Speech by SEC Commissioner:
Covering the Bases: Remarks before the Directors' College
Linda C. Thomsen
Director, Division of Enforcement
U.S. Securities and Exchange Commission
June 21, 2005
Good morning. Thank you so much for having me here it is a treat and honor for me.
I should start with the usual disclaimer my views are my own and do not necessarily reflect the views of the Commission, any particular Commissioner, any particular Chairman, either pending in or pending out, or any other member of the staff. I should also add my own unusual disclaimer I love baseball, and having come to this love late in life, it tends to make its way into many of the things I say, as it will today. If your summer sport of choice is tennis, or cricket, or fly fishing, I apologize.
It’s a particularly swell time for baseball in Washington my beloved Orioles are in first place in the American League East and the Washington Nationals are improbably in first place in the National League East. The last time a Washington team was in first place this late in the season was, as I heard on the news, 1933, a year near and dear to my, and I’m sure your, hearts.
The 1988 baseball movie, Bull Durham, is, to my mind, one of the best, if not the best, baseball movie. The running contrast between the young pitcher with the million dollar arm and the five cent head and the aging catcher with the million dollar head and the nickel everything else provides many wonderful moments.
One of them is a scene on the team bus when the pitcher, Nuke Laloosh, attempts to sing the Otis Redding song “Try a Little Tenderness.” Of course, Nuke being Nuke, he misses the entire point of the song. When he gets to the line “young girls the do get weary” he sings “young girls they do get wooly,” giving a whole new meaning to the term “tone deaf.” Needless to say, this is too much for cranky aging catcher Crash Davis who explodes “no one gets wooly.”
I digress on this, I don’t know if you can call it a digression, as I’ve barely started, to say I think it’s fair to say all of us in the securities world, whether on the business side or the government side or the investor side or some other side, and whether we identify with Nuke or Crash or, being fly fishermen, or none of the above, are a little wooly. It has been a crazy few years, often down right exhausting. And phrases like, “just make this stop,” “where do I go to surrender,” “can’t we just declare victory and go home,” and “enough already,” are either said or thought. I understand, but as Crash says no one gets wooly and none of us can afford to get weary.
George Will once described baseball as a game for grownups. You’re in it for the long haul, it depends on fundamentals, you need to be able to handle disappointment. As Will points out, in what other sport are you viewed as a great performer if you fail two thirds of the time which is exactly what a 333 hitter does. Greatness in the field depends on taking the backup position every time even though you know 9 times out of 10 it will be entirely unnecessary.
Baseball is also a bit of an acquired taste it takes a while before you notice the player who never fails to back up, you begin to anticipate a shifting outfield, you silently cheer the pitcher who battles back from a 3 and 0 count, or not so silently cheer the rookie, who at his first major league at bat, after standing stock still as two strikes whiz by, manages to hit a semi-solid single. Baseball is rarely glamorous, but it is, when played right, elegant. It is also a sport for the long haul you have to play every day and success is measured not in a single spectacular game but in a record of a season’s worth of games some spectacular, many ho hum, and some downright ugly.
To my mind law enforcement is similar. Our success requires showing up every day, playing hard every day, covering the bases. To be sure, we have had some of the spectacular of late Enron, WorldCom, Adelphia, to name a few. But our successes in those matters are not, and can not, be the end of the story. Our season is not over, and unlike baseball, our season is never over.
Like it or not, and mostly people like it, success in the businesses we see be it in a public company, in a financial services company, or in a regulated entity depends on other people’s money. And success in many of the businesses we see, and I know that people in those businesses like this fact--can be quite lucrative. There are of course, many synergies in the relationship between the company and its customers, clients and investors. I provide you with money, you provide me with a service, a product, an investment, I want. There are, however, conflicts too and there will never be a perfect symbiotic relationship. And, as we all know, conflicts and money are each, separately and surely in combination, Petri dishes for problems.
