The Government Accountability Office, the investigative arm of the US congress and known for its poisonous pen, strongly criticises the leadership of former SEC chairman Christopher Cox in a report released on Tuesday.
The report bears the long-winded and obtuse title “Greater Attention Needed to Enhance Communication and Utilization of Resources in the Division of Enforcement”, but its criticisms are much more pointed.
For instance, the watchdog said that under Cox – who resigned in January – the SEC was plagued by internal conflicts and quoted an unidentified attorney saying that it was “widely felt” the enforcement unit was prevented from doing its job.
SEC enforcement managers and investigative attorneys believed that recent corporate penalty policies delayed cases and generated fewer, smaller penalties, the report said.
Moreover,
GAO also identified other concerns, including the perception that SEC had “retreated” on penalties, and made it more difficult for investigative staff to obtain “formal orders of investigation,” which allow issuance of subpoenas for testimony and records. Our review also showed that in adopting and implementing the penalty policies, the Commission did not act in concert with agency strategic goals calling for broad communication with, and involvement of, the staff. In particular, Enforcement had limited input into the policies the division would be responsible for implementing. As a result, Enforcement attorneys reported frustration and uncertainty in application of the penalty policies
“Some investigative attorneys came to see the Commission as less of an ally in bringing enforcement actions and more of a barrier,” the GAO said.
Cox’s policies “contributed to an adversarial relationship between enforcement and the commission,” the report said.
There are some interesting examples of the effects of some of the more contentious policies highlighted in the report, like this one (emphasis ours):
the factor in the 2006 penalty policy that anchors penalties to benefits derived by the corporation serves to bar a corporate penalty in a significant number of cases, or likewise limit the scope of many cases. For instance, if a company committed fraud to inflate its stock price, that, by itself, would not qualify for a penalty, because the company would have derived no calculable benefit. Yet, the manager said, companies benefit in several ways from having a higher stock price-such as by having a better reputation, being in a better position to offer stock option compensation to executives, and being able to obtain financing at lower cost. Enforcement officials told us that given the effects of the penalty policies, a $10 million penalty today might have been $50 million to $60 million before adoption of the policies.
The GAO also quoted a “former commissioner” who said the policies implemented by Cox could not be blamed for “declining amounts of penalties and disgorgement, nor for less vigorous pursuit of corporate penalties.”
But Cox is not let off the hook here, for the report continues (emphasis ours):
Instead, the former commissioner said the issue facing Enforcement has been quality of management. The former commissioner added that Enforcement staff has not been properly managed to bring a sufficient range of cases on a timely basis. In addition, Commission actions have not discouraged the staff from seeking corporate penalties. To the extent penalties are down, it may be due to the staff electing on its own to retreat from penalties.
It gets worse, painting a picture of the SEC as workshy:
Furthermore, a number of investigative attorneys and others told us that the policies, as applied, also have discouraged pursuit of more complicated cases, those based on novel legal reasoning, or those with industrywide implications, in favor of those seen as more routine or more likely to win Commission approval. For example, one attorney said there has been relatively more focus on modest cases like small Ponzi schemes, insider trading, and day trading, because such cases were thought to stand a better chance of winning Commission approval, compared to more difficult and time-consuming cases like financial fraud. Likewise, one Enforcement manager said that the Commission signaled that it did not favor cases involving industrywide practices.
And obstructive:
Investigative attorneys with whom we spoke said that obtaining approval of a formal order, once routine, lately had become more difficult and time-consuming, which delayed investigations. They said that it could take months to obtain Commission approval. One attorney said it took about 5 months and several rounds of comments on a supporting memorandum before a request seeking a formal order in a Ponzi scheme investigation was set for Commission consideration.
The decline in formal orders issued is summed up neatly in this table:
A Senate Banking subcommittee will meet on Thursday for a hearing on SEC enforcement. FT Alphaville expects that many a senatorial aide will be preparing crib notes of the GAO report overnight. And that the hearing, even if it is only half as critical as the 55 page report, should make for interesting watching.
Related links:
GAO to Paulson: must do better – FT Alphaville