equity funds.  This unit will address issues such as disclosure, valuation, portfolio performance, due diligence and diversification, transactions with affiliates, misappropriation and conflicts of interest.
• The Market Abuse Unit will focus on large-scale market abuses and complex manipulation schemes by institutional traders, market professionals and others.  Mr. Khuzami expects the Division to build technological tools and screening programs to analyze trading across equities, debt securities and derivatives markets.
• The Structured and New Products Unit will focus on complex derivatives and financial products, including credit default swaps, credit default obligations and other securitized products.
• The Foreign Corrupt Practices Act Unit will focus on new approaches to identifying violations of the Foreign Corrupt Practices Act ("FCPA").  Mr. Khuzami intends to be more proactive in investigations, work more closely with its foreign counterparts, and take a more global approach to violations of the FCPA.
• The Municipal Securities and Public Pensions Unit will focus on offering and disclosure issues, tax and arbitrage-driven activity, unfunded or underfunded liabilities, and "pay-to-play" schemes.

Other existing working groups, such as the Subprime Working Group, which was created in 2007, will continue their work alongside these newly created specialized units.

B.  Streamlining Management and Internal Processes

Mr. Khuzami is also streamlining the Division’s management structure and processes.  The Division will reduce the number of managers by redeploying the branch chiefs to conducting investigations.  According to Mr. Khuzami, the goal of this flattening of the Division’s management structure is to push more decision-making to the front-line staff.

In addition, the Division will change a number of its internal processes.  First, the Commission has delegated to Mr. Khuzami as Division Director the authority to issue formal orders of investigation, which authorize the staff to issue subpoenas.  Mr. Khuzami in turn intends to delegate that authority to "senior officers" throughout the Division (i.e., Regional Directors and Associate Directors in Washington and the Regional Offices).  Mr. Khuzami stated that, as a result of this change, if defense counsel resist or delay voluntary production of documents or witnesses, the staff will be able to serve a subpoena within a day, rather than weeks. 

Second, the Division intends to streamline decision-making by delegating the authority to approve routine case decisions, such as issuing Wells notices or settlement demands, from the Deputy Director at the national level to the Division’s senior officers located throughout the country.  This represents a reversal of a trend under the prior Commission toward more centralized decision-making and a return to the practice as it existed until a few years ago.

Third, the Division has changed its practice on tolling agreements.  Going forward, the staff will be permitted to enter into a tolling agreement only with the Director’s personal approval.  Mr. Khuzami made clear that he intends to make granting tolling agreements the exception, rather than the rule.

Fourth, Mr. Khuzami reported that the staff’s memoranda to the Commission recommending specific enforcement actions will be shorter, subject to fewer reviews, and turned around more quickly.

C.  Fostering Cooperation by Individuals

Mr. Khuzami described a number of steps underway to create greater incentives for individuals to cooperate in enforcement investigations:

• creating a "Seaboard Report" for individuals – that is, a public policy statement that will set forth standards under which to evaluate an individual’s cooperation;
• expediting the process by which the Division Director is delegated authority to submit immunity requests to the Department of Justice;
• exploring ways to provide witnesses early on in appropriate cases an oral assurance that the Division does not intend to file charges against them; and
• recommending to the Commission, where appropriate, that the SEC enter into Deferred Prosecution Agreements, in which the Commission agrees to forego an enforcement action against a party subject to certain terms, including cooperation, waiver of statute of limitations and compliance with undertakings.

Mr. Khuzami emphasized, however, that the purpose of these tools is to reward only extraordinary cooperation, not simply responding to requests for information.

D.  Commitment to Strategic Use of New Resources

Mr. Khuzami outlined areas to which the Division intends to devote greater resources.  First, the Division has committed to triple its complement of fulltime paralegals and support personnel.  Second, the Division has committed additional resources to a number of technology initiatives, including revamping how tips, complaints and referrals are handled and expanding the Division’s document management, reporting and case management capabilities.  Third, the Division will add litigators to its Trial Unit.  Mr. Khuzami pointed to the Division’s eight trial wins since April 2009 as evidence of the SEC’s commitment to going to trial.  Fourth, the Division will hire a Chief Operating Officer to manage information technology and oversee processes such as the distribution of Fair Funds to harmed investors, thus relieving staff attorneys of those responsibilities.

E.  Office of Market Intelligence

Mr. Khuzami also announced the creation of an Office of Market Intelligence.  This office will be responsible for collecting, analyzing, evaluating, triaging, referring and monitoring the many tips, complaints and referrals received by the Division.

III.  Conclusion

The initiatives announced by Mr. Khuzami present both a challenge and an opportunity to defense counsel.  By reducing supervisory oversight, the flattening of the Division’s organizational structure will place a greater burden on counsel to persuade and educate the front-line staff.  On the other hand, the creation of standards for individual cooperation and for deferred prosecution agreements as well as the potentially greater availability of immunity orders suggest new opportunities for defendants who wish to resolve matters at the outset of an investigation.

Unquestionably, we are in an era of heightened enforcement.  The greater level of discretion and autonomy being delegated to the staff and the effort to incentivize cooperation by individuals will likely continue to result in greater enforcement activity.  In this environment, there will be greater emphasis than ever on insuring appropriate compliance by market participants and public companies.

Gibson Dunn is one of the nation’s leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators.

Our Securities Enforcement Group offers broad and deep experience. Our partners include the former Director of the SEC’s prestigious New York Regional Office, a former Associate Director of the SEC’s Division of Enforcement, the former Director of the FINRA Department of Enforcement, the former general counsel of the PCAOB, the former United States Attorney for the Central District of California, and former Assistant United States Attorneys from federal prosecutor’s offices in New York, Los Angeles, and Washington, D.C.

Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Practice Group, and our White Collar Defense Group.

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