Speech by SEC Commissioner:
Remarks at the Eighth Annual A. A. Sommer, Jr. Corporate, Securities and Financial Law Lecture
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
Fordham University Law School
New York, New York
October 9, 2007
Thank you, Ben, for that kind introduction. Thank you also Dean Treanor, [Professor] Jill [Fisch], and Mrs. Sommer. Before I get started, and as all of you will expect, I need to tell you that the comments that I am about to make are my own and do not necessarily reflect official SEC policy or the opinions of my fellow Commissioners.
It is a true honor to be here with you today. Over the last eight years, this lecture has become a prominent feature in the ongoing dialogue among securities regulators, practitioners, and the regulated community. That is fitting given that the lecture honors the legacy of former SEC Commissioner, and former securities law practitioner, Al Sommer. The SEC has seen many Commissioners come and go over the last 73 years, and it would be difficult for even the most seasoned SEC veteran to name them all, much less point out their legacy. But I am sure that many of even the newest securities practitioners have heard of Al Sommer and his legacy at the Commission. At the SEC, Commissioner Sommer was extremely well-regarded for his efforts to eliminate fixed commissions in the brokerage industry, and his work in creating and overseeing an advisory committee on corporate disclosure that eventually resulted in the promulgation of Regulation S-K. Among other things, Regulation S-K was a much-needed rationalization of the corporate disclosure rules — for once, there was essentially one place to go to find a set of integrated requirements. After he left the SEC, Commissioner Sommer made his mark in private practice, primarily at Morgan Lewis & Bockius, and in his role with the accounting industry's Public Oversight Board and the American Institute of Certified Public Accountants (AICPA).
From a personal perspective, I very much enjoyed working with Al. When I worked for Chairman Richard Breeden in the early 1990s, Al was a great advisor and always was ready to help us accomplish what needed to be done. For example, you might not think of Al as party planner, but when we were searching for a way to be able to host the 16th annual conference of the International Organization of Securities Commissions, Al stepped in to head up a private committee that hosted several events to showcase the best and brightest of the American capital markets for several hundred international guests. At the time, the SEC had no budget for such things. Al also was immensely kind. After I left the SEC, he continued to be a kind and helpful friend and advisor.
I am honored to deliver this lecture tonight in Commissioner Sommer's memory, particularly in the presence of his widow, Starr Sommer, his daughter, and son-in-law.
This evening I would like to talk about an issue that barely preceded, but substantially affected, Commissioner Sommer's tenure at the SEC. Before I reveal the topic, though, some background is in order.
The SEC is fast approaching the seventy-fifth anniversary of its creation. Next year, of course, marks the 75th anniversary of the Securities Act of 1933. Thereafter, the Securities and Exchange Act of 1934 established the SEC to keep the Federal Trade Commission out of the securities markets, which is a story full of political intrigue itself, and endowed it with a wide array of powers. Through legislative amendments, those powers have expanded since 1934, and the Commission was also charged with the administration of the other federal securities statutes. Today, the SEC is charged with administering the Trust Indenture Act of 1939, the Investment Company and Investment Advisers Acts of 1940, and certain provisions of the Sarbanes-Oxley Act, some of which fall outside of the earlier securities laws. That is a lot of statutory responsibility, but at least we finally were able to shed responsibility for the now-dead Public Utility Holding Company Act of 1935.
The SEC was created to be, and remains, primarily a disclosure agency. In pursuing its statutory missions of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation, the SEC since its inception has mandated public disclosure of current and accurate information from issuers and regulated entities. The theory behind a rigorous disclosure regime is that investors should have current, materially complete, and accurate information in order to make educated, informed investment decisions. At the same time, however, investors should enter the markets knowing that there is no governmental insurance policy protecting them from unwise decisions.
Often, however, despite Commissioner Sommer's legacy in Regulation S-K and efforts by others to promote transparency, disclosure rules are not enough. Therefore, a necessary corollary to a disclosure regime is a program of strong enforcement. If you make materially false disclosures, or if you omit required disclosures, the SEC has, and can bring, a cause of action against you. With that in mind, Congress has given the SEC strong enforcement powers in the federal securities laws. These powers have evolved — and increased — over time through legislation, regulation (just look at Rule 10b-5), and judicial interpretations. To be sure, the arsenal of enforcement remedies possessed by today's SEC, including the ability to penalize corporations, is markedly different from the stop orders and injunctions of 70 years ago.
The current SEC enforcement program is highly visible and highly regarded. The Division of Enforcement now has over eleven hundred staff members located in the home office in Washington and in the eleven regional offices. The staff brings hundreds of enforcement recommendations to the Commission each year (who's counting, right?), and many other matters are investigated and then closed. The enforcement staff investigates and recommends cases involving a wide range of activities, including Ponzi and pyramid schemes, bogus offerings, untrue disclosure, insider trading, market manipulation, a new wave of internet intrusion matters, and the more esoteric, often controversial accounting cases. In every substantive area, and in all of the SEC's far-flung offices, the staff of the Division of Enforcement prove themselves every day to be professionals of the first rate.
It comes as a surprise to many when they hear that the SEC has had a stand-alone Division of Enforcement only for 35 years — since 1972. For the preceding 38 years of the Commission's existence, enforcement was a function handled within each of the various regulatory divisions, but primarily in the Division of Trading and Markets.
I will not go into a whole lot of detail about the first 38 years of the Commission's enforcement efforts. However, that history plays a critical part in the evolution of the Enforcement Division, and so I will commend to your reading an article written by Dan Hawke, the Director of the SEC's Philadelphia Regional Office, for the SEC Historical Society. The article, which you can find on the historical society's website,1 is very comprehensive. Many thanks to Dan Hawke for producing such an excellent piece — the quality of his work certainly comes as no surprise to me.
I would like to focus on one event in the history of the SEC's enforcement program that may have been the "big bang" from which the current Division of Enforcement was born. That event was the Wells Committee review in 1972. The Committee was a formal advisory committee created by Chairman William Casey. In a speech given to the New York State Bar Association in early 1972, Chairman Casey announced the formation of the Committee, stating:
[It is] essential for the Commission to redouble its efforts to keep in touch with the best thinking on investor protection at the private bar, in the accounting profession, and in the financial community generally. As one step — and I hope that it will prove a significant step — toward that end, I have created a special committee of three highly experienced practicing lawyers who will at my request examine the SEC's enforcement policy and practices, engage in frequent dialogue with the members of the Commission and with our staff, seek and sift the suggestions of the bar and make recommendations to the Commission for worthwhile improvements to our time-honored ways.2
Chairman Casey appointed to the Committee John A. Wells, who was in private practice at Royall, Koegel & Wells here in New York, and former SEC Chairmen Manny F. Cohen and Ralph Demmler. Specifically because Jack Wells was not a securities lawyer, Chairman Casey asked him to be the Chairman of the Committee, and thus began what we now know as the "Wells Committee."
In line with the comments in Chairman Casey's speech, the Committee's express mandate was: (1) to advise how the SEC's enforcement objectives and strategies may be made still more effective, (2) to assess the due process implications of enforcement practices, (3) to evaluate enforcement policies and procedures, (4) to make recommendations on the appropriate blend of regulation, publicity and formal enforcement action and on methods of furthering voluntary compliance, and (5) to make recommendations on criteria for the selection and disposition of enforcement actions, and on the adequacy of sanctions imposed in SEC proceedings.3
The Wells Committee did not conduct extensive independent research and analysis. Instead, the Committee solicited comment from "persons outside the Commission who are affected by the Commission's enforcement activities."4 The Committee started its work in January 1972, and published a report with forty-three recommendations for the Commission in June of the same year. Although some believe the Wells Committee specifically recommended a stand-alone enforcement division, that is not true. Chairman Casey, on his own initiative — but apparently with the advice of the Wells Committee — created the enforcement division shortly after the Wells Committee report was published. Depending on whom you listen to, Chairman Casey was either trying to build a national, high profile enforcement program — or he was simply trying to get Irv Pollack out of the regulation business!5 No matter the reason, few would say that the move was a bad one.
The most obvious product of the Wells Committee's efforts was the SEC's adoption of a formal "Wells process." As most or all of you know, the Wells process allows for respondents in SEC proceedings to submit a writing — essentially a brief — to the Commission and its staff after the staff's investigation is completed, but before the staff has made a recommendation to the Commission. In many ways, these "Wells submissions" operate as a last clear chance for respondents to persuade the staff that an enforcement recommendation is not warranted. If that fails, the Wells submissions are submitted to the Commission, along with a staff recommendation memorandum, so respondents are assured that the Commission has both sides of the story when it considers a recommendation in a contested matter.
As an aside, believe it or not, when I returned to the SEC as a commissioner after 8 years back in the private sector, the practice had developed of not providing commissioners with Wells submissions in settled cases. I was wondering why the materials for our closed Commission enforcement meetings had grown so thin! Well, I changed that practice right away, at least with respect to my office, and asked for all Wells submissions and all substantive correspondence that is functionally equivalent to Wells submissions. It is very helpful to understand the evidence and positions of all parties in the case, so I believe that the whole Commission should read Wells submissions even in settled matters.
The appellation "Wells" submission suggests that the Wells committee conceived the idea of allowing a respondent to submit a brief with opposing views before final Commission action. However, the real credit for this process should go to former Chairman Hamer Budge (who was also called Judge Budge, from his service on the bench before he came to the SEC) and his fellow Commissioners. So, instead of "Wells Submission," we could call it a Judge Budge brief. A "Wells that smells" because of shading facts or bad arguments could become a "Budge Fudge." A "swell Wells", on the other hand, could become a "Budge Nudge," because it nudges the Commission in a different direction. A truly exceptional one could be a "Hamer Famer," because of its fame and acclaim. A really long Wells — a "Hell's Wells" — would be a "Budge Trudge," because it takes so long to get through it.
Seriously, though, my jokes should not be construed to take away from my deep respect for the important work and legacy of Hamer Budge and Jack Wells. I was just concerned that mid-way through my speech you would be in high dudgeon if there were no levity (as a nod to my former boss, Arthur Levitt).
So, back to history. In 1970, just months before Chairman Budge left the SEC, the Commission issued a memo to the all division directors and office heads regarding procedures to be followed in enforcement proceedings. The memo had two significant components: (1) it required the staff to get Commission approval before engaging in settlement discussions, and (2) it required the staff to provide a summary of the defendant's arguments in a recommendation memo sent to the Commission. The latter requirement became a subject of study by the Wells Committee, and resulted in the following Wells Committee recommendation to the Commission:
Except where the nature of the case precludes, a prospective defendant or respondent should be notified of the substance of the Staff's charges and probable recommendations in advance of the submission of the Staff memorandum to the Commission recommending the commencement of enforcement action and be accorded an opportunity to submit a written statement to the Staff which would be forwarded to the Commission together with the Staff memorandum.6
The Wells Committee also recommended that this process be formalized in SEC rules. The Commission agreed with these recommendations, and they were eventually codified in the SEC's procedural rules.7 However, because the Commission was faced with "strong opposition from its enforcement staff," the published version differed from the recommendation in a few respects.8 The most significant nod to the staff was language stating that the staff would have discretion in deciding whether to advise a respondent of: the nature of the investigation, the potential charges, and the amount of time available to send a written submission.
Unlike the Wells submission process, most of the Wells Committee recommendations were not adopted by the Commission. Looking at the 43 recommendations, it makes you wonder how things would be different today if the Commission had expressly addressed all of them 35 years ago. Indeed, many of the recommendations remain highly relevant today — and some should give the current Commission a serious case of déjà vu.
The first Wells Committee recommendation was for an SEC planning office "whose primary purpose would be to identify emerging regulatory and enforcement problems and to develop a coordinated response by the Commission."9 Of course, a former Chairman created just such a group — the Office of Risk Assessment — a few years ago in a response to some scandals that the SEC had not anticipated. Despite what would seem to be the timeless wisdom of a planning office, it has had only limited success. This is not because of a lack of talent in the office, but probably because of the SEC's ages-old problem with a lack of inter-division and inter-office cooperation. I hope that the Commission will soon be able to breathe new life into that office.
Recommendation 20 in the Wells Committee report is another blast from the past. That recommendation was for the Commission to "adopt procedures permitting discussions of settlement between the Staff and the prospective defendant or respondent prior to the authorization of the proceeding."10 This was a response to the 1970 Chairman Budge memo. Apparently, some commenters in the Wells Committee process felt strongly that the settlement authorization procedures in the Budge memo should not be continued.11 Boy, does that sound familiar! Well, the Casey Commission did not agree, perhaps for due process concerns and to retain Commission prerogatives, so for all intents and purposes, the Budge memo and its procedures are still binding Commission policy today. In fact, in 1979, the Commission under Chairman Harold Williams, who was very concerned with due process and procedure, formally adopted in the SEC procedural rules a requirement that the enforcement staff must have Commission authorization before engaging in settlement discussions.12
With all of this precedent, and considering that the 1979 rule is still on our books, it makes you wonder why there was so much clamor from some quarters when the Commission recently started enforcing that policy in corporate issuer penalty cases. The backlash is especially odd given that issuer penalty cases constitute approximately five percent or less of the SEC's annual enforcement cases. I imagine that much of the criticism arises from a lack of public guidance on how the SEC is implementing the new policy, and I would hope that — if the Commission decides to continue with the procedure — detailed formal guidance will be provided in the near future.
Several other Wells Committee recommendations deserve the attention of the current and future Commissions, and not all of them relate to the Enforcement function. For instance, recommendation 5 would have the Commission promptly reflect staff interpretive positions in published revisions of the applicable rules and policies.13 Because such revisions would be subject to the Administrative Procedure Act (APA), I believe that recommendation 5 was, and is, an appropriate idea. And, the problem of substantive staff guidance being provided outside the APA is even more acute today than it was in 1972 — we now have 35 years of additional staff guidance to deal with. Recently, for example, under Alan Beller, the Corporation Finance Division began to publish staff comment letters on disclosure filings so that all issuers and practitioners have access to the information.
As much as I would like to discuss each of the 43 recommendations with you, I realize that my time — and your patience — is limited. So I will mention only one more. In recommendation 13, the Wells Committee advised the Commission to ensure that examination and enforcement staffs have, and maintain, proper policies and procedures manuals. Although this recommendation may have been loosely and informally adhered to over the years, this issue has become a hot topic following the recent issuance of highly critical reports by Senators Grassley and Specter, and the Government Accountability Office (GAO). Both of these reports find significant shortcomings with the Division of Enforcement's written policies and procedures. This is a serious issue, and one I know and expect the Chairman, the Commission, and the Enforcement Division senior staff will carefully examine and remedy. I should not like others to criticize the SEC for being unresponsive if we do not consider these common-sense suggestions from Congress and the GAO.
Although most of the recommendations proposed by the Wells Committee in its report were not adopted by the Commission, the Wells process remains the SEC's central due process mechanism in enforcement matters. But, after 30 years, even the Wells process has its challenges. The corporate scandals of recent years and the markets' jitters over the effect of potential enforcement problems on a corporation's management and business, combined with today's disclosure practices (and sky-high legal bills), make it difficult for the spirit of the Wells process — giving someone the ability to tell their side before the SEC takes public action — to run its course as it originally was intended.
I believe that advisory committees like the Wells Committee can play a key role in the review and improvement of SEC rules and processes, and in fact they have performed such a function many times over the years. I, in fact, helped to set up a number of them to good effect under Chairmen Richard Breeden and Arthur Levitt. Chairman Casey was exactly right — in order to satisfy the SEC's statutory missions, it is incumbent on the Commission to seek the best advice from outside sources, including the securities bar and the regulated community, to refine the agency's policies and practices. This is critical not only for investor protection purposes, but also for the Commission to satisfy its mandates to facilitate capital formation and maintain fair, orderly, and efficient markets.
To that end, I welcome the idea of new advisory committees to review the functions of our divisions and offices. In light of the many issues raised in the three recent capital market competitiveness reports, the 2006 Chamber of Commerce report on the SEC enforcement program, and the Congressional and GAO reports, I think it is clear that this would be a good time for a new "Wells-like" advisory committee to review the policies and procedures of our enforcement program. The Commission and the staff should welcome, not fear, such a review.
You have been a very patient audience, and I appreciate your attention. I welcome your active involvement in the issues I discussed today, and all of our issues. My phone and office are always open to you. Please call or stop by if you have any comments or concerns. Thank you again for your time and attention.