That is neither judgment nor condemnation. It is however, a fact. It is a vulnerability that exists. It can’t be cured. It will, from time to time, erupt in problems, both large and small. That’s the bad news. The good news is that, by and large, the businesses we see are legitimate businesses, dedicated to making a buck to be sure, but an honest buck. They are populated by people who are, by and large, law abiding. The trick for all of us is to exploit the good news to manage the bad news. One of the answers is governance, a topic near and dear to all of your hearts I know.
I am reminded of a scene in Herman Melville’s masterpiece Moby Dick, which in addition to giving a pretty complete, some would argue far too complete, picture of the whaling business, has a fair amount to say about human nature generally. It being set in nineteenth century New England, and the oceans you could get to from there, it is not surprising that more than one sermon shows up in the book.
My favorite is the cook’s sermon to the sharks. Apparently after a whale is caught, it takes some time to process. Melville describes, elaborately, the elaborate process of securing a whale to the ship. The tethered whale causes a feeding frenzy among all sharks in the vicinity. Upon one such occasion the harpooner, who was also dining on whale flesh, urges the cook to tell the sharks to quiet down. And the cook then makes his sermon to the sharks.
There are several false starts the cook fails to have the appropriate demeanor for sermonizing and the harpooner Stubbs orders him to start again with a more gentlemanly tone. The successful sermon finally begins: “Your voraciousness, fellow-critters, I don’t blame you so much for; that is nature, and can’t be helped; but to govern that wicked nature, that is the point. You is sharks, certain; but if you govern the shark in you, why then you be angel; for all angel is nothing more than the shark well governed.” And that may be the definitive word on governance, at least within the context of great American literature.
Effective law enforcement serves the goals of punishment, protection and prevention. And I think it’s fair to say while all are equally important, prevention may be a little more equal. If we can motivate the generally law abiding person to be even more diligent, that’s a good thing. And we have a head start. The white collar population can be motivated. That is not true in other areas of law enforcement if your choice is to steal or starve, the logical choice, whatever the risk of being caught or the severity of the sanctions if caught, is to steal. If your reasons for violating the law are less compelling, the reasons to comply with the law become more compelling.
So what do we do? We make the reasons for compliance more compelling. We, for example, teach ethics. We, and here I am talking to things you can do, create a corporate culture that values and rewards ethical behavior. My predecessor, Steve Cutler once said, it speaks volumes when a company disciplines a big rainmaker for ethical violations. And it speaks volumes when it doesn’t.
In law enforcement, we need to do two fundamental things one, make people and institutions understand, feel, believe that if they violate the law, we will be there; and two, we need to impose sanctions that people and institutions will work hard to avoid.
As to the first, effective enforcement requires more than a string of big cases, For every big case that makes headlines, there are dozens of cases that aren’t that big, that don’t make headlines, that are some of our ho hum games. We need to be sure we cover the entire securities law landscape, bringing enforcement attention to all segments of our business broker dealer, insider trading, financial reporting, offering fraud, etc. Our annual report shows relatively consistent patterns of covering the waterfront. Perception is often to the contrary. I spoke recently to a large group of people in the mutual fund industry. I did a pop quiz on what percentage of our cases last year were in the mutual fund area. The vast majority of the attendees estimated the percentage well above the actual 14%. But that misperception from a law enforcement perspective is probably positive. For the moment that is an industry that thinks they have our attention and, as a result, we have theirs.
We aspire to addressing issues long before they explode into massive frauds. We need to continually root out the ubiquitous small scale scams and offering frauds that prey upon the most vulnerable investors, particularly the elderly and those drawn into affinity frauds that take advantage of investors’ confidence in groups to which they already belong.
In this age of ever-evolving technology, we must also identify and eradicate the latest cutting edge scams, designed to reach thousands if not millions of potential investors at once.
Of course covering the landscape generally is not enough we won’t get to everything. So we have to be smart and anticipatory. It is, in enforcement, a very nuanced concept. We can’t bring an enforcement action unless and until a violation has occurred, so at a certain level we are always reactive. However, we can exercise foresight as to possible next issues. This has been one of the cornerstones of Chairman Donaldson’s tenure the need for all of us to, as he says, look around the corner and over the hill.
