Speech by SEC Commissioner:
"Reinvigorating the Enforcement Program to Restore Investor Confidence"
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
Introductory Remarks before the District of Columbia Bar
March 18, 2009
Thank you Steve for your kind introduction. It is my pleasure to be here today with such distinguished SEC alumni as former Commissioner Campos, Peter Bresnan, and Steve Crimmins. I look forward to discussing a topic that is of critical importance in protecting the nation's investors and in maintaining fair and orderly markets — that topic is reinvigorating the SEC's enforcement program. At a time when the nation's investors are staring in disbelief at their account statements, a robust SEC enforcement program must be a catalyst to improving conduct and restoring investor confidence in the integrity and trustworthiness of the markets.
In my eight month tenure at the Commission, it has become obvious to me that there are actions that must be undertaken to simultaneously unshackle and empower the SEC Enforcement staff. I have been speaking out about how to best empower our Enforcement program and I'm looking forward to sharing my thoughts with you today. These thoughts are my own, and do not necessarily reflect the views of the Commission, my fellow Commissioners, or members of the staff.
By dismantling the penalty pilot program and by permitting Commission approval of formal orders by the Duty Officer, Chairman Shapiro has already moved in the right direction. As a vocal public advocate for empowering SEC enforcement and these actions in particular, I strongly support her actions as important first steps. The question now is what are our next steps? In my view, the Commission needs to promptly take a number of additional actions, including:
- Further streamlining the formal order process;
- Improving the Distributions process;
- Implementing a risk-based data analysis system; and
- Revising the corporate penalty guidelines.
Moreover, Congress should better equip the SEC enforcement staff through its own legislative action.
Further Streamlining the Formal Order Process
The Commission should further streamline the formal order process by delegating the power to issue a formal order, in circumstances that do not present extraordinary issues, to the Enforcement Division Director and Heads of the Regional Offices. The delegation would be guided by clear policy direction to the staff, and conditioned on appropriate, but streamlined, consultation with other divisions and offices. The process put in place in early February by Chairman Shapiro authorizes many formal orders to be approved by the Commissioner designated as Duty Officer for that day — and, while this is an improvement — delegating formal order authority for the routine, non-controversial matters streamlines the entire process, not just the final step.
Improving the Distributions Process
The Commission also needs to improve the distributions to investors of the money collected in enforcement actions. There are two key problems that need to be addressed. First, the time between the collection and distribution of money to investors is too long. Second, and related, the Commission's administration of the distribution needs to be less bureaucratic. To get a sense of the problem, the Commission has authorized approximately 220 Fair Funds or distributions to shareholders since it was granted Fair Fund authority in 2002. The expected amount of disbursements in those distributions is approximately $9 billion. Although we have distributed approximately $4.6 billion to date, the distributions can be on a faster timeline. From start to finish, it can take years after money is collected for the checks to find there way to investors.
I believe we can reduce this delay. Currently, the same investigative staff responsible for successful cases resulting in large monetary distributions to investors are also tasked with trying to create, implement, and monitor these distribution programs. Our current system is one that grew out of necessity after Sarbanes Oxley authorized Fair Funds, and the Enforcement Division staff found themselves needing to become "administrators" over very large distributions of funds.
It seems to make more sense to have the investigative staff hand-off the distribution portion of a particular case to colleagues who are experts in this area. Some steps are already being taken in this direction. In 2007, the Enforcement Division formed an Office of Collections, Distributions and Financial Management. This office, however, does not yet have the personnel and expertise to shoulder full responsibilities for distributions. Building out this capability seems a logical move and the quicker this is done, the better. Besides better utilizing internal expertise, this would also free up the investigative staff to do what they do best and investigate other potential cases.
In addition to placing full responsibility for a distribution program in specialized staff, the Commission approval-process related to a distribution plan needs to be streamlined. For example, a single distribution program may require seeking separate Commission action for everything from appointing the fund administrator, to publishing a distribution plan for comment, to paying quarterly taxes, to paying quarterly fees and expenses, and for approval for disbursing each tranche from a respective fund. This just seems like bureaucracy that ought to be simplified.
We can better serve investors by streamlining our current system to remove unnecessary bureaucratic hurdles and more efficiently allocate responsibilities among our staff.
