In a speech before the New York City Bar Association on August 5, 2009, Robert Khuzami, the director of the U.S. Securities and Exchange Commission's (the "SEC") Division of Enforcement (the "Division"), discussed the restructuring of and changes in operations within the Division, as well as recent enforcement actions that the Division has initiated. The changes within the Division come in the wake of harsh criticism of the SEC for failing to detect and prevent the Bernard Madoff scandal.
CHANGES TO THE DIVISION'S STRUCTURE AND OPERATIONS
Director Khuzami, who has held such title for just over 100 days, highlighted five new initiatives that the Division is implementing and which are aimed at enhancing investor protection.
1. Specialization
The SEC will be creating national specialized units dedicated to particular highly specialized and complex areas of securities laws. These units will provide the structure and resources for staff to educate themselves with respect to certain products, markets, regulatory regimes, practices and transactions. The units will improve the efficiency of investigations and allow the Division to be more proactive in determining where to focus investigations.
The specialized units will be:
- Asset Management Unit, which will focus on investment advisors, investment companies, hedge funds, and private equity funds;
- Market Abuse Unit, which will focus on large-scale market abuses and complex manipulation schemes by institutional traders, market professionals and others;
- Structured and New Products, which will focus on complex derivatives and financial products, including certificates of deposit, collateralized debt obligations and securitized products;
- Foreign Corrupt Practices Act, which will focus on new and proactive approaches to identifying violations of the Foreign Corrupt Practice Act; and " Municipal Securities and Public Pensions, which as its name suggests, will focus on municipal securities and public pension funds.
2. Streamlining Management and Internal Processes
The second initiative is to streamline the Division's management structure and internal processes. The Division will reduce the number of managers by redeploying branch chiefs to focus full-time on investigations. Additionally, Director Khuzami will be delegated the authority to issue formal orders of investigation, including the accompanying subpoena power. Director Khuzami indicated he will, in turn, delegate such authority to senior officers throughout the Division. This will expedite the issuances of formal orders of investigation and will allow SEC Staff, in most cases, to obtain approval from their senior supervisor to issue a subpoena. Previously, in order to obtain an order of investigation, the Staff had to prepare and submit to the Commissioners a memorandum which set forth the basis for the issuance of the order; the Commissioners would consider the submission and make a determination whether the order should be issued. The Division also will be streamlining its Action Memo process, which is its process for recommending specific enforcement actions to the SEC, to require fewer reviews and quicker turn around times.
Senior officers throughout the country also will be given the power to approve all routine case decisions; a power that currently is held only by the Deputy Director of the Division. Finally, all tolling agreements must be approved by Director Khuzami, who stated that he will approve such agreements as an exception, not the rule.
3. Office of Market Intelligence
The third initiative is to create an Office of Market Intelligence, which will be responsible for the collection, analysis, risk-weighing, triage, referral and monitoring of the tips, complaints and referrals the SEC receives each year.
4. Fostering Cooperation by Individuals
The fourth initiative, which is to increase incentives to individuals to cooperate in SEC investigations, is comprised of four parts. First, the Division is planning to create a set of standards to evaluate cooperation by individuals in enforcement actions. Second, the Division intends to implement an expedited process by which the Division Director is delegated the authority to submit immunity requests to the Department of Justice. Third, the Division is considering ways to provide witnesses in the appropriate cases with oral assurance early on in a case that the Division does not intend to file charges against them. Finally, the Division will be prepared to recommend to the SEC Commissioners that the SEC enter into Deferred Prosecution Agreements, in which the SEC agrees to forego an enforcement action subject to certain terms, including full cooperation, a waiver of statutes of limitations, and compliance with certain undertakings. Director Khuzami made clear that these incentive tools are primarily to reward extraordinary cooperation.
5. Commitment to Strategic Use of New Resources
Using the resources Congress has allocated to it, the SEC has more than tripled the number of paralegals and support personnel in the Division and added Staff to the Division's Trial Unit. In addition, for the first time in its history, the Division will be appointing a Chief Operating Officer to manage information technology, oversee project management and build efficient workflow processes. The SEC is hopeful that Congress will increase its resources so it can do even more to improve the Division's effectiveness at preventing, deterring, identifying and prosecuting conduct that violates the federal securities laws.
CURRENT CASES
Director Khuzami explained that the Division's two highest enforcement priorities at the moment are illegal conduct related to the mortgage and credit crisis and Ponzi schemes.
In the Division's most publicized case involving subprime mortgages, it charged three former executives of Countrywide with fraud for allegedly, deliberately misleading investors about the significant risks Countrywide was undertaking by taking on subprime mortgages. Additionally, the Division charged one of the executives (namely, Countrywide's CEO) with insider trading.
The Division also has recently charged (i) a broker-dealer firm, Brookstreet, for allegedly making false statements in marketing investments in mortgage backed securities, (ii) an investment advisor, Evergreen, for allegedly making false statements with respect to the value of a mutual fund that invested primarily in mortgage-based securities and for selective disclosure to favored investors, which allowed them to bail out early to avoid losses, and (iii) money market fund managers of Reserve Fund for allegedly failing to fully disclose information related to the value of the fund's assets, which were based in part on investments in Lehman-backed paper.
Ponzi schemes also are receiving a great amount of attention from the Division, which has filed more than 40 cases since January of this year that involve a Ponzi scheme or Ponzi-like payments. The most publicized of these cases is the Stanford case in which the Division charged Mr. Stanford, top executives of Mr. Stanford's Stanford Financial Group, and multiple Stanford corporate entities for orchestrating a major Ponzi scheme. Most recently, the Division added to its February complaint, charges against two accountants for allegedly producing bogus financial statements and charges against an Antiguan regulator for allegedly taking bribes to turn a blind eye to the $8 billion fraud.
Other notable charges by the Division involved broker-dealer Cohmad Securities, three associated individuals and investment advisor Stanley Chaise for their alleged roles in raising money for Bernard Madoff.
Director Khuzami noted that while the mortgage and credit crisis and Ponzi schemes have been a primary focus of the Division, it has not ignored traditional misconduct. The Director briefly highlighted cases the Division has brought for conduct involving kickbacks, breaches of fiduciary duties, violations of Section 204 of the Sarbanes-Oxley Act of 2002, violations of proxy disclosure rules, the use of improper accounting methods, violations of "naked" short sale rules and failing to supervise.
CONCLUSION
Director Khuzami concluded his speech by explaining that in these challenging times the Division is aggressively pursuing long-term improvements in the Division's structure and processes, while at the same time working hard to continue its vigorous enforcement efforts.
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