Financial Poise
Share this...

Revisiting SEC’s Crackdown On Small Securities Law Infractions

The Securities and Exchange Commission announced in October, 2014 that it brought a record of 755 enforcement actions, a 10 percent leap from 2013’s 686. The enforcement actions amounted to orders worth $4.16 billion in repayments and penalties. The securities agency earned $3.4 billion in all of paybacks and penalties in 2013. With the use of a reward system for whistleblowers and technology like data analytic tools, the SEC was able to spot more anomalies and streamline investigative efforts.

“Aggressive enforcement against wrongdoers who harm investors and threaten our financial markets remains a top priority, and we brought and will continue to bring creative and important enforcement actions across a broad range of the securities markets,” SEC Chair Mary Jo White said in a statement.

White gave the account following former SEC officials’ assessment on the relevance of the agency’s no-tolerance policy during the director’s panel in the Securities Enforcement Forum.  And there were plenty of criticisms about the so-called “penalty-driven” approach.

“The perception out here in this environment is if you catch one that doesn’t meet the six-inch test, you don’t throw it back,” William McLucas said. He became the SEC Enforcement Division head in the late 1980s.  “And that, to a certain extent, that may backfire in terms of encouraging cooperation,” added Linda Chatman Thomsen, enforcement director from 2005 to 2009.

The Broken Windows Strategy

Patterned after former New York City Mayor Rudolph Giuliani’s “broken window” strategy, the SEC aimed at focusing on the smallest of violations to deter more serious crime.  “Minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines,” White said in a speech last year.

In September, the SEC charged 34 people and companies for failing to file timely disclosures about their dealings in company stock. Nearly all the cases settled for fines.

Clearly, the broken windows strategy has significant impact on the SEC’s enforcement cases and total number of actions. But whether it will protect investors and facilitate capital formation has yet to be seen.

The “Broken” in the Broken Windows

In an interview with the New York Post, Dallas Mavericks owner Mark Cuban said the harm of the strategy comes from the complexity of securities laws.

“Here’s why it doesn’t work: If I walk up to a policeman in any neighborhood in America and say, ‘if I throw a rock into a window and break it, is it against the law?’ you know what he’s going to say. Not so with securities laws,” Cuban told New York Post. Cuban won a high-profile insider-trading case the SEC brought against him.

The agency’s rationale for adopting the strategy concerned former Commissioner Mike Piwowar. Piwowar said