This is the accessible text file for GAO report number GAO-02-771
entitled 'SEC Enforcement: More Actions Needed to Improve Oversight of
Disgorgement Collections' which was released on July 24, 2002.
This text file was formatted by the U.S. General Accounting Office
(GAO) to be accessible to users with visual impairments, as part of a
longer term project to improve GAO products’ accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
Report to Congressional Requesters:
July 2002:
SEC ENFORCEMENT:
More Actions Needed to Improve Oversight of Disgorgement Collections:
GAO-02-771:
Contents:
Letter:
Results in Brief:
Background:
SEC’s Reported Collection Rate Is Not an Effective Measure of SEC’s
Collection Efforts:
SEC Lacks Strategic Guidance, Clear Policies and Procedures, and an
Effective Monitoring Mechanism for the Disgorgement Collection Process:
SEC Has Improved Its Process for Selecting and Monitoring Receivers but
Does Not Have a Central Monitoring System:
SEC Has Taken Steps to Ensure that Disgorgement Waivers Are
Appropriate:
Conclusions:
Recommendations:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Securities and Exchange Commission:
Appendix III: GAO Contacts and Staff Acknowledgements:
GAO Contacts:
Acknowledgments:
Figures:
Figure 1: Percent of Disgorgement Reported as Waived and Collected by
SEC, 1995-2001:
Figure 2: Percent of Disgorgement SEC Reported Collecting in the 2
Years
After the Orders Were Issued:
Abbreviations:
DPTS: Disgorgement Payment Tracking System:
GPRA: Government Performance and Results Act of 1993, P.L. 103-62:
SEC: Securities and Exchange Commission:
Letter:
July 12, 2002:
The Honorable John D. Dingell
Ranking Minority Member
Committee on Energy and Commerce
House of Representatives:
The Honorable John J. LaFalce
Ranking Minority Member
Committee on Financial Services
House of Representatives:
The Honorable Paul E. Kanjorski
Ranking Minority Member, Subcommittee on Capital Markets,
Insurance, and Government Sponsored Enterprises
Committee on Financial Services
House of Representatives:
Every year some investors lose money to individuals and corporations
that violate federal securities laws. Part of the mission of the
Securities and Exchange Commission (SEC) is to deter such violations
and, where possible, return lost funds to investors who have been
harmed. One of SEC’s primary tools for achieving these goals is the
disgorgement order, which requires violators to give up money obtained
through securities law violations. In order for disgorgement to succeed
both as a deterrent and as a means of returning funds to harmed
investors, SEC must have an effective disgorgement collection program.
Although the courts have ordered billions of dollars in disgorgement in
the last decade, concerns exist about SEC’s success in collecting these
funds. We reported on SEC’s disgorgement collection program in 1994 and
made several recommendations designed, among other things, to help SEC
better assess the effectiveness of its disgorgement collection
efforts.[Footnote 1] That report also included recommendations relating
to SEC’s oversight of the receivers appointed by courts to collect and
distribute disgorged funds. A January 2001 press article reported that
SEC’s disgorgement collection rate had declined significantly since our
1994 report, raising questions about the ongoing effectiveness of SEC’s
collection program.[Footnote 2] Finally, a recent report by SEC’s
Inspector General[Footnote 3] raised concerns about the process SEC
uses
to waive some or all of a disgorgement amount based on the violator’s
financial condition. At your request, this report focuses on SEC’s
current
disgorgement collection efforts. Specifically, we (1) discuss the
usefulness of the collection rate as a measure of the effectiveness of
SEC’s collection efforts, (2) assess SEC’s program for collecting
disgorgement, (3) evaluate the changes in SEC’s process for
recommending
receivers and monitoring their activities, and (4) evaluate the
improvements in SEC’s process for recommending waivers of disgorgement
amounts.
To determine the usefulness of the collection rate as a measure of
SEC’s collection efforts, we analyzed information in SEC’s disgorgement
database to calculate a single collection rate for 1995 to
2001[Footnote 4] and individual rates from 1989 until 1999. As part of
this, we also assessed the reliability of the database by comparing its
data to that contained in a sample of case files from three SEC
offices. These files included 35 civil disgorgement cases judgmentally
selected for a range of characteristics, such as whether collections
had been successful or whether receivers had been appointed, and the 10
largest disgorgement orders from 1995 through 2000, which represented a
significant portion of the total disgorgement amount ordered during
that period. We also spoke with officials from SEC, private collection
agencies, and other federal agencies that conduct collection activities
to learn how various factors can affect SEC’s ability to collect
disgorgement and the resulting collection rate. To assess SEC’s
disgorgement collection program, we reviewed SEC’s strategic and annual
plans to determine how these plans addressed disgorgement collections.
To identify the actions that SEC staff had taken to collect and
distribute disgorgement amounts, we reviewed the files from our
judgmental sample of cases and spoke with the SEC staff familiar with
these cases. To evaluate the changes in SEC’s process for recommending
receivers, we reviewed related policies and procedures and examined 10
recent receiver recommendations to verify compliance with these
procedures. To review SEC monitoring of receivers, we examined seven
cases to determine what actions SEC staff took to oversee receiver
activities and spoke with three receivers appointed to SEC disgorgement
cases on the extent to which they interacted with SEC staff. To
evaluate the improvements in the waiver recommendation process, we
reviewed 10 cases with partial and full waivers for which final
judgments had been ordered in fiscal year 2001. Because we judgmentally
selected our case file sample, the results of our case file reviews may
not be representative of all SEC disgorgement cases. Appendix I
contains a full description of our scope and methodology.
Results in Brief:
For several reasons, SEC’s disgorgement collection rate is not adequate
as a measure of the effectiveness of SEC’s disgorgement program. First,
while SEC data showed a collection rate of 14 percent for the $3.1
billion in disgorgement ordered in 1995-2001--compared with the 50
percent collection rate we reported in our 1994 report--we found that
the rate varied widely from year to year and was heavily influenced by
large individual disgorgement orders. Second, the data used to
calculate the collection rate was not reliable because of weaknesses in
the procedures for entering and updating information in SEC’s
disgorgement tracking database. These weaknesses resulted in
inaccuracies in the amounts of disgorgement ordered, collected, and
waived and, as a result, we could not determine SEC’s actual
disgorgement collection rate. Third, factors beyond SEC’s control,
including violators’ inability to pay, reduce the likelihood that SEC
will be able to collect the full amount of disgorgement ordered.
To deprive securities law violators of illegally obtained funds, SEC
needs an effective collection program with clearly defined objectives
and measurable goals, specific policies and procedures for its staff,
and systems to allow management to monitor performance. However, SEC’s
strategic and annual performance plans do not address disgorgement
collection or clarify its priority relative to other activities. SEC
also has not developed performance measures and, therefore, lacks the
information necessary to evaluate the program’s effectiveness. Without
such guidance and measures, competing priorities and increasing
workloads could prevent SEC staff from pursuing collection activity to
the degree desired by the agency. SEC is assessing some ways to address
this issue, including contracting out some collection activities and
dedicating more staff to collections, but does not have a time frame
for completing or taking action on its assessment. Another weakness we
identified was that SEC did not have in place specific policies and
procedures that would provide staff with guidance on the type, timing,
and frequency of collection actions they should consider and help them
understand what is expected of them. Near the end of our review, SEC
officials provided us with draft collection guidelines that they plan
to implement by the end of July 2002, but had not fully developed the
means they would use to ensure the guidelines are followed. Without
such guidance and controls, SEC management cannot ensure that
sufficient and appropriate collection efforts are being made
consistently across all cases. Finally, SEC management did not have
reliable, accessible information it could use to ensure that collected
funds are distributed promptly to investors.
SEC has improved its process for recommending receivers to work on
disgorgement cases and has taken steps to monitor receivers’ actions,
but lacks a mechanism for tracking receiver fees. Court-appointed
receivers perform a variety of tasks, such as gathering and liquidating
a violator’s assets and distributing the funds collected to harmed
investors. In July 2001, SEC implemented revised guidelines for
recommending receivers to the court. These guidelines are designed to
ensure that the recommendations are made objectively and that the
justification for each recommendation is documented. We reviewed a
sample of recent receiver recommendations and found that, in general,
the procedures were being followed. We also found that SEC staff were
monitoring receivers’ activities and gathering enough information to
assess receivers’ fee applications. However, SEC does not have a system
for tracking individual case data on receivers’ fees, as we recommended
in our 1994 report. Some receiver’s duties can be complex, and
consequently their fees can sometimes exceed half the funds collected.
Tracking this information could improve management’s ability to
identify cases in which receiver’s fees are high. In turn, identifying
these cases would make it easier to take prompt action to minimize
costs, so that harmed investors receive as much money as possible.
In response to concerns noted in a recent internal report, SEC also has
improved its waiver recommendation process for disgorgement orders. An
audit completed in June 2000 by SEC’s Inspector General found that SEC
could improve its ability to provide reasonable assurance that the
violators were unable to pay the entire disgorgement amount or that all
assets had been identified. The Inspector General recommended that SEC
improve its procedures for verifying violators’ financial information.
These improvements included using databases and analyzing insurance
policies, tax returns, and passports to identify possible leads for
detecting fraudulent information or hidden assets. In October 2000, SEC
implemented new guidelines that incorporated the improvements
recommended by the Inspector General. We reviewed a sample of recent
waiver recommendations and found that SEC staff were following the
revised guidelines.
