This is the accessible text file for GAO report number GAO-09-358
entitled 'Securities And Exchange Commission: Greater Attention Needed
to Enhance Communication and Utilization of Resources in the Division
of Enforcement' which was released on May 6, 2009.
This text file was formatted by the U.S. Government Accountability
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.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
March 2009:
Securities And Exchange Commission:
Greater Attention Needed to Enhance Communication and Utilization of
Resources in the Division of Enforcement:
GAO-09-358:
GAO Highlights:
Highlights of GAO-09-358, a report to congressional requesters.
Why GAO Did This Study:
The Securities and Exchange Commission’s (SEC) Division of Enforcement
(Enforcement) plays a key role in meeting the agency’s mission to
protect investors and maintain fair and orderly markets. In recent
years, Enforcement has brought cases yielding record civil penalties,
but questions have been raised about its capacity to manage its
resources and fulfill its law enforcement and investor protection
responsibilities. GAO was asked to evaluate, among other issues, (1)
SEC’s progress toward implementing GAO’s 2007 recommendations; (2) the
extent to which Enforcement has an appropriate mix of resources
dedicated to achieving its objectives; and (3) the adoption,
implementation, and effects of recent penalty policies. GAO analyzed
information on resources, enforcement actions, and penalties; and
interviewed current and former SEC officials and staff, and others.
What GAO Found:
SEC has fully implemented three of GAO’s four 2007 recommendations. GAO
recommended SEC establish procedures for approving new investigations
and for operating its new investigation management information system
called the Hub; consider procedures for closing inactive cases; and
improve management of the Fair Funds program, which returns funds to
harmed investors. Enforcement has developed the procedures for new
investigations and for operating the Hub, and made case closings a
higher priority. SEC has also staffed a new Office of Collections and
Distributions (OCD), which is responsible in part for administering the
Fair Funds program. However, OCD has a dual reporting structure in
which most of the staff report to Enforcement, not the OCD director.
According to OCD management, this structure has slowed work and
confused staff. SEC strategic goals and GAO internal control standards
call for making efficient and effective use of resources a priority.
SEC’s strategic plan also calls for improving program design and
organizational structures.
Recent overall Enforcement resources and activities have been
relatively level, but the number of investigative attorneys has
decreased 11.5 percent over fiscal years 2004 through 2008. Enforcement
management said resource levels have allowed them to continue to bring
cases across a range of violations, but both management and staff said
resource challenges have delayed cases, reduced the number of cases
that can be brought, and potentially undermined the quality of some
cases. Specifically, investigative attorneys cited the low level of
administrative, paralegal, and information technology support, and
unavailability of specialized services and expertise, as challenges to
bringing actions. Also, Enforcement staff said a burdensome system for
internal case review has slowed cases and created a risk-averse
culture. SEC’s strategic plan calls for targeting resources
strategically, examining whether positions are deployed effectively,
and improving program design and organizational structure. Enforcement
management has begun examining ways to streamline case review, but the
focus is process-oriented and does not give consideration to assessing
organizational culture issues.
Enforcement management, investigative attorneys, and others agreed that
two recent corporate penalty polices—on factors for imposing penalties,
and Commission pre-approval of a settlement range—have delayed cases
and produced fewer, smaller penalties. GAO also identified other
concerns, including the perception that SEC had “retreated” on
penalties, and made it more difficult for investigative staff to
obtain “formal orders of investigation,” which allow issuance of
subpoenas for testimony and records. Our review also showed that in
adopting and implementing the penalty policies, the Commission did not
act in concert with agency strategic goals calling for broad
communication with, and involvement of, the staff. In particular,
Enforcement had limited input into the policies the division would be
responsible for implementing. As a result, Enforcement attorneys
reported frustration and uncertainty in application of the penalty
policies.
What GAO Recommends:
GAO recommends the SEC Chairman (1) consider an alternative
organizational structure for OCD; (2) further review the level and mix
of resources dedicated to Enforcement, and assess the impact of the
division’s internal case review process; (3) examine whether the 2006
corporate penalty policy is achieving its intended goals; and (4) take
steps to ensure appropriate staff participation in policy development
and review. SEC agreed with the recommendations.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/products/GAO-09-358]. For more
information, contact Orice Williams at 202-512-8678 or
williamso@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
SEC Has Made Progress in Addressing Our 2007 Recommendations, but to
Date Has Not Fully Implemented All of Them:
Investigative Staffing Has Fallen and Resource Challenges Undermine the
Ability to Bring Enforcement Actions:
Various Factors Affect the Amount of Penalties and Disgorgements
Ordered, While Overall, Total Amounts Have Declined in Recent Years:
Recent Corporate Penalty Policies--Adopted and Implemented with Only
Limited Communication--Have Delayed Cases and Discouraged Penalties:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Securities and Exchange Commission:
Appendix III: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Enforcement Budget, Fiscal Years 2004 through 2008:
Table 2: Formal Orders of Investigation Issued, Fiscal Years 2004
through 2008:
Figures:
Figure 1: Enforcement Staffing Changes, Fiscal Years 2002 through 2008:
Figure 2: Enforcement Staff Turnover, Fiscal Years 2003 through 2008:
Figure 3: Years of Service for Non-supervisory Attorneys, Fiscal Years
2002-2008:
Figure 4: Trends in Number of Investigations and Case Filings, Fiscal
Years 2002 through 2008:
Figure 5: Distribution of Types of Enforcement Actions Filed for Fiscal
Year 2008:
Figure 6: Dollar Totals of Penalties and Disgorgements, Fiscal Years
2002 through 2008:
Abbreviations:
CATS: Case Activity Tracking System:
FMFIA: Federal Managers' Financial Integrity Act of 1982:
FINRA: Financial Industry Regulatory Authority:
OCD: Office of Collections and Distributions:
OCIE: Office of Compliance Inspections and Examinations:
OEA: Office of Economic Analysis:
SEC: Securities and Exchange Commission:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
March 31, 2009:
The Honorable Christopher J. Dodd:
Chairman:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Jack Reed:
Chairman:
Subcommittee on Securities, Insurance, and Investment:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Division of Enforcement (Enforcement) of the Securities and
Exchange Commission (SEC) plays a key role in helping the agency meet
its mission of protecting investors and maintaining fair and orderly
markets. Enforcement is charged with investigating possible securities
law violations; recommending civil enforcement actions when
appropriate, either in a federal court or before an administrative law
judge; and negotiating settlements on behalf of the Commission. The
types of remedies that Enforcement can seek on behalf of the Commission
include monetary penalties and disgorgements of the profits that
individuals or companies may derive by having committed securities
violations.[Footnote 1] In 2006 and 2007, SEC adopted two policies for
determining penalties in cases involving corporate respondents.
Current economic conditions and recent turmoil in financial markets
have underscored the importance of the role Enforcement plays. In
recent years, Enforcement has initiated some high-profile actions that
resulted in record civil penalties against corporations and senior
officers.[Footnote 2] However, we and others have criticized
Enforcement's capacity to effectively manage its activities and fulfill
its critical law enforcement and investor protection responsibilities
on an ongoing basis. Some of the challenges Enforcement faces include
resource and workload imbalances, operational inefficiencies, and
limitations in information systems.[Footnote 3] More recently, our
August 2007 report noted limitations with Enforcement's processes and
systems for planning, tracking, and closing investigations, which have
hampered the division's capacity to effectively manage its operations
and allocate limited resources.[Footnote 4]
Because of your interest in ensuring that Enforcement effectively
manages its resources and enforces compliance with securities laws and
regulations, you requested that we review Enforcement's resource level,
the two recently adopted penalty policies, as well as follow up on our
previous work as appropriate. Accordingly, this report (1) evaluates
Enforcement's progress in implementing our 2007 recommendations; (2)
assesses the extent to which Enforcement has an appropriate mix of
resources dedicated to achieving its objectives, including support
staff, information technology, and access to specialized services; (3)
discusses the factors that influence the amount of penalties and
disgorgements that are ordered and the total amount of these remedies
in recent years; and (4) evaluates the adoption, implementation, and
effects of the recent corporate penalty policies.
To address our objectives, we analyzed information on trends in
resources, enforcement actions, and penalties. We obtained data from
SEC on, among other things, the level and type of Enforcement staffing
over time; the division's budget; staff turnover and experience; number
of cases filed annually; number of investigations opened or pending;
the distribution of enforcement actions by case type; annual amounts of
penalties and disgorgements ordered; and annual number of formal orders
of investigation issued. We reviewed relevant documents on the revised
penalty policies and examined a group of cases processed since
implementation of the policies. Primarily, these cases were those
resolved under a policy on corporate penalties adopted in 2007, and our
work included a review of the facts developed, and legal basis for,
recommended enforcement actions. We also met with SEC officials, former
SEC commissioners, current and former Enforcement staff, and outside
parties knowledgeable about Enforcement practices, such as securities
defense attorneys and academics who study the securities industry and
SEC. Our work included 11 small group meetings with a total of more
than 80 front-line Enforcement staff--investigative attorneys, and
first-level supervisors, known as branch chiefs--in four SEC offices
across the country (Chicago, San Francisco, New York, and Washington,
DC).[Footnote 5] We also examined the agency's strategic plan, its
annual performance and accountability reports, and its budget
justification documentation.
We undertook this performance audit from August 2008 to February 2009,
in accordance with generally accepted government auditing standards.
These standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. Appendix I provides a more
detailed description of our scope and methodology.
Results in Brief:
SEC has made progress in implementing recommendations we made in 2007,
but has not fully implemented all of them to date. Our recommendations,
which were designed to strengthen Enforcement management of its
activities, focused on approval of new investigations, establishing
procedures for a new investigative information system, closing inactive
investigations, and improving management of the Fair Funds program.
[Footnote 6] We said that, while Enforcement had demonstrated success
in carrying out its law enforcement mission, significant limitations in
the division's management processes and information systems hampered
its ability to operate at maximum effectiveness and to use limited
resources efficiently, and may have contributed to delays in Fair Fund
distributions. In line with our recommendations, Enforcement has
developed procedures for review and approval of new investigations, as
well as procedures for closing investigations that have not resulted in
an enforcement action and are no longer being pursued. The division has
implemented its new investigation management information system, called
the Hub, which can generate various management reports. As part of an
effort to improve management of the Fair Funds program, the agency has
staffed a new Office of Collections and Distributions (OCD). However,
the office's organizational structure may hamper efficiency and
effectiveness, because it has a dual reporting structure in which most
of the staff do not report to the OCD Director. Both SEC strategic
goals and GAO internal control standards call for making efficient and
effective use of resources a priority.[Footnote 7] SEC's strategic plan
also calls for exploring how to improve program design and
organizational structure. According to OCD management, the office's
structure has slowed work and created confusion. The new office has
also developed standardized reports for completed Fair Funds, but
Enforcement management said additional work is needed to integrate the
reports into SEC's financial management system.[Footnote 8]
While overall Enforcement resources and activities have remained
relatively level in recent years, the number of non-supervisory
investigative attorneys, who have primary responsibility for developing
enforcement cases, decreased by 11.5 percent, from a peak of 566 in
fiscal year 2004 to 501 for fiscal year 2008. At the same time, staff
turnover has decreased and staff tenure has increased. Measured by the
number of enforcement cases opened annually, and number of enforcement
actions brought annually, Enforcement activity has been relatively
level in recent years. Case backlogs have declined as the division has
made case closings a greater priority. Nevertheless, Enforcement
management and investigative attorneys agreed that resource challenges
have affected their ability to bring enforcement actions effectively
and efficiently. Although Enforcement management told us that the
current level of resources has not prevented the division from
continuing to bring cases across a range of violations, management and
staff acknowledged that current staffing levels mean some worthwhile
leads cannot be pursued, and some cases are closed without action
earlier than they otherwise would have been. More specifically,
investigative attorneys cited the low level of administrative,
paralegal, and information technology support, unavailability of
specialized services and expertise, and a burdensome system for
internal case review as causing significant delays in bringing cases,
reducing the number of cases that can be brought, and potentially
undermining the quality of cases. Effective and efficient use of
resources is important to accomplishing Enforcement's mission. SEC's
strategic plan calls for targeting resources strategically, examining
whether positions are deployed effectively, and exploring how to
improve program design and organizational structure. Recently,
Enforcement management has begun an initiative that seeks to streamline
the case review process. This effort is focused on process, but our
review suggests that organizational culture issues, such as risk
aversion and incentives to drop cases or narrow their scope, are also
present. If the division does not consider such issues in its
initiative, the effort may not be as successful as it otherwise could
be.
Enforcement staff consider multiple factors when determining the dollar
amounts of penalties and disgorgements, which in total have declined in
recent years. To determine a penalty in an individual case, Enforcement
staff consider factors such as nature of the violation, egregiousness
of conduct, cooperation by the defendant, remedial actions taken, and
ability to pay. Disgorgement is intended to recover gains made, or
losses avoided, through a defendant's actions. In 2006 and 2007, the
Commission articulated certain policies for determining the
appropriateness and size of corporate penalties. The 2006 policy
focuses on the direct benefit a corporation has gained through its
conduct and whether a penalty stands to cause additional harm to
shareholders.[Footnote 9] The 2007 policy required Enforcement staff,
when contemplating a corporate penalty, to obtain Commission approval
of a penalty range before settlement discussions can begin. Setting
aside the effect of the implementation of any policy, the total amount
of penalties and disgorgement ordered on an annual basis can vary
according to the type and magnitude of cases concluded in a given
period. Since fiscal years 2005 and 2006, total annual penalty and
disgorgement amounts have declined. While both have fallen, penalties
have been declining at an accelerating rate, falling 39 percent in
fiscal year 2006, another 48 percent in fiscal year 2007, and then 49
percent in fiscal year 2008. Although there were more corporate penalty
cases in fiscal year 2007 than in fiscal year 2006, penalty amounts
were larger in the fiscal year 2006 cases. Four of the six cases in
2006 resulted in penalties of $50 million or more, with the two
largest, American International Group (AIG) and Fannie Mae, totaling
$100 million and $400 million, respectively. By contrast, 2 of the 10
cases in fiscal year 2007, against MBIA, Inc., and Freddie Mac,
assessed penalties of at least $50 million.
We found that Enforcement management, investigative attorneys, and
others concurred that the 2006 and 2007 penalty policies, as applied,
have had the effect of delaying cases and producing fewer and smaller
corporate penalties. Our review also identified several other concerns:
* That the policies have had the effect of making penalties less
punitive in nature--by conditioning corporate penalties in large part
on whether a corporation has benefited from improper practices,
penalties effectively become more like disgorgement.
* That the 2007 policy (Commission pre-approval of a settlement range;
also known as the "pilot program") could have led to less-informed
decisions about corporate penalties. This is because settlement
discussions can further reveal relevant information about conduct of
the wrongdoer, and the Commission would have decided upon a penalty
range without having received such information.
* That the policies have reduced incentives for subjects of enforcement
actions to cooperate with the agency, because of the perception that
SEC has retreated on penalties.
