Jan. 31, 2003
Audit No. 355
This document is an HTML formatted version of a printed document. The printed document may contain agency comments, charts, photographs, appendices, footnotes and page numbers which may not be reproduced in this electronic version. If you require a printed version of this document contact the United States Securities and Exchange Commission, Office of Inspector General, Mail Stop 11-7, 450 Fifth Street N.W., Washington, D.C. 20549 or call (202) 942-4460.
Audit No. 355
January 31, 2003
We found that the Commission's bankruptcy program was effective overall. The Commission implemented several of the recommendations from our 1995 audit, however certain issues discussed in the prior report remain today. These include the program staff's desire to obtain increased delegated authority and additional financial analysts or accountants to review financial statements. Program staff generally believe that increased delegated authority and additional staff would enhance the bankruptcy program's effectiveness. The Office of General Counsel (OGC) continues to explore these issues.
Approximately two years ago, program staff began monitoring Securities Investor Program Corporation (SIPC) cases. We are recommending that senior program officials issue guidance to program staff regarding their role in reviewing fee applications. To enhance accountability, we are also recommending that the division of Market Regulation request that SIPC require the attorneys and trustees hired for SIPA proceedings to submit fee applications in a more detailed format and timely basis. We also believe that communication should be improved among Commission staff and are recommending that OGC staff resume quarterly meetings with other Commission offices and divisions to discuss SIPC issues.
OBJECTIVES AND SCOPE
Our objectives were to review the status of previous audit recommendations and identify possible improvements to the bankruptcy program.
During the audit, we interviewed Commission staff, U.S. Trustees, bankruptcy attorneys, and staff at the Securities Investor Protection Corporation. We also reviewed available documentation. We did not review fee applications in detail.
The audit was performed from March 2002 to September 2002 in accordance with generally accepted government auditing standards.
Chapter 11 of the US Bankruptcy Code grants the Commission authority to participate in bankruptcy proceedings. Specifically, under 11 U.S.C. 1109(a), the Commission "may raise and may appear and be heard on any issue in a case under this chapter."
Generally, the Commission's role in a bankruptcy consists of participating in legal issues that affect public investors, reviewing the disclosure documents to determine if the company is disclosing to investors and creditors the information they need to know to make informed decisions, and ensuring that stockholders are represented by an official committee, if appropriate. The program staff also spend a significant amount of time assisting Division of Enforcement staff with bankruptcy-related cases.
In September 2000, the program staff began monitoring Securities Investor Protection Corporation (SIPC) cases to ensure that claim determinations are consistent with the Securities Investor Protection Act (SIPA) of 1970.
GAO and the Commission's OIG performed an audit of SIPC in 2001 and 2000, respectively.1
Staff in three regional offices (Midwest, Northeast, and Pacific) and one district office (Atlanta) perform the bankruptcy program work. The work is supervised by the Office of the General Counsel's (OGC) Appellate Litigation and Bankruptcy Group.
We found the Commission's bankruptcy program is managed by a team of experienced, collegial staff. We also found communication among the bankruptcy program staff in headquarters and the regional offices to be effective. Additionally, U.S. Trustees and bankruptcy attorneys outside the Commission commended program staff on their helpfulness and efforts to ensure that bankruptcy cases proceed in accordance with the law.
Senior staff are exploring the possibility of obtaining increased delegated authority. They are also re-assessing staffing needs. Program staff believe that increased delegated authority and additional staff would enhance the bankruptcy program's effectiveness. These issues are further discussed below.
We are recommending that senior program officials issue increased guidance to program staff regarding their role in reviewing SIPA fee applications. To enhance accountability, we are also recommending that the Division of Market Regulation (MR) request that SIPC require attorneys and trustees hired for SIPA proceedings to submit fee applications in a more detailed format and timely basis. We are also recommending that OGC staff resume quarterly meetings with other Commission offices and divisions to discuss SIPC issues.
Currently, OGC has delegated authority to file notices of appearance in most bankruptcy cases.2 This enables program staff to receive case-related documents. However, before taking an official position in bankruptcy court, program staff must obtain Commission authority. Staff may seek authority at closed Commission meetings, or through a duty officer if faced with a tight deadline.3
Program staff suggested that an additional delegation of authority to the Commission's General Counsel, for a limited number of recurring issues where the staff exercise a consistent viewpoint, would enhance program efficiency and effectiveness. These issues include:
- Objecting to disclosure statements that lack adequate information for investors to make an informed decision on accepting or rejecting a plan;
- Objecting to plan provisions that call for the issuance of unregistered new securities that do not qualify for the exemption from Securities Act registration in section 1145 of the Bankruptcy Code;
- Objecting to plan provisions that purport to release nondebtors from liability in contravention of section 524(e) of the Bankruptcy Code;
- Objecting to plan provisions that purport to grant a discharge to a liquidating corporate debtor in contravention of section 1141(d)(3) of the Bankruptcy Code and the policy against trafficking in corporate shells;
- Supporting appointment of an equity committee pursuant to section 1102(a)(2) of the Bankruptcy Code in cases that satisfy Commission criteria for a committee; and
- Objecting to proposals to dissolve an equity committee or to restrict its activities or the payment of professional fees.
- Objecting to disclosure statements that lack adequate information for investors to make an informed decision on accepting or rejecting a plan;
The staff sometimes do not take a position on certain matters because they do not believe they will have enough time to obtain Commission authority. Some court actions are scheduled only a few hours in advance or are added to the court's agenda without prior notice. In such instances, staff were sometimes unable to file a motion with the court to obtain additional time to file an objection. As a result, requests were granted by the courts without staff input. Staff also said that the time it takes to prepare documentation for Commission approval of routine matters could be better spent working directly on bankruptcy proceedings.
In one instance, as part of a first day order, a bankruptcy court approved a retention agreement for a prominent accounting firm that included a provision exculpating the firm from liability for negligent conduct. The firm was subsequently paid for services rendered. Staff said they could not object because there was not enough time to obtain Commission authority to do so. Staff believe that the program could become more involved in these types of issues if they had delegated authority.
Other program staff said that the time required to seek Commission authority has not prevented them from participating in issues of importance to the program. These officials also said they have been able to obtain Commission approval when it was needed.
Senior staff considered the possibility of obtaining increased delegated authority in 19964 and recently examined this issue again.
We believe that the bankruptcy program could be more efficient and effective with increased delegated authority. However, we did not find any evidence that, without increased delegated authority, program staff were unable to accomplish the program's mission or an ultimate case outcome was adversely affected. In instances where staff refrained from a particular action because they could not obtain Commission authority in time, it was impossible to determine whether staff participation would have resulted in a more equitable outcome for investors.
Accordingly, we are not taking a position as to whether the Commission should grant increased delegated authority to OGC. Program staff should continue to monitor this issue. It may be useful if the staff document all cases where the absence of delegated authority prevented them from taking a particular position and how the failure to take this position affected or potentially affected a proceeding. This type of documentation could support a future request for increased delegated authority.
Staff in three regional offices (Midwest, Northeast and Pacific) and one district office (Atlanta) perform the bankruptcy work. Program staffing (full-time equivalents) is currently as follows: Midwest (3.6), Northeast (5), Pacific, (2) and Atlanta (2). Authorized staffing levels have remained at 13 for several years. Due to a significant increase in the number of bankruptcy filings over the past two years, senior program staff are exploring the possibility of hiring additional attorneys or paralegals.
Senior program staff are also looking into the possibility of hiring accountants or financial analysts to assist with the review of disclosure statements. Because of its financial complexity, an adequate review of a typical statement requires accounting or financial expertise, according to the program staff. For example, program staff said that accountants are better able to determine if a debtor properly valued its assets or if the debtor established a shell company for personal gain. Although some of the program's attorneys also have some accounting or financial expertise and sometimes receive assistance from an accountant or financial analyst in another division, no accountants or financial analysts are formally assigned to the bankruptcy program.
Several staff in the four regional and district offices said they would like to hire a full-time or part-time accountant or financial analyst for their office.
SIPC is a private, not-for-profit corporation that insures the securities and cash in customer accounts of member brokerage firms against failure of those firms.
In September of 2000, the Commission granted delegated authority to OGC to enter notices of appearance in broker-dealer liquidations under SIPA. By entering notices of appearance in a liquidation proceeding, the Commission receives pleadings and can monitor the progress of the proceeding. The staff monitor the resolution of customer claims to ensure that claim determinations are consistent with SIPA.
The Office of Compliance Inspections and Examinations (OCIE) and MR are completing an in-depth inspection of SIPC that was more comprehensive than our audit. The related draft report indicates that problems were identified indicating a lack of detail in certain fee applications and infrequent submissions of fee applications to SIPC. We also identified these issues in our review.
Reviewing Fee Applications
Staff also review fee applications in an attempt to monitor legal and administrative costs incurred in SIPA proceedings. The fee applications outline fees charged by professionals (e.g., lawyers and trustees). The reasonableness of these fees has been an area on on-going concern.
The bankruptcy program staff are not responsible for conducting a detailed analysis of fee applications. The statute assigns this function to SIPC. However, when certain fees appear excessive, program staff bring their concerns to the attention of MR, which oversees SIPC.
In reviewing fee applications, bankruptcy program staff said they look for instances of fees being charged for unnecessary research, duplicative work or work that a partner performs but is more suitable for a lower level professional. They also use their judgment to assess whether fees and expenses appear reasonable. However, while program staff are experienced bankruptcy attorneys and are familiar with fee applications, they have received no formal guidance indicating to what extent they should review fee applications.
Senior bankruptcy staff plan to develop guidance to define the program's role in reviewing fee applications. However, they have not developed a timeframe for completing this task.
OGC should prepare guidance for its staff, further defining the staff's role in reviewing fee applications, and set a timeframe for completing this task.