This report includes recommendations to the SEC Chairman to improve
SEC’s ability to ensure the effectiveness of its disgorgement
collection program. These recommendations include (1) ensuring the
reliability of disgorgement data, (2) delineating the objectives of the
disgorgement program and including measures of its effectiveness in
SEC’s strategic and annual plans, (3) addressing the competing
priorities within SEC’s Division of Enforcement, (4) finalizing
collection guidelines, and (5) monitoring the distribution of
disgorgement. We received comments on a draft of this report from the
director of SEC’s Division of Enforcement. SEC agreed with most of the
report’s conclusions and recommendations and stated that the agency is
already implementing some of the most important recommendations. SEC’s
comments are discussed in greater detail at the end of this letter, and
its written comments are reprinted in appendix II.
Background:
As the organization charged with responsibility for overseeing U.S.
securities markets at the federal level, SEC’s mission is to protect
investors and ensure fair and orderly markets. Within SEC, the Division
of Enforcement is responsible for investigating possible violations of
the securities laws, litigating against violators in federal civil
courts and administrative proceedings, and negotiating settlements.
When an investigation reveals a possible violation, SEC can seek a
range of sanctions and remedies, including disgorgement. When seeking
disgorgement, SEC staff attempt to recover the amount of illegal
profits or misappropriated funds as a way of ensuring that securities
law violators do not profit from their illegal activities. When
possible, SEC also attempts to return these funds to any investors
harmed as a result of the violation. When it is not economically
practical or efficient to locate and notify investors, the collected
amounts are transferred into the general fund of the U.S. Treasury.
Disgorgement sanctions are imposed against violators involved in
activities such as insider trading, investment adviser fraud, market
manipulation, and fraudulent financial reporting. Until 1990, SEC could
obtain a disgorgement sanction only by obtaining a court order from a
civil suit filed in federal district court. However, in 1990, Congress
gave SEC the authority to impose disgorgement sanctions in its
administrative proceedings through the Securities Enforcement Remedies
and Penny Stock Reform Act of 1990. The majority of disgorgement orders
result from suits filed in federal court.
The amount to be disgorged in civil and administrative proceedings is
based on the amount of the illegal gain, but SEC has discretion to
waive all or part of a disgorgement claim. Waivers are granted based on
a violator’s inability to pay and are typically granted in settled
matters. If SEC believes that a violator is able to pay but refuses to
make payments, it can take actions to compel the violator to pay, such
as requesting that the court hold the violator in contempt for failure
to pay. In addition, SEC may request that the court appoint a receiver,
generally a private sector lawyer, to perform certain tasks, such as
obtaining and managing a violator’s assets and overseeing the
distribution of funds to harmed investors. Receivers are paid out of
the funds collected to pay the disgorgement order.[Footnote 5] After
SEC exhausts all practical collection actions, the agency is required
to transfer its uncollected debt to the Treasury Department’s Financial
Management Service for final collection efforts.
As we have stated in two recent reports, SEC faces several challenges
in fulfilling its mission.[Footnote 6] U.S. securities markets have
grown tremendously and become more complex and international,
increasing the volume and complexity of SEC’s workload. SEC’s staff
resources have not increased at a similar rate. For example, between
1991 and 2000, Division of Enforcement staff devoted to investigations
increased 16 percent, from 414 to 482 staff years, while the number of
cases opened increased 65 percent, from 338 to 558. In addition, the
number of cases pending at the end of the year increased 77 percent,
from 1,264 in 1991 to 2,240 in 2000. As a result, SEC has been forced
to become selective in its enforcement activities and has experienced
an increase in the time required to complete certain enforcement
investigations. In addition, SEC has been experiencing a staffing
crisis that has left it with a large number of less experienced staff.
For example, from 1998 to 2000 over 1,000 employees, or about one-third
of all staff, left SEC, and in 2000 its overall turnover rate averaged
15 percent--more than twice the rate for comparable positions
governmentwide. SEC’s Division of Enforcement has, likewise, had
substantial turnover, with 89 professional staff leaving the division
during 2000 and 2001, which was about 16 percent of the 553 staff in
the division in 2001.
SEC’s Reported Collection Rate Is Not an Effective Measure of SEC’s
Collection Efforts:
SEC’s current collection rate is limited as a measure of the
effectiveness of SEC’s collection program for several reasons. First,
although its collection rate appeared to decline from prior periods, we
found that SEC’s varying success in collecting large individual
disgorgement orders caused the rate to differ significantly over time.
Second, we found that weaknesses in the processes SEC staff used to
enter and update the Disgorgement Payment Tracking System (DPTS), which
tracks SEC’s disgorgement collections, have created errors that
prevented us from determining the actual disgorgement collection rate.
Finally, the collection rate is less useful to measure SEC’s program
because factors beyond SEC’s control reduce the likelihood that the
agency will be able to collect all disgorgement ordered.
SEC Data Show That a Large Amount of Disgorgement Is Not Collected, but
the Collection Rate Varied Widely:
As recommended in our 1994 report, SEC now collects aggregate data on
the amount of disgorgement ordered, waived, and collected. Our analysis
of SEC data found that, as of November 2001, SEC apparently had
collected approximately $424 million, or 14 percent, of the $3.1
billion in disgorgement that was ordered from 1995 through 2001 (fig.
1).
Figure 1: Percent of Disgorgement Reported as Waived and Collected by
SEC, 1995-2001:
[See PDF for image]
Note: Collection data are current as of November 16, 2001.
Source: GAO analysis of SEC data.
[End of figure]
However, our analysis also found that SEC’s collection rate varied over
time and was heavily influenced by large individual disgorgement
orders. According to SEC data, the disgorgement collection rate varied
greatly from year to year. SEC data show that between 1990 and 1999 SEC
was able to collect between 2 and 84 percent of the disgorgement
amounts owed, not including amounts waived (fig. 2).
Figure 2: Percent of Disgorgement SEC Reported Collecting in the 2
Years After the Orders Were Issued:
[See PDF for image]
Note: We calculated the collection rate for each fiscal year by
totaling any collections made on disgorgement ordered during each year.
To ensure that the amount of time for collection was comparable for
each of these years, we totaled the amount of disgorgement collected
within a 2-year period following the date of each individual order.
Source: GAO analysis of SEC data.
[End of figure]
An analysis of these collection rates shows that SEC’s success in
collecting large individual disgorgement orders can greatly influence
the collection rate. For example, figure 2 shows that in 1990 SEC
collected approximately 75 percent of the disgorgement ordered (not
including waived amounts) in the 2 years after the orders were issued
but only 17 percent of the disgorgement ordered in 1991. However, our
analysis found that approximately $400 million of the $427 million
collected on disgorgement ordered in 1990 came from a single payment
made by one violator. Excluding this case, the reported collection rate
for 1990 would have been approximately 15 percent. Similarly, SEC’s
reported collection rate of 84 percent for 1994 included a disgorgement
order of $939 million for a single violator, the majority of which was
collected in the 2 years following the order. Excluding this single
case, the collection rate for 1994 would have been 23 percent.
Similarly, comparing the overall 14 percent collection rate for 1995 to
2001 to the rate we reported in 1994 also is not meaningful as a result
of the impact of these large cases. In our 1994 report, we calculated
that SEC had collected 50 percent of the $2 billion of disgorgement
ordered from 1987 to April 1994. However, if the $400 million 1990 case
cited above is excluded from the collection rate for 1987 to 1994, the
rate for that period would have been about 38 percent. As a result of
the impact that just a few cases can have on SEC’s collection rate,
using this rate as a measure of changes in the overall effectiveness of
SEC’s collection efforts can be misleading.
Data Entry and Update Procedures Have Not Ensured Accurate or Current
Information:
Another reason that we were unable to use SEC’s reported collection
rate as a measure of SEC’s collection efforts is that the data used to
calculate that rate are unreliable. According to standards issued by
GAO,[Footnote 7] appropriate internal controls are necessary to ensure
that data are accurate and complete. In addition, data about events
should be promptly recorded so that they maintain their relevance and
value to management. However, weaknesses in SEC’s procedures have
resulted in unreliable data in its disgorgement database. As part of
our review, we selected a sample of 57 cases and compared information
from SEC case files and other documents to entries in DPTS. We found
that 18 cases, or approximately 32 percent, contained at least one
error in the amount ordered, waived, or collected, or in the status of
the case or of the individual violators. Overall, for the 57 cases that
we reviewed, DPTS data showed that SEC had collected around $25
million, or approximately 4 percent of the $597 million in disgorgement
ordered, not including amounts waived. However, after correcting for
the inaccuracies we identified in our review, we found that SEC had
actually collected around $55 million, or approximately 11 percent of
the disgorgement ordered, not including the amounts waived. Because we
judgmentally selected the cases we reviewed, this error rate cannot be
projected beyond our sample.
SEC’s process for entering data on disgorgement orders into DPTS did
not ensure the accuracy or completeness of that data. We found that the
sources used as a basis for entering data into DPTS did not always
provide the most accurate information. SEC staff in the Office of the
Secretary who entered the data into DPTS relied heavily on SEC
litigation releases that, according to the staff, may not contain all
the details of a disgorgement order. The staff also told us that they
do not independently verify the information in the litigation releases.
Further, the staff told us that the payment dates recorded in DPTS
might not be accurate, because staff used the day entry was made as the
payment date if no other date was specified. Finally, we found that it
was awkward for staff to accurately record information for individual
violators when disgorgement orders were issued to multiple
violators.[Footnote 8] In these instances, payments made by one
violator may subsequently reduce the amount all the violators owe.
However, the DPTS system does not provide a way to easily enter and
track the amounts owed under joint and several liability cases.
Instead, staff input the total amount of the disgorgement judgment
under one violator and enter a $0 balance for the others, with a
notation indicating that each violator is jointly and severally liable
with other violators. Payments are recorded under the name of the
selected violator, not necessarily the violator making the payment, and
a note is made in the system as to which violator had paid. SEC staff
said that they entered the data in this way to avoid overstating the
amount of disgorgement ordered and paid. SEC officials told us that
they will revise their procedures for entering information in cases
with joint and several liability in order to more clearly present
information related to individual violators.
Of the cases we reviewed, five contained errors that appeared to result
from the use of incomplete or inaccurate information as a source of
data for DPTS. For instance, in one case with a disgorgement order of
over $300,000, the entire disgorgement amount was waived at the same
time the disgorgement was ordered in October 1997. But as of November
2001, DPTS did not show that any amount had been waived. In another
case involving 10 violators, the attorney responsible for the case told
us that 9 of the violators were jointly and severally liable for a
disgorgement order of around $800,000. However, several litigation
releases contained information on some, but not all, of the violators.
As a result, a disgorgement order amount was recorded for one violator
from each litigation release, resulting in an overstatement of the
total amount of disgorgement ordered by approximately $1.6 million, or
about 200 percent.
We also found that SEC’s process for updating the information in DPTS
may result in the information not being current. SEC’s Office of the
Secretary sends out a report with the details of each case three times
a year and asks that responsible SEC staff correct any inaccuracies and
update the information. However, the staff who send out the report said
that they have no assurance that each office has carefully reviewed the
report and noted that some offices have not been timely in returning
their reports. Thus the time lag in entering information into DPTS can
be about 4 or 5 months, and the information in DPTS may not be
current.[Footnote 9]
Of the cases we reviewed, 14 contained errors that appeared to be
caused by information not being updated in a timely manner. For
example, in one case with a disgorgement order of around $18 million,
court documents showed that as of late 1999, over $3 million had been
collected and distributed to investors. However, as of November 2001,
DPTS did not show that any money had been collected. In another case, a
disgorgement order of over $5 million was discharged as part of
bankruptcy proceedings in 1998, but this fact was not recorded in DPTS
until at least October 2001.
Without reliable data that is accurate and up to date, SEC management
is limited in its ability to assess its collection program--for
instance, in its efforts to determine the reasonableness of the amount
of disgorgement waived or collected in individual cases or the overall
effectiveness of its collection program. In addition, SEC cannot
provide Congress with accurate statistics related to its disgorgement
collection activities.
Factors Beyond SEC’s Control Make It Unlikely That SEC Will Collect All
Disgorgement:
Another limitation in the adequacy of the collection rate as a measure
of the effectiveness of SEC’s disgorgement collection efforts is that
factors beyond SEC’s control limit its ability to collect the full
amount of disgorgement ordered in some cases. Disgorgement orders are
based on all the funds obtained through violations and do not take into
account the violators’ ability to pay.[Footnote 10] That is, the amount
of disgorgement ordered represents the amount of illegal profits or
misappropriated funds rather than the amount the violator might be able
to pay. For example, in one case we reviewed, SEC obtained a
disgorgement order for around $670,000, even though at the time of the
order SEC knew the violator did not have any assets. SEC did not
collect any money from the violator. According to SEC officials,
although SEC may not collect the entire amount of disgorgement ordered
in such cases, disgorgement can be a deterrent to future violations and
limit the violator’s ability to raise funds to engage in new frauds.
This contrasts with the way SEC seeks fines against violators of
securities laws. When seeking fines, SEC can take into account a
violator’s ability to pay or other factors such as the severity of the
violation and the degree to which the violator cooperates with SEC. For
example, the court can state that a fine is merited but not levy any
amount based on the violator’s lack of ability to pay. According to SEC
officials, the fact that fines are assessed this way is one reason why
SEC’s collection rate is significantly higher for fines than for
disgorgement; in a recent report, GAO calculated the collection rate
for fines at approximately 91 percent.[Footnote 11] SEC officials also
said that they are more successful in collecting fines than
disgorgements for at least two other reasons. First, disgorgement
orders are often much higher than fines, and the larger amounts are
more difficult to collect. Second, many violators fined by SEC are
current members of the securities industry and are motivated to pay
their fines in order to maintain their reputation within the industry.
But many of the violators who are ordered to pay large disgorgement
orders are either not members of the securities industry or have no
desire to remain so.
Securities law violators can lack the ability to pay for a variety of
reasons. In many cases, for instance, violators have few or no assets
left and may have used the proceeds of their illegal activity on
nonrecoverable expenses. For example, in 21 of 37 cases we reviewed in
which violators did not pay all the disgorgement ordered, SEC staff
said that disgorgement was not collected because the violators had
already spent the money on personal or business expenses that SEC could
not recover. In one case we reviewed, the violator had spent $175,000
on custom-made furniture, which the case’s court-appointed receiver was
able to sell for only about 10 percent of its original cost. In
addition, disgorgement orders may be obtained against defunct
companies. In two of the cases we reviewed, disgorgement orders were
obtained against shell companies, one for $1.6 million and one for $1.5
million. In each case, SEC staff knew that the company was defunct and
most likely did not have any assets but obtained the disgorgement order
to prevent the company from becoming involved in future fraudulent
activities. Further, a violator’s assets may already have been used to
pay other judgments, leaving little for SEC to collect. In one case
involving a disgorgement judgment of $147 million, all the violator’s
assets--around $40 million--were used to pay investors through private
class action claims in a Securities Investor Protection Act case and a
Chapter 11 bankruptcy case.[Footnote 12]
Another reason that violators can lack the ability to pay is that they
have little earning capacity. In some cases, violators may be unable to
satisfy their disgorgement debt because they declare bankruptcy or are
incarcerated. For example, for the period 1995 through 2000 at least 5
of the 10 violators with the largest disgorgement orders were
incarcerated because of their fraudulent activities. Also, violators
may be defunct companies with no prospects for future income. For
example, the two shell companies in the example noted above were
defunct at the time of the disgorgement judgment and had no prospects
for future operations or income. In other cases, violators may have
been banned from further participation in the securities industry,
depriving them of their source of income. According to SEC staff, in
many cases in which a violator has been ordered to pay disgorgement,
SEC also bars the violator from working in the securities industry.
SEC Lacks Strategic Guidance, Clear Policies and Procedures, and an
Effective Monitoring Mechanism for the Disgorgement Collection Process:
Although disgorgement is intended to help deter fraud by forcing
violators of the securities laws to return illegal profits, we found
weaknesses in SEC’s disgorgement collection program. First, SEC lacks
clearly defined strategic objectives and measurable goals for its
collection program. SEC’s strategic and annual performance plans,
prepared under the Government Performance and Results Act
(GPRA),[Footnote 13] do not address the importance of disgorgement
collections or provide measures that would help SEC management monitor
its staff’s collection efforts. Without such guidance and measures,
competing priorities and increasing workload could prevent SEC staff
from pursuing collection activities to the degree desired by the
agency. Second, SEC lacks the specific policies and procedures that
would help maximize collection by ensuring that all appropriate actions
are taken to collect disgorgement--for example, the types of collection
actions staff should take and the timing of specific actions. Third,
SEC does not have systems with accurate or complete information for
monitoring whether staff are taking appropriate, prompt collection and
distribution actions.
SEC Has Not Strategically Addressed Disgorgement Collection Priority In
Light of Competing Priorities and Increased Workload:
Although its staff consider disgorgement collection to be an important
means of deterring fraud, SEC had not clearly defined the priority that
should be placed on disgorgement collection or established performance
measures to monitor collection efforts. Currently, SEC Division of
Enforcement staff must balance their disgorgement collection efforts
with various other priorities and a workload that in recent years has
been increasing faster than their resources. SEC has begun some efforts
to assess alternatives means of reducing the conflicting demands on its
staff, such as by contracting out collections or taking other actions,
but these assessments have not been completed.
SEC Strategic Plans Do Not Address Disgorgement Priority or Provide
Effectiveness Measures:
Under GPRA, federal agencies are held accountable for achieving program
results and are required to clarify their mission, set program goals,
and measure their performance in achieving those goals. According to
the Office of Management and Budget and GAO guidance related to GPRA,
effectively achieving program results requires each agency to create a
strategic plan that articulates the agency’s mission and includes long-
term goals.[Footnote 14] To supplement the overall strategic plan,
agencies are also required to prepare annual performance plans that
specify goals and measures and that describe strategies to achieve
results. Such goals and measures help managers determine whether the
agency’s programs are achieving desired results.
According to SEC’s strategic and annual performance plans, deterring
fraud is an important part of protecting investors. SEC officials told
us that disgorgement is an effective deterrent because it deprives
violators of their illegal profits. However, SEC’s strategic and annual
plans do not clarify the priority disgorgement collection should have
in relation to SEC’s other goals. In addition, the plans do not
establish performance measures for disgorgement collection. According
to GPRA, agencies also are to establish performance indicators that can
be used to measure or assess the relevant outputs, service levels, and
outcomes of each program activity.[Footnote 15] SEC has not created the
measures needed to assess the effectiveness of its disgorgement
collection program or its deterrent effect. Such measures could include
the percentage of disgorgement funds returned to investors, the
timeliness of collection actions, or the number of violators ordered to
pay disgorgement who go on to commit other violations.
SEC’s Competing Priorities and Increasing Workload Create the Risk That
Staff Cannot Make Sufficient Collection Efforts:
Without a well-defined strategy that clearly communicates the role and
relevance of disgorgement in relation to SEC’s other goals--and without
performance measures that assess the effectiveness of collection
activities--the competing priorities and increasing workload faced by
SEC staff create the risk that those staff will not be able to pursue
collection activities to the level desired by the agency. The staff in
SEC’s Division of Enforcement responsible for collecting disgorgement
amounts have multiple additional responsibilities. Depending on the
office to which they are assigned, they might also investigate
potential violations of the securities laws, recommend SEC action when
violations are found, prosecute SEC’s civil suits, negotiate
settlements, and conduct collection activities for fines SEC levies.
SEC staff told us that the agency’s limited resources force them to
choose between the competing priorities of collecting disgorgement and
taking direct action to stop ongoing fraud, and that they choose to
devote more effort to stopping fraud than to collections. Similarly,
SEC officials said that if a large, complex case requires SEC’s
immediate attention, the agency shifts its resources to focus on that
case. In such situations, collection actions on other cases are a
secondary priority. As a result, a risk exists that SEC staff will not
be able to pursue collection activities to the degree desired by the
agency. SEC officials and staff also told us that, in most cases,
investors are best served if the agency concentrates more of its
resources on stopping ongoing fraud than on collecting disgorgement,
because stopping ongoing fraud keeps investors from losing more money.
Similarly, a former director of the Division of Enforcement stated that
SEC’s primary responsibility is investor protection, not collecting all
the money from fines and disgorgement.
SEC Is Considering Actions to Address the Competing Priorities Faced by
Its Staff:
SEC is considering some actions to help address the challenges it faces
in ensuring that staff have enough time to collect disgorgement but has
yet to finalize any plans. For example, SEC is exploring contracting
out a portion of its collection work to private collection agencies.
Officials from the National Association of Securities Dealers
Regulation, Inc., which began contracting out its collection activities
in June 2001, told us that they saw contracting out as a way to help
ensure that effective collection actions are taken. Contracting out
allows the National Association of Securities Dealers Regulation, Inc.
to use its resources to hire litigators and investigators rather than
collection attorneys.[Footnote 16] Using external organizations to
conduct collection activities would help alleviate the problem of
competing priorities facing SEC staff and allow them to focus primarily
on stopping ongoing fraud. As of the time of this report, SEC officials
told us that they had spoken with several private collection agencies
and were in the process of examining the legal issues involved with
delegating some collection responsibilities to these agencies.
Another step SEC has considered is increasing the number of staff
dedicated to collection activities. In 1999, SEC created a position for
an attorney dedicated to collections. This attorney and one paralegal
are the only Division of Enforcement staff devoted solely to collection
activities. SEC officials told us that they would like to expand the
number of staff devoted exclusively to collections but added that they
did not feel they could do so because they could not afford to take
resources away from other areas.
A recent initiative by SEC’s Chairman and commissioners may also affect
how staff balance their priorities. In November 2001, SEC announced an
initiative called real-time enforcement,[Footnote 17] which is intended
to provide quicker and more effective protection for investors and
better oversight for the markets with SEC’s limited enforcement
resources. To achieve this, SEC intends to take action sooner than it
has in the past. For example, the agency plans to:
* obtain emergency relief in federal court to stop illegal conduct more
expeditiously;
* file enforcement actions more quickly, thereby compelling disclosure
of questionable conduct so that the public can make informed investment
decisions; and:
* impose swifter and more serious sanctions on those who commit
egregious frauds, repeatedly abuse investor trust, or attempt to impede
SEC’s investigatory processes.
Such prompt enforcement action may help SEC collect a greater amount of
disgorgement by preventing violators from spending or hiding their
assets. However, SEC officials also told us that such actions require
significant staff resources, and may reduce the amount of resources
that can be devoted to collection actions in other cases or later on in
the same case.
SEC’s Lack of Clear Collection Policies and Procedures Hinders
Management Oversight of Staff Collection Activities:
SEC’s overall disgorgement collection program lacks clear policies and
procedures that specify the actions that staff could take to collect
disgorgement. According to federal internal control
standards,[Footnote 18] policies and procedures should be designed to
help ensure that management’s directives are carried out. During the
period covered by our review, SEC did not have in place such policies
and procedures for disgorgement collections. Instead, the lead
attorneys on the individual cases determined what actions should be
taken, with supervisors reviewing the decisions. Supervisors told us
that they met periodically with the lead attorneys to review the
collection activities already taken and to determine whether further
actions were needed.
However, SEC management cannot readily determine whether staff take
appropriate collection actions in all cases without clear collection
procedures outlining which actions should be taken and when. SEC staff
can take a wide range of collection actions, depending on the facts and
circumstance of the case. For example, they can file a contempt action,
seek to obtain liens on a violator’s property, or seek to have a
violator’s wages garnished. Our review of the actions taken in
individual cases reflected such a range of actions. In some cases, we
could not determine what actions had been taken, because staff had left
the agency or actions were not documented in the files we reviewed. In
these cases, we relied on current staff to tell us what actions had
been taken. Although collection actions must be tailored to individual
cases, having clear guidance on the actions suited to different
developments in a case would assist SEC management in ensuring that
sufficient and appropriate efforts are made. This type of consistency
is particularly important given SEC’s relatively high staff turnover
rate.
Collection policies that specify the timing and frequency of actions
would also assist SEC management in establishing clear expectations on
how the program should be managed. For example, we identified two cases
in which certain collection and distribution actions appeared to have
been delayed. In one case, the violator made the final payment in April
2000, but as of February 2002 a plan to distribute the assets had not
been finalized. SEC staff on the case cited internal disagreement and
staff turnover as reasons for the delay. In another case, little action
was taken for about 14 months, during which time a new attorney was
assigned to the case. The new attorney then unsuccessfully filed for
contempt for nonpayment, but another 16 months elapsed with little
activity. SEC ultimately transferred the case to the Treasury
Department’s Financial Management Service without collecting any money.
The lack of guidance that specifies when to pursue certain collection
actions, and how often, affects staff as well as management, since
staff are not held accountable to any clear standards. And SEC
management cannot determine whether staff take all collection actions
promptly, which increases the risk that staff could miss opportunities
to maximize collections.
SEC officials agreed that such guidance is needed, and in June 2002
provided us with draft collection guidelines that they plan to
implement by the end of July 2002. The draft guidelines detail the
types of actions that should be considered and give specific timeframes
for their completion. If implemented, the guidelines would address the
concerns noted above. At the time of our review, SEC had not finalized
a means for ensuring that staff comply with the guidelines, such as a
checklist that could be placed in each case file indicating the actions
taken, how frequently, and why.
SEC Management Does Not Have a System to Monitor Disgorgement
Collections:
At the time of our review, SEC did not have in place a system that
would allow management to monitor activities to ensure that all
appropriate actions are promptly taken. According to federal internal
control standards, internal controls should assure not only that
ongoing monitoring is a part of normal operations but also that it
assesses the quality of performance over time. In our 1994 report, we
recommended that SEC enhance DPTS to include aggregate and individual
information on disgorgement cases. SEC’s current system for tracking
disgorgement case information does not provide the accurate data SEC
managers need to monitor collection efforts and identify cases that
require their intervention.
We also found that SEC was not using a monitoring system to oversee the
distribution of disgorgement collected. In our 1994 report, we
recommended that DPTS include the amounts of disgorgement distributed
and the recipients. Currently, information on disgorgement funds
available for distribution to investors is maintained in case files
that are manually maintained and, therefore, cannot be easily analyzed
or aggregated. SEC officials told us that aggregating this information
would not help them collect or distribute funds. But because SEC cannot
easily aggregate information on the distribution of funds, SEC staff
could not tell us how much of the disgorgement collected was paid to
investors or to the Treasury. As a result, neither SEC nor we could
tell to what extent the disgorgement program was returning funds to
harmed investors.
Relying on individual SEC staff or their supervisors to monitor
distribution efforts is not always adequate. Of the 18 cases we
reviewed in which disgorgement had been collected in full, we found two
cases in which the disgorgement collected had not been promptly
distributed. In one case, the violator’s final disgorgement order
payment occurred in July 2001, but as of March 2002, the funds had not
been distributed, and SEC staff were still in the process of obtaining
bids from potential receiver candidates. The attorney in charge
attributed this 9-month delay to his heavy workload and trial
responsibilities. In another case, approximately $100,000 collected
through criminal restitution was transferred to SEC’s Office of the
Comptroller and was to be distributed by the court-appointed receiver.
However, SEC staff responsible for the case did not realize that the
Office of the Comptroller had received the funds from the criminal
restitution action until the case was examined in preparation for our
review. As a result, this amount was not included in the final
distribution made by the receiver. SEC staff responsible for the case
stated that this was an oversight on the part of both the receiver and
SEC. However, they also noted that the case was unusual in that the
judge had required SEC to oversee not only disgorgement funds from
SEC’s case but also restitution funds recovered as a result of the
criminal case.
Without reliable, accessible data, SEC is limited in its ability to
monitor whether collection activity is taking place and whether
collected funds are promptly distributed. More importantly, without
using a system to manage the program, SEC management is unable to
assess the extent to which its staff are returning funds to defrauded
investors.
SEC Has Improved Its Process for Selecting and Monitoring Receivers but
Does Not Have a Central Monitoring System:
SEC has improved its process for selecting individuals to recommend as
court-appointed receivers. In addition, although SEC is not responsible
for supervising receivers, its staff are taking actions to monitor the
cases that have receivers. However, SEC still lacks a mechanism for
tracking information such as the fees receivers charge and the amounts
they collect, limiting management’s ability to ensure that as much
money as is reasonably possible is returned to harmed investors.
SEC Has Improved Its Process for Selecting Individuals to Recommend As
Receivers:
Receivers are used on SEC’s cases to perform tasks such as gathering
and liquidating violators’ assets and distributing funds to harmed
investors. SEC usually selects a candidate and then recommends the
individual for receivership to the court for final approval. According
to an SEC official, some courts accept SEC’s recommended receiver, but
other courts prefer to appoint a receiver on their own. Because the
court appoints the receivers and ultimately defines their duties,
receivers are answerable to the judge of the court rather than to SEC.
As court-appointed fiduciaries, receivers are subject to the same
standards of trust and confidence as other fiduciaries, and need to be
selected as impartially as possible.[Footnote 19] In 1994, we examined
whether SEC had procedures and management controls for selecting
receivers in response to concerns that former SEC employees were
favored in the receiver selection process. We reported that SEC had no
formal policies or qualifying standards in place to ensure that
receivers were selected impartially, and we were unable to determine
how many receivers were former SEC employees.
As we recommended, SEC implemented guidelines in July 2001 for
selecting candidates for receiverships that appear to address the
concerns raised in our 1994 report. The guidelines have shifted
responsibility for choosing receivers from the SEC attorneys themselves
to a committee of higher-level managers. When receivers are needed, SEC
must now obtain written proposals from at least three candidates
detailing the applicants’ experience, fees, and staffing and
operational plans. The candidates’ proposals are then submitted to a
three-person committee for final evaluation and selection. The
committee is composed of the chief or deputy chief litigation counsel;
the investigating or litigating attorney on the case; and an associate
director, regional director, or district administrator.
SEC has also formalized criteria to use when evaluating candidates’
proposals. These criteria include costs and the candidate’s reputation,
experience in securities regulations, and past service as a receiver on
another SEC matter. The guidelines state that the committee should
avoid selecting the same person repeatedly for appointments as a
receiver, so as to avoid the appearance of favoritism. The committee
must also justify its selection in writing. The names of receivers
selected are entered into a database that can be used to identify
receiver candidates on short notice.
We reviewed 10 recent receiver recommendations and found that SEC was
generally following the guidelines for selecting receivers. In every
case we reviewed, the three-person committee had evaluated at least
three candidates and documented the reasons for its selection. In
addition, all the cases contained summary information on the
candidates’ backgrounds, and nine cases contained fee information from
at least two candidates. We found that most of the individuals selected
as receivers--7 of the 10 selected--were not former SEC employees. In
cases in which SEC had recommended former employees, documentation was
provided justifying the nominations. In two such cases, SEC recommended
former employees because they had the most experience relevant to the
job. In one case, we could not tell whether the candidate was a former
SEC employee, but SEC documented the candidate’s extensive relevant
experience.
SEC Does Not Directly Supervise Receivers but Does Monitor Their
Activities:
SEC assists the court in monitoring receivers, helping to ensure that
they adhere to their responsibilities as court-appointed fiduciaries
tasked with protecting recovered funds and complying with court orders.
In our 1994 report, we found that SEC did not have adequate oversight
over receivers, and we could not tell whether SEC staff were adequately
reviewing receiver fee applications. We recommended that SEC establish
guidelines for monitoring court-appointed receivers.
Although SEC still has not established such guidelines, we found that
it has taken steps to monitor receivers’ actions. Staff in SEC’s
Division of Enforcement told us that they monitor court-appointed
receivers by working closely with them and by asking them to consult
with SEC before taking any major actions, such as seizing or selling
assets. In one case we reviewed, we saw documentation of phone
conversations between SEC and the receiver concerning the receiver’s
distribution plan and case status. In another case, we saw
correspondence from the receiver regarding the progress made and the
results of disposed assets. We also spoke with three receivers who work
on SEC cases and it appeared that SEC was working closely with them to
monitor their actions. One receiver we spoke with said that he
regularly interacts with SEC while working on a case in order to avoid
disputes about his handling of the case and fees. He added that
disputes over how he handles a case could cost his firm time and money
that are often not reimbursable under the receivership. Another
receiver we spoke with said that while working on an SEC case, he is in
frequent communication with the SEC attorney on the case, whom he found
to be available, responsive, aggressive, and concerned about the
progress of cases.
We also found that SEC staff had reviewed the receiver fee applications
and obtained additional information needed to assess the application.
Reviewing the applications serves as an important control for ensuring
that as much money as possible is returned to investors, as receivers
are compensated for their services from the amounts collected in the
case. Although the courts approve receivers’ fee applications, SEC
attorneys review the applications beforehand and comment on the
reasonableness of the fees. In the absence of guidelines, SEC attorneys
use their knowledge of the facts and circumstances of a case to
determine whether fees are reasonable. One senior SEC staff member told
us that he reviews fee applications by considering the exact tasks the
receivers and their staff have performed, assessing the need for
specialized staff, and comparing the fees to fees for similar services
in the same geographic area. During our review, we saw documentation
showing that the attorney in one case had examined the number of staff
the receiver hired to complete necessary tasks, assessed the necessity
of the tasks, and examined the appropriateness of the receiver’s
expenses. In the same case, we also saw documentation showing that the
attorney had requested and examined information such as record of hours
worked in order to assess the reasonableness of the fees. In another
case, SEC had noted in a motion filed in support of the receiver’s fee
application that the receiver apparently was not billing for all the
work performed. In a third case, one attorney told us that after
monitoring the rising costs of the fee applications, the SEC attorney
had taken over some of the receiver’s duties, such as preparing a
distribution plan, to minimize the receiver’s expenses and fees.
SEC Does Not Centrally Monitor Information on Receiver Fees:
We found that SEC was not using a centralized system to monitor
receiver fees. Receivers are compensated for their services from the
amounts collected, so when receivers’ fees are high, less money is
available for distribution to investors. In our 1994 report, we found
that SEC did not track information on receivers, limiting its ability
to assess the effectiveness of receivers and to monitor trends in
costs. We recommended that SEC collect such information in a
centralized management information system. However, SEC staff told us
that they do not track this information in DPTS or any other system
because it would not help with their collections efforts. Currently,
receiver data on the amount recovered, costs and expenditures, and the
amount disbursed to investors is accessible through case files that are
manually maintained.
However, tracking receiver data through a centralized management
information system could improve SEC’s oversight of all cases. Managers
would be able to identify specific instances in which receivers’ fees
are high or are absorbing a large share of the funds available for
distribution and, if appropriate, take prompt action to minimize these
costs. While we found no evidence in the cases we reviewed that
receiver fees were excessive, we did find that receivers’ fees have
sometimes amounted to half or more of the disgorgement funds collected
in cases. For example, in one case we reviewed, a receiver appointed to
find and liquidate assets received over $285,000 in fees and expenses-
-approximately half of the total amount collected. In another case, the
fees paid to the receiver exceeded the amount returned to harmed
investors. This receiver, who negotiated the sale of oil and gas
interests, was paid approximately $11.6 million for his services; the
investors received around $10 million. Furthermore, if managers had
access to such a centralized system, they would not have to rely solely
on the case attorneys for information--a factor that is particularly
important given SEC’s relatively high turnover rate and resulting loss
of experienced staff with knowledge of cases.
SEC Has Taken Steps to Ensure that Disgorgement Waivers Are
Appropriate:
A report by SEC’s Inspector General found that SEC staff were not
making sufficient efforts to verify the financial condition of
violators seeking waivers of a disgorgement amount. In response, SEC
issued new guidelines on the waiver process, and our review of a sample
of recent waiver recommendations found that SEC staff were following
these guidelines.
SEC’s Inspector General Identified Weaknesses in SEC’s Waiver Process:
According to SEC officials, waivers are a tool SEC can use to more
easily reach settlements with violators and thus avoid spending
resources on litigation. When violators request a waiver based on an
inability to pay, SEC staff are to gather the necessary information to
validate this claim and provide to the Commission, which must approve
any such waivers, a recommendation to either approve or deny the
request.[Footnote 20] The Commission usually approves waivers at the
same time it approves the settlement of the enforcement action, prior
to the court’s final approval of the disgorgement order. Waivers also
must be approved by the court, and in recommending that courts grant
waiver requests, SEC must be able to show that it cannot collect the
total amount of the court-ordered disgorgement. SEC guidelines also
require that waiver recommendations be supported with sworn financial
statements and stipulate that depositions and information from third
parties can be used for further support. SEC staff must analyze the
financial statements to determine whether the information is accurate
and complete. SEC generally does not consider waivers when the violator
is a recidivist, when SEC believes the violator has withheld
information, or when SEC has spent significant resources obtaining a
judgment.
A June 2000 audit by SEC’s Inspector General staff found that SEC could
improve its process for verifying the accuracy of the violator’s
claimed lack of ability to pay the entire disgorgement order before
recommending that waivers be approved by the Commission. Specifically,
the audit identified two problems. First, staff did not verify that the
information violators submitted was complete and accurate. Second, the
procedures staff used to ensure that they had identified all of the
violators’ assets were inadequate. For example, SEC staff did not
sufficiently utilize online databases to verify the information
contained in financial statements or to identify hidden assets. As a
result, SEC staff could not offer sufficient assurance that violators
had disclosed all of their assets to SEC. To improve SEC’s ability to
provide such assurance, the Inspector General identified best practices
that enforcement staff could use in verifying violators’ financial
information and recommended that SEC adopt these procedures.
SEC Has Implemented Revised Guidelines, and Staff Are Following Them:
In October 2000, SEC implemented guidelines designed to improve the
waiver recommendation process. The guidelines require SEC staff to
analyze violators’ financial statements by reviewing supporting
documentation such as bank statements, tax returns, credit reports, and
loan statements. In addition, SEC has contracted with a database
provider that performs searches for information such as real property
and motor vehicle records. SEC officials told us that under the
guidelines, supervisors now review waiver recommendations made by their
staff and that the Chief Counsel’s Office also reviews every waiver
recommendation before it is submitted to the commissioners. The
officials also told us that, when funds become available, they plan to
hire an outside contractor to audit a sample of waiver recommendations
in order to ensure that the guidelines are being followed and that the
problems identified by SEC’s Inspector General have been addressed.
We reviewed a sample of 10 recent waiver recommendations and found that
SEC staff were following the revised guidelines. For example, the
guidelines describe certain types of situations in which SEC staff
should investigate further or request additional information, and we
found that SEC staff were taking these actions. In one case we
reviewed, the violator owned stock in a company, and enforcement staff
on the case requested information on this stock in order to determine
its value. In another case, the violator did not initially submit
complete information on his financial condition. Enforcement staff
questioned him about his sources of income, obtained all relevant loan
statements, and verified the value of his personal property, real
estate, and business interests. Enforcement staff also were using
database searches to obtain information on violators’ assets and
financial condition, as the guidelines require. However, not enough
time has elapsed since the revised guidelines were put in place to
determine their effect on the number or size of waivers recommended by
SEC.
Conclusions:
Depriving securities law violators of their illegally obtained funds
can help SEC achieve its mission of protecting investors and
maintaining confidence in the fairness and integrity of the U.S.
securities markets. Although we acknowledge that the collection rate is
not likely the best measure for assessing the effectiveness of SEC’s
disgorgement collection activities, improving the process for entering
and updating the information in DPTS would provide accurate and current
information for SEC to use to monitor progress on individual cases.
Having such information would also allow SEC’s management to analyze
potential trends in the aggregate data to ensure that any changes in
the collection rate can be explained.
Although SEC officials considered disgorgement to be an important tool
for sanctioning securities law violators and deterring additional
fraud, we identified weaknesses in various elements of SEC’s
disgorgement collection program. Under GPRA, federal agencies are
expected to become more performance oriented by setting goals for
program performance and measuring progress toward those goals. However,
we found that the strategic and annual performance plans that SEC has
prepared under GPRA did not specifically address disgorgement
collection or establish performance measures to assess the
effectiveness of the agency’s disgorgement collection efforts. Because
SEC’s Division of Enforcement staff already juggle competing priorities
and an expanding workload, the lack of strategic guidance and measures
against which to assess performance could result in less collection
activity being undertaken than SEC management desires. To reconcile the
competing demands on its staff, SEC will have to weigh the importance
of other enforcement activities relative to disgorgement collection
against the concern that disgorgement may lose its effectiveness as a
sanction and deterrent to further fraud if collection activities are
not attempted. The agency has begun this process as part of considering
various alternative means of collecting disgorgement amounts but has
yet to complete its assessment and take action to implement any
resulting program changes.
Similarly, SEC did not have in place specific policies and procedures
that would provide staff with guidance on the type, timing, and
frequency of collection actions they should consider and help them
understand what is expected of them. SEC provided us with draft
collection guidelines to be implemented by the end of July 2002 that
would address these concerns, but has not yet finalized controls to
help management ensure that staff follow the guidelines. Without such
guidance and controls, SEC management cannot ensure that sufficient and
appropriate collection efforts are being made consistently across all
cases. Given SEC’s relatively high staff turnover rate, a tool to
quickly determine what actions have been taken and when could help any
staff that assume responsibility for cases with which they lack
familiarity. Finally, SEC management did not have reliable, accessible
information it could use to ensure that collection activity is taking
place and that collected funds are being distributed promptly. With an
accurate and current disgorgement tracking system, SEC managers could
identify cases that may require attention, such as cases that have had
considerable time pass without any collection activity. Furthermore,
without an ability to centrally monitor subsequent distribution
activities, SEC cannot assess the extent to which it is returning
disgorgement funds to harmed investors.
Since our last report, SEC has improved its process for selecting
individuals to recommend as receivers, and in the cases we reviewed
staff have been taking actions to oversee receivers’ efforts. However,
SEC still does not track individual case information on receivers’ fees
and expenses in a central management information system, as we
recommended in our 1994 report. Without such a system, SEC managers
cannot readily identify cases in which receiver fees have risen to a
significant portion of the amount collected and thus could miss the
opportunity to take additional actions to ensure that such charges are
appropriate and that the maximum amount is returned to harmed
investors.
SEC has also taken steps to improve its ability to ensure that
disgorgement waivers are recommended only when SEC has verified the
violator’s inability to pay. Specifically, the agency implemented
guidelines designed to provide better assurance that the financial
information violators provide is accurate and that all assets have been
identified. Based on our review of a sample of recent waiver
recommendations, we found that SEC staff were following these
guidelines. However, it was too early to determine what effect, if any,
these guidelines were having on the number or amount of waivers
granted.
Recommendations:
To improve SEC’s ability to ensure that the disgorgement collection
program meets its goal of effectively deterring securities law
violations and returning funds to harmed investors, we recommend the
Chairman, SEC, take the following actions:
* Develop appropriate procedures to ensure that information maintained
in DPTS is accurate and current.
* Ensure that disgorgement and the collection of disgorgement are
addressed in SEC’s strategic and annual performance plans, including
the development of appropriate performance measures.
* Expeditiously complete the evaluation of options for addressing the
competing priorities and increasing workload faced by SEC’s Division of
Enforcement staff, including assessing the feasibility of contracting
certain collection functions and increasing the number of staff devoted
exclusively to collections, and take steps to implement any recommended
actions.
* Ensure the prompt implementation of collection guidelines that
specify the various collection actions available, explain when such
activities should be considered, and stipulate how frequently they
should be performed. In addition, SEC should develop controls to ensure
that staff follow these guidelines.
* Ensure that management uses information on the distribution of
disgorgement, including the amounts due to and received by investors
and the fees paid to receivers, to monitor the distribution of
disgorgement, including the reasonableness of receiver fees.
Agency Comments and Our Evaluation:
SEC officials provided written comments on a draft of this report that
are reprinted in appendix II. In general, SEC agreed with most of the
report’s findings, conclusions, and recommendations. As detailed in the
written comments, SEC is taking or planning to take action to implement
most of our recommendations. SEC officials also provided technical
comments, which we have incorporated as appropriate.
In response to our recommendation to monitor the distribution of
disgorgement, including fees paid to receivers, SEC officials said that
the agency plans on implementing a system to monitor when courts enter
distribution plans and when receivers distribute funds. However, as
stated in its letter, SEC does not believe that aggregating information
on distributions of disgorgement and receiver fees would help the
agency assess how well it is meeting its goal of deterring fraud and
depriving wrongdoers of their ill-gotten gains. SEC noted that the
amount distributed to investors is a function of numerous factors that
vary from case to case, including the size of the disgorgement award,
how much the agency could collect, and the costs of administering the
receivership. We agree that aggregate statistics on the amount of
disgorgement distributed to investors and the fees paid to receivers
may have limitations as measures of SEC’s performance in these areas.
However, in addition to depriving violators of their illegally obtained
funds, returning money to harmed investors is an important element of
the disgorgement program. Knowing the total amount of funds returned to
investors every year would provide SEC with an important means of
documenting the impact of its efforts in this area. Reviewing such
information over time would also help SEC focus on ensuring that harmed
investors receive the maximum, reasonable amount of funds.
Another focus of our recommendation was to ensure that SEC management
had an effective means for monitoring the fees paid to receivers in
order to determine whether they are reasonable. While we recognize that
receivership fees are within the purview of the court, SEC does have
opportunity to object to those fees if they appear unreasonable. In
addition, while we also recognize that the facts and circumstances of
each individual case must be considered when making such
determinations, a system that allows management to monitor cases across
the Division of Enforcement can be a useful tool for identifying cases
for further review. We believe that the system SEC plans to implement
for monitoring the distribution of disgorgement can also be used for
this purpose and would likely require only minimal additional
resources.
As agreed with your offices, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to the Chairman and Ranking Minority Members of the Senate Committee on
Banking, Housing, and Urban Affairs and its Subcommittee on Securities
and Investment; the Chairman, House Committee on Energy and Commerce;
the Chairman of the House Committee on Financial Services and its
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises; and other interested congressional committees. We also
will send copies to the Chairman of SEC and will make copies available
to others upon request. In addition, the report will be available at no
charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions regarding this report, please
contact me or Cody J. Goebel at (202) 512-8678. Additional GAO contacts
and acknowledgements are listed in appendix III.
Richard J. Hillman
Director, Financial Markets and
Community Investment:
Signed by Richard J. Hillman:
[End of section]
Appendix I Scope and Methodology:
To determine SEC’s collection rate, we obtained and analyzed a copy of
SEC’s database, as of November 16, 2001, containing all disgorgement
orders ever entered into the database. Using this information, we
calculated a single collection rate for all orders issued in fiscal
years 1995 through 2001. We calculated a collection rate on
disgorgement ordered for each fiscal year from 1989 to 1999. To ensure
that the amount of time for collection was comparable in each of these
years, we totaled the amount of disgorgement collected within a 2-year
period following the date of each individual order.
We also assessed the reliability of the database by comparing data on
the amounts and dates of the disgorgement orders, waived amounts, and
payment amounts in the database to information in the case files for 57
judgmentally selected disgorgement orders. These 57 cases included a
judgmentally selected sample of 35 cases with full, partial, and no
payments; 10 cases with waivers; and 2 cases used to pre-test our data
collection instrument. We selected these cases based on a printout from
DPTS to ensure that we reviewed cases with a variety of
characteristics, such as whether collections had been successful and
whether a receiver had been appointed. We confined our sample to civil
cases with disgorgement ordered from fiscal years 1998 through 2000
from the SEC Chicago, Los Angeles, and Washington, D.C., offices, and
we visited these offices to review the files maintained there and to
discuss the cases with attorneys who had worked on them, whenever
possible. Finally, we also reviewed the 10 case files with the largest
disgorgement amounts ordered from fiscal years 1995 until 2000 because
these represented about 24 percent of the total dollar amount of
disgorgement ordered during that period. We compared data on the
amounts and dates of the disgorgement orders, waived amounts, and
payment amounts. We also interviewed SEC officials knowledgeable about
DPTS regarding the purpose of the system, security, data quality
controls, and the data entry process. We were unable to determine the
extent of the errors in the database because our sample was not
representative of all SEC cases.
To determine factors that affect SEC’s ability to collect disgorgement,
we spoke with officials from SEC, two private collection agencies, and
three receivers that had worked on SEC disgorgement cases. In addition,
we spoke with officials from other organizations and federal agencies
that also conduct collections to learn how the characteristics of SEC’s
disgorgement debts may have varied from other types of debts. These
organizations and agencies included the Commodity Futures Trading
Commission, the Department of Education, the Securities Investor
Protection Corporation, and the National Association of Securities
Dealers Regulation, Inc. We also used the case files we selected to
identify any characteristics that appeared to affect collections and to
corroborate the factors described by the officials with whom we spoke.
To assess SEC’s disgorgement collection program, we reviewed SEC’s
strategic and annual plans, its administrative rules of practice
regarding disgorgement payments, rules relating to debt collection, and
guidelines on distribution. We also discussed the collection and
distribution processes with SEC officials from Washington D.C., the
Chicago Midwest Regional Office, and the Los Angeles Pacific Regional
Office. We also reviewed the judgmentally selected case files to
examine collection actions taken after the disgorgement order date. In
cases in which collections had occurred, we also used the files to
determine what distribution activities had taken place. In instances in
which we could not determine what collection actions had been taken or
the reasons disgorgement went uncollected, we spoke with SEC attorneys
familiar with these cases to learn what collection efforts had been
made and what had contributed to any inability to collect the owed
amounts. The results of our case file review are not representative of
all SEC cases. We also spoke to officials at the National Association
of Securities Dealers Regulation, Inc. about their experience with
contracting out collection activities.
To evaluate the changes in SEC’s process for recommending receivers and
monitoring their activities, we reviewed documentation on SEC’s
policies and procedures for selecting receivers. In addition, we
discussed the selection and monitoring activities with officials from
the Division of Enforcement, SEC’s Office of the General Counsel, and
the Chicago and Los Angeles regional offices. We also spoke with three
receivers appointed to SEC disgorgement cases to obtain their views on
their role, responsibilities, and relationship with SEC officials.
Finally, we reviewed a printout from the agency’s receiver database and
examined 10 recent cases in which a receiver was recommended to assess
SEC’s compliance with its selection procedures. We also reviewed seven
cases in which a receiver had been appointed to determine how SEC
monitors receiver activities. We also spoke with SEC attorneys to learn
what actions had been taken to monitor receivers and to review receiver
fee applications. The results of our case file review are not
representative of all SEC disgorgement cases.
To evaluate the improvements in SEC’s process for recommending the
waiving of disgorgement amounts, we reviewed the SEC Inspector
General’s January 2001 report and applicable guidelines related to
recommending waivers. We discussed the waiver process with officials
from SEC’s Division of Enforcement and the SEC Inspector General’s
Office. In addition, we conducted a case file review of 10 cases with
partial and full waivers and a final judgment ordered in fiscal year
2001. We judgmentally selected between two to four disgorgement cases
from the SEC Chicago, Los Angeles, and Washington, D.C., offices. The
results of our case file review are not representative of all SEC
cases. In addition, our office of investigation conducted an asset
search on one waiver case to confirm that the defendant had no means to
pay and that the waiver was justified.
We conducted our work at the SEC Washington, D.C., headquarters,
Chicago Midwest Regional Office, and Los Angeles Pacific Regional
Office from August 2001 through July 2002 in accordance with generally
accepted government auditing standards.
[End of section]
Appendix II Comments from the Securities and Exchange Commission:
DIVISION OF ENFORCEMENT:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C.
20549:
July 3, 2002:
Mr. Richard J. Hillman Director:
Financial Markets and Community Investment U.S. General Accounting
Office:
441 G Street, N.W. Washington D.C. 20548:
Re: Draft Report Entitled “More Actions Needed to Improve Oversight of
Disgorgement Cases”:
Dear Mr. Hillman:
Thank you for providing us with the opportunity to review and comment
on your draft report addressing the Securities and Exchange
Commission’s collection efforts regarding disgorgement. The report
discusses the usefulness of collection rates as a measure of the
effectiveness of our disgorgement efforts, assesses our collections
program, evaluates the changes in the SEC’s process for recommending
receivers and evaluates our process for recommending waivers of
disgorgement amounts.
As the report points out, we have obtained a number of large judgments
for disgorgement knowing that it was unlikely they would ever be paid.
We believe that it is important to continue to obtain these judgments,
and have them hang over defendants’ heads, both for their general and
specific deterrent effect and because of the limits they place on these
defendants in terms of their ability to raise further capital or to use
entities as vehicles for fraud in the future. As a result, however,
since many large judgments are uncollectable from the time they are
entered and for the other reasons you articulate in your report, the
collection rate is not an appropriate measure of our effectiveness as
to disgorgement.
We agree with most of your conclusions and recommendations and are
already implementing some of the most important recommendations. In
sum, we will: * distribute clearer guidance for our staff on more timely
and effective collection efforts,
* develop a new procedure for obtaining updated information on
disgorgement amounts ordered and collected,
* seek to develop a performance measure related to disgorgement and
collections,
* examine contracting with outside firms to do collection work, and:
* implement a system to monitor when courts enter distribution plans
and
when funds are distributed under those plans.
Our specific comments as to several of the recommendations follow.
I. Ensuring Reliability of Disgorgement Data:
The draft report found inaccuracies in the sample of data examined
which are largely the results of delays in obtaining updated
information concerning actions in Federal Court or payments to a court
registry or court appointed receiver. The draft report recommends that
the SEC develop procedures to ensure that information in the
Disgorgement Penalty Tracking System be current and accurate. We agree
with this recommendation and accordingly, we are developing a new
procedure for obtaining updated information more rapidly. As an
alternative to our existing practice of generating periodic reports for
review and update by staff, we have determined to require that the
responsible staff must submit to DPTS a Financial Judgment Record Form
as soon as they receive notice of any reportable event that pertains to
disgorgement. The Form will be made available to all staff
electronically and staff will be instructed to submit completed forms
via a dedicated e-mail mailbox.
11. Ensuring Disgorgement and Collections are Addressed in Strategic
and
Performance Plans:
The draft report recommends that disgorgement and collections be
addressed in the SEC’s strategic and annual performance plans. We view
judgments for disgorgement and collection of those judgments as
important components of our mission of investor protection. We will
seek to develop a performance measure related to disgorgement and
collections for inclusion in the fiscal 2004 performance plan and the
strategic plan when it is next updated. We do not believe that the new
performance measure should be the rate at which disgorgement is
collected, however. As you point out, the collection rate can be skewed
by whether we have a large payment from one defendant in a given year
and because the individuals who owe large sums of disgorgement
generally have long since spent their ill-gotten proceeds and there is
simply no hope that money will be obtained. We will develop a measure
based on the timeliness of our collection efforts.
111. Addressing Competing Priorities within the Division of
Enforcement:
The draft report recommends that we expeditiously complete our current
efforts to assess the feasibility of (i) contracting for certain
collection functions, and (ii) increasing the number of staff devoted
to collection efforts. The report accurately describes the enormous
workload and:
the competing priorities of the staff, including whether to do
collection work or to work on stopping new and ongoing frauds. While
collections have always been viewed as extremely important, our first
priority has been, and we believe should continue to be, to stop
ongoing frauds with the aim of protecting investors from additional
losses. We have been examining contracting with outside firms to do
collection work and will make every effort towards issuing a request
for proposals expeditiously.
As to devoting more staff exclusively to collections: we do not
currently have the staff to accomplish this goal. There are, however,
proposals to increase our staffing levels and we will reexamine our
ability to devote more staff exclusively to this effort as our staffing
levels increase.
VI. Finalizing Collection Guidelines:
The draft report recommends that we establish a specific time frame for
developing and implementing collection guidelines. The Division of
Enforcement has developed collection guidelines and will implement the
guidelines during July 2002. These guidelines address all aspects of
your recommendations; they include practice guides to assist the staff
in enforcing judgments through litigation, requiring the staff to
adhere to certain deadlines and tracking the staff’s efforts and
results.
V. Monitoring Distributions of Disgorgement:
Last, your draft report recommends that we:
[e]nsure that management uses information on the distribution of
disgorgement, including the amounts due to and received by investors
and the fees paid to receivers, to monitor the distribution of
disgorgement, including the reasonableness of receiver fees.
As noted in the draft report, the SEC staff currently monitors the
distribution of disgorgement, typically by court appointed receivers,
on a case-by-case basis. We plan on implementing a system to monitor
when courts enter distribution plans and when receivers (or other
distribution agents) distribute funds.
We do not believe that aggregating information on distributions of
disgorgement would help the agency assess how well it is meeting its
goal of deterring fraud and depriving wrongdoers of their ill-gotten
gains. The amount distributed to investors (rather than given to the
United States Treasury) is a function of numerous factors that vary
from case to case, including the size of the disgorgement award, how
much the agency (and the receiver, if one is appointed) could collect,
and the costs of administering the receivership, including fees paid to
receivers and attorneys and accountants under their direction. In some
complex cases, receiver fees and costs will necessarily consume a
substantial portion of the disgorged assets. In some simple cases, the
fees and costs necessary to distribute the disgorged funds will be
minimal. Combining the amounts distributed and the fees paid to
receivers in many cases will not shed any light on whether defrauded
investors could or should have received more in any particular case or
even overall. The only way to determine if the amount returned to
investors is appropriate is to evaluate the particular facts and
circumstances of the case. Since the receivership fees are totally
within the purview of the court in any particular matter, we do not
believe that accumulating data:
on these fees would be useful in accomplishing our mission of investor
protection. We are issuing new guidelines for collections and
establishing new systems for tracking collections and distributions. We
believe that those measures will greatly improve our ability to monitor
the effectiveness of our disgorgement program. In addition, we note
that these efforts will be an enormous undertaking with limited staff
resources. While we will continually review the effectiveness of these
measures, and consider modifications as appropriate, we do not believe
that accumulating additional data is realistic or useful at this time.
We appreciate the care and thought that is evident throughout your
report and recommendations. If we can be of any further assistance
please contact me at (202) 942-4500 or Joan McKown at 942-4530.
Yours truly,
Stephen M. Cutler Director:
[End of section]
Appendix III GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Richard J. Hillman (202) 512-8678
Cody J. Goebel (202) 512-7329:
Acknowledgments:
In addition to those individuals named above, Patrick Ward, Michele
Tong, Anita Zagraniczny, Carl Ramirez, Jerry Sandau, Sindy Udell, and
Emily Chalmers made key contributions to this report.
[End of section]
FOOTNOTES
[1] U.S. General Accounting Office, Securities Enforcement:
Improvements Needed in SEC Controls Over Disgorgement Cases, GAO/GGD-
94-188 (Washington, D.C.: Aug. 23, 1994).
[2] Kevin McCoy, “Conned Investors May Never See Refunds: SEC
Collection Rate Falls Sharply Since 1994,” USA Today, Jan. 9, 2001,
final edition.
[3] Securities and Exchange Commission, Office of the Inspector
General: Disgorgements, Audit No. 311 (Washington, D.C.: Jan. 11,
2001).
[4] Unless otherwise noted, years presented are fiscal years ending
September 30.
[5] The process of imposing and enforcing court-ordered disgorgement is
detailed in appendix II of GAO/GGD-94-188.
[6] U.S. General Accounting Office, SEC Operations: Increased Workload
Creates Challenges, GAO-02-302 (Washington, D.C.: Mar. 5, 2002) and
Securities and Exchange Commission: Human Capital Challenges Require
Management Attention, GAO-01-947 (Washington, D.C.: Sept. 17, 2001).
[7] GAO issues standards for internal control in the federal government
as required by 31 U.S.C. 3512. These standards provide the overall
framework for establishing and maintaining internal controls and for
identifying and addressing major performance challenges. See U.S.
General Accounting Office, Standards for Internal Control in the
Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November
1999).
[8] Courts sometimes make more than one violator jointly and severally
liable for the entire amount in the disgorgement order. In such cases,
payments by one or more violators reduce the total amount owed by all
violators, and if one violator pays the entire amount, the order would
be considered satisfied for all violators.
[9] The timeliness of the data contained in DPTS has been an issue
since at least 1991 when SEC’s Inspector General noted similar problems
and recommended that procedures be developed to ensure that the data
are current.
[10] In a recent report, we noted that the Department of Justice faces
a similar situation in collecting criminal restitution, which is
assessed without consideration of the criminal’s ability to pay. See
U.S. General Accounting Office, Criminal Debt: Oversight and Actions
Needed to Address Deficiencies in Collection Processes, GAO-01-664
(Washington, D.C.: July 16, 2001).
[11] U.S. General Accounting Office, SEC and CFTC: Most Fines
Collected, but Improvements Needed in the Use of Treasury’s Collection
Service, GAO-01-900 (Washington, D.C.: July 16, 2001).
[12] In bankruptcy proceedings, disgorgement is treated as unsecured
debt, which is paid after any secured debts are satisfied.
[13] U.S. General Accounting Office, Managing for Results: The
Statutory Framework for Performance-Based Management and
Accountability, GAO/GGD/AIMD-98-52 (Washington, D.C.: Jan. 28, 1998).
[14] See Office of Management and Budget, Circular No. A-11, Part 2:
Overview of Strategic Plans, Annual Performance Plans, and Annual
Program Performance Reports (Washington, D.C.: Nov. 18, 2001) and U.S.
General Accounting Office, Agency Performance Plans: Examples of
Practices That Can Improve Usefulness to Decisionmakers, GAO/GGD/AIMD-
99-69 (Washington, D.C.: Feb. 26, 1999).
[15] GAO/GGD/AIMD-98-52.
[16] The National Association of Securities Dealers Regulation, Inc.
did not yet have enough experience with the contracting effort to
evaluate its success.
[17] The SEC Chairman announced this initiative in a November 8, 2001
speech at the Practicing Law Institute’s 33RD Annual Institute on
Securities Regulation.
[18] See GAO/AIMD-00-21.3.1.
[19] A fiduciary must act with the same degree of care and skill that a
reasonably prudent person would use in connection with his or her own
affairs.
[20] SEC has five commissioners, who are appointed by the President to
5-year terms. Among their other responsibilities, the commissioners
approve actions that SEC staff seek to bring against violators.
GAO’s Mission:
The General Accounting Office, the investigative arm of Congress,
exists to support Congress in meeting its constitutional
responsibilities and to help improve the performance and accountability
of the federal government for the American people. GAO examines the use
of public funds; evaluates federal programs and policies; and provides
analyses, recommendations, and other assistance to help Congress make
informed oversight, policy, and funding decisions. GAO’s commitment to
good government is reflected in its core values of accountability,
integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through the Internet. GAO’s Web site (www.gao.gov) contains
abstracts and full-text files of current reports and testimony and an
expanding archive of older products. The Web site features a search
engine to help you locate documents using key words and phrases. You
can print these documents in their entirety, including charts and other
graphics.
Each day, GAO issues a list of newly released reports, testimony, and
correspondence. GAO posts this list, known as “Today’s Reports,” on its
Web site daily. The list contains links to the full-text document
files. To have GAO e-mail this list to you every afternoon, go to
www.gao.gov and select “Subscribe to daily E-mail alert for newly
released products” under the GAO Reports heading.
Order by Mail or Phone:
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or
more copies mailed to a single address are discounted 25 percent.
Orders should be sent to:
U.S. General Accounting Office
441 G Street NW, Room LM
Washington, D.C. 20548:
To order by Phone: Voice: (202) 512-6000
TDD: (202) 512-2537
Fax: (202) 512-6061
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: www.gao.gov/fraudnet/fraudnet.htm
E-mail: fraudnet@gao.gov
Automated answering system: (800) 424-5454 or (202) 512-7470
Public Affairs:
Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800
U.S. General Accounting Office, 441 G Street NW, Room 7149
Washington, D.C. 20548: