Speech by SEC Staff:
Regulatory Keynote Address — Outlook From the SEC
Linda Chatman Thomsen
Director, Division of Enforcement
U.S. Securities and Exchange Commission
Second Annual Capital Markets Summit
U.S. Chamber of Commerce
March 26, 2008
Good afternoon. Thank you, Mike [Ryan], for that kind introduction. Before I go any further let me get to the only required portion of my remarks — my views are my own and do not necessarily reflect the views of the Commission or any other member of the staff. Now, I can talk with a clear conscience. I am delighted to be here — I think. Given the Chamber of Commerce's positions on certain issues, which some, perhaps unenlightened souls, might take as — shall we say skeptical — about the work we do in Enforcement, it is especially heartening to be so warmly welcomed. Thank you. But as I say that I have an image of the warm welcome of another public servant — Daniel who was warmly welcomed into the lion's den — as lunch. But things turned out alright for Daniel — he had the angels on his side after all — so I'm happy to proceed (I am also happy you've already eaten).
While I expect each of us can find things about which we disagree, I think it is important to remember there are some things about which we profoundly and fundamentally agree: We all want competitive U.S. financial and capital markets that offer a fair and level playing field, that facilitate capital formation and that will continue to prosper and thrive in our increasingly interrelated global markets.
Another thing I think we agree on is that individuals matter and that we are all heartened and inspired by individual success stories. So here are a few:
Consider, for example, Michael Gold. First, he built a successful career as tax partner at a major accounting firm. Then he became the CFO of a Fortune 500 company. Next he built his own business — a chain of sports apparel stores — which was eventually, and successfully, taken public.
Or, think about Sam Weber. He had a meteoric rise in the banking industry and was running the preeminent investment bank for doing bank M&A deals before he was 40.
Then there's Nick Carlton. After serving as a fighter pilot, he ultimately became the CEO of a major defense contractor. He then chose to serve his country again and was appointed Deputy Secretary of Defense by the President of the United States.
On another front we have the scientist Harold Cooper. After getting a doctorate degree in immunobiology, he became the CEO of a biotechnology firm. His firm has developed a promising anti-obesity drug.
And finally we have Karen Bowens. After a short career in advertising, she followed her passion and built a mega-business around her love of gardening. She's a media darling and is on the top of virtually every list of successful business women.
Now with any luck I have you all a little confused. I expect few, if any of you, recognize the names I just mentioned. I expect a few more of you think the biographies sound familiar but you can't quite place them. And I expect almost all of you are wondering why I am talking about them.
Let me explain. The names are fictional — they are the names of characters from the movie The Big Chill, which was released 25 years ago. The biographies, however, are derived from some genuine business success stories and I'll tell you who they are in a minute. But they are not only business success stories, they are also law enforcement success stories. Because all of the summaries I just gave you left out one critical fact — each of these people has been convicted of, pleaded guilty to, held civilly liable for, or settled civil charges of insider trading. So why The Big Chill? I picked The Big Chill because, as the movie buffs among you might remember, there was an insider trading theme running throughout the movie. So, in real life, who were these people?
Michael Gold, the one with the sports apparel chain? He's actually David E. Lipson, former CEO of the Supercuts hair salon chain. Mr. Lipson was held liable for dumping his shares of Supercuts stock on non-public inside information about the company's financial condition. After a two-week civil jury trial on the SEC's charges of insider trading, Mr. Lipson was held liable, permanently enjoined from future violations of the securities laws and ordered to pay a total of $2.8 million, which included disgorgement of the full amount of losses he avoided, plus a civil penalty of three times that amount — the maximum penalty legally permissible.1
Sam Weber, the CEO of the investment bank? He's James McDermott, Jr., former Chairman and CEO of an elite investment bank for the banking industry, Keefe, Bruyette & Woods. Mr. McDermott pled guilty to insider trading and went to jail for five months after tipping his girlfriend, who appeared in pornographic movies as "Marilyn Starr," about upcoming transactions. The girlfriend traded on Mr. McDermott's tips and passed them on to another boyfriend, who also traded on them. In settlement of the SEC's civil proceedings, Mr. McDermott agreed to pay about $230,000, including disgorgement of his girlfriend's profits and a penalty in the same amount, and a permanent bar from the securities industry.2
What about Nick Carlton, the Deputy Defense Secretary? He is actually Paul Thayer, who was indeed Deputy Defense Secretary under President Reagan. He stepped down as Deputy Defense Secretary while under investigation by the SEC for trading on, and tipping friends with, inside information about upcoming corporate events he had previously learned of as CEO of a major defense contractor and as a board member of two other corporations. When the SEC later filed insider trading charges against him, Mr. Thayer settled — agreeing to a permanent anti-fraud injunction and paying disgorgement of $550,000. In related criminal proceedings, he pled guilty to obstruction of justice for lying to the SEC and was sentenced to four years in prison.3
Harold Cooper — the biotech wizard? He's Sam Waksal of ImClone Corporation, the company that invented the cancer drug Erbitux. When he received confidential information suggesting that the drug was about to be rejected by the FDA, Dr. Waksal began selling his own ImClone shares and tipped his family, who also sold their shares before the public announcement of the news. Dr. Waksal pled guilty to insider trading. He is presently serving a seven-year term in federal prison. In settlement of the SEC's insider trading charges, Dr. Waksal agreed to a permanent anti-fraud injunction and to pay a total of over $5.8 million in disgorgement and civil penalties on behalf of himself, his father and his daughter. He also agreed to a permanent officer and director bar.4 Ironically, the cancer drug was eventually approved by the FDA and later became a commercial success for ImClone.5
Finally, what about Karen Bowens — the gardening guru? She, of course, is Martha Stewart of Martha Stewart Omnimedia.6
All of this is a long winded way of introducing the role of law enforcement in market competitiveness. And the point I would make about these people and their stories is two-fold. First, in our financial and business markets, all are welcome and all can succeed. Second, no one is above the law. Indeed, the latter — that no one is above the law — is essential to the former. An integral part of the attraction of our financial markets to companies and investors from around the globe is that our markets offer a level playing field.
There is substantial evidence that financial markets succeed not in spite of strong enforcement and regulation, but because of it. One academic study stated that the U.S. securities regulatory system that has evolved since the 1930s "has proven itself the most successful in the world."7 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.8 The merits of the existing U.S. securities regulatory and enforcement model are demonstrated by the ongoing trend toward the adoption of U.S.-type standards in other countries. As we speak, our regulatory and enforcement regimes are being adopted and emulated in other countries all over the world.9 If imitation is the sincerest form of flattery, then our securities regulation and enforcement regime is being honored with the highest possible accolades.10
Let's look at a few aspects of U.S. securities law that have been adopted by other countries. Consider our prohibition of insider trading: While the U.K. and France have long prohibited insider trading, an E.U. Directive in 1989 required that all member states adopt laws against insider trading. By the year 2000, virtually all developed countries had enacted insider trading prohibitions consistent with U.S. law.
The same is true of the Foreign Corrupt Practices Act. The FCPA prohibits U.S. public companies from offering bribes to officials of foreign governments in order to obtain business abroad and was enacted as part of the post-Watergate reforms. The enactment of the FCPA was decried by many as the end of U.S. competitiveness in foreign markets. But in fact it was not. The U.S. took a stand against global corruption, and much of the rest of the world followed suit by subscribing to international or regional anti-bribery conventions that are similar the FCPA.11 With respect to bribery, what ensued was an international regulatory "race to the top."12
More recently, the international community is adopting standards similar to those created by the Sarbanes-Oxley Act.13 Other countries are adopting portions of the Act, or creating similar compliance regimes.14 These foreign countries are adopting the standards set by the Act as the new international ideal — the "gold standard," if you will, for market integrity — in yet another "race to the top."15 Indeed, even countries with developing markets that are just struggling to their financial feet are adopting standards similar to those of Sarbanes-Oxley to enhance their competitive position in the international financial community.16 This convergence provides yet more evidence that instead of harming our competitive position, good governance, rigorous compliance and tough enforcement provide significant competitive benefits to our financial markets, which other countries are seeking to obtain for their own markets by adopting similar standards.
Of course, no law of the magnitude of SOX is going to be without controversy. It and other events have been the subject of many reports and articles.17 I've read many of them. I've recently read an article from Fortune magazine that raised a number of concerns. The author of the Fortune article suggested that newly enacted securities legislation 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 suits.18 But the Fortune article was not about Sarbanes-Oxley. The author was in fact writing about the Securities Act of 1933 — the key law governing our securities offering process — just a few months after its passage. 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 made in the Fortune article nearly 75 years ago are in some ways similar to the concerns about the effects of Sarbanes-Oxley on the U.S. capital markets. But the law that was predicted to be a major calamity for business in 1933 quickly became a widely accepted standard for market fairness. This year marks the 75th anniversary of the '33 Act. It will be interesting to see how history judges Sarbanes-Oxley 75 years out.
With respect to our program of securities law enforcement at the SEC, I would like to take a few moments to tell you about our priorities. What are we investigating now and what will be the focus of the SEC's enforcement efforts over the next few years? The single most important thing that lies ahead for us is more of the same. We want to continue covering all the bases in our enforcement program and maintain our vigilance against securities law violations of all kinds.
Beyond that, a few areas of concern have emerged in our caseload. First, for the last several years, we have devoted substantial resources to the investigation of financial frauds by large firms at the very top of our financial markets — Enron, WorldCom, and Tyco, to name a few — and we will continue to do so. But we are also committing additional resources to enforcement efforts at the other end of the financial spectrum, one you may not see. We have recently created a new permanent staff section devoted to addressing various kinds of microcap fraud in the Over-The-Counter markets. With the creation of this group, we are already seeing more emphasis on enforcement actions regarding microcap issues. We are increasingly concerned with smaller-scale frauds that are being facilitated by developments in communications technology. Fraudulent promoters are coming to rely on methods like the internet, fax blasts and mass voicemail messaging to bring their fraudulent offerings to millions of potential investors. In our approach to these kinds of microcap fraud, we are paying particular attention to "repeat perpetrators" and related third-parties (like attorneys, accountants or financial firms) that may be facilitating frauds on a continuous hit-and-run basis.
The group has already launched a very successful Anti-Spam Campaign in which it suspended trading in the securities of 50 issuers, most of which appeared to be nothing more than shell companies, that were nonetheless the subjects of massive spam promotions. In addition, it has brought a number of enforcement actions against fraudulent microcap issuers, promoters and insiders. Just last week, the group suspended trading in three more shell companies that were featured in promotional internet videos on YouTube. Since the start of the Anti-Spam Initiative only one year ago, online complaints to the SEC about promotional spam have dropped by a remarkable 68%.
Other areas of current attention are reflected in four Working Groups we recently formed: Subprime Lending; Options Backdating; Municipal Securities; and Hedge Funds, with particular emphasis on insider trading by hedge funds. Our Working Groups consist of Enforcement staff throughout the country who are working on investigations related to the same subject matter. The four Working Groups all operate slightly differently, but each group typically meets through periodic nationwide conference calls. In these conference calls, the groups discuss the status of open investigations and issues of common concern. In some instances, the Working Groups provide advanced training to staff on the relevant subject matter. The Working Groups also coordinate with other Divisions and Offices at the SEC, as well as with other federal and state regulators. On the whole, the Working Group concept is ensuring greater coordination, better communication and more consistent approaches to investigations, cases and settlements.
So, what are they doing? The Subprime group was formed about a year ago and is focused on enforcement efforts in those areas. As many of you know, there is also a Commission-wide Subprime Task Force that was formed by Chairman Cox earlier this year. The SEC's efforts in this area are being very carefully coordinated to support and strengthen the financial markets, and to promote consistency with the efforts of other federal agencies, such as the Federal Reserve Bank, that have an even greater role in addressing these issues. Enforcement staff investigating these issues are coordinating amongst themselves, with the various SEC Divisions and Offices participating in the Subprime Task Force, and with many other federal agencies and state regulatory authorities.
Enforcement's Subprime Working Group is pursuing several different categories of investigations. These involve subprime mortgage lenders; investment banks and other firms that created, bought or sold credit derivative products — such as securities backed by pools of mortgages; retail and institutional sales of such products; and a host of other participants in the subprime lending and credit markets, such as credit rating agencies, insurers, investment advisers and home builders. Given the continuing volatility in the credit markets, subprime and credit markets issues are likely to be a high priority at the SEC for some time to come.
Another Working Group, Options Backdating, has been investigating and filing cases related to options backdating and related accounting violations for about two years now. The backdating investigations are well-advanced and many cases have already been filed against the responsible individuals and firms. Through the end of 2007, the SEC had charged 8 public companies and 29 corporate executives (including 7 former General Counsel) with stock options backdating. Many of the same defendants are involved in parallel criminal proceedings. While it is not universally true, one of the most gratifying aspects of the options backdating investigations has been the extent to which corporate boards of directors were willing to address options backdating entirely on their own, with no prompting from the SEC. In many cases, boards promptly investigated potential violations, dismissed the offenders and took thorough remedial measures — all without so much as a phone call from us. The boards stepped up to their responsibilities and acted in the best interests of the shareholders — and that's how effective corporate governance should work.
The Municipal Securities Working Group addresses securities law violations in the complex and specialized world of municipal finance. The overall size of the municipal securities market is enormous. There now are nearly $2.5 trillion of municipal securities outstanding. Last year alone, more than $430 billion of new municipal bonds and notes were issued. That's roughly the size of the U.S. defense budget. Though large and complex, the municipal securities market is particularly favored by individual investors. Fully 36% of all municipal securities are owned directly by households. And up to another one-third of the total municipal market is held indirectly through money market funds and mutual funds.
You may recall the SEC's recent case against the City of San Diego for issuing bonds without adequately disclosing the City's overwhelming financial obligations related to employee pensions. But San Diego may not be unlike many other American cities, and accordingly there is some concern that San Diego may be a harbinger of things to come as other cities wrestle with their own burgeoning financial obligations. At the same time, the Enforcement Division has also been concerned with the functioning and fairness of the municipal securities markets themselves — investigating several instances of political "pay-to-play" and bid rigging in municipal securities auctions. These issues appear to be arising with increasing frequency and led to the formation of the Muncipal Securities Working Group. Because municipal securities markets are complex and have their own separate rules and practices, the Municipal Securities Working Group has enabled the SEC to more readily address these issues with specially-trained staff nationwide.
Trading by hedge funds and other institutional investors also continues to be among the Enforcement Division's highest priorities. The Enforcement Division's Hedge Fund Working Group was established to address securities law violations by hedge funds, with particular attention to the issue of insider trading by hedge funds. Many of you may be familiar with recent studies showing unusual spikes in trading volumes ahead of up to 60% of recent corporate merger and acquisitions transactions. The authors suggest that these trading patterns and the large volumes of trading involved indicate a substantial amount of insider trading by hedge funds. While one might reasonably question the merits of any particular study, it is clear that there is a widespread public perception of insider trading by hedge funds ahead of the public announcement of significant corporate transactions. This perception, in and of itself, is harmful to the reputation of our markets for fairness and integrity and therefore warranted further investigation — which has been undertaken by our Hedge Fund Working Group.
Since I started with insider trading and the Big Chill, I would like to touch on a couple of related themes before I close. First, we are still very much interested in insider trading, whether by hedge funds or individuals. Last year featured the largest wave of insider trading cases since the days of Dennis Levine and Ivan Boesky in the 1980s. Perhaps even more disturbing, this wave of insider trading featured the active participation of securities industry professionals at the highest levels, including several Wall Street married couples. But almost without exception, the insider traders in this latest wave of cases were under forty — and probably were too young to remember the images of Boesky and Levine being led away in handcuffs. Because they did not learn the lessons of the past, the insider traders of this later generation were destined to repeat them.
Speaking of generations, one of the Enforcement Division's other priorities relates to fraud against seniors. If you remember the movie the Big Chill, then odds are that you, like me, are one of the Baby Boomers. Indeed, all of the characters you met earlier would be too. The first of the Boomers reached retirement age last year, and that means we, collectively, will soon be seniors whose retirement funds may be in need of protection. The greatest population wave in U.S. history is now preparing to enter retirement with more per capita wealth than any generation before. To be ready for fraudsters who would prey on that wealth, the SEC and other regulators are gearing up now. The SEC already puts a high priority on enforcement cases involving fraud against seniors, and that focus will intensify in coming years. We are also concerned about frauds affecting pension funds, as more U.S. citizens than ever before are participating in the financial markets through their pension fund investments.
Because seniors may be unable to recoup any financial losses resulting from fraud, education and prevention are of primary importance in protecting seniors. The SEC will soon hold its Third Annual Senior Summit at our D.C. headquarters in conjunction with other regulators and the AARP. Indeed, some interesting findings that came out a study conducted for the first Summit were that contrary to popular belief, seniors who fell victim to financial fraud were better-educated, had higher income levels and scored higher on financial literacy questions than non-victims.19 In this regard, virtually all of our regional offices are conducting educational outreach programs aimed at protecting seniors from financial predators. The SEC will continue to be fully engaged in all of these efforts to keep seniors safe and financially sound.
Our securities law enforcement efforts aim to preserve the integrity of the U.S. financial markets so that they are fair for all investors — seniors and younger investors, U.S. citizens and foreigners, professionals and non-professionals. One of the primary objectives of the Enforcement Division is to maintain a level playing field for all — the very hallmark of U.S. financial markets. In reality, the SEC's constant vigilance in protecting the integrity of our markets is not a burden to our global competitiveness, but an essential element of our continued success. Thank you.