Speech by SEC Staff:
Remarks Before the Stanford Law School Directors' College 2007
Linda Chatman Thomsen1
Director, Division of Enforcement
U.S. Securities and Exchange Commission
June 26, 2007
From time to time, I am honored by being asked to speak to a group such as this one. I have three simple objectives when I agree to do so: first, to talk about something I know something about; second, to say something that is relevant to the audience; and third, to say something that is fresh. It turns out that I am too ambitious, especially as to the last point. I have found that everything worth saying has already been said, usually said better than I can manage and often, it turns out, said by William Shakespeare. Indeed, many of my favorite expressions are ones I have stolen from Shakespeare. For example, ever see a method in some madness? Hamlet. Or declare that something was too much of a good thing? As You Like It. The Merchant of Venice brings us love is blind. The world is your, his, my, someone’s oyster has its roots in The Merry Wives of Windsor. Ever give the devil his due? Henry IV. Or declare, as I often do, that discretion is the better part of valor? Also, Henry IV. When clueless, we often say it’s Greek to me. You can thank the play Julius Caesar for that expression. Ever not sleep one wink? Neither did Pisanio in Cymbeline. Remember wearing your heart on your sleeve? I was going to say you were in good company until I discovered it was the not so wonderful Iago who declared that he had in Othello. I know that some of you in the private sector have gotten worked up into a lather—not Shakespearean, by the way, as far as I can tell—because some government bureaucrat wouldn’t budge an inch. Eventually, I suspect, he or she did budge some, just as Kate did in The Taming of the Shrew. For the record, from the perspective of this particular shrew, Kate budged way too much and I wouldn’t put her on any enforcement negotiating team. And speaking of perspective, my views are my own and do not necessarily reflect the views of the Commission or any other member of the staff.
Anyway, the fact that there really is nothing new to say is downright depressing to all of us who are called upon from time to time to say something to groups such as this one. I take some comfort that this very idea was also recognized by Shakespeare. In Sonnet 59 he wrote: “there be nothing new, but that which . . . [h]ath been before.” And the very best thing about that phrase is that Shakespeare stole it from Ecclesiastes.
So that is a long, roundabout way of getting to my point: not that Shakespeare plagiarized the Bible or that we all plagiarize Shakespeare but that, in the words of Ecclesiastes, there is nothing new under the sun. There is a corollary to this point which, to a certain extent, takes some of the sting out: it’s okay that we are constantly repeating what someone else has done or said, or repeating ourselves, because collectively we have really lousy long-term memories. My favorite example of our leaky memories comes from a 2005 episode of Jeopardy. This would probably be a good time to confess that I have seen many more episodes of Jeopardy than plays by Shakespeare. Anyway, it was a Tournament of Champions and the final Jeopardy answer was: “CEOs must personally certify their corporate books following a July 2002 law named for these two men.” Two out of the three contestants in this, let me remind you, Tournament of Champions, answered McCain and Feingold. Only one guy got it right and he was Canadian.2
Why, you patient souls are quietly asking yourselves, is she carrying on about all this? Simply this: as directors, one of the very valuable things you do is remember and retell the stories of your experience. Whether that experience is deep or different or both, the perspectives you bring are some of the most valuable assets you contribute in your board service.