* That it became more difficult to obtain "formal orders of
investigation," which allow issuance of subpoenas to compel testimony
and produce books, records, and other documents. Since fiscal year
2005, the number of formal orders approved by the Commission has
decreased 14 percent.
Our review also showed that in adopting and implementing the policies,
the Commission did not act in concert with agency strategic goals
calling for broad communication with, and involvement of, the staff. In
particular, Enforcement, which is responsible for implementing the
policies, had only limited input into their development. As a result,
Enforcement attorneys say there has been frustration and uncertainty in
application of the penalty policies.
This report makes four recommendations designed to strengthen
Enforcement's ability to achieve its objectives. In summary, we
recommend that the SEC Chairman:
1. Consider an alternative organizational structure and reporting
relationship for OCD;
2. Further review the level and mix of resources dedicated to
Enforcement, and assess the impact that the division's current review
and approval process for investigative staff work has on organizational
culture and the ability to bring timely enforcement actions;
3. Examine the effects of the 2006 corporate penalty policy to
determine whether the policy is achieving its stated goals, and any
other effects the policy may have had in adoption or implementation;
and:
4. Take steps to ensure that the Commission, in creating, monitoring,
and evaluating its policies, follows the agency strategic goal and
other best practices for communication with, and involvement of, the
staff affected by such changes.
We provided a draft of this report to SEC, and the agency provided
written comments that are reprinted in appendix II. In its written
comments, the agency agreed with our recommendations and said officials
are taking steps to implement them. Specifically, the SEC Chairman said
the agency will evaluate alternative organizational structures for OCD;
conduct a comprehensive review of Enforcement's investigation
processes, use of resources, and organizational culture; review whether
the Commission's 2006 corporate penalty policy is achieving its
intended goals; and take steps to ensure that the Commission better
involves, and communicates with, Enforcement staff in managing the
enforcement program. SEC also provided technical comments, which we
have incorporated as appropriate.
Background:
SEC is an independent agency created in 1934 to protect investors;
maintain fair, honest, and efficient securities markets; and facilitate
capital formation. SEC has a five-member Commission that comprises the
Chairman and four commissioners, who are appointed by the President and
confirmed by the Senate. The Commission oversees SEC's operations and
provides final approval of SEC's interpretation of federal securities
laws, proposals of new or amended rules to govern securities markets,
and enforcement activities.
To accomplish its mission, SEC has established four strategic goals:
(1) enforce compliance with federal securities laws, (2) promote
healthy capital markets through an effective and flexible regulatory
environment, (3) foster informed investment decision-making, and (4)
maximize the use of SEC resources. Enforcement and the agency's Office
of Compliance Inspections and Examinations (OCIE) share responsibility
for implementing SEC's compliance goal. According to SEC's 2008 Annual
Report, in fiscal year 2008, more than half of SEC's resources--a total
of 2,340 full-time equivalent positions, and more than $595 million--
were dedicated to programs to enforce securities laws.[Footnote 10]
In 2002, Congress passed the Sarbanes-Oxley Act of 2002 (Sarbanes-
Oxley), following high-profile corporate failures and accounting
scandals, and in response to resulting demands that public companies be
held more accountable for information reported to investors.[Footnote
11] The act, which addressed concerns involving corporate governance,
auditor independence, and regulation and oversight of the accounting
profession, also provided additional resources to SEC. Subsequently,
Congress appropriated $716 million for SEC in fiscal year 2003, an
increase of 45 percent over its fiscal year 2002 budget. SEC was
directed to use this increase both to add personnel and acquire new
information technology to increase its effectiveness.
Enforcement staff conduct investigations through informal inquiry,
interviewing witnesses, examining brokerage records, reviewing trading
data, and other methods.[Footnote 12] At the request of Enforcement
staff, the Commission may issue a "formal order of investigation,"
which allows the division's staff to compel witnesses by subpoena to
testify and produce books, records, and other documents. Following an
investigation, SEC staff present their findings to the Commission for
its review, recommending Commission action either in a federal court or
before an administrative law judge. On finding that a defendant has
violated securities laws, the court or the administrative law judge can
issue a judgment ordering remedies, such as civil monetary penalties
and disgorgement. In many cases, the Commission and the party charged
decide to settle a matter without trial. In these instances,
Enforcement staff negotiates settlements on behalf of the Commission.
Each year, Enforcement brings hundreds of civil enforcement actions
against individuals and companies accused of violating securities laws.
The mix and types of actions vary from year to year, based upon market
conditions and changes in financial instruments being used. In general,
violations could include financial and accounting fraud, insider
trading, market manipulation, providing false or misleading information
about securities and the companies that issue them, selling securities
without proper registration, and violating the broker-dealer
responsibility to treat customers fairly.
Enforcement personnel are located in SEC's headquarters in Washington,
D.C., and the agency's 11 regional offices. Enforcement staff located
in headquarters include the director and two deputy directors, five
investigative groups, or Offices of Associate Directors, and internal
support groups (Office of Chief Counsel, Office of Chief Accountant,
the trial unit, Office of Collections and Distributions, market
surveillance, and Office of Internet Enforcement). An associate
director heads each Office of Associate Director and has one or more
assistant directors. Branch chiefs report to assistant directors and
supervise the work of investigative attorneys assigned to individual
investigations, with review and support provided by division
management. SEC regional office staff typically are divided between
Enforcement and OCIE personnel. Enforcement units in the regional
offices have Office of Associate Director structures similar to those
in headquarters and report to the Director of Enforcement in
Washington, D.C.
SEC Has Made Progress in Addressing Our 2007 Recommendations, but to
Date Has Not Fully Implemented All of Them:
In 2007, we made four recommendations designed to strengthen
Enforcement's management of its operations, which focused on:
* Establishing written procedures for reviewing and approving new
investigations. We said that establishing such guidance would help
focus the review of investigations, reinforce the consistency of those
reviews, and assist in communicating new policies to the staff.
* Establishing written procedures for entering data into the new
investigation management information system called the Hub, and
establishing a control process for assessing reliability of data in the
system. We said that without written guidance and establishment of
independent and regular reviews of the accuracy of Hub data,
Enforcement was not well-positioned to get reliable program
information, and that the system's capacity to aid management of the
investigation process might be limited.
* Closing inactive investigations. We said that leaving investigations
open indefinitely compromises management's ability to effectively
manage its portfolio of cases, and has potentially negative
consequences for individuals and companies that are no longer under
investigation.
* Improving management of the Fair Funds program. We noted that because
SEC had not yet staffed or defined the roles and responsibilities of a
new office being established to administer the Fair Fund program, it
was not possible to determine the extent to which the office may better
facilitate the distribution of funds to investors harmed by securities
fraud and other violations. We also said that in the meantime, the
division had not taken other steps to allow it to develop a better
perspective on reasonableness of Fair Fund program expenses.[Footnote
13]
SEC has implemented several aspects of these recommendations, but more
work is needed for full implementation of the recommendation on the
Fair Funds program as it relates to the organizational structure of the
new Office of Collections and Distributions.
Enforcement Has Developed Procedures for Reviewing New Investigations,
Implemented the Hub System, and Encouraged Closing of Inactive
Investigations:
In 2007, we reported that under a largely decentralized approach for
approving new investigations, Enforcement was not always able to ensure
efficient resource allocation or maintain quality control in the
investigative process. Enforcement has now developed written procedures
for review and approval of new investigations, which are included in a
recently completed enforcement manual.[Footnote 14] The procedures
address various steps in the investigative process, such as handling
tips, referrals, and complaints; opening a Matter Under Inquiry, which
can be a preliminary step toward opening a full investigation; and
opening a full investigation. According to the procedures, the primary
consideration for opening an investigation should be whether the
inquiry has the potential to substantively and effectively address the
potentially improper conduct at issue. Other key factors are the
magnitude or nature of the violation, the size of the victim group, and
the amount of potential or actual losses to investors.[Footnote 15]
In 2007, we reported that Enforcement planned to start using the Hub
system by late in the year. An initial phase of the Hub was planned to
provide an ability to interact with the division's system for tracking
Matters Under Inquiry, investigations, and enforcement actions--the
Case Activity Tracking System (CATS)--which contains information on
these actions. In a second phase, SEC planned to replace CATS and
expected the project to be completed in fiscal year 2009.
Enforcement management reports that the initial phase is complete. The
Hub, as currently implemented, is an interface into CATS, and is
intended to provide a management information tool for viewing
information stored in CATS. The need arises because CATS was designed
to be an information repository, not a system for querying and
displaying data. Using the Hub, Enforcement staff can now generate
various reports on enforcement activity. For example, the Hub can
produce a report of an investigative attorney's roster of current
cases, containing items such as general case information, status, or
other case information. Other reports allow queries by case type, and
searching for cases by time period. In response to our recommendation
that Enforcement provide guidance on the use of the Hub, the division
has developed a user manual, and Enforcement management said that staff
have had access to training and various demonstrations of the Hub's
capabilities.
In connection with the Hub guidance, we recommended that the then-
Chairman direct Enforcement to establish a control process for
assessing the reliability of data in the Hub system.[Footnote 16] To
the extent that the Hub relies on CATS information, there are already
some processes for monitoring entry of information, because the CATS
system, which Enforcement officials call their system of record, has
controls on data entered into the system.[Footnote 17] This includes
use of case management specialists, whose specific duties include entry
of case information. According to Enforcement management, under the
current implementation of the Hub, investigative staff are responsible
for entering quarterly, narrative-style case updates into the system.
Specifically, staff attorneys are to enter this narrative data into the
Hub as part of quarterly case reviews that management conducts, plus
other Hub-only information not kept in CATS. Enforcement management
told us the formal control on entry of this data is that all staff are
aware of the management reviews and that the Hub user guide directs
that information should be updated at least quarterly.[Footnote 18]
They said that ultimately, it is a manager's responsibility to make
sure the information indeed gets into the Hub system. The officials
said that if the narrative case updates are not entered into the system
on a timely basis as directed, this information, which is not
quantitative data used to track items such as dollar amounts or
caseload, is considered to be a low-risk area that will not compromise
overall system quality.
In 2007, we reported that Enforcement officials characterized CATS as
severely limited and virtually unusable as a management tool.[Footnote
19] In addition, Enforcement officials said that obtaining technical
support for CATS could be difficult because the system is proprietary,
and the company that created it is no longer in business. According to
Enforcement officials, CATS' deficiencies resulted from the fact that
the system was hastily designed to prepare for expected year 2000
technical challenges.[Footnote 20] As part of this study, Enforcement
officials told us that following the departure of an information
technology contractor on the Hub project, the division has chosen to
reevaluate the entire effort to replace CATS. They told us that the
most likely scenario for implementation of a CATS replacement is now
2011 and that availability of funding will be a key factor. The
officials told us they are considering whether to add new capabilities
to the new system, in order to allow production of information that is
unavailable in the current CATS/Hub implementation without time-
consuming custom programming. Examples of such capabilities include
annual tallies of penalties and disgorgements by type of case, and data
on length of time for cases to reach certain milestones in the
enforcement action process. In addition to information on individual
cases, such aggregate information could be useful to Enforcement as a
management tool. In particular, the officials told us they are
examining the replacement project from the standpoint of achieving
efficiencies in design, development, and financial system integration,
including cost reductions related to training and internal controls.
This will improve the division's ability to capture and produce
management information, the officials said.
Finally, we recommended in 2007 that Enforcement consider developing
expedited procedures for closing investigations that had not resulted
in enforcement actions and were no longer being actively pursued. We
found that Enforcement was not addressing inactive cases where
documentation required to close a matter had not been completed. The
new Enforcement manual encourages staff to close investigations when it
becomes apparent that no enforcement action will be recommended.
According to SEC's fiscal year 2008 Performance and Accountability
Report, the division closed 1,355 cases in fiscal year 2008--its
highest annual total, according to Enforcement management--compared to
374 in fiscal year 2007, a 262 percent increase. Officials attributed
this to the new guidance, new quarterly reports that list
investigations that are 5 or more years old, and periodic conference
calls and meetings to discuss closings and case status.
SEC Has Established an Office to Improve Fair Fund Management, but Dual
Chain of Command for the Office Impedes Its Work:
Under the Fair Fund program, SEC can combine penalties and
disgorgements ordered in an enforcement action and distribute the
proceeds to harmed investors. In 2007, we recommended implementing a
plan for improving Fair Fund management, to include: (1) staffing a new
central Fair Fund office, defining its roles and responsibilities, and
establishing written procedures; and (2) ensuring the consistency of,
and analyzing, final accounting reports on completed Fair Fund plans.
We found that Enforcement's management of the Fair Fund program may
have contributed to delays in distributing funds to harmed investors
and that the division lacked data necessary for effective program
oversight.
In February 2008, SEC announced creation of OCD, to handle
disgorgements and Fair Fund activity, plus other collection and
distribution functions, such as collection of delinquent penalties or
disgorgements that are not part of Fair Fund plans, and investment of
funds received. As of October 2008, 23 of 25 full-time positions
earmarked for OCD had been staffed. As we concluded our review, efforts
were continuing to formulate policies and procedures for the office, in
areas such as conflict-of-interest and ethics rules, as well as
guidance for selection of consultants, distribution agents, and others
who assist with distributions. OCD was envisioned as having agencywide
responsibilities, but to date, has handled collections for the
headquarters office in Washington and the Boston regional office only.
For other offices, OCD advises on collections and distributions, and
Enforcement staff remain responsible for collections and distributions
in their respective offices.
Furthermore, our review identified questions about the efficiency and
effectiveness of a dual reporting structure established for OCD.
According to GAO internal control standards, optimal organizational
structure focuses on a management framework for planning, directing and
controlling operations to achieve agency objectives. The structure
should clearly define key areas of authority and responsibility, and
establish appropriate lines of reporting.[Footnote 21] Similarly, SEC's
strategic plan calls for examining whether positions are deployed
effectively, and exploring how to improve organizational structure.
According to interviews and documentation we reviewed, the OCD director
reports to SEC's executive director, who reports to the SEC Chairman.
OCD has a deputy director. But the deputy director--to whom all but two
OCD staff ultimately report--has a direct report relationship to both
the OCD director and the Director of Enforcement. Thus, a dual
reporting arrangement has been established: A small portion of OCD
reports directly to one superior (the OCD director), while nearly all
of the office reports to a deputy whose supervisory chain also leads to
a different superior outside OCD (the Enforcement director). This
bifurcated reporting leads to a situation where, as the OCD director
said, most staff ostensibly in his office are in fact within the
organizational structure of a different division. Meanwhile, the OCD
deputy director believes that the director must seek her permission to
draw upon resources that would seem to lie under the OCD director's
control, but in practice do not. The deputy director typically decides
when it is appropriate to advise the director on significant matters,
but takes primary direction from the Enforcement director, who has no
formal link to the OCD director.
According to a senior Enforcement manager, this structure was the
product of an arrangement between the then-Chairman and the then-
Director of Enforcement. This arrangement raises questions about
potential effect on unit performance and SEC's goal of prompt
distribution of funds to harmed investors. The result of this
structure, according to both the OCD director and deputy director, and
former Enforcement officials, has been twofold: confusion within the
office and among Enforcement staff at large about who is responsible
for what duties; and delay, as additional meetings and deliberations
among a larger group of parties are required to consider issues and
reconcile viewpoints. For example, the OCD director said that when
seeking to implement ideas for OCD, he must schedule additional rounds
of meetings in order to seek consensus among divisions. Similarly, the
OCD deputy director said that when differences of opinion have arisen
on plans the OCD director wanted to pursue, she has sought direction
from Enforcement management. Also, the deputy director said that there
has been confusion among OCD staff reporting to her on what issues are
appropriate for the attention of the OCD director. Both OCD officials,
and others, told us the arrangement is unsatisfactory.
Finally, in response to our recommendation that SEC implement a plan
for ensuring the consistency and analysis of final accounting reports
for completed Fair Fund plans, Enforcement staff, with the assistance
of the agency's Office of Financial Management, have created templates
to standardize reporting of final accounting for completed
distributions and Fair Fund plans. SEC uses outside consultants for
Fair Fund duties, such as identifying investors harmed in a particular
case, or making payments to investors. The nature of such duties may
vary by case type. We said that without a standardized reporting
process, Enforcement could not examine the reasonableness of Fair Fund
administrative expenses. With creation of the templates, SEC has taken
a step toward collecting information to examine administrative costs.
As of our review, the new reports are not yet integrated with Phoenix,
a system that is linked manually with the agency's financial management
system. According to Enforcement officials, the change in information
technology contractor is the chief reason. Enforcement management
recognizes the need to complete integrating the new reports with
Phoenix and is taking steps to address it.
Investigative Staffing Has Fallen and Resource Challenges Undermine the
Ability to Bring Enforcement Actions:
Overall Enforcement resources and case activity generally have been
level in recent years, but the number of front-line investigative staff
has fallen. Enforcement management and investigative attorneys told us
that resource challenges hinder the ability to bring cases. They cited
weaknesses in administrative and paralegal support, information
technology support, and specialized services and expertise; and delays
in workflow due to the division's supervisory review of investigations.
Overall Enforcement Resources and Case Activity Generally Were Steady
in Recent Years, but Investigative Staff Positions Fell by Nearly 12
Percent:
After Sarbanes-Oxley increased SEC's appropriations authorization,
Enforcement resources grew as well. As shown in figure 1, Enforcement
staffing increased following enactment of the legislation in 2002,
before subsequently declining. In fiscal year 2008, staffing increased,
but remained below the post-Sarbanes-Oxley peak. Total Enforcement
staffing has declined 4.4 percent, from a peak of 1,169 positions in
fiscal year 2005 to 1,117 positions for fiscal year 2008.
Figure 1: Enforcement Staffing Changes, Fiscal Years 2002 through 2008:
[Refer to PDF for image: line graph]
Fiscal year: 2002;
Total enforcement: 959;
Investigative attorneys: 461;
Trial attorneys: 69.
Fiscal year: 2003;
Total enforcement: 1029;
Investigative attorneys: 525;
Trial attorneys: 77.
Fiscal year: 2004;
Total enforcement: 1150;
Investigative attorneys: 566;
Trial attorneys: 88.
Fiscal year: 2005;
Total enforcement: 1169;
Investigative attorneys: 540;
Trial attorneys: 86.
Fiscal year: 2006;
Total enforcement: 1097;
Investigative attorneys: 497;
Trial attorneys: 81.
Fiscal year: 2007;
Total enforcement: 1077;
Investigative attorneys: 477;
Trial attorneys: 86.
Fiscal year: 2008;
Total enforcement: 1117;
Investigative attorneys: 501;
Trial attorneys: 93.
Source: GAO analysis of SEC data.
[End of figure]
Within Enforcement, investigative attorneys, who are the cornerstone of
SEC's enforcement efforts, account for the largest number of positions-
-about 54 percent of all non-supervisory positions. They are followed
by staff accountants (10.5 percent) and trial attorneys (10.3 percent.)
Compared to the division overall, investigative staffing has
experienced a greater decline. While total Enforcement staffing is down
4.4 percent from its peak, the number of non-supervisory investigative
attorneys has declined 11.5 percent, from a peak of 566 in fiscal year
2004 to 501 for fiscal year 2008. Enforcement management attributed
this greater decline to several factors: staff attorneys were promoted
into management during a hiring freeze, which left their former
positions vacant; investigative positions were diverted to other
functions; and non-attorney support staff had fewer opportunities to
move to other positions outside the agency.
Enforcement's budget, as shown in table 1, has followed the same
general pattern--increasing post-Sarbanes-Oxley, then falling, and
turning back up. Adjusted for inflation, the fiscal year 2008 amount is
down 8.2 percent from the fiscal year 2005 peak.
Table 1: Enforcement Budget, Fiscal Years 2004 through 2008:
Fiscal year: 2004;
Program budget: $235,385,100.
Fiscal year: 2005;
Program budget: $316,279,800.
Fiscal year: 2006;
Program budget: $311,425,700.
Fiscal year: 2007;
Program budget: $298,027,400.
Fiscal year: 2008;
Program budget: $314,950,700.
Source: SEC.
[End of table]
In addition to the number of positions Enforcement has, staff turnover
and experience are also factors important to the effectiveness of
division operations. In each of these areas, Enforcement has shown
improvements in recent years. As shown in figure 2, Enforcement staff
turnover has been declining generally, and for investigative and trial
attorneys in particular.[Footnote 22]
Figure 2: Enforcement Staff Turnover, Fiscal Years 2003 through 2008:
[Refer to PDF for image: multiple line graph]
Fiscal year: 2003;
Investigative attorneys: 10.2%;
Trial attorneys: 7.2%;
All enforcement: 7.8%.
Fiscal year: 2004;
Investigative attorneys: 7.8%;
Trial attorneys: 10.4%;
All enforcement: 7.3%.
Fiscal year: 2005;
Investigative attorneys: 11%;
Trial attorneys: 4.5%;
All enforcement: 8.5%.
Fiscal year: 2006;
Investigative attorneys: 8%;
Trial attorneys: 9.3%;
All enforcement: 7.2%.
Fiscal year: 2007;
Investigative attorneys: 8.9%;
Trial attorneys: 7.4%;
All enforcement: 8.1%.
Fiscal year: 2008;
Investigative attorneys: 5%;
Trial attorneys: 2.3%;
All enforcement: 4.9%.
Source: GAO analysis of SEC data.
[End of figure]
As turnover has decreased, the experience level of front-line attorneys
has increased. The majority of Enforcement's non-supervisory attorney
workforce has 10 years of experience or less. As shown in figure 3, the
distribution of experience within this category has undergone a
reversal in recent years. The portion with 0 to less than 3 years of
experience has declined by about half, while the portion with 3 to less
than 10 years of experience has increased by about 55 percent. The
segment of the Enforcement workforce with 10 to less than 15 years
worth of experience, while small overall, has also grown recently, by
about 14 percent.
Figure 3: Years of Service for Non-supervisory Attorneys, Fiscal Years
2002 through 2008:
[Refer to PDF for image: multiple line graph]
Fiscal year: 2002;
0 to less than 3 years: 46.2%;
3 to less than 10 years: 35%;
10 to less than 15 years: 9.9%;
15 to less than 20 years: 3.9%;
20 to less than 25 years: 1.5%.
Fiscal year: 2003;
0 to less than 3 years: 36.9%;
3 to less than 10 years: 47%;
10 to less than 15 years: 7.1%;
15 to less than 20 years: 4.8%;
20 to less than 25 years: 1.3%.
Fiscal year: 2004;
0 to less than 3 years: 38.6%;
3 to less than 10 years: 45.7%;
10 to less than 15 years: 6.1%;
15 to less than 20 years: 5%;
20 to less than 25 years: 1.5.
Fiscal year: 2005;
0 to less than 3 years: 43.9%;
3 to less than 10 years: 40.4%;
10 to less than 15 years: 5.7%;
15 to less than 20 years: 5.8%;
20 to less than 25 years: 1.6%.
Fiscal year: 2006;
0 to less than 3 years: 30.9%;
3 to less than 10 years: 52.7%;
10 to less than 15 years: 5.8%;
15 to less than 20 years: 5.8%;
20 to less than 25 years: 2.1.
Fiscal year: 2007;
0 to less than 3 years: 20.7%;
3 to less than 10 years: 59.8%;
10 to less than 15 years: 7.6%;
15 to less than 20 years: 6.9%;
20 to less than 25 years: 2.5%.
Fiscal year: 2008;
0 to less than 3 years: 23.5%;
3 to less than 10 years: 54.4%;
10 to less than 15 years: 11.3%;
15 to less than 20 years: 5.7%;
20 to less than 25 years: 3.3%.
Source: GAO analysis of SEC data.
Note: Categories for years of service 25 years or greater omitted.
[End of figure]
Enforcement management welcomed these trends in turnover and
experience, but believed that they were the product of a weaker private
sector job market for attorneys. They felt that had market conditions
been better recently, with more job opportunities in the private
sector, departures would have been greater, which would depress the
experience level. They also said that longer tenures create a corollary
problem, because opportunities for advancement may be more limited with
staff remaining longer.
Because Enforcement pursues actions against alleged securities law
violators, and the entire population of such violators is unknown,
there is no metric, such as volume of trading or number of public
company filings, for directly measuring the division's workload or
results achieved. As a result, Enforcement officials said they focus on
two process-oriented performance indicators to track the division's
activities: number of investigations opened annually, and number of
enforcement actions filed annually. By these indicators, Enforcement
activity has generally been level in recent years. Meanwhile,
Enforcement's case backlog has declined somewhat, as the division has
made case closings a greater priority (see fig. 4). Senior Enforcement
officials said the staff has cleared a previous backlog of cases ready
to be closed.
Figure 4: Trends in Number of Investigations and Case Filings, Fiscal
Years 2002 through 2008:
[Refer to PDF for image: multiple line graph]
Fiscal year: 2002;
Number of investigations opened: 479;
Number of investigations pending: 2,302;
Number of cases filed: 98.
Fiscal year: 2003;
Number of investigations opened: 910;
Number of investigations pending: 2,929;
Number of cases filed: 679.
Fiscal year: 2004;
Number of investigations opened: 973;
Number of investigations pending: 3,770;
Number of cases filed: 639.
Fiscal year: 2005;
Number of investigations opened: 947;
Number of investigations pending: 4,097;
Number of cases filed: 630.
Fiscal year: 2006;
Number of investigations opened: 914;
Number of investigations pending: 4,144;
Number of cases filed: 574.
Fiscal year: 2007;
Number of investigations opened: 776;
Number of investigations pending: 4,545;
Number of cases filed: 656.
Fiscal year: 2008;
Number of investigations opened: 890;
Number of investigations pending: 4,080;
Number of cases filed: 671.
Source: SEC.
[End of figure]
Some investigative attorneys and others with whom we spoke said such
case tallies can present an incomplete view of Enforcement activity.
They said that gross tallies do not indicate the relative significance
or magnitude of cases, and are vulnerable to manipulation. For example,
a major enforcement case involving significant violations or market
practices would be reported in the statistics with the same weight as a
matter more administrative in nature, such as failure to make required
filings with the agency.
Enforcement Management and Investigative Attorneys Both Said Resource
Challenges Undercut Their Ability to Bring Enforcement Actions:
In interviews and small group meetings, Enforcement management and
investigative attorneys agreed that resource challenges have affected
their ability to bring enforcement actions.[Footnote 23] In general,
Enforcement management told us the current level of resources has not
prevented the division from addressing any major program area, as the
division continues to bring cases across a range of securities
violations (see fig. 5). This is in line with an agency goal to avoid
over-concentrating in any particular area.
Figure 5: Distribution of Types of Enforcement Actions Filed for Fiscal
Year 2008:
[Refer to PDF for image: pie-chart]
Issuer reporting and disclosure: 23%;
Securities offerings: 18%;
Delinquent filings: 16%;
Investment advisors: 12%;
Broker-dealer: 9%;
Insider trading: 9%;
Market manipulation: 8%;
Other: 5%.
Source: SEC.
Note: Each action included in only one primary category, although a
single action may encompass more than one category.
[End of figure]
However, management and staff said that more resources were desirable,
especially in the areas of professional, information technology, and
support staff. Current and former Enforcement management told us that
the division has gained new resources recently, but these new positions
generally were dedicated to specific areas, such as micro-cap fraud or
financial restatements, and particular areas within Enforcement,
including OCD, the Office of Internet Enforcement, and the PAUSE
program, in which the agency compiles information on securities
solicitations by unregistered entities. As a result, some investigative
attorneys as well as Enforcement management told us that current
staffing levels mean some worthwhile leads cannot be pursued, and some
cases are closed without action earlier than they otherwise would have
been. One Enforcement manager told us that the division did not have
enough resources to pursue many leads involving offering fraud and
market manipulation and that, once investigations began, some were
closed for insufficient resources. Too few investigative attorneys also
affect the ability to pursue some referrals from the Financial Industry
Regulatory Authority (FINRA) and OCIE.[Footnote 24] One attorney told
us of closing several cases that were promising, but which could not be
pursued for lack of resources. A former Enforcement manager told us of
difficulty finding investigative staff to be assigned to cases,
including cases related to sub-prime mortgages.
More specifically, investigative attorneys with whom we spoke cited a
number of resource challenges that have undercut their efforts, causing
significant delays in bringing cases, reducing the number of cases that
can be brought, and potentially undermining the quality of cases.
[Footnote 25] Enforcement management concurred with the staff's
observations in these areas.
Administrative and Paralegal Support:
Investigative attorneys with whom we spoke concurred that having little
or no administrative or paralegal support causes them to spend
considerable time on non-legal duties such as copying, filing, document
scanning, preparing exhibits, making travel arrangements, soliciting
bids for court reporters, and logging and processing documents
submitted by respondents. For example, one attorney told us such duties
can take from 2 to 3 hours daily. Another, who joined the agency from
private practice, said that investigative attorneys can spend up to
half their time on tasks handled by support staff in their previous
position. One attorney told us of plans to spend a day assembling
document storage boxes. Because there is insufficient in-house copying
capability, confidential documents sometimes are sent to non-secure
outside copy shops. Frequent equipment breakdowns mean attorneys must
search for working copiers and scanners, a number of attorneys told us.
Because investigative attorneys must handle incoming documents,
correspondence and documents often stack up, unprocessed. In addition,
we have reported previously on the lack of support staff.[Footnote 26]
One attorney told us that one effect of the lack of support is that
Enforcement staff must rely on representations from defense counsel in
conducting investigations, because they have not had enough resources
to undertake research independently. Similarly, a former Enforcement
manager told us that while it can be good policy to rely on companies
to produce information, resource constraints mean this reliance
sometimes reaches undesirable levels--for example, in identifying
documents that are key to a case.
Information Technology Support:
A number of investigative attorneys said information technology support
of enforcement actions is inefficient and outdated. Enforcement's
Concordance system for managing documents is a particular area of
concern. Some attorneys told us it takes weeks, or even months, for
case records to be sent to headquarters and loaded onto the system to
become available for use. Meanwhile, the system lacks useful functions
that are available to the private sector, such as certain search
features or the ability to reconstruct chains of e-mail communication.
Some attorneys said searches in the system fail to identify information
known to be present, probably due to poor quality scanning of documents
initially. A securities defense attorney told us it is not uncommon for
Enforcement attorneys to call, asking to be directed to information of
interest in records the defense already has produced, because the staff
cannot search for the information themselves. The defense attorney said
that this could limit Enforcement's analysis of issues.
While downloading of information from computer hard drives has become a
basic evidentiary technique, some investigative attorneys told us there
can be lengthy delays for information technology support staff to
retrieve the contents from hard drives obtained during an
investigation. For example, one attorney told us about a case in active
litigation in which Enforcement had to seek an extension of time for
discovery because after 6 months, only two of a number of hard drives
had been downloaded. Some investigative attorneys also said that the
division is at a disadvantage in testimony transcription. They said
that, while systems used by private parties allow for real-time
transcription of testimony, Enforcement uses an antiquated taping
system, in which sessions are recorded and transcribed later. The
transcripts frequently come back with errors, such as misidentified
parties.
Some investigative attorneys suggested that Enforcement would benefit
from a divisionwide system for sharing information, such as litigation
documents or legal analyses. The attorneys with whom we spoke said that
such a system, found in private law firms, would allow attorneys
developing cases to be more productive by taking advantage of work
already done by others. Enforcement also cannot access information
maintained by OCIE. One attorney told us that OCIE information would be
useful because when investigating a company, attorneys would like to
know of results from any previous inspections.
Access to Specialized Services and Expertise:
A number of Enforcement attorneys told us they often cannot get access
to specialized services that would aid in case development, such as
forensic accounting, and that the division lacks expertise in some
subject areas involved in recent financial markets turmoil. According
to some attorneys, while the agency has accountants on staff, demand
for their time outstrips availability. For example, one attorney told
us that twice in recent months, a request for an accountant to be
assigned to cases under investigation, including one involving sub-
prime mortgages, was ignored. Another told us of handling accounting
work alone, after being unable to obtain accounting support.
Similarly, some attorneys felt that in-house expertise in a range of
areas was inadequate. These include complex trading, government
securities, collateralized debt obligations, credit default swaps, sub-
prime bonds, and collateralized mortgage obligations. One attorney told
us of a situation where an investigation was put on hold for several
months because staff with trading expertise were unavailable.
Several attorneys said that another significant shortcoming is that the
investigative staff does not have access to real-time trading
information. Such information can be pivotal to bringing certain cases,
such as "pump and dump" schemes where promoters use high-pressure
tactics to hype a stock, before subsequently unloading their holdings.
Currently, when attorneys need such information, they manually query
hundreds of broker-dealers, a process that initially produces only
incomplete records. Or, they might request data from a regulated entity
such as FINRA. Attorneys told us that it can take weeks or longer to
obtain the necessary information.
Internal Case Review:
Investigative attorneys also strongly agreed that the process for
supervisory review of enforcement cases is burdensome and unnecessarily
redundant, and thus not a good use of resources. They said that the
amount of time devoted to review significantly reduces the time
available for investigations. Under Commission procedures, enforcement
actions are undertaken after investigative staff present a matter for
consideration to the Commission. This is done by means of an "action
memorandum." Such memorandums, which can be lengthy and detailed,
provide information including the facts and circumstances of a case,
alleged violations of securities laws, legal analysis, and
recommendations. Subject to individual circumstances, action
memorandums generally go through multiple levels of review:
* Staff investigative attorney;
* Branch chief;
* Assistant director;
* Associate director;
* Regional director (for regional offices);
* Senior Enforcement management, other relevant divisions of the
agency, and Office of General Counsel;
* "To-be-calendared" review (for additional review by senior
Enforcement management in advance of Commission meeting); and:
* Pre-calendar review immediately before Commission meeting.
Investigative attorneys with whom we spoke noted that an action
memorandum can be subject to review and revision numerous times as it
moves through this process. Enforcement also requires other
memorandums, such as a 6-month status report after cases are opened, or
when an investigating attorney proposes sending a "Wells notice," which
is a formal notice to a party that Enforcement is considering
recommending, or intends to recommend, that the Commission file an
action or proceeding against them.
Some attorneys estimated that they spend as much as a third to 40
percent of their time on the internal review process, thus making it
harder to meet the division's emphasis on bringing cases on a timely
basis. A number of attorneys told us that the effect of the intensive
review process is to create a culture of risk aversion, an atmosphere
of fear or insecurity, or incentives to drop cases or narrow their
scope. They provided several personal examples. In one instance, an
attorney closed a case rather than go through a review with another
division. Indeed, according to a number of attorneys, there is a
perception that other divisions have become too influential in
effectively controlling Enforcement activities. In two other cases,
charges were dropped or reduced because the matters had taken so long
that people were unable to recall earlier considerations of evidence.
In another situation, it took 2-˝ months to prepare a paragraph
requesting permission to send a Wells notice; in another case, staff
prepared multiple drafts of a Wells memo over 3 years before finally
closing the case because it was so old. Finally, one investigative
attorney told us that a company under investigation offered to pay
whatever penalty amount Enforcement asked; 5 months later, the matter
still remained open, with an action memorandum in its tenth draft. Some
attorneys noted that such delays may encourage violators.
The resource issues identified by Enforcement investigative attorneys
and management--including deployment of resources, adequacy of
investigative staff support, availability of expertise and specialized
services, and questions about the burden of the division's internal
review process--stand to affect SEC's ability to bring enforcement
actions on a timely, efficient, and effective basis. Delays in bringing
enforcement actions, for example, affect not only cases immediately at
hand, but also investigative work foregone in the meantime. Similarly,
any unavailability of specialized expertise can potentially affect the
quality or scope of an enforcement action. These resource issues
reflect a combination of the level of agency appropriations and
management decisions about deployment of available resources. For
example, senior division management told us that overall, Enforcement
needs to add more than 100 professional positions in order to return to
post-Sarbanes-Oxley peak staffing, as well as an equal number of
support staff positions. Under the agency's budgeting practice, the
division is granted authority to hire to fill a specified number of
positions. Under this "slot" system, the agency has traditionally
favored allocating positions to professional staff over support staff.
Another management decision that has affected investigative capability
has been the decision to dedicate resources to specified tasks, as
opposed to general investigative duties.
Both SEC strategic goals and GAO internal control standards call for
making efficient and effective use of resources a priority. One SEC
strategic goal is for the agency to be efficient and well-managed
through investment in human capital and new technology--in particular,
by keeping pace with technological innovation--and through enhancement
of internal controls. Overall, the agency's strategic plan calls for
targeting resources strategically, examining whether positions are
deployed effectively, and exploring how to improve program design and
organizational structure. GAO internal control standards place
effectiveness and efficiency of operations as a key objective of
internal control.[Footnote 27]
Senior Enforcement managers said that they have begun an initiative to
address some of the concerns identified above. These include study of:
* The internal case review process, including reviews that take place
within Enforcement and in other divisions. Enforcement management said
that over time, as new steps have been added to the review process, it
has become unwieldy, and that this review aims to identify streamlining
measures.
* The handling of incoming referrals. Investigative tips and referrals
now come from seven sources, and Enforcement is examining how to track
their assignment and ultimate outcomes.
* Methods to develop and prospect for investigative leads, based on the
risk presented by a practice or situation.
Based on documentation we reviewed, this effort is focused on process.
However, as noted, our review indicated that concerns about the
burdensome review process have created organizational culture issues as
well.
Various Factors Affect the Amount of Penalties and Disgorgements
Ordered, While Overall, Total Amounts Have Declined in Recent Years:
For an individual case, a number of factors can affect the amount of a
penalty or disgorgement that Enforcement staff seek in an enforcement
action. On an annual basis, penalty and disgorgement amounts may vary
according to the mix of cases concluded in a particular period. In 2006
and 2007, the Commission adopted two corporate penalty polices that
focus on economic benefit derived through wrongdoing and the effect a
penalty might have on shareholders, as well as giving the Commission
earlier involvement in the penalty determination process. Overall,
penalties and disgorgements ordered have declined significantly since
the 2005-2006 period.
For Individual Cases, Several Factors Can Affect the Amount of Penalty
or Disgorgement Sought:
Numerous factors affect penalty and disgorgement amounts, which may
vary widely from case to case. Penalties are generally punitive, and
are to have a deterrent effect. In determining a recommended penalty
amount, Enforcement staff consider such factors as the nature of the
case, egregiousness of the conduct, degree to which a respondent has
cooperated during an investigation, remedial actions taken, and ability
to pay. For example, in October 2007, Nortel Networks Corp. agreed to
pay a $35 million penalty to settle an action for accounting fraud in
which the company allegedly inflated revenues to meet performance
targets.[Footnote 28] When the sanction was announced, a Commission
official said the fraud was "long-running, intentional and pervasive."
But the Commission acknowledged in settling the matter the company's
cooperation and remedial efforts, which included an independent
investigation that uncovered improper accounting; replacement of senior
management; and several restatements of financial results. In another
case, in June 2004, Gemstar-TV Guide International, Inc., agreed to pay
a $10 million penalty in connection with alleged overstating of its
revenues. The Commission in assessing the penalty amount considered the
severity of the misconduct, Gemstar's initial failure to cooperate or
undertake remedial actions, as well as later cooperation and
remediation after a change in senior management and restructuring of
its corporate governance.[Footnote 29] Prior cases have also served as
a guide for determining penalties.
Disgorgement is intended to recover ill-gotten gains realized or losses
avoided through a defendant's illegal actions. For example, in July
2008, the former head of an Enron Corp. division agreed to pay $30
million in disgorgement and interest, after the Commission charged him
with illegally selling Enron stock on the basis of nonpublic
information. SEC alleged the former executive avoided substantial
losses by selling shares before the company's stock price later
collapsed in the fall of 2001. In another example, in May 2007, Morgan
Stanley & Co. agreed to pay $5.9 million in disgorgement after the
Commission alleged the company recognized revenue when it improperly
priced, and delayed execution of, certain retail orders for securities.
Annual Penalty and Disgorgement Amounts May Vary According to Case Mix:
Setting aside the effect of any policy change, the total amount of
penalties and disgorgement that the Commission seeks on an annual basis
also can vary according to the type and magnitude of cases concluded in
a given period. For example, from 2003 through 2005, when penalty
amounts were comparatively high, a small number of cases with large
penalties accounted for a disproportionate share of the total. In
fiscal year 2003, approximately $950 million in penalties were imposed.
Of that amount, nearly 80 percent came from a single case--a $750
million penalty ordered against WorldCom, Inc., for alleged fraud.
Similarly, in fiscal year 2005, the peak year for penalties, $1.6
billion in fines were imposed, with three alleged accounting fraud
cases--Qwest Communications International, Inc.; Time Warner, Inc.; and
HealthSouth Corp.--accounting for $650 million, or about 40 percent of
the total.
Additionally, certain types of cases are more or less likely to produce
penalties or disgorgements. As an example, Enforcement management cited
financial fraud cases, which comprised nearly one-third of
Enforcement's cases brought in fiscal year 2007, as actions less likely
to result in disgorgement orders. According to the officials, if a
company experiences a large loss in the market value of its stock as a
result of a financial fraud, this does not amount to an ill-gotten gain
in the traditional sense. In addition, even if disgorgement was to be
based on such a loss in market value, the amounts involved in financial
fraud cases could be so large--reaching billions of dollars--as to be
prohibitive. Another example where amounts have been constrained is
penalties for stock options backdating, where the Commission
effectively set a ceiling on such cases, Enforcement management told
us.[Footnote 30] According to senior Enforcement officials and former
commissioners, the Commission agreed that stock options backdating
provides a benefit to a corporation, but views differed on quantifying
the size of the benefit. The effective ceiling was established after
one company was judged to have committed the worst violation, and its
penalty became the upper bound for assessing penalties in other
backdating cases.
Because penalty and disgorgement amounts can vary in these ways, a
number of observers, including current and former Enforcement staff,
cautioned against relying on penalties levied in a single year, or year-
to-year changes, as conclusive measures of the division's performance
or attitude toward enforcement actions.
Two Recently Adopted Policies Have Provided the Context for Determining
the Appropriateness and Size of Corporate Penalties:
Two recently adopted policies have provided overall guidance for
determining the appropriateness and size of corporate penalties for
individual enforcement actions. Below, we describe the features and
basis of these policies. In the next section, we address the effects of
the policies.
January 2006 Policy:
The Commission announced its January 2006 policy in conjunction with
the settlement of two corporate enforcement actions. The Commission
said the policy stems from "the fundamental principle that corporate
penalties are an essential part of an aggressive and comprehensive
program to enforce the federal securities laws, and that the
availability of a corporate penalty, as one of a range of remedies,
contributes to the Commission's ability to achieve an appropriate level
of deterrence through its decision in a particular case."
The policy established nine factors for evaluating imposition of
corporate penalties, but said two were of primary importance: [Footnote
31]
* Direct benefit to the corporation. The Commission said that if a
corporation has received a direct and material benefit from the
offense, such as through reduced expenses or increased revenues, a
corporate penalty is more appropriate. The weakest case for a corporate
penalty is when shareholders are the principal victims of the
securities law violation.
* Additional harm to shareholders. The Commission said a corporate
penalty risks hurting shareholders who have committed no violation but
may bear the burden of the penalty. Thus, the ability to use a penalty
to compensate injured shareholders supports a corporate penalty, but if
the penalty will unfairly injure investors, the corporation, or others,
that weighs against the penalty.
In announcing the policy, the Commission emphasized what it said was a
need to provide "clarity, consistency, and predictability" when
exercising its penalty authority.[Footnote 32] The Commission
acknowledged differing views among commissioners on when a corporate
penalty was appropriate, but said that the commissioners had approved
the policy unanimously, in particular the two primary factors.
The first of the two primary factors--direct benefit to the
corporation--focuses attention on economic analysis to determine what
benefit, if any, a company may have obtained from its conduct.
According to management of SEC's Office of Economic Analysis (OEA), the
facts and circumstances of a particular situation generally dictate the
analytical approach used to consider corporate benefit. One widely used
technique that OEA employs is an "event study," which considers changes
in stock price upon disclosure of violations and subsequent corrective
events. The event study method, which addresses both materiality and
magnitude of the potential inflation in securities prices, is generally
accepted and considered to be robust because it uses marketplace
reaction to gauge the significance of information. Overall, the
officials told us that estimating benefit is not a precise process.
Therefore, for a given case, OEA communicates any additional factors
that should be considered in calculating an issuer benefit. Sometimes,
OEA considers submissions from defendants as part of its analyses when
defendants provide analysis of issuer benefit. The nature of a
corporate benefit can vary. For example, a company can benefit if a
fraud, such as overstatement of earnings, results in an inflated stock
price, and the company then either issues stock or makes an acquisition
using stock. In such cases, the corporation realizes a benefit because
it realizes a higher price in issuing the stock, or it makes the
acquisition using stock with a fraudulently inflated value.
The second of the two primary factors--additional harm to shareholders-
-addresses whether shareholders who were harmed by a drop in stock
price after initial disclosure of a violation effectively would be
penalized again through a corporate penalty, according to some former
commissioners. One key element of analysis of this issue involves
shareholder turnover over time. According to Enforcement management,
turnover and impact of penalties can be considered in different ways.
They explained that ordinary turnover means that a company's collection
of shareholders at the time a violation is committed or disclosed
likely will not be the same group at the time any penalty is
subsequently assessed. If there is little turnover, the shareholder
population when a penalty is levied will be close to what the
population was at the time a violation was disclosed. But if there is a
great deal of turnover, then to the extent a penalty hurts
shareholders, the impact is diminished because many current
shareholders would not have held stock at the time the violation was
disclosed. On the other hand, more recent shareholders would not have
received any benefit from the initial fraud.
OEA officials told us they approach the shareholder harm analysis by
considering current shareholders, and trying to estimate how many might
have benefited from the company's fraud and how many did not. OEA
officials said that although attaining precise results is difficult,
the office uses data on shares held by institutions to conduct its
analysis. For shareholders who bought after a fraud, or SEC
investigation, was disclosed, a complicating factor is the degree to
which that information is priced into the cost of shares. OEA believes
that expected penalties are reflected in stock prices; therefore, those
buying after such disclosures are purchasing at a lower price. OEA
officials told us that the precision of the analysis could be improved
by considering holdings of non-institutional shareholders, but that
would be costly and time-consuming. OEA estimates that doing so for a
single case would require four people working 6 months. Given the
effort, this would provide only a marginal benefit of questionable
cost.
April 2007 Policy ("Pilot Program"):
The then-Chairman announced the April 2007 policy, also known as the
"pilot program," in a speech at a conference. The policy, now
discontinued, required Enforcement staff, when contemplating a
corporate penalty, to obtain Commission approval of a penalty range
before settlement discussions could begin.[Footnote 33] Cases that
subsequently were settled within the range specified by the Commission
were eligible for approval on an expedited basis. At the same time the
Commission provided the settlement range, it also granted Enforcement
staff authority to sue. According to Enforcement management, there was
no written documentation for this policy beyond the text of the
Chairman's speech. As announced by the Chairman, the policy applied to
any corporate penalty case; however, as put into practice by
Enforcement, it was applied to a subset of corporate penalty cases,
namely financial fraud cases only.
According to Enforcement staff and former commissioners with whom we
spoke, and as stated in the Chairman's speech, the purpose of the pilot
program was to:
* Provide earlier Commission involvement in the penalty process.
Previously, Enforcement staff would present to the Commission a
proposed settlement that already had been fully negotiated with a
respondent. Some commissioners, facing a choice of accepting a
settlement as presented or rejecting it and forcing the staff to go
back to the defendant, wanted to have more involvement earlier in the
process.
* Strengthen Enforcement staff's negotiating position. Obtaining pre-
approval of a penalty range would put Enforcement staff in the
"strongest negotiating position" because the Commission had reviewed
outcomes before settlement offers were made. In addition, the staff's
position in settlement negotiations would be strengthened by the
authority to sue that accompanied approval of the settlement range.
* Maintain consistency, accountability, and due process. The
Commission's review would ensure consistency and fairness in applying
the January 2006 policy on corporate penalties. The policy provides
accountability because it is the commissioners who are responsible for
the decisions, and it offered due process protection to defendants by
providing Commission review of evidence of alleged misconduct.
At the time of our review, eight cases had been settled in accordance
with the policy. Our comparison of the penalty range recommended by
Enforcement staff with the range approved by the Commission showed that
those ranges were similar in most cases. Specifically,
* In five of the eight cases, the Commission approved the staff's
recommended penalty range, and the staff obtained settlements within
those ranges.
* In two cases, the Commission approved a range that overlapped with,
but was lower than, the range recommended by the staff. The penalty
ultimately obtained was within the staff's original recommended range.
* In one case, the Commission approved a penalty range that was lower
than that requested by the staff. The Commission approved a lower bound
of the range that was 10 percent of the staff's recommended amount, and
an upper bound that was 25 percent of the staff's recommendation. The
staff then obtained a settlement within the lower, Commission-approved
range.
This summary reflects ultimate dispositions and does not necessarily
reflect actions or discussions that may have taken place prior to final
consideration. For example, in one case involving a technology
defendant, the Commission, in adopting a settlement range, concurred
with a staff recommendation. But an earlier staff recommendation for a
settlement range had an upper limit about 40 percent higher than that
eventually approved.
In February 2009, the current Chairman announced that this policy was
being discontinued. The Chairman said that the change was designed to
expedite enforcement efforts and that at a time when SEC needs to be
deterring corporate wrongdoing, the policy sent the wrong message. She
said that according to Enforcement staff, the policy caused significant
delays, discouraged staff from arguing for penalties in cases that
might deserve a penalty, and sometimes resulted in reductions in the
size of penalties imposed. (A full discussion of the effects of the
2006 and 2007 corporate penalty policies appears in the following
section.)
Penalty and Disgorgement Amounts Have Declined Since Fiscal Years 2005
and 2006:
Since fiscal years 2005 and 2006, total annual penalty and disgorgement
amounts have declined, as shown in figure 6. While both penalties and
disgorgements have fallen in recent years, penalties have been
declining at an accelerating rate, falling 39 percent in fiscal year
2006, another 48 percent in fiscal year 2007, and then 49 percent in
fiscal year 2008.[Footnote 34] Also, penalties have declined in the
aggregate by a greater amount than disgorgements. In particular,
penalties have fallen 84 percent, from a peak of $1.59 billion in
fiscal year 2005 to $256 million in fiscal year 2008. Disgorgements
fell 68 percent, from a fiscal year 2006 peak of $2.4 billion to $774.2
million in fiscal year 2008.
Figure 6: Dollar Totals of Penalties and Disgorgements, Fiscal Years
2002 through 2008:
[Refer to PDF for image: multiple line graph]
Fiscal year: 2002;
Disgorgements: $1,211,000,704;
Penalties: $122,540,032.
Fiscal year: 2003;
Disgorgements: $863,875,264;
Penalties: $955,632,512.
Fiscal year: 2004;
Disgorgements: $2,147,710,976;
Penalties: $1,401,890,688.
Fiscal year: 2005;
Disgorgements: $1,670,800,640;
Penalties: $1,605,780,736.
Fiscal year: 2006;
Disgorgements: $2,387,791,104;
Penalties: $977,263,232.
Fiscal year: 2007;
Disgorgements: $1,084,820,480;
Penalties: $505,470,144.
Fiscal year: 2008;
Disgorgements: $774,231,360;
Penalties: $255,967,024.
Source: SEC.
[End of figure]
Compared to fiscal year 2006, SEC brought more corporate penalty cases
in fiscal 2007, but for smaller amounts. In 2007, SEC brought 10 cases,
compared to 6 in 2006. Four of the six cases in 2006 resulted in
penalties of $50 million or more, with the two largest, AIG and Fannie
Mae, totaling $100 million and $400 million, respectively. By contrast,
in the fiscal year 2007 cases, only two issuers, MBIA, Inc., and
Freddie Mac, were assessed penalties of at least $50 million.
In addition to corporate penalties, enforcement actions also can result
in penalties against individuals. For example, in April 2007, Apple,
Inc.'s former chief financial officer was ordered to pay a $150,000
penalty for failure to ensure accurate reporting of executive
compensation, in a case stemming from stock options backdating. Also in
2007, two individuals agreed to pay $175,000 in penalties for an
alleged scheme that defrauded a number of savings banks and their
depositors in connection with the banks' conversion from mutual to
stock ownership.
While there has been some variation, the distribution of enforcement
actions by type of case has generally been consistent in recent years.
Enforcement management said that the division has met its goal that a
single category of cases not account for more than 40 percent of all
actions.
Recent Corporate Penalty Policies--Adopted and Implemented with Only
Limited Communication--Have Delayed Cases and Discouraged Penalties:
Enforcement management, investigative attorneys, and others concurred
that the 2006 and 2007 policies on corporate penalties, as applied,
have had the effect of significantly delaying cases, and producing
fewer and smaller corporate penalties. Our review also shows that in
adopting and implementing the policies, the Commission did not act in
concert with agency strategic goals calling for broad communication
with, and involvement of, the staff.
Enforcement Management, Investigative Attorneys, and Others Said That
the Recent Penalty Policies have Contributed to Delays in Cases, and
Fewer and Smaller Corporate Penalties:
According to Enforcement management, investigative attorneys, and
others, the 2006 and 2007 corporate penalty policies, as applied, have
had a number of effects. They have led to less vigorous pursuit of
corporate penalties, may have made penalties less punitive in nature,
and could have compromised the quality of settlements. Investigative
attorneys have also been concerned that at the same time, it became
more difficult to obtain formal orders of investigation, which compel
witnesses by subpoena to testify and produce books, records, and other
documents. We queried six other commission-style federal regulatory
agencies and found only one with a policy similar to the Commission's
2007 policy on pre-approval of settlement ranges.
Policies Believed to Have Resulted in Less Vigorous Pursuit of
Corporate Penalties:
On their face, the 2006 and 2007 penalty policies are neutral, in that
they neither encourage nor discourage corporate penalties. However,
Enforcement management and many investigative attorneys and others said
that Commission handling of cases under the policies both transmitted a
message that corporate penalties were highly disfavored and caused
there to be fewer and smaller corporate penalties.
Case delay was one of two major factors accounting for the belief many
expressed that corporate penalties have been disfavored. Under the 2006
policy, to recommend a corporate penalty, investigative attorneys
conduct an analysis based on the policy's nine factors. A number of
attorneys told us that this can be time-consuming, especially when
evaluating a corporate benefit, as required under one of the two main
factors. In such cases, as described above, OEA becomes involved, and
this can add months to the process. Meanwhile, attorneys said that
under the 2007 policy, the process of bringing a case could come to a
halt for long periods, when investigative attorneys were required to
seek Commission approval of a settlement range, before undertaking
settlement negotiations.
Furthermore, the time between recommendations for penalties reaching
the Commission and the Commission acting upon them could be lengthy.
According to a former commissioner, many cases involving corporate
penalties stalled because of different views among commissioners. For
example, an attorney told us that a company confessed and was willing
to pay the penalty sought, but it still took more than 6 months to
complete the settlement because the commissioners lacked consensus.
Another attorney told us that a company agreed to a settlement,
announced it publicly, and escrowed money for the payment, but the
matter took a year to win Commission approval. One attorney cited a
case that went on and off the Commission's meeting agenda eight times.
A former commissioner said that even when Enforcement staff tried to
make recommendations according to the terms of the policies, there were
lengthy delays when cases reached the Commission. In addition to delay,
the attorneys also cited perceived Commission antipathy toward such
penalties as contributing to their belief that corporate penalties have
been disfavored. For example, several Enforcement attorneys told us
that even when they presented cases in which a corporation had agreed
to pay a penalty, the Commission might lower or eliminate the amount.
One attorney described a case in which a company proposed a settlement
with a higher penalty than was approved by the Commission, which
required the attorney to return to the company and explain that the
Commission wanted a lower amount. Another described a case in which the
Commission halved a proposed penalty. Yet another described having
conducted the required nine-factor analysis, and arriving at a proposed
penalty range of $10 million to $35 million, but having the Commission
reduce it to $5 million to $15 million. We did not independently review
details of these cases.
According to a number of Enforcement attorneys and division managers,
experiences like these caused an anti-penalty message to be
transmitted, with the result that investigative attorneys began
avoiding recommendations for corporate penalties. For example, a former
Enforcement manager told us that some investigative attorneys concluded
it was not worth seeking a corporate penalty and that the Commission
did not follow terms of its own policy. A current Enforcement manager
characterized the situation as investigative attorneys "following the
path of least resistance" and not recommending penalties.
Some investigative staff with whom we spoke said that in principle, the
policies made sense. For example, one Enforcement manager told us that
in the abstract, the factors announced in the 2006 policy were
reasonable. One investigative attorney said that having guidelines is
useful and another commented that the 2006 policy was a laudable effort
to bring consensus to a philosophically divided commission. But as
applied, according to Enforcement management and a strong consensus of
investigative attorneys with whom we spoke, the ultimate outcome of the
polices has been fewer and smaller corporate penalties. For example,
when the question of whether to seek a corporate penalty is a close
one, the staff will default to avoiding the penalty. Or, if
investigative staff decides to seek a penalty, they will change their
focus from pursuing what they otherwise would recommend as most
appropriate to tailoring recommendations to what they believe the
Commission will find acceptable. As described by one attorney,
investigative staff sought to identify the "maximum minimum amount" the
Commission will approve. In one case, an attorney told us that a
company offered to pay $1 million to settle a case, but the attorney
chose to recommend no penalty because they did not believe the
Commission would approve the company offer. Likewise, an Enforcement
manager described having encouraged dropping penalties from a case for
fear the matter would not otherwise be cleared for consideration by the
Commission.
For these reasons, according to many investigative attorneys, the
penalty policies contributed to an adversarial relationship between
Enforcement and the Commission, where some investigative attorneys came
to see the Commission as less of an ally in bringing enforcement
actions, and more of a barrier. For example, one attorney told us that
it was widely felt that Enforcement was barred from doing its job.
Another said the policies represented Commission attempts to make it
more difficult for Enforcement to do its job. Others told us the
Commission was an obstacle or not supportive.
Moreover, according to an Enforcement manager, the factor in the 2006
penalty policy that anchors penalties to benefits derived by the
corporation serves to bar a corporate penalty in a significant number
of cases, or likewise limit the scope of many cases. For instance, if a
company committed fraud to inflate its stock price, that, by itself,
would not qualify for a penalty, because the company would have derived
no calculable benefit. Yet, the manager said, companies benefit in
several ways from having a higher stock price--such as by having a
better reputation, being in a better position to offer stock option
compensation to executives, and being able to obtain financing at lower
cost. Enforcement officials told us that given the effects of the
penalty policies, a $10 million penalty today might have been $50
million to $60 million before adoption of the policies.
In discussing how the Commission considers corporate penalty
recommendations by the investigative staff, Enforcement management and
some staff cited one case to us as providing what they characterized as
a striking example of the Commission reducing a proposed penalty of
significant size to zero, which went as follows: In initial settlement
discussions, a corporate penalty of several tens of millions of dollars
was considered against a financial institution defendant. The case was
the first of its type, involving several billion dollars in investor
losses. After further discussion, the case was presented to the
Commission, with the defendant offering to settle by paying a penalty
one-half the amount initially discussed, plus disgorgement of several
million dollars. In justifying the proposed remedies, Enforcement staff
said the defendant ignored repeated, highly suspicious signs of fraud
and that a lack of previous cases in this area underscored need for
action. Next, the Commission rejected the settlement as agreed by
Enforcement staff and the corporate defendant. Although rejecting the
settlement, the Commission authorized the staff to negotiate further
with the defendant, but under different legal reasoning. Under this
different approach, a corporate penalty was precluded. Enforcement
staff resubmitted the matter to the Commission and the settlement
ultimately won approval, but with no penalty and a reduction of about
80 percent in the disgorgement amount. We did not independently review
the complete details of this case or the appropriateness of the actions
of either the staff or the Commission.
Enforcement management told us they concurred in these observations
about the effect of the application of the penalty policies. Although
the Commission never directed that there be fewer, or smaller,
penalties, the officials said that has been the practical effect
because Commission handling of cases made obtaining corporate penalties
more difficult. Over time, the officials said they struggled with
implementation and were unable to provide guidance to the staff,
because they saw the Commission's application of the penalty factors as
inconsistent. Furthermore, the widely held view within Enforcement was
that the unstated purpose of the 2006 policy was to scale back
corporate penalties.
On the contrary, a former commissioner said that the 2006 and 2007
policies have not accounted for declining amounts of penalties and
disgorgement, nor for less vigorous pursuit of corporate penalties.
Instead, the former commissioner said the issue facing Enforcement has
been quality of management. The former commissioner added that
Enforcement staff has not been properly managed to bring a sufficient
range of cases on a timely basis. In addition, Commission actions have
not discouraged the staff from seeking corporate penalties. To the
extent penalties are down, it may be due to the staff electing on its
own to retreat from penalties. Another former commissioner said that,
although some Commission actions may have caused Enforcement to feel
constrained or that its authority was diminished, it was nevertheless
important to understand that the division worked at the direction of
the Commission, not as an independent entity.
Furthermore, a number of investigative attorneys and others told us
that the policies, as applied, also have discouraged pursuit of more
complicated cases, those based on novel legal reasoning, or those with
industrywide implications, in favor of those seen as more routine or
more likely to win Commission approval. For example, one attorney said
there has been relatively more focus on modest cases like small Ponzi
schemes, insider trading, and day trading, because such cases were
thought to stand a better chance of winning Commission approval,
compared to more difficult and time-consuming cases like financial
fraud. Likewise, one Enforcement manager said that the Commission
signaled that it did not favor cases involving industrywide practices.
The manager added that the preferred approach for handling industrywide
issues was not through enforcement actions, but instead through the
rule-making process.[Footnote 35]
Policies Believed to Have Affected the Nature of Penalties and the
Quality of Settlements:
Current and former Enforcement management and a number of investigative
attorneys and others expressed concern that the penalty policies may
have the effect of changing the nature of penalties, as well as
potentially compromising the quality of settlements. As noted earlier,
penalties punish violators and are intended to deter misconduct. But
according to current and former Enforcement management and some
investigative attorneys, by conditioning corporate penalties in
significant part on whether a corporation has benefited from improper
practices, penalties effectively become less punitive and more like
disgorgement. In relying on corporate benefit, the penalty policies
have the effect of disconnecting penalties from egregiousness of
conduct, one Enforcement manager told us. For example, one
investigative attorney described a case in which a respondent, based on
conduct at issue, would have paid two or three times the amount
ultimately levied. But it was not possible to recommend such a
sanction, the attorney said, because a benefit could not be quantified
in support of the amount. A former Enforcement manager emphasized that
the purpose of a penalty is not to recover wrongful gains, but instead
to deter conduct. Thus, corporate benefit should not matter in
determining a penalty. Yet under the current approach, Enforcement
officials acknowledged that there could be flagrant misconduct, but no
penalty, if corporate benefit cannot be identified through economic
analysis.
One issue with quality of settlement involves the now-discontinued 2007
policy that required pre-approval of a settlement range, and whether
the Commission, when setting the range, made fully informed decisions.
Several current and former officials told us that the question arises
because settlement discussions themselves often reveal relevant
information about conduct at issue. However, under the 2007 policy, the
Commission set the penalty range before the settlement negotiations
took place. Thus, those officials noted, the Commission acted without
the benefit of information that would surface in the settlement talks;
the settlement range set by the Commission would not reflect what would
be learned later, after settlement discussions had taken place.
[Footnote 36]
Another quality-of-settlement issue stems from what several
investigative attorneys said has been an additional outcome of the
corporate penalty policies: Reduced cooperation by the subjects of
enforcement investigations. For instance, one attorney told us that a
company said it would not settle a matter because it did not believe
the Commission would approve a penalty. Another said they believed
defense counsels less often recommended that companies approach the
agency voluntarily if they suspected securities law violations may have
occurred. Similarly, another said that corporations have been less
willing to turn over individuals for sanction. A number of
investigative attorneys told us that because the policies, as applied,
created a perception that SEC has retreated on penalties, defendants or
potential violators have become more confident or emboldened.
Enforcement concludes most of its cases by settlement, so to the extent
incentives for cooperation are reduced, settlements could be affected.
Policies Believed to Have Resulted in Increasing Difficulty in
Obtaining Formal Orders of Investigation:
At the same time the penalty policies were being implemented, it also
became more difficult to obtain orders formally authorizing
investigations, a number of attorneys said. Some of Enforcement's case
investigations take place with subjects providing information on a
voluntary basis. However, formal orders of investigation compel
witnesses by subpoena to testify and produce books, records, and other
documents. The Commission must approve such orders. The previous
Chairman recently highlighted the significance of these orders, saying
that, in the Madoff investor fraud matter, investigative staff never
sought a formal order of investigation, and that such an order would
have facilitated a more probing investigation.[Footnote 37]
Investigative attorneys with whom we spoke said that obtaining approval
of a formal order, once routine, lately had become more difficult and
time-consuming, which delayed investigations. They said that it could
take months to obtain Commission approval. One attorney said it took
about 5 months and several rounds of comments on a supporting
memorandum before a request seeking a formal order in a Ponzi scheme
investigation was set for Commission consideration. As shown in table
2, SEC statistics show fewer formal orders have been approved in recent
years, with the number down 14 percent since fiscal year 2005.
Table 2: Formal Orders of Investigation Issued, Fiscal Years 2004
through 2008:
Fiscal year: 2004;
Formal Orders of Investigation Issued: 261.
Fiscal year: 2005;
Formal Orders of Investigation Issued: 272.
Fiscal year: 2006;
Formal Orders of Investigation Issued: 255.
Fiscal year: 2007;
Formal Orders of Investigation Issued: 229.
Fiscal year: 2008;
Formal Orders of Investigation Issued: 233.
[End of table]
In February 2009, the new Chairman announced policy changes designed to
expedite issuance of formal orders. She said that she had directed a
return to a previous policy, where commissioners can approve formal
orders one after another in sequence, without a meeting; or, where
appropriate, a single Commissioner acting as a duty officer can approve
an order.
Other Federal Regulatory Agencies' Enforcement Policies:
As part of our review, we queried six other commission-style federal
regulatory agencies, to determine whether they have policies similar to
the former 2007 policy on pre-approval of a settlement range. These
agencies were the Federal Communications Commission, the Nuclear
Regulatory Commission, the Federal Energy Regulatory Commission, the
Consumer Product Safety Commission, the Commodity Futures Trading
Commission and the Equal Employment Opportunity Commission. Only one,
the Federal Energy Regulatory Commission, reported having a similar
policy. Under that agency's procedures, in seeking to resolve a case,
the staff requests settlement authority from the commission, and in
that request, seeks authority to negotiate within a range of potential
penalties or disgorgement. The policy is new, having been issued in May
2008, and has not been reviewed since then.
In Adopting and Implementing the Recent Penalty Policies, Communication
between the Commission and Enforcement Staff Was Limited:
Our review identified questions about the effectiveness of
communication between the Commission and Enforcement in adopting and
implementing the recent corporate penalty policies. In particular, the
Enforcement division, which is responsible for implementing the
policies, had only limited input into their development. Furthermore,
questions and confusion arose about the policies after they were
enacted. According to Enforcement management, the broad Enforcement
staff had no input into creation of either the 2006 or 2007 penalty
policies. Senior division management did have input into the 2006
policy, but no input into the 2007 policy.
Enforcement management said that the process for creating the 2006
policy was designed to be closed and without broad staff input. Using
consideration of two pending enforcement actions as a vehicle for
discussion, commissioners, the agency general counsel, and the
Enforcement director met in a series of executive sessions over several
months in late 2005. Senior management told us their understanding was
the Commission's desire for a closed process reflected several factors,
including a contentious topic, concern that anxiety over the issue
could be directed at staff if they participated, or concern that
commissioners might be less than candid with staff present or might
posture for their benefit.
In the case of the 2007 policy, the Commission presented a completed
policy to Enforcement without division input, according to Enforcement
management. The genesis of the policy came when the then-Chairman
raised the issue of establishing penalty ranges for cases. Following
that, Enforcement management suggested using an upcoming case as a
trial run for setting a penalty range. But according to Enforcement
management, for reasons unknown, no such trial (as Enforcement
understood it; i.e., a one-case trial run) took place, and the
Commission then summarily presented the policy to the division. In
addition, although the 2007 policy, with its pre-approval requirement,
had a material effect on the process by which enforcement actions are
brought, there was no written guidance or documentation for its
implementation. Also, although the policy was set up as a pilot
program, there was no scheduled conclusion date or any identified
process for evaluating its effectiveness.
According to agency records, the Commission has increasingly met in
executive session when considering division recommendations for
enforcement actions. Commission meetings to approve enforcement actions
are closed to the public, but ordinarily, any division staff may
attend.[Footnote 38] At executive sessions, however, the Commission
restricts attendance in two ways: (1) to only those involved in a case;
or (2) even further, to only the Director of Enforcement, and the
agency general counsel and secretary, thus excluding staff who worked
on a case. Agency records show that of the days the Commission met to
vote on enforcement actions in 2008, it held an executive session 40
percent of the time--a rate that has tripled since 2005. However, that
40 percent is roughly equal to the frequency at which executive
sessions were held in 2003 and 2004.
Similarly, investigative attorneys and current and former Enforcement
management told us that the Commission increasingly made a practice of
removing enforcement cases scheduled for consideration from its meeting
calendar with little or no notice, and often only a short time before
meetings were scheduled. Enforcement management's understanding of this
practice is that the then-Chairman removed cases for which he believed
there was insufficient support for a recommended action. We were unable
to examine the nature of removed cases because Enforcement does not
compile such data. But Enforcement management said that such cases
generally included those considered controversial.
Both SEC strategic goals and GAO internal control standards emphasize
the importance of communication and its link to organizational
effectiveness. SEC's strategic plan states that success requires a team
approach and commitment to the "highest standards" of trust,
cooperation, and communication throughout the agency, and that an
agency goal is to formulate and communicate policy proactively. GAO
internal control standards provide that effective communication should
occur in a broad sense, with information flowing down, across, and up
an organization. Similarly, a best practices approach for policy
development includes incorporating the first-hand knowledge and
insights of employees, and making employees stakeholders in developing
strategies for achieving organizational success. Employee involvement
likewise creates an opportunity to increase employees' understanding
and acceptance of organizational goals and objectives, and gain buy-in
for new polices and procedures.
The limited organizational communication in the adoption and
implementation of the penalty policies is not in accord with these
standards. According to Enforcement management and many investigative
attorneys and others, all these developments and their effect on
communication among significant constituencies within the agency
created frustration and confusion. One senior division manager noted
that the closed process of policy development angered people and
handicapped the staff's subsequent efforts to apply the policies.
Indeed, several investigative attorneys cited uncertainty about when to
apply the policies. Likewise, some commented that the inability of the
staff to see Commission deliberation of cases hindered the staff's
ability to understand how to implement the policies. For example, some
attorneys told us that investigative staff struggled to understand and
apply the 2006 policy, because its nine factors could be interpreted in
different ways, and even in contradiction to one another. At the same
time, a former commissioner questioned whether the policy was
sufficiently explained to the staff, and whether the staff was properly
applying the factors for analysis.
Conclusions:
SEC has implemented aspects of a number of our 2007 recommendations.
Among other actions, Enforcement management has developed procedures
for using the Hub system, and the Hub can now produce various
management reports. Our review did, however, identify concerns that
OCD's organizational structure could affect its efficiency and
effectiveness. SEC has identified prompt distribution of Fair Funds to
harmed investors as a goal, which was a key reason OCD was established.
SEC has partially addressed our previous recommendation by initially
staffing the office and beginning to create policies and procedures.
Dual reporting relationships are not unusual. However, the division of
authority within OCD has raised questions about the effect the office's
structure may have on its performance. As noted earlier, neither of the
two principal officials believe the current structure is optimal. The
problems cited--confusion about duties and delays in progressing toward
objectives--stand to affect the agency goal of prompt distribution of
funds to harmed investors. Furthermore, any ineffectiveness or
inefficiency within OCD stands to affect enforcement efforts in
general, because OCD is intended to assume greater responsibility
across the agency for execution of Fair Fund plans created as part of
enforcement actions. To the extent that investigative staff are
responsible for a smaller portion of Fair Fund plan execution, because
OCD has assumed those duties, the staff will be more able to
concentrate on their primary tasks of investigating violations and
bringing enforcement actions.
In recent years, Enforcement has experienced a decline in investigative
staff, but continues to face an open-ended mandate to protect investors
and enforce the federal securities laws. Its ability to deploy
resources efficiently and effectively is thus of critical importance to
accomplishing SEC's mission, especially in today's environment of
economic and financial market turmoil and volatility. Our review has
identified two key resource challenges that could hamper Enforcement's
ability to bring cases: the level of administrative and technical
support provided to investigative attorneys, and the process for
division review and approval of enforcement actions against alleged
violators. Inadequate administrative and paralegal services,
specialized services and subject matter expertise, and information
technology support can delay the completion of a case or affect its
quality and scope. Similarly, although Enforcement should take due care
in exercising its authority and discretion in bringing an enforcement
action, a burdensome internal review process can undermine efficient
use of investigative resources. As noted in SEC's strategic plan,
making effective and efficient use of resources is a priority. While
Enforcement management has moved to address some of these resource
concerns, the effort may benefit from a focus that includes both
process and organizational culture issues.
