SEC Chairman Schapiro Announces Changes to Enforcement Process

February 6, 2009

First Steps in "Empowering" the Enforcement Staff

In her first speech as Chairman of the Securities and Exchange Commission, Mary Schapiro announced today two changes to the enforcement process at the SEC intended to "empower" the staff of the Enforcement Division.  First, Chairman Schapiro announced an end to a two-year "pilot" program which had required the Enforcement staff to obtain a special set of approvals from the Commission in cases involving civil monetary penalties against public companies as a sanction for securities fraud.  Second, Chairman Schapiro announced a plan to provide more rapid approval of formal orders of investigation authorizing the staff to issue subpoenas. 

Although these changes affect only the internal procedures of the SEC, by announcing these changes in her second week on the job, it appears that Chairman Schapiro intends to make good on her promise to reinvigorate the SEC’s enforcement program.  The changes will also have implications for companies involved in investigations of their accounting practices.

Penalty Procedure

In 2007, then Chairman Christopher Cox announced in a speech a "pilot program" for cases against a public company in which the staff recommends seeking a monetary penalty.  In such cases, before the staff could negotiate a settlement with the issuer, the staff was required first to obtain the authorization of the Commission to negotiate within a proposed range of penalties.  This was a departure from the practice followed up to that point, namely that the staff would first negotiate all aspects of a settlement and then recommend the settlement to the Commission for final approval.  At the time, Chairman Cox explained the merits of the pilot program as threefold.  First, the negotiating position of the staff would be strengthened by knowing that the Commission had already approved the penalty.  Second, cases that were settled within the range approved by the Commission would be eligible for expedited final approval by the Commission through its seriatim procedure.  Third, Commission pre-authorization would help to bring national consistency and predictability to the use and determination of penalties.

The pilot program has been subject to criticism for adding delay to the settlement process and reducing the penalties assessed against companies.  In a speech in January 2009, before Chairman Schapiro’s confirmation hearing, Commissioner Luis Aguilar cited data indicating a decrease in the total penalties assessed against public companies in each year since implementation of the pilot program.  Commissioner Aguilar called for the immediate termination of the pilot program and announced his intention to ask Chairman Schapiro to make termination of the pilot program her first official act.

At her confirmation hearing, Senator Jack Reed (D-RI) asked Chairman Schapiro about her views on the pilot program.  Chairman Schapiro responded that as to the pilot and other aspects of the enforcement process, she intended to "take the handcuffs off the Enforcement Division."  It appears that Chairman Schapiro intends to make good on that promise.  In her speech, Chairman Schapiro stated that the pilot program introduced significant delays into the process of bringing a corporate penalty case, discouraged staff from arguing for a penalty and sometimes resulted in reductions in the size of penalties imposed.  Chairman Schapiro further stated that the end of the program is designed "to expedite the Commission’s enforcement efforts and ensure that justice is swiftly served."

Formal Orders

Chairman Schapiro also announced a change to the process for approving formal orders.  Under current procedures, formal orders have been subject to full review at a meeting of all Commissioners.  This required several weeks advance notice in order to have the formal order request placed on the Commission’s meeting agenda.  Chairman Schapiro announced that, going forward, formal order requests would be reviewed and approved within a couple of days pursuant to the Commission’s "seriatim" procedure or simply by one Commissioner acting as the "duty officer" on behalf of the entire Commission.  This change too reflects a return to prior Commission procedures.  As Chairman Schapiro explained the change, "in investigations that require subpoena power, time is always of the essence…."

Other Issues

Speaking more broadly, Chairman Schapiro stated that she anticipates further improvements in the coming weeks and months "to ensure swift and vigorous enforcement."  Following up on the Chairman’s speech, George Curtis, Deputy Director of the Division of Enforcement, gave remarks reflecting the Division’s efforts to streamline its investigations and bring cases more quickly.  In particular, Deputy Director Curtis spoke of imposing deadlines on the enforcement staff, focusing investigations, and not endeavoring to turn over "every stone" in an investigation. 

In addition to the changes to enforcement, Chairman Schapiro also announced the following initiatives:

• the formation of an Investment Advisory Committee to enable the Commission to hear about issues of concern to investors,
• improving credit ratings by addressing conflicts of interest,
• creating a central clearinghouse for credit default swaps,
• strengthening risk-based oversight of broker-dealers and investment advisers, and
• improving audits of nonpublic broker-dealers.

Implications

In general, Chairman Schapiro’s first speech clearly signals an intent to make good on her promise to reinvigorate SEC enforcement.  As a result, subjects of SEC investigations are likely to start to experience greater pressure from the SEC staff to respond more quickly to requests for documents and testimony.

More specifically, the termination of the pilot program on corporate penalties could have significant consequences for public companies under investigation.  First, to the extent the elimination of the program expedites the process of resolving investigations, companies may benefit from the ability to bring more prompt closure to a process that otherwise adversely affects the company’s franchise. 

Second, penalties may go up, both in size and frequency.  In the current environment, there is substantial pressure on the SEC to demonstrate that it will be aggressive against securities fraud.  At the same time, however, the Commission and its staff will need to weigh sanctions against the precarious financial condition in which many public companies currently find themselves and the substantial shareholder value that has already been lost due to the broader economic turmoil. 

Third, the change may heighten the importance of factors, other than the specific conduct alleged, which go into the Commission’s determination of an appropriate penalty.  For example, beyond the egregiousness of the alleged fraud, the company’s pre-existing compliance procedures and internal controls, cooperation in the investigation and remediation of deficiencies will be important factors in the outcome of any settlement.  More to the point, it will be the staff’s perception of the company’s response that will be relevant.  As a result, it will be important that a company responding to an SEC investigation demonstrate early to the SEC staff that it had reasonable compliance procedures in place and that it is responding appropriately to the investigation. 

The full text of Chairman Schapiro’s speech can be found at
http://sec.gov/news/speech/2009/spch020609mls.htm

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