Senior bankruptcy staff found that a meaningful review of fee applications may be hampered because the fee applications are not always broken out into categories of work or the categories of work are too broad. Staff also noted that some fee applications were submitted to SIPC more than six months after completion of the related work, further hindering an effective review. 5
OCIE staff concurred with these findings, based on work performed during an on-going inspection of SIPC. During this inspection OCIE had some questions regarding the reasonableness of certain fees and concluded that it is sometimes difficult for SIPC to perform a detailed review of its fee applications to determine if the fees are reasonable. However, SIPC officials told us that its staff perform a detailed review of all fee applications and did not consider the fees it paid to be unreasonable.
Bankruptcy program senior staff said it would be useful if all of the attorneys and trustees hired for SIPA proceedings reported their fees in accordance with the Guidelines of the U.S. Trustees. These guidelines provide that all fees be arranged by project category and list 13 suggested categories. The guidelines also require services to be noted in detail and generally prohibit the combining of services into a single fee category.6
The guidelines do not currently apply to SIPA proceedings. However, according to bankruptcy program staff, it should not be difficult for trustees and attorneys selected for SIPA liquidations to report fees in accordance with these guidelines. This is because the trustees and law firms hired for SIPA proceedings are generally experienced in chapter 11 bankruptcy proceedings, where they are required to file fee applications in accordance with these guidelines.
The Commission is hampered in its ability to oversee SIPC when it is unable to assess the reasonableness of the fees in fee applications.
MR should instruct SIPC to require attorneys and trustees hired for SIPA proceedings to report fees in accordance with the U.S. Trustee Guidelines (or in some other format allowing for a meaningful review by SIPC and the Commission).7
MR, in consultation with OGC, OCIE and Enforcement, should establish guidelines concerning the frequency of draft8 fee application submissions to SIPC. After establishing these guidelines, MR should instruct SIPC to adopt these guidelines.9
We noted differences of opinion among different offices and divisions within the Commission (i.e., among OGC, MR, OCIE, and Enforcement) over what types of customer claims should be covered by SIPA and whether professional fees are reasonable.
SIPA outlines what types of claims are covered. However, according to program staff, some elements of this determination are subjective. In some of these subjective areas, OGC bankruptcy program staff have contended that customer claims should be covered, in opposition to SIPC and other Commission officials.
A 2001 GAO report10 and 2000 SEC OIG report11 recommended that MR, OCIE, OGC and Enforcement establish a procedure to share information about SIPC issues. These recommendations were intended to provide an opportunity for the staff to discuss differing opinions over SIPC issues, improve communication among Commission staff and ensure a comprehensive oversight program. In response, quarterly meetings among these offices and divisions were established. Program staff participated in these meetings and said they were useful.
At the time of our review, these offices and divisions had informal communications regarding SIPC issues. However, a quarterly meeting had not been held for nearly a year, since February 2002.
OGC should contact MR, OCIE and Enforcement to resume quarterly meetings to discuss on-going SIPC issues and try to reach a consensus on the issues identified above (i.e., what types of claims are covered by SIPA and what fees are considered reasonable). Additionally, an official should be designated to ensure that future quarterly meetings are timely held.
1 GAO Report 01-653, "Securities Investor Protection: Steps Needed to Better Disclose SIPC Policies to Investors" and SEC OIG Report 301, "Oversight of Securities Investor Protection Corporation".
2 OGC has delegated authority to file a notice of appearance in bankruptcy reorganization cases under section 1109(a) of the Bankruptcy Code involving debtors, the securities of which are registered or required to be registered under section 12 of the Securities Exchange Act. Most of the companies monitored by program staff are covered under this section.
3 On a rotating basis, each Commissioner (excluding the Chairman) is assigned as a duty officer, authorizing him or her to approve certain staff actions on behalf of the Commission. The actions must be subsequently affirmed by the Commission.
4 OGC sent a memorandum to the Commission in 1996, requesting delegated authority to appear in bankruptcy cases on issues that arise frequently and have been previously authorized by the Commission. After encountering resistance from a Commissioner, OGC withdrew the memorandum.
5 OGC discussed these issues with MR and OCIE and issued a related memo in February 2002.
6 The guidelines above are referred to as: "U.S. Trustee Program: Guidelines for Reviewing Applications for Compensation & Reimbursement of Expenses Filed Under 11 U.S.C. § 330." This document can be found at title 28 of the Code of Federal Regulations, part 58, Appendix. Some attorneys and trustees hired for SIPA liquidations already report fees in accordance with U.S. Trustees guidelines.
7 Following their examination of SIPC, OCIE and MR prepared a draft report, which also recommends that SIPC require the attorneys and trustees hired for SIPA proceedings to report fees in a format such as that recommended by the U.S. Trustees Guidelines.
8 Bankruptcy attorneys are only allowed to submit fee applications to the courts three times a year (per case). However, interim or draft fee applications could be submitted to SIPC more frequently.
9 Following their examination of SIPC, OCIE and MR prepared a draft report, which recommends that SIPC require the attorneys and trustees hired for SIPA proceedings to submit monthly invoices describing all fees and work performed in a particular month.
10 GAO Report 01-653, "Securities Investor Protection: Steps Needed to Better Disclose SIPC Policies to Investors", pages 58-59.
11 SEC OIG Report 301, "Oversight of Securities Investor Protection Corporation", page 7.