I’d like to talk for a moment or two about some of the recent stories in our experience in enforcement. If we consider these challenges in light of history, it turns out there is nothing new here either. Broadly viewed, these challenges are new variations on old themes. Or, as Mark Twain said, undoubtedly stealing from Shakespeare, and the Bible and whatever else was handy: “History may not repeat itself, but it sure does rhyme a lot.”3
One current example of the rhyming of history is insider trading by Wall Street professionals. In the late 1990s, my penultimate predecessor, Dick Walker, was concerned about insider trading making a comeback from Main Street to Wall Street. After bringing many cases against Wall Street professionals in the massive insider trading scandals of the 1980s, the SEC had no such cases in the first half of the 1990s. Walker’s concern arose from the fact that in the last half of the 1990s, the SEC charged a total of ten Wall Street professionals with insider trading. Roll forward to today: in the past four months, we have sued about twice that number of professionals for insider trading.4
In March of this year, we filed the largest insider trading case against Wall Street professionals since the days of Ivan Boesky, Dennis Levine, and Michael Milken in the 1980s.5 Our complaint alleged two overlapping insider trading schemes: One involved trading ahead of upcoming UBS analyst upgrades and downgrades. At the center of this scheme was a senior UBS professional who served on a powerful internal committee dedicated to reviewing and approving proposed analyst recommendations. He tipped traders outside the firm regarding upgrades and downgrades before they were publicly announced. The other scheme involved trading ahead of corporate acquisition announcements on information stolen from Morgan Stanley. At the center of that scheme was a lawyer in Morgan Stanley’s global compliance department whose duties included safeguarding confidential information. Far from safeguarding the company’s confidential information, she stole it and passed it on to others. The conduct alleged in these two schemes included carefully planned efforts to conceal the behavior: use of disposable cell phones, discreet meeting places, coded messages, and cash payoffs. Some of these attempts were more creative than others--you may have seen press reports that cash was passed in empty snack bags. Now I ask you: What kind of a genius do you have to be to know that being paid in cash in an empty Cheetos bag is probably a bad thing? Discouragingly, when other Wall Street professionals happened upon the scheme, their instincts were not to stop it but instead to find ways to personally profit from it. All told, the SEC’s complaint alleged unlawful conduct by 14 defendants, including numerous Wall Street professionals. We alleged conduct occurring over five years and involving hundreds of tips, thousands of trades and millions of dollars in illegal profits.
Also in March, we filed a case alleging insider trading related to the TXU buyout; in that case two professionals were charged—an analyst in New York and an investment banker in Pakistan.6 In the TXU case, the complaint alleged that the New York analyst misappropriated confidential information about the TXU buyout and eight other upcoming transactions from his employer, Credit Suisse. We further alleged that the analyst passed the information along to the Pakistani investment banker, who traded on it for total profits of over $7 million. Just a month before, in February, we brought an insider trading action against a pharmaceutical company executive and his three sons, all of whom were Wall Street accountants or lawyers. According to our complaint, their scheme was a “family business” in which the father regularly tipped his sons with confidential information misappropriated from his employer, the pharmaceutical company. The sons then traded on the information and tipped others as well. We alleged that, in the course of the scheme, the family created a hedge fund to conduct the trading and further obscure their identities.7
We also brought insider trading cases against other corporate professionals not technically employed on Wall Street. In April, we sued a corporate executive who served as both general counsel and chief insider trading compliance officer of a public company.8 We alleged that he traded in his company’s stock in advance of five corporate announcements. Fifty trades. And, according to our complaint, almost all of them were made during blackout periods he was supposed to be administering.
To round out this ugly picture, May was professional couples month. We obtained a TRO and asset freeze in connection with our allegations that a Hong Kong couple engaged in insider trading in advance of the announcement that News Corp. made an acquisition bid for Dow Jones.9 In the two weeks immediately before the News Corp. bid, this couple allegedly bought $15 million worth of Dow Jones stock and sold it all a few days after the announcement for a profit of about $8 million. Another couple, both Wall Street professionals, was sued for allegedly trading in advance of corporate acquisitions the wife learned about through her employment.10 According to our complaint, this couple conducted their trading in an account in the name of the wife’s mother, who was a resident of Beijing.
