Now that Bernie Madoff has been handed his long anticipated life sentence, attention has returned to the United States Securities and Exchange Commission (SEC) and how it missed the "Ponzi scheme of the century." It might hardly seem the time to consider giving the SEC more power, but the SEC is not going away, and will continue to be the nation's principal financial market enforcer. Many proposals to beef up its enforcement powers are floating around, and some reforms are underway, but the best idea to kick-start the agency has to date gained little traction: giving the SEC criminal enforcement power. The forces aligned against this idea are formidable: most of the SEC civil defense bar and, presumably, the turf-conscious Department of Justice (DOJ), do not want the SEC to be able to bring criminal cases. Only one SEC Commissioner, Luis A. Aguilar, has suggested that criminal jurisdiction should be given the SEC, and then only in cases the DOJ declines to prosecute.
As a former SEC enforcement trial lawyer, and a former federal prosecutor, I would argue the SEC should have criminal jurisdiction for any case it investigates, regardless of whether the DOJ has reviewed and declined the matter. There is simply too much criminal fraud out there to let tradition and turf concerns prevail over expanding the government's ability to bring the necessary criminal enforcement.
The SEC, a proud agency with a history of success and now under new leadership, is trying to streamline an enforcement process that had become a bureaucratic pyramid requiring layers of reviews and approvals to take significant action. More resources will help, and the funds appear to be on the way, but in addition to adding new staff (hopefully including non-lawyer insiders who can coach the staff on how the games are played), the SEC's enforcement process needs to be radically overhauled and streamlined. Newly installed SEC Commissioner Mary Schapiro and Enforcement Chief Rob Khuzami are clearly intent on addressing these issues.
Regardless of how much new staff, or jurisdiction, the SEC gets when the dust has cleared, the single most powerful weapon the SEC could add to its arsenal would be the power to use the federal criminal law to investigate, prosecute and imprison those guilty of securities fraud. Unlike in Britain, where the counterpart to the SEC can bring criminal cases, in the United States, federal criminal securities cases are the sole responsibility of the DOJ. Needless to say, the Attorney General would prefer to keep it that way.
DOJ's ability to use criminal securities cases to maximum impact is limited. Justice Department fraud prosecutions against financial institutions dropped 48% between 2000 and 2007, while securities fraud cases dropped 17%. While several individual U.S. Attorney's offices, such as New York's, have expertise in such cases, other offices seldom assign overworked prosecutors to devote the time needed to successfully prosecute these complex cases. Many FBI agents who used to chase securities fraud now work on anti-terrorism beats. The sad truth is that many securities law violations which merit criminal review are never criminally prosecuted.
Since the SEC may handle only civil cases, the vast majority are settled, resolved by fines, the return of ill-gotten gains, and "officer and director bars" of individual defendants from future management of public companies. Nobody goes to jail. The SEC can refer potential criminal cases to the DOJ, but reportedly the number of such referrals leading to prosecutions has declined 87% since 2000, to just nine cases in 2007. The referral process is cumbersome. SEC lawyers have to wait for DOJ lawyers to reevaluate the case while the SEC civil litigation is put on hold. While the SEC officials are usually seen at joint-press conferences with the DOJ brass when big criminal cases are brought, the SEC case, if not settled in a plea deal, is always "stayed" in favor of the criminal case.Of course, the SEC has the authority to alert the DOJ to matters it is investigating that have criminal case potential, and DOJ lawyers are increasingly being seen in the room while SEC lawyers take testimony. This causes SEC defense lawyers and their clients considerable consternation, and leads more individuals to invoke their Fifth Amendment rights in their SEC testimony, slowing down SEC investigations. Most investigations go the SEC civil route, some get picked up criminally by the DOJ, and there is oftentimes no rime or reason as to which road a case may take. A defendant who has clearly acted with intent to commit securities fraud may settle with the SEC for a fine and disgorgement in New York, since his conduct falls below the unwritten cut-off for criminal action in that venue. Another offender who has done virtually the same thing (or something else even worse) may be indicted in another district (possibly because an aggressive U.S. Attorney there wants to score some white-collar victories). The decision to single a target out for the guillotine of criminal prosecution sometimes turns on how well documented their fraud is, perhaps on the basis of a few bad emails. The selection process is random, haphazard and largely inscrutable. This one goes to jail for years, the next one pays a fine and starts a new career as a greeter at a big-box store. Some uniformity and coherence is demanded.
The SEC should be allowed to create a criminal division of its own, to accept referrals from its civil enforcement staff, investigate and seek criminal indictments, or refer the matters on to the DOJ. SEC trial lawyers have considerable experience in developing and trying such cases as civil matters, and could easily adapt to bringing the most serious among them as criminal prosecutions. The investigations would be expedited by avoiding the bureaucracy of the civil investigation process, and through use of the federal grand jury, which remains the single most effective vehicle to investigate and indict sophisticated fraud cases. Of course, the DOJ could continue to bring criminal cases as well, but might look to the SEC over time to establish some baseline as to when certain actions and patterns of fraud merit criminal, as opposed to civil, enforcement.
The ability of SEC staff to make criminal referrals within the walls of the SEC itself, and to indict and try the truly bad guys, would add real teeth to the SEC enforcement program. For example, high-profile criminal prosecutions of the securities laws would secure real punishment for well-healed perpetrators of the current financial crisis. Repeated significant jail sentences (not just a Madoff or Ebbers every couple of years) would be an effective deterrent for corporate managers tempted to commit the next big fraud.
SEC defense lawyers understandably fear that the SEC would not use criminal authority properly, and might "intertwine" its civil and criminal investigations, using the criminal power to force civil settlements and base immunity decisions in criminal cases on their usefulness in civil enforcement proceedings.1 In fact, once a civil investigation was turned over to the SEC "criminal unit", there would be no more involvement by the civil enforcement staff. Grand jury secrecy rules would take hold and the SEC civil investigation would cease. In civil litigation, the threat by any side to inform criminal authorities if a civil settlement is not reached is treated as a serious ethical violation. The same could hold true for SEC lawyers who use the threat to "walk this one down the hall" to force a civil settlement. In any event, overreaching could be held in check through resort by defense counsel in the federal district courts which preside over SEC cases.
Part of the reason aggressive state attorney generals have often charged ahead of the SEC in recent years is their ability to determine in-house if a civil case is serious enough to become criminal. New York's powerful Attorney General enforcement operation is the prime example. The SEC, with its historic premier role as enforcer of the securities laws, should have similar powers. It has the expertise and resources to enforce the broad reach of the federal securities laws in both civil and criminal arenas. An SEC with criminal enforcement power would quickly become a powerful financial fraud crime fighter. We need a financial regulatory agency with that kind of clout now.
Daniel J. Hurson is a former SEC trial attorney and Assistant United States Attorney. He practices securities enforcement and white collar defense law in his own firm in Washington D.C. His email is dan@hursonlaw.com. His website is http://www.hursonlaw.com.
Footnote
1. See, e.g., "Don't Give Agencies Criminal Power", by David Z. Seide and Brian M. White, National Law Journal, June 8, 2009.
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