Implementing a Risk-Based Data Analysis System
Additionally, the SEC must make better use of technology to assist its staff in keeping pace with the tremendous growth in the financial sector. Monitoring market activity for manipulation, insider trading, and other misconduct has become much more difficult over the past several years because the location of trading activity is fragmented, trading in the securities markets has become increasingly intermediated, and trading activity has shifted from regulated markets to unregulated markets — the appropriately named "dark pools" are such an example. These changes are layered on top of an enormous increase in the volume of trading activity.
To respond to these developments, the Commission needs to improve our rules for electronic recordkeeping and reporting so we can receive more uniform detailed information about market activity. This information should feed into state-of-the-art surveillance and analysis programs, manned by appropriately trained staff, to monitor for quantitative signals of possible misconduct.
Relatedly, the Commission should enhance its ability to manage risk in the financial markets. The agency needs to have a robust risk assessment program in place that is able to assess and spot problems before they cause even greater harm. A risk-based approach to regulation and enforcement is not a new idea and the agency has begun to address it, but currently we are not doing nearly enough to effectively implement and sustain such a program. This requires immediate attention.
Improving the quality of the information the SEC collects, and improving our ability to manage and analyze the information collected, will be a large project in terms of vision, planning and implementation. I expect that it will be very expensive. Nonetheless, we cannot afford to wait.
I was pleased to see Chairman Shapiro discuss allocating resources to technology and risk assessment during her testimony on the SEC's budget appropriation. I support her in this. One additional area where I think technological development is needed is market surveillance. Although SROs perform some surveillance, the SEC cannot outsource its responsibilities. The SEC's oversight responsibilities cover SROs themselves, and are broader than that of any particular SRO. The SEC's collection and processing of market information capabilities should reflect these responsibilities.
Revising Corporate Penalty Guidelines
The last SEC action that I will discuss today, and one of the most vital, is revising the Commission's 2006 statement on factors concerning whether a financial penalty against a corporation is appropriate.
The 2006 statement was the Commission's first attempt to identify penalty factors. Like many first attempts, it can be significantly improved. It certainly does not reflect my views. For example, the 2006 statement prioritizes two factors:
- The presence or absence of a direct benefit to the corporation as a result of the violation; and
- The degree to which the penalty will recompense or further harm the injured shareholders.
Under this framework, the conduct itself becomes of secondary importance. Clearly, this is a serious flaw. The purpose of penalties is to deter and punish misconduct. By penalizing, or not penalizing, corporations based primarily on things other than their misconduct — such as whether the company happened to benefit from a fraud by issuing shares at an inflated price — the 2006 factors misdirects where the focus should be and fails to serve investors.
One of the greatest responsibilities of a Commissioner is exercising prosecutorial discretion to decide what cases to bring and what remedies to seek. I exercise that discretion carefully on the facts of each case, informed by my views of justice and the objectives of enforcement from a programmatic perspective.
In evaluating whether a corporate penalty is appropriate, the factors I believe should be considered include:
The nature of the misconduct and the violation
First, the nature of the misconduct and the violation. By this, I mean looking at the degree of harm to investors, the capital markets, and innocent parties. It also means considering the level of intent of the wrongdoer, the difficulty in detecting the type of violation, and the degree to which a violation involved action dispersed throughout the corporation.
The nature of the defendant, its governance and its other conduct prior to the violation
One should also consider the defendant company, and whether the company previously engaged in misconduct or whether it was a good citizen. To what degree was the company's culture respectful of the law, on the one hand, or driven to achieve particular results, on the other hand? Did the company have appropriate policies and procedures reflecting best practices for its size, business, and other circumstances? Was the board vigilant in overseeing management and steering the company?
Fraud is more difficult in the face of serious internal controls implemented by well-trained employees and overseen by directors that are engaged and dedicated to their shareholders. Penalties should encourage self-regulation and I am confident that companies can design efficient systems of compliance if properly motivated.
Self-reporting, cooperation, and remediation (conduct after the violation)
Other factors to consider are self-reporting, remediation, and cooperation. As many of you know, the Commission's Seaboard report addresses these factors and the degree to which they should be considered in the context of exercising prosecutorial discretion generally. Self-reporting and the degree of cooperation and remediation affect my views on charging decisions and remedies, including whether to issue a penalty and the size of a penalty. I am generally supportive of the factors set out in the Seaboard report. What I want to highlight today is the importance of early cooperation: Cooperation that begins at the time a company discovers possible misconduct or is contacted by the SEC staff, whichever happens first.