This new wave of insider trading cases gives me a weird sense of déjà vu. I am reminded, as I said, of Ivan Boesky, Dennis Levine and Michael Milken—infamous Wall Street professionals who were at the center of similar insider trading scandals in the 1980s. Many of you probably remember them too. I remember Michael Douglas’s portrayal of Gordon Gekko in the movie “Wall Street” (a character said to be based on Boesky), and his signature line: “Greed is good.”11 I remember reading the aptly-titled best seller “Den of Thieves.”12 And I also remember the barely fictional “masters of the universe” in Tom Wolfe’s “Bonfire of the Vanities.”13 Apparently, I’m not alone in this sense of déjà vu. I’m told that Hollywood is now planning a sequel to the movie “Wall Street” titled “Money Never Sleeps,”14 and Tom Wolfe is once again writing about barely fictional Wall Street traders, described by his publisher as the new “masters of the universe.”15
But I’m not sure everyone remembers. Many of the new defendants are young enough that they weren’t around for the headlines or the movies or books that chronicled them. They weren’t on trading floors from which colleagues were removed, courtesy of the U.S. Marshals. They have seen Enron collapse, but they don’t remember the demise of Drexel. They don’t remember that some of the insider traders of the 1980s not only paid record penalties to the SEC, but were also criminally charged and went to prison. As a result, many of these new insider traders are literally too young to have learned the lessons of Boesky, Levine and Milken. We, in the enforcement business, will remind them.
Speaking of corporate collapses, I recently read a “post-mortem” sort of law review article describing one such case. Listed among the contributing factors was “questionable business activity” by the corporation’s officers, such as “[u]nique and delusive accounting practices [that] painted a rosy picture of success” while the company was in fact losing millions of dollars a year.16 There was also questionable conduct involving an investment venture set up by company officers for their own personal benefit that, while legally separate from the company, was inextricably involved in its affairs (and privy to non-public information). At this point, you may be thinking about the collapse of Enron, the private investment partnerships set up by Enron insiders for their personal profit, and the creatively-named transactions between those partnerships and the company through which the insiders realized that profit. But the law review article wasn’t about Enron. It was about a big corporate collapse 37 years ago that I would bet few of you remember: the bankruptcy of Penn Central Railroad in the summer of 1970. The company’s stock price plummeted from $86 ½ in July 1968 to $8 a share a few days after the bankruptcy. 120,000 shareholders bore the brunt of those losses, including the University of Pennsylvania and the Philadelphia Museum of Art. The victims also included the 94,000 employees of Penn Central, who experienced mass layoffs, worthless payroll checks, and the loss of their pensions, which were heavily invested in the stock of Penn Central and companies tied to its board members. In 1972, the SEC detailed the causes of Penn Central’s demise in a report to the Senate subcommittee investigating the collapse. Those causes included its “stretch[ing] of accounting principles to cover novel situations, emphasizing form over substance on a number of major transactions . . .,” as well as its use of subsidiaries to engage in what “were essentially paper transactions which should not have been recorded as profit.”17 Sounds just like Enron, doesn’t it?
In a Harvard Law Review article, the Commission’s Chairman decried the types of conduct that characterized some of the recent corporate scandals: “secret loans to officers and directors, undisclosed profit-sharing plans, timely contracts unduly favorable to affiliated interests, dividend policies based on false estimates, manipulations of credit resources and capital structures to the detriment of minority interests . . . and trading in securities of the company by virtue of insider information, to mention only a few.”18 I think we would all agree that the Chairman’s statements provide a fairly accurate depiction of the corporate scandals that rocked our financial markets a few years ago –Enron, WorldCom, Adelphia, Tyco, and the like. But these statements were not made by our present Chairman, Chris Cox – they were made in 1934 by a highly respected professor at Yale Law School, William O. Douglas, who later became the Commission’s third Chairman (and, incidentally, also went on to become the longest-serving Justice on the U.S. Supreme Court). In his 1934 law review article, Douglas was talking about the corporate scandals of the late 1920s that led to the enactment of the 1933 and 1934 Acts some 70-odd years ago.
Perhaps short memories have also been contributing to some of the gloomy views about the Sarbanes-Oxley Act with respect to the U.S. markets’ global competitiveness. Three reports authored by various business interests have recently predicted that the requirements of Sarbanes-Oxley and excessive securities litigation will cause U.S. markets to lose their competitive advantage over other major market centers like London and Hong Kong.19 Along with these reports, I recently read an article from Fortune magazine that reached the same conclusions. The Fortune article railed against newly enacted securities legislation that, in the author's view, would increase the cost of capital, make independent directors reluctant to sit on corporate boards, push companies offshore and away from U.S. regulatory requirements, and increase the number of shareholder strike suits brought as a form of legal blackmail.20 But the Fortune article was not about Sarbanes-Oxley. The author was discussing the Securities Act of 1933 -- the key law governing our securities offering process -- just a few months after its passage. The historians among you will recall that the 1933 Act, like Sarbanes-Oxley, was passed with resounding support in the wake of a financial crisis and subsequent Congressional findings of corruption and wrongdoing in the securities markets. The predictions of disaster made in the Fortune article nearly 75 years ago are eerily similar to the recent reports’ dire predictions about the effects of Sarbanes-Oxley and the purported doom of the U.S. capital markets. But the sky was not falling in 1933, and it is not falling now. It will be interesting to see how history judges Sarbanes-Oxley 75 years out.
It is worth noting that even now, numerous academic studies conducted after the passage of Sarbanes-Oxley have concluded that the U.S. system of securities regulation creates significant advantages for the U.S. securities markets over their international competitors. The academic evidence shows that U.S. financial markets are robustly competitive not in spite of U.S. regulatory standards, but because of our high standards.21 Just last month, yet another academic study concluded that the U.S. system of securities regulation creates a substantial and permanent “corporate governance premium” for initial public offerings listed on U.S. markets that cannot be found in similar public offerings listed on foreign exchanges. The existence of the “corporate governance premium” is directly related to our strong system of securities regulation.22
On a related topic, I would be remiss if I didn’t mention a recent Wall Street Journal editorial by one of our hosts, Joseph Grundfest, which discusses data showing a dramatic decrease in the number of securities class action suits.23 After discussing and dismissing some explanations for the recent drop in class action filings, Professor Grundfest writes:
The remaining explanation is more interesting and profound: Perhaps fewer companies are being sued for fraud because there is less fraud. Under this theory, the government's aggressive criminal and civil enforcement strategy following the Enron and WorldCom frauds has caused corporate boards and management to "get religion" when it comes to complying with the securities laws. Executives are acutely aware that a major accounting or disclosure fraud is more likely than ever to leave them fired or indicted. They respond to this new regime like rational economic actors: If you increase the penalties for engaging in fraud then you reduce the incentives to commit fraud. Nothing complicated here at all.24
This brings me to yet another enforcement story of the day—internal investigations. Given all the talk about them of late, you would think they were newly invented by today’s defense counsel. But they’re not at all new and I think it’s fair to give most of the credit for them to directors. Directors created the corporate internal investigation as we know it today. The investigation of corporate wrongdoing by an independent third party originated as a sanction that was occasionally imposed by the SEC in settling enforcement actions. And we have one of today’s speakers, Stan Sporkin, to thank for that. In these settlements, an independent receiver was formally appointed to investigate the wrongdoing at issue and to ensure that sufficient remedial steps were taken by the corporation. However, the institution of receivership proceedings was extremely disruptive and costly. In the 1970s, the Commission adopted a voluntary disclosure program in response to the questionable payments scandal in which some of America’s best-known corporations were found to have used slush funds to make illegal campaign contributions in the United States and to bribe foreign officials for business. During the voluntary disclosure program, outside directors who were not involved in the payment practices came to have a central role in overseeing companies’ internal investigations and the resulting reports.25
To their credit, directors came to realize that an internal investigation could be made more efficient and less disruptive if it was conducted by the board, rather than by a third-party receiver. They also realized that an investigation would be more productive and might result in lesser sanctions if it was conducted before -- rather than after -- an SEC enforcement action. Of course, the directors realized that their investigative work would be reviewed and tested by the SEC, and that the independence of the investigation was crucial to its credibility. Thus, the “special committee” was born. Outside directors who had no role in the questionable payments were appointed to a committee that would conduct a thorough and independent investigation of the practices at issue, institute remedial measures and report their findings to the SEC.
In reporting to Congress on the questionable payments scandal, the SEC acknowledged outside directors’ initiative in taking responsibility for internal investigations. The SEC found that outside directors “increase[d] their involvement and knowledge of corporate affairs . . .” and that “[i]n many cases, these outside directors reportedly [were] instrumental in initiating internal investigations and requiring more stringent auditing controls.”26
From my perspective, the evolution of the internal investigation has been an overwhelmingly positive development for shareholders and for our enforcement program. More than 30 years after the initiation of the Commission’s voluntary disclosure program, the internal investigation continues to play a key role in our enforcement efforts.
We continue to encourage and reward cooperation from the business community for very important reasons. As our Chairman has said:
The danger is not that we will interfere too often but that we may act too late. That is why I appeal so frankly to you [in the business community] . . .You can help us. . . .[O]ur job will be better done and your interest will be better protected if, by alert and vigilant cooperation, you [in the business community] . . . share our task. . . . Have no fear that Government supervision will destroy honest enterprise. . . . This Commission will destroy nothing in our business life that is worth preserving. You are warranted in having confidence in our plans and purposes -- confidence . . . “that if business does the right thing it will be protected and given a chance to live, make profits, and grow, helping itself, and helping the country.” Honest business needs nothing more; the Commission promises nothing less.27
I expect by now you have figured out my gimmick. I said these were the remarks of our Chairman, but they were the words not of our current Chairman, but our first Chairman, Joseph Kennedy, on November 15, 1934 in one of his first speeches, at a meeting of the Boston Chamber of Commerce. I should note that I found this speech because our current Chairman, Chris Cox, quoted it in one of his recent speeches.
Before I end, let’s look to the past one last time this afternoon – this time to the four allegorical sculptures that frame the entrances to the National Archives building in Washington. According to Herbert Hoover, the grand edifice that houses the National Archives was built to serve as a “temple of our history.” Coincidentally, the cornerstone of the building was laid in 1933, the year of enactment of the first federal securities law. One sculpture, “The Past,” is inscribed “Study the Past.” Another, “Guardianship,” is inscribed with one of my favorite quotations: “Eternal Vigilance is the Price of Liberty.” While I often borrow this line in talking about securities enforcement, it seems the author may have borrowed it himself. The quote is attributed to the 19th century abolitionist Wendell Phillips, who is believed to have borrowed the quote from Thomas Jefferson or Patrick Henry (or possibly from an 18th century Irish statesman who may have gotten the idea from an ancient Greek orator). The remaining two sculptures speak to the future and its relationship to the past. One, “Heritage,” instructs us that “The Heritage of the Past is the Seed that Brings Forth the Harvest of the Future.” And finally, the last one is “The Future,” which brings us back to the beginning of my remarks today. It is inscribed with a line from Shakespeare’s The Tempest: “What is Past is Prologue.” What that leaves off is the next, very important line, “what to come [i]n yours and my discharge.”
So, with apologies and thanks to William Shakespeare, Wendell Phillips, Mark Twain, and their many predecessors, let’s discharge our duties to shareholders with vigilance, and not forget the rhyming of the past.
1 The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
2 See http://boards.sonypictures.com/boards/showthread.php?t=14978.
3 See, e.g., http://www.brainyquote.com/quotes/quotes/j/jdhaywor374057.html; http://www.insidevandy.com/drupal/node/3833.
4 Bob Drummond, Insider Trading Makes Comeback in Options 20 Years After Boesky, Bloomberg, June 20, 2007.
5 SEC v. Guttenberg et al., Lit. Rel. No. 20022 (Mar. 1, 2007).
6 SEC v. One or More Unknown Purchasers of Call Options for the Common Stock of TXU Corp. et al., Lit. Rel. No. 20105 (May 4, 2007); Lit. Rel. No. 20113 (May 11, 2007) (adding Pakistani investment banker Ajaz Rahim to third amended complaint).
7 SEC v. Aragon Capital Management LLC et al., Lit. Rel. No. 19995A (Feb. 13, 2007).
8 SEC v. Heron, Lit. Rel. No. 20079 (Apr. 18, 2007).
9 SEC v. Wong et al., Lit. Rel. No. 20106 (May 8, 2007).
10 SEC v. Wang et al., Lit. Rel. No. 20112 (May 10, 2007).
11 See http://www.imdb.com/title/tt0094291/quotes.
12 James B. Stewart, Den of Thieves (1991).
13 Tom Wolfe, Bonfire of the Vanities (1987); http://www.brainyquote.com/quotes/t/tomwolfe166712.html.
14 Dave McNary, Fox Heads Back to ‘Street,’ Variety (May 6, 2007), available at http://variety.com/article/VR1117964380.html?categoryid=13&cs=1.
15 Tom Wolfe, The Pirate Pose (Apr. 16, 2007), available at http://www.portfolio.com/executives/features/2007/04/16/The-Pirate-Pose.
16 Daniel J. Schwartz, Penn Central: A Case Study of Outside Director Responsibility Under the Federal Securities Laws, 45 UMKC L. Rev. 394, 398 (1976-77).
17 The Financial Collapse of the Penn Central Company, Staff Report of the Securities and Exchange Commission to the Senate Special Subcommittee on Investigations 4, 6 (Aug. 1972).
18 William O. Douglas, Directors Who Do Not Direct, 47 Harvard L. Rev. 1305, 1306 (June 1934).
19 Committee on Capital Markets Regulation, Interim Report of the Committee on Capital Markets Regulation (Nov. 30, 2006) (Scott Report); McKinsey & Company, Sustaining New York's and the US' Global Financial Services Leadership (Jan. 22, 2007) (Schumer-Bloomberg Report); United States Chamber of Commerce, Commission on the Regulation of U.S. Capital Markets in the 21st Century—Report and Recommendations (Mar. 2007) (U.S. Chamber of Commerce Report).
20 Arthur H. Dean, The Federal Securities Act: I, 2 Fortune 50, 104 (Aug. 1933).
21 In general, transnational studies have found a strong correlation between the maturity and size of financial markets and the aggressiveness of the enforcement efforts on behalf of investors. Robert A. Prentice, The Inevitability of a Strong SEC, 91 Cornell L. Rev. 775, 836 (2005-2006) (citing Gerard Hertig et al., Issuers and Investor Protection in The Anatomy of Corporate Law: A Comparative and Functional Approach 193, 213 (R. Kraakman et al. eds., 2004)). Further evidence of the positive economic effects of a strong regulatory and enforcement environment has been found by numerous empirical studies concluding that in countries with stricter enforcement of securities laws there is a lower cost of equity and more liquid capital markets. See, e.g., Utpal Bhattacharya, Enforcement and Its Impact on Cost of Equity and Liquidity of the Market (Indiana University, Working Paper, May 2006); Luzi Hail and Christian Leuz, International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter? (The Wharton Financial Institutions Center, Working Paper, Nov. 2003); Rafael La Porta, Andrei Shleifer, Robert W. Vishny, and Florencio Lopez de Silanes, Law and Finance, 106 J. of Political Economy 1113 (Dec. 1998).
22 Craig Doidge, G. Andrew Karolyi, and Rene M. Stulz, Has New York Become Less Competitive in Global Markets? Evaluating Foreign Listings Over Time, National Bureau of Economic Research Working Paper No. 13079 (May 2007), available at http://nber.org/papers/w13079?sfgdata=4.
23 Joseph A. Grundfest, The Class Action Market, Wall St. J., Feb. 7, 2007 at A15.
25 The SEC brought 62 enforcement actions in connection with the questionable payments scandal, while about 400 more firms self-reported under the Commission’s voluntary disclosure program, in exchange for more lenient treatment. See Joel Seligman, The Transformation of Wall Street 540-44 (1995); Arthur F. Mathews, Internal Corporate Investigations, 45 Ohio St. L.J. 662-70 (1984).
26 Report of the Securities and Exchange Commission on Questionable and Illegal Corporate Payments and Practices, Report to the Senate Committee on Banking, Housing and Urban Affairs 44 (May 1976).
27 Remarks of Joseph P. Kennedy, Chairman, U.S. Securities and Exchange Commission, Before the Boston Chamber of Commerce (Nov. 15, 1934), available at http://www.sechistorical.org/collection/papers/1930/1934_11_15_Kennedy_Boston_Sp.pdf.