So that’s the first fundamental we need to make people believe that we are there, on the job, in our positions if you will, and able to shift those positions and back up in the face of new or changing circumstances.
The second fundamental thing we need to do is impose penalties that people will work hard to avoid. To be effective, penalties have to sting and must be seen as something more than a cost of doing business. It’s certainly true that we have sought and obtained stiffer sanctions against wrongdoers in recent years. And the gross misconduct we have seen merited nothing less. In those cases, the sanctions and remedies be they compliance undertakings, or suspensions or bars, or disgorgement, or penalties or some combination were tied to the specific wrongdoing by the specific party or parties. In short, to borrow a phrase from criminal law enforcement, the punishments have fit the crimes. And it is worth noting that in many of these matters, the conduct was a crime.
To be sure, toughness is not the only measure of an enforcement program. It must also be fair. Not surprisingly, I am convinced that the results we have obtained have been just that. Maybe that’s because our actions are, and have been throughout our history, the product of an abundance of process. Indeed, you would be hard pressed to find many other law enforcement functions with as much process.
Our investigations are conducted by professionals supervised by a series of other professionals. Subpoena power requires an act of the Commission. Whenever the staff reaches a conclusion that it is inclined to recommend enforcement action, we engage in what is called the Wells process in which the potential defendant or respondent is told about the views of the staff and is afforded an opportunity to tell us we’re wrong. This process involves meetings and submissions and often results in the staff rethinking its views, from modifying the ultimate recommendation as to charges and/or defendants or respondents, to deciding not to recommend any action. Every recommendation is approved by senior management within the Division of Enforcement and is reviewed by the General Counsel’s office and by any Division or office that has an interest in the substance of the recommendation. And, every action is authorized by the Commission, usually after it has been discussed at a meeting among the Commission.
While this takes time, it is time well spent and is part of a proud tradition at the SEC. We have a responsibility to get it right and we take that responsibility very seriously.
Most importantly, however, our enforcement program is working--the enhanced enforcement efforts and tough sanctions appear to be having the desired effect across the board. Throughout corporate America there are signs of fundamental change a profound shift to a corporate culture of compliance. The Wall Street Journal recently observed that “there seems to be a kind of sea change going on here a maturation of American corporate governance.” Boards of directors are becoming stronger and more independent. They are taking decisive action in response to ethics and compliance failures. As one observer told the New York Times, “Boards are flexing their muscles and beginning to take on the role they are supposed to take on, and that is very healthy for American business.”
So what’s next? Surely the same effort from us we’re staying in the game and will continue to track down the problems and respond to them appropriately. With any luck, they will be different problems; that is, our efforts, in combination with the efforts of companies and compliance professionals and boards and so many others, will prevent a recurrence of the kind of problems we have seen over the past few years.
I’d like to end with some thoughts I had on a recent visit to the Grand Canyon. Now I know the connection between the Grand Canyon and baseball, let alone law enforcement, is not obvious. But as to the Grand Canyon and baseball, George Will has helped me out.
He knows that there are those who do not share his passion for the game. He once remarked: “Baseball, it is said, is only a game. True. And the Grand Canyon is only a hole in Arizona. Not all holes, or games, are created equal.”
I saw the Grand Canyon for the first time about a year ago. And all the hype didn’t do it credit. While I was there I was astonished at just how close you could get to the edge. The problem with that, of course, is that you could fall in. With a little luck and a lot of attention, you can avoid falling in. But there is another problem with staying so close to the edge in order to successfully navigate the edge, and keep yourself from falling in, you have to keep your head down and focus exclusively on the edge. And you miss the view.
So in closing, I know there are times when all of us are at the edge, but it’s not a place you want to stay all the time you risk falling in and you’ll miss a spectacular view.
Thank you for your very gracious attention.