In addition, companies and their advisors should understand that the degree of cooperation, such as promptly providing information and responding to document requests, will affect the penalty analysis favorably. Doing otherwise will have the opposite effect.
Equitable concerns and effects on parties other than the corporation
The particular needs of fairness and equity arising from any given set of facts should also be considered. Circumstances vary and there can be no bright lines, no "one size fits all". In unusual circumstances, issuing a financial penalty against a corporation could be unfair or unnecessary, such as where criminal sanctions have been applied or where necessary to conform sanctions to a closely-related action. Consideration also should be given to whether shareholders who have been previously harmed by a company's misconduct would be materially harmed by a penalty. But that should not be an overriding consideration when circumstances dictate the need to send a strong message to deter future misconduct.
If a corporate penalty is appropriate, the penalty amount should reflect the deterrence and other programmatic objectives of penalties. It should reflect the harm to be deterred, the facts and circumstances of the corporation, and the nature of the violations. Misconduct by larger and more widely held companies, which generally would harm investors and investor confidence to a greater degree, require greater deterrence. In addition, misconduct that is designed to yield substantial benefits and that is hard to detect requires greater deterrence, because the incentives to attempt such misconduct are greater.
The factors I have just discussed are what I expect the staff to consider when developing recommendations that could involve a corporate penalty.
The 2006 factors were a first step to formalize the analysis of corporate penalties. I believe, however, that the factors need to be more focused on the conduct and less so on serendipitous factors such as whether there was a benefit to the company. I believe the Commission should revisit the 2006 factors promptly.
Congressional Action to Permit the Commission to Punish Obstruction of Investigations, Bring Criminal Cases in Certain Circumstances, and to Provide for Self-Funding
In addition to the SEC's own action, there are three areas that need Congressional action in order to empower the Commission's enforcement program.
First, the Commission's civil authority must be expanded to include the ability to bring cases against people who obstruct a Commission investigation, such as by lying or destroying documents. Second, the Commission needs authority to bring criminal charges where the Department of Justice has declined to do so. Third, the SEC must have an adequate budget.
The need for the SEC to have a bigger budget is obvious. Here are some quick statistics to highlight the SEC's needs — its budget has been in the $888 to 900 million-dollar range over the last four years and its staff is approximately 3,500 to 3,600. With these resources, the SEC is responsible for approximately 12,000 public companies, 11,300 investment advisers, 950 fund complexes, 5,500 broker-dealers (with over 173,000 branch offices), 600 transfer agents, 11 exchanges, 5 clearing agencies, 10 credit rating agencies, a number of key SRO's and, in addition, has oversight over the nation's financial accounting standards setter, the FASB.
By comparison, the self-funded FDIC employs approximately 5,000 staff, over 40% more than the Commission, to oversee approximately 5,100 FDIC-insured banks, and has a budget that ranges from $1.2 to $2.2 billion.
While additional resources are necessary, the SEC must also be provided with the ability to budget and self-fund its operations.
This last recommendation is especially vital. The SEC needs to be in the position to set multi-year budgets and respond in real time to a drastically changing market, while also maintaining appropriate staffing. Currently, the SEC's budget is recommended by the President and annually appropriated and apportioned. This structure has harmed the agency's ability to perform its mission in terms of long-range planning, developing necessary technology and maintaining appropriate staffing levels.
Being self-funded is not a novel idea. In addition to the Federal Deposit Insurance Corporation, other regulators that are independently funded include the Office of Thrift Supervision, Office of the Comptroller of the Currency, and the Federal Reserve, to name a few. There is no logical reason to treat the SEC differently, and many reasons to similarly empower the Commission.
A recent example that underscores way these other regulators can better address new challenges is the FDIC's recent announcement that it would more than double its budget to be able to increase staffing and respond to the changing market conditions. The ability to control its own budget has allowed it to respond quickly. The SEC should be in the same position as it faces similarly important, if not greater, challenges.
There is much to be done, and by taking these actions the SEC will emerge from this financial crisis stronger and more robust then ever before. Fair and efficient capital markets operated by people and institutions that respect and obey the law are essential to our capitalist economy, and vigorous enforcement by the SEC is crucial to the protection of investors and the continued success of this country.
Thank you for having me here today. I look forward to hearing your comments and suggestions as we open up the discussion.