The Commission adopted two corporate penalty policies in 2006 and 2007
that, respectively, affirmed corporate penalties as an essential part
of an "aggressive and comprehensive program" to enforce the federal
securities laws, and attempted to provide earlier Commission
involvement in the settling of cases. Yet these policies, as applied,
appear to have had a number of effects at odds with SEC goals or
objectives. In particular, investigative attorneys reported that they
have not sought corporate penalties because of perceived difficulties
in winning Commission approval of such sanctions. Also, during both the
adoption and implementation of these policies, the Commission has
restricted communication, curtailing Enforcement management and staff
input and insight into policies that management and staff are
responsible for executing. Furthermore, while SEC goals call for the
"highest standards" of trust and cooperation, a number of investigative
attorneys told us the policies have caused them to see the Commission
in an adversarial light. To the extent that communication has been a
factor in the post-adoption effects cited by Enforcement management,
investigative attorneys, and others, the Commission has forgone an
opportunity to improve organizational effectiveness. Enforcement cannot
detect and prosecute all violations. Thus, its success in enforcing the
securities laws, deterring violations, and protecting investors rests
on its ability to create and implement the most effective policies. For
these reasons, the division and its enforcement efforts could benefit
from better communication with the staff affected by policy changes.
Recommendations for Executive Action:
To help ensure that SEC is effectively and efficiently using its
resources in bringing enforcement actions, and that its enforcement
policies are working effectively, we recommend that the SEC Chairman
take the following four actions:
To help ensure effective and efficient operation of the Office of
Collections and Distributions, consider an alternative organizational
structure and reporting relationship for the office, to address the
organizational concerns identified.
As part of ongoing efforts to explore the more effective use of
resources, and to streamline internal review of cases and
investigations, expand Enforcement's current examination of its methods
to include the level and mix of resources available to investigative
staff in the areas of administrative and paralegal support, specialized
services and expertise, and information technology support; and include
in the examination an evaluation of the impact of the case review
process on organizational culture factors such as risk aversion and
incentives to drop or narrow the scope of cases.
Examine the effects of the 2006 corporate penalty policy to determine
whether the policy is achieving its stated goals and any other effects
the policy may have had in adoption or implementation.
In light of the effects we have reported involving adoption and
implementation of the 2006 and 2007 corporate penalty policies, take
steps to ensure that the Commission, in creating, monitoring, and
evaluating its policies, follows the agency strategic goal and other
best practices for communication with, and involvement of, the staff
affected by such changes.
Agency Comments and Our Evaluation:
We provided a draft of this report to the Chairman of SEC for her
review and comment, and we received written comments that are reprinted
in appendix II. In these comments, the Chairman agreed with our
recommendations and said officials are taking steps to implement them.
The Chairman said senior officials will immediately evaluate
alternative organizational structures for the Office of Collections and
Distributions, in order to effectively collect ill-gotten gains and
penalties and to distribute funds to harmed investors. Also, the
Chairman said SEC's new Enforcement director will conduct a
comprehensive review of Enforcement's investigation processes and its
organizational culture. She said the review will focus on ways to make
more effective use of current resources and to identify the best use of
any additional funding. Further, the Chairman said senior officials
will review whether the Commission's 2006 corporate penalty policy is
achieving its intended goals, and will report back to her with findings
and recommendations. Finally, the Chairman agreed that SEC should take
steps to ensure that the Commission better involve, and communicate
with, Enforcement staff in managing the enforcement program. She said
no improvement to SEC's enforcement program can be successful without
deep involvement of Enforcement staff and clear communication to the
staff of the Commission's goals and expectations. SEC also provided
technical comments, which we have incorporated as appropriate.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after its date. At that time, we will send copies of this report to
interested congressional committees, the Ranking Member of the Senate
Committee on Banking, Housing, and Urban Affairs, the Ranking Member of
the Senate Subcommittee on Securities, Insurance, and Investment, and
others. We will also send a copy to the Chairman of the SEC. The report
will be available at no charge on the GAO Web site at [hyperlink,
http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or williamso@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. Key contributors to this report are
listed in appendix III.
Signed by:
Orice M. Williams, Director:
Financial Markets and Community Investment:
[End of section]
Appendix I: Scope and Methodology:
To address our first objective--evaluating the Securities and Exchange
Commission (SEC) Division of Enforcement's (Enforcement) progress made
in implementing our August 2007 recommendations--we reviewed relevant
SEC and Enforcement documentation, including a report by the SEC Office
of Inspector General on the Hub investigation management information
system, the division's Enforcement Manual, a user manual created for
the Hub system, the agency's fiscal year 2009 Congressional
Justification, and documents detailing the organization and activities
of SEC's Office of Collections and Distributions (OCD). We also
reviewed SEC's strategic plan, federal internal control standards, and
prior GAO reports on SEC and Enforcement processes and operations,
including information technology systems and the Fair Fund program.
[Footnote 39] We interviewed Enforcement management, former Enforcement
management, the principal managers of OCD, and Office of Inspector
General personnel.
To address our second objective--the extent to which Enforcement has an
appropriate mix of resources--we obtained data from SEC on Enforcement
personnel and staffing levels, the division's budget, number of
enforcement cases opened annually, number of enforcement actions
brought annually, case backlog, and distribution of types of
enforcement actions filed. We also reviewed SEC's strategic plan, its
fiscal year 2009 Congressional Justification, annual Performance and
Accountability reports, the division's Enforcement Manual, annual
Select SEC and Market Data reports, federal internal control standards,
prior GAO work on SEC human capital issues, the Sarbanes-Oxley Act of
2002, and other Enforcement program documentation.[Footnote 40] We
interviewed Enforcement management, former Enforcement management,
former SEC commissioners and chairmen, private sector securities
attorneys, academics, and others. We conducted 11 small group meetings
with approximately 80 Enforcement investigative attorneys and branch
chiefs in three regional offices of varying size--Chicago, San
Francisco, and New York--plus SEC headquarters in Washington, D.C.
Using agency data, we identified and invited participants to these
meetings by random selection, and a GAO research contractor assisted us
in conducting the sessions. While we spoke to a variety of Enforcement
staff in small group meetings, the comments we received are not
necessarily representative of the beliefs of all staff.
To address our third objective--factors influencing the amount of
penalties and disgorgements, and the total amount of these remedies in
recent years--we obtained data from SEC on total annual amounts ordered
in penalties and disgorgements, and corporate penalties ordered in
individual cases. We also reviewed SEC news and litigation releases on
enforcement actions filed, annual Performance and Accountability
reports, and terms of the corporate penalty policies implemented in
2006 and 2007. Our focus was application of the policies, not the
reasonableness or scope of their terms. For the 2007 policy, we
reviewed penalty history for a number of cases: corporate penalty
amounts as initially proposed by Enforcement staff; penalty ranges as
approved by the Commission; and penalty amounts as cases were
ultimately resolved. We also interviewed sources as indicated for our
second objective, plus officials from SEC's Office of Economic
Analysis.
To address our fourth objective--the adoption, implementation, and
effects of the recent corporate penalty policies--we reviewed decision
memorandums, in draft and final form, for a number of enforcement
actions involving corporate penalties. We reviewed these memorandums
for such matters as facts of a case, violations alleged, and penalties
proposed and approved, but did not examine them in order to determine
appropriateness of any particular action by either Enforcement staff or
the Commission. We obtained SEC statistics on formal orders of
investigation granted, and data on Commission consideration of
enforcement actions in executive session. We reviewed terms of the 2006
and 2007 corporate penalty policies, SEC's strategic plan, federal
internal control standards, and previous GAO work detailing best
practices for policy development. We queried a number of other
commission-style federal regulatory agencies: the Federal
Communications Commission, the Nuclear Regulatory Commission, the
Federal Energy Regulatory Commission, the Consumer Product Safety
Commission, the Commodity Futures Trading Commission, and the Equal
Employment Opportunity Commission. We also interviewed sources as
indicated for our third objective.
We undertook this performance audit from August 2008 to February 2009,
in accordance with generally accepted government auditing standards.
These standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusion based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
[End of section]
Appendix II: Comments from the Securities and Exchange Commission:
United States Securities And Exchange Commission:
The Chairman:
Washington, D.C. 20549:
March 25. 2009:
Ms. Orice M. Williams:
Director. Financial Markets and Community Investment:
United States Government Accountability Office:
Washington. DC 20548:
Dear Ms. Williams:
I appreciate the opportunity to respond to the GAO's draft report,
"Securities and Exchange Commission: Greater Attention Needed to
Enhance Communication and Utilization of Resources in the Division of
Enforcement." Given that the reinvigoration of the SEC's enforcement
program is a top priority for me as the newly-appointed Chairman. the
GAO's report is particularly timely and welcome.
In this time of market crisis. it is more critical than ever for
investors to have confidence in the SEC and its enforcement program. As
such. we must act swiftly to respond to market events and he willing to
find ways to improve how we do business. The GAO's draft report has
identified four specific recommendations for actions that the SIC can
take to enhance the operations of our enforcement program. I agree with
each of the recommendations. In fact, I have already taken action to
implement the steps that you have recommended.
In addition, I have recently hired Robert Khuzami, a longtime federal
prosecutor who served as Chief of the Southern District of New York's
Securities and Commodities Fraud Task Force. as the new Director of the
Division of Enforcement, starting at the end of this month. I will work
with him on management reforms including harnessing technology,
improving risk assessment, and improving training and supervision for
our line law enforcement personnel so that we can maximize our
resources to combat fraud and wrongdoing in our markets. As committed
as we are to vigorous enforcement of the securities laws, we are also
mindful that the complexity of 21st century markets, as well as the
varied nature of frauds and scams. require that the sophistication and
tools available to our enforcement program keep pace.
I am also pleased to provide you with a summary of the actions the SEC
has taken, or is currently taking, to reinvigorate our enforcement
program and ensure that it uses taxpayer resources effectively.
First, the GAO recommends that the SEC consider an alternative
organizational structure for the Office of Collections and
Distributions ("OCD" ), which is responsible for distributing over $4
billion to investors who have been injured by securities fraud. I am
pleased that the GAO has found that the SEC has made progress in
improving the management of its Fair Fund distribution program, most
notably through the creation in February 2008 of the OCD to oversee
these efforts.
However, the GAO's review has identified the need for improvements to
the OCD's organizational structure, including clearer reporting lines
and more clearly defined areas of authority and responsibility. I
concur with this recommendation, and have asked the SEC's new Director
of the Division of Enforcement to make this an immediate locus, and to
work with the Executive Director to identify and carefully evaluate
various alternatives for reforming OCD's organizational structure.
These steps will ensure that the agency will he able to effectively
collect ill-gotten gains and penalties and distribute monies to harmed
investors.
Second, the GAO recommends that the SEC further review the level and
mix of resources dedicated to Enforcement, and assess the impact of the
internal case review process. I appreciate the careful work that the
GAO has done to document the SEC's use of resources in the enforcement
program in recent years, and to acknowledge the impact that declining
staffing levels have had on the SEC's ability to pursue an aggressive
enforcement program. The report notes that the total number of staff
who work in the enter-cement program is down 4.4% since 2005, and the
total number of investigative attorneys is down even more
significantly, by 11.5%. over the same period. The report also
identifies the need for additional resources in Enforcement devoted to
administrative and paralegal support. information technology support.
and specialized services and expertise. Based on concerns expressed by
Enforcement staff the report further points out that the current mix of
resources results in the Division's inability to pursue leads it would
otherwise investigate. Finally. the report identifies the need to
ensure efficiency in the internal case review process to so that
investigative attorneys can bring enforcement cases more quickly and
spend more time on investigations.
I concur with the GAO's recommendation, and strongly agree that the
recent reductions in enforcement staffing levels have seriously
undermined the agency's ability to effectively pursue violations of the
securities laws. In response, I have asked the SEC's new Director of
the Division of Fillet-cement to conduct a top-to-bottom review of the
Enforcement Division's processes and culture, to work with the
Commission and the Division's highly talented professional staff to
find ways to work smarter with its current resources, and to identify
the highest impact use of any additional funds that Congress may
provide.
The GAO report expresses concern about delays in the approval of formal
orders of investigation. In fact. upon my arrival. I streamlined our
process for consideration of formal orders of investigation, which
allow SEC staff to use the power of subpoenas to compel witness
testimony and the production of documents. The GAO's draft report
identifies concerns by enforcement staff that obtaining approval of' a
formal order of investigation. once routine. had become more difficult
and time-consuming in recent years. In investigations that require the
use of subpoena power, time is of the essence: delay can he quite
costly to an investigation. Having heard these concerns, one of my
first actions as Chairman was to provide for more rapid approval of
formal orders of investigation. This was achieved by reinstituting a
policy considering such formal orders by the seriatim process or, where
appropriate. by a single Commissioner acting as duty officer. And, I
have been seeking opinions within the Enforcement Division as to how
else we can streamline internal processes to he more efficient.
Third, the GAO raises significant questions about the Commission's 2007
"penalty pilot program. and recommends that the SEC examine whether the
Commission's 2006 corporate penalty statement is achieving its intended
goals. I appreciate the GAO's acknowledgment of several of the actions
that I have already taken to respond to these concerns. One of my very
first actions as Chairman was to end the 2007 "penalty pilot" program,
which had required the Enforcement staff to obtain a special set of
approvals from the Commission in cases involving civil monetary
penalties against public companies as punishment for securities fraud.
In my view. the "penalty pilot" program sent the wrong message to
enforcement staff and to the public. at a time when the SEC needs to he
sending a message that corporate wrongdoing will not he tolerated. The
GAO's draft report also provides important documentation that the
"penalty pilot" program not only contributed to unnecessary delays in
the prosecution of cases but also discouraged the staff from seeking
corporate penalties or seeking appropriately high penalties.
The GAO's draft report also cites concerns about the Commission's
practice, in recent years. to remove. often with little or no notice.
from its meeting calendar enforcement cases that had been scheduled for
consideration if there was no consensus among Commissioners. The report
notes concern from enforcement staff that delays in Commission
consideration can significantly hinder the progress of an
investigation. Although the GAO provides no specific recommendation for
action. I have ended this past practice because I share the concerns
expressed by enforcement staff. In its place. I have established a
process for consideration of cases as expeditiously as possible but
which allows each Commissioner the opportunity to have his or her views
fully heard and taken into account.
I also agree with the GAO's recommendation that the SEC examine whether
the Commission's 2006 corporate penalty statement is achieving its
intended goals. I have asked the SEC's General Counsel and new Director
of the Division of Enforcement to conduct this review and to report
back to me with findings and recommendations.
Finally, the GAO recommends that the SEC take steps to ensure that the
Commission better involves, and communicates with, enforcement staff in
its decision making process relating to the management of the
enforcement program. I wholeheartedly agree with this suggestion. From
the moment of my arrival, I have made improved communication with staff
a top priority. In my view, no improvements to the SEC's enforcement
program can ever he successful without the deep involvement of the
agency's professional enforcement staff, and without clear
communication to the staff of the Commission's goals and expectations.
I appreciate the careful work that is evident in the GAO report and its
recommendations. and look forward to continuing the extensive
cooperation and collaboration that the SEC has had with the GAO
leadership and staff. If I can be of any further assistance, please
contact me or have your staff contact William Schulz, Director of the
Office of Legislative and Intergovernmental Affairs, who can he reached
at 202-551-2010.
Sincerely,
Signed by:
Mary L. Schapiro:
Chairman:
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice M. Williams (202) 512-8678 or williamso@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Karen Tremba, Assistant
Director; Anthony Paras; Carl Ramirez; Linda Rego; Barbara Roesmann;
and Christopher Schmitt made significant contributions to this report.
[End of section]
Footnotes:
[1] Disgorgement deprives securities law violators of ill-gotten gains
linked to their wrongdoing.
[2] See GAO, Mutual Fund Trading Abuses: SEC Consistently Applied
Procedures in Setting Penalties, but Could Strengthen Certain Internal
Controls, [hyperlink, http://www.gao.gov/products/GAO-05-385]
(Washington, D.C.: May 16, 2005). This report generally addressed SEC
enforcement actions pertaining to market timing and late trading
violations. Market timing typically involves the frequent buying and
selling of mutual fund shares by sophisticated investors who seek
opportunities to make profits on the difference in prices between
overseas and U.S. markets. Late trading is illegal and occurs when
investors place orders to buy or sell mutual fund shares after the
mutual fund has calculated the price of its shares, but still receive
that day's fund share price. As of February 2005, SEC had obtained
penalties and disgorgements of $1.94 billion against investment
advisory firms and managers.
[3] [hyperlink, http://www.gao.gov/products/GAO-05-385]; GAO, SEC
Operations: Increased Workload Creates Challenges, [hyperlink,
http://www.gao.gov/products/GAO-02-302] (Washington, D.C.: Mar. 5,
2002); GAO, SEC and CFTC Penalties: Continued Progress Made in
Collection Efforts, but Greater SEC Management Attention Is Needed,
[hyperlink, http://www.gao.gov/products/GAO-05-670] (Washington, D.C.:
Aug. 31, 2005); and GAO, Securities and Exchange Commission:
Opportunities Exist to Improve Oversight of Self-Regulatory
Organizations, [hyperlink, http://www.gao.gov/products/GAO-08-33]
(Washington, D.C.: Nov. 15, 2007).
[4] See GAO, Securities and Exchange Commission: Additional Actions
Needed to Ensure Planned Improvements Address Limitations in
Enforcement Division Operations, [hyperlink,
http://www.gao.gov/products/GAO-07-830] (Washington, D.C.: Aug. 15,
2007).
[5] In this report, we collectively refer to investigative attorneys
and branch chiefs as "investigative attorneys." Also, while we spoke to
a variety of Enforcement staff in small group meetings, the comments we
received are not necessarily representative of the beliefs of all
staff.
[6] The Fair Funds program returns penalties and disgorgements ordered
in a particular enforcement action to investors who have been harmed by
the defendant(s)' conduct. For a description of the Fair Funds program
and a complete version of our recommendations, see GAO-07-830.
[7] Under 31 U.S.C. § 3512 (c), (d), commonly known as the Federal
Managers' Financial Integrity Act of 1982 (FMFIA), agency management is
responsible for establishing, maintaining, and assessing internal
control to provide reasonable assurance that it is meeting FMFIA's
broad internal control objectives consistent with the standards GAO
prescribes. For more information on GAO's current internal control
standards and guidance for federal entities, see GAO, Standards for
Internal Control in the Federal Government, [hyperlink,
http://www.gao.gov/products/GAO/AIMD-00-21.3.1] (Washington, D.C.:
November 1999).
[8] The term "financial management system" is generally used to include
the financial systems and the financial portions of mixed systems
necessary to support financial management, including automated and
manual processes, procedures, controls, data, hardware, software, and
support personnel dedicated to the operation and maintenance of system
functions. See, e.g., Federal Financial Management Improvement Act of
1996, Pub. L. No. 104-208, div. A., § 101(f), title VIII, § 803(c)(4),
110 Stat. 3009, 3009-389 (Sept. 30, 1996).
[9] See SEC, Statement of the Securities and Exchange Commission
Concerning Financial Penalties (Jan. 4, 2006), available at [hyperlink,
http://www.sec.gov/news/press/2006-4.htm]. In this statement, the
Commission noted that SEC's authority to impose civil penalties was
relatively new and that the existing SEC penalty cases did not provide
a clear public view of when and how the Commission would in future
cases seek civil penalties against corporations. In describing a
particular framework that it followed for penalty determinations in two
cases, the Commission said it relied on the legislative history of the
Securities Enforcement Remedies and Penny Stock Reform Act, Pub. L. No.
101-429, 104 Stat. 931 (Oct. 15, 1990), which provided the SEC
authority generally to seek civil money penalties in enforcement cases.
Prior to this act, the SEC's authority to seek civil penalties was
generally limited to cases filed in district court for insider trading
violations. In its January 2006 statement, the Commission relied upon
and quoted a passage from S. Rep. 101-337 as follows:
The [Senate] Committee [on Banking, Housing, and Urban Affairs]
believes that the civil money penalty provisions should be applicable
to corporate issuers, and the legislation permits penalties against
issuers. However, because the costs of such penalties may be passed on
to shareholders, the Committee intends that a penalty be sought when
the violation results in an improper benefit to shareholders. In cases
in which shareholders are the principal victims of the violations, the
Committee expects that the SEC, when appropriate, will seek penalties
from the individual offenders acting for a corporate issuer. Moreover,
in deciding whether and to what extent to assess a penalty against the
issuer, the court may properly take into account whether civil
penalties assessed against corporate issues will ultimately be paid by
shareholders who were themselves victimized by the violations. The
court also may consider the extent to which the passage of time has
resulted in shareholder turnover.
S. Rep. No. 101-337 (1990). In the same statement, the SEC identified
other factors from the statute and its legislative history to be
pertinent to the analysis of corporate issuer penalties and these,
along with the factors identified in the quote above, were set forth as
factors properly considered by the SEC in determining whether to impose
a penalty, with the first two being of principal consideration: (1) the
presence or absence of a direct benefit to the corporation as a result
of the violation; (2) the degree to which the penalty will recompense
or further harm the injured shareholders; (3) the need to deter the
particular type of offense; (4) the extent of the injury to innocent
parties; (5) whether complicity in the violation is widespread
throughout the corporation; (6) the level of intent on the part of the
perpetrators; (7) the degree of difficulty in detecting the particular
type of offense; (8) presence or lack of remedial steps by the
corporation; and (9) the extent of cooperation with Commission and
other law enforcement. These factors, as applied by the Commission and
Enforcement staff, are further discussed in this report.
[10] "Full-time equivalent" is a measure of staff hours equal to those
of an employee who works 40 hours per week in 1 year.
[11] Pub. L. No. 107-204, 116 Stat. 745 (July 30, 2002).
[12] The Commission delegates various authorities to the Director of
Enforcement, such as instituting subpoena enforcement proceedings in
federal court or demanding production of various records. See 17 C.F.R.
§ 200.30-4(10).
[13] See [hyperlink, http://www.gao.gov/products/GAO-07-830].
[14] The manual is available publicly at [hyperlink,
http://www.sec.gov/divisions/enforce.shtml].
[15] According to the procedures, other supplemental factors to be
considered include whether: there is immediate need for action to
protect investors; the conduct undermines the fairness or liquidity of
U.S. securities markets; the case involves a repeat offender; the
subject matter has been designated an enforcement priority; the conduct
is part of a widespread industry practice; the subject matter gives SEC
an opportunity to be visible in a portion of the marketplace that might
not otherwise be familiar with the agency or protections of the
securities laws; or the case presents a good opportunity to coordinate
with other agencies.
[16] In January 2009, Chairman Christopher Cox resigned, and Mary
Schapiro was sworn in as his replacement.
[17] GAO prescribes specific standards for control activities for
information systems, including application controls related to data
processing, including controls designed to ensure the completeness,
accuracy, authorization, and validity of all system input and output
transactions. [hyperlink,
http://www.gao.gov/products/GAO/AIMD-00-21.3.1], at 16-17.
[18] Control activities are the automated or manual procedures,
mechanisms, and other processes that an agency uses to address risks,
such as management reviews and verifications. [hyperlink,
http://www.gao.gov/products/GAO/AIMD-00-21.3.1], at 11-16.
[19] See [hyperlink, http://www.gao.gov/products/GAO-07-830]. In 2005,
we reported that SEC said it had begun a multi-year project to upgrade
CATS, with work expected to be complete by 2008. See [hyperlink,
http://www.gao.gov/products/GAO-05-670].
[20] The technical challenges resulted from the practice in computer
program design of abbreviating years by their last two digits. This
could cause some date-related processing to operate incorrectly for
dates and times on and after January 1, 2000.
[21] See [hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1].
[22] We calculated turnover as the number of departures in a fiscal
year as a fraction of total employees at the start of the year.
[23] According to a variety of current and former Enforcement
personnel, Enforcement can be overmatched in a particular case by
resources available to private-sector respondents, and no one with whom
we spoke expected that situation to change. For example, Enforcement
usually staffs smaller and more routine cases with one attorney, while
respondents might employ several times as many. One Enforcement
attorney told us of recently facing 23 lawyers on the opposing side.
[24] FINRA is a non-governmental regulator of securities firms doing
business in the United States. FINRA oversees nearly 5,000 brokerage
firms, about 173,000 branch offices, and approximately 659,000
registered securities representatives. It was created in July 2007
through consolidation of the National Association of Securities Dealers
and the member regulation, enforcement, and arbitration functions of
the New York Stock Exchange.
[25] Enforcement management told us that computer capability, as
currently configured, does not allow tracking of the progress and
development of cases, such as time elapsed between various case
milestones. Thus, there are no detailed statistics on length of time
for bringing enforcement actions.
[26] See GAO, Securities and Exchange Commission: Human Capital
Challenges Require Management Attention, [hyperlink,
http://www.gao.gov/products/GAO-01-947] (Washington, D.C.: Sept. 17,
2001).
[27] See [hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1].
[28] In this and other examples of enforcement actions cited in this
report, the parties settled without admitting or denying the charges
brought.
[29] Corporate governance refers to a corporation's process of
providing leadership, direction, and accountability in fulfilling its
mission, meeting objectives, and providing stewardship of corporate
resources, while establishing clear lines of responsibility for
results.
[30] In stock options backdating, a company misrepresents the date of
an employee stock option award to make it appear that the option was
granted at an earlier date, and at a lower price, than when the award
was actually made. This allows the option recipient to potentially
realize larger gains when exercising the options.
[31] The other seven factors are: need for deterrence; extent of injury
to innocent parties; whether complicity is widespread throughout the
corporation; intent of the perpetrators; degree of difficulty in
detecting the offense; remedial action by the corporation; and
cooperation with the Commission and other law enforcement. Although
addressed in a new policy, the nine factors have all been among factors
determining corporate penalties in the past.
[32] In this report, we do not evaluate the reasonableness of the
policy or the factors that comprise it; our focus is on the policy as
applied.
[33] In February 2009, the current Chairman announced this policy was
being discontinued. We nevertheless include this discussion of the
policy here, because it raised questions about attitudes toward
enforcement and because our discussions with investigative staff and
Enforcement management showed the policy had a significant impact on
enforcement activities.
[34] Penalties are those ordered under the Insider Trading Sanctions
Act of 1984, Pub. L. No. 98-376, 98 Stat. 1264 (Aug. 10, 1984), and the
Securities Enforcement Remedies and Penny Stock Reform Act of 1990,
Pub. L. No. 101-429, 104 Stat. 931 (Oct. 15, 1990). Penalties under the
latter account for about 98 percent of the total.
[35] Under the Administrative Procedures Act of 1946 (APA), codified,
as amended, at 5 U.S.C. § 551, enforcement actions dispose of a matter
related to past conduct of particular parties, whereas notice-and-
comment rule making, which has the force and effect of law, has general
applicability and future effect.
[36] Prior to the settlement talks, and depending on the course a case
has taken, a defendant may have filed a "Wells submission"--a response
to the agency's "Wells notice." A Wells notice provides formal notice
to a party that Enforcement is considering recommending, or intends to
recommend, that the Commission file an action or proceeding against
them. The subsequent Wells submission provides an opportunity for a
defendant to present a statement setting forth their interests and
position. However, even if a defendant made a Wells submission before
the Commission considered a settlement range, that does not necessarily
mean a defendant would get complete consideration of its position,
according to Enforcement management and others. This is because a
defendant, in writing a Wells response, would not yet necessarily know
how to best make an argument. To cover different legal analyses and
possible outcomes, a defendant could argue different defenses, but we
were told that such arguments are not as effective as arguing a single
defense directly. However, the best line of argument may not become
clear until after settlement talks.
[37] See Statement Regarding Madoff Investigation, SEC press release
2008-297, December 16, 2008, available at: [hyperlink,
http://www.sec.gov/news/press/2008/2008-297.htm].
[38] Staff in regional offices can view by video link.
[39] See GAO, Securities and Exchange Commission: Additional Actions
Needed to Ensure Planned Improvements Address Limitations in
Enforcement Division Operations, [hyperlink,
http://www.gao.gov/products/GAO-07-830] (Washington, D.C.: Aug. 15,
2007); and GAO, SEC and CFTC Penalties: Continued Progress Made in
Collection Efforts, but Greater SEC Management Attention Is Needed,
[hyperlink, http://www.gao.gov/products/GAO-05-670] (Washington, D.C.:
Aug. 31, 2005).
[40] See GAO, Securities and Exchange Commission: Some Progress Made on
Strategic Human Capital Management, [hyperlink,
http://www.gao.gov/products/GAO-06-86] (Washington, D.C.: Jan. 10,
2006); and GAO, Securities and Exchange Commission: Human Capital
Challenges Require Management Attention, [hyperlink,
http://www.gao.gov/products/GAO-01-947] (Washington, D.C.: Sept. 17,
2001).
[End of section]
GAO's Mission:
The Government Accountability Office, the audit, evaluation and
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 GAO's Web site [hyperlink, http://www.gao.gov]. Each
weekday, GAO posts newly released reports, testimony, and
correspondence on its Web site. To have GAO e-mail you a list of newly
posted products every afternoon, go to [hyperlink, http://www.gao.gov]
and select "E-mail Updates."
Order by Phone:
The price of each GAO publication reflects GAO’s actual cost of
production and distribution and depends on the number of pages in the
publication and whether the publication is printed in color or black and
white. Pricing and ordering information is posted on GAO’s Web site,
[hyperlink, http://www.gao.gov/ordering.htm].
Place orders by calling (202) 512-6000, toll free (866) 801-7077, or
TDD (202) 512-2537.
Orders may be paid for using American Express, Discover Card,
MasterCard, Visa, check, or money order. Call for additional
information.
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]:
E-mail: fraudnet@gao.gov:
Automated answering system: (800) 424-5454 or (202) 512-7470:
Congressional Relations:
Ralph Dawn, Managing Director, dawnr@gao.gov:
(202) 512-4400:
U.S. Government Accountability Office:
441 G Street NW, Room 7125:
Washington, D.C. 20548:
Public Affairs:
Chuck Young, Managing Director, youngc1@gao.gov:
(202) 512-4800:
U.S. Government Accountability Office:
441 G Street NW, Room 7149:
Washington, D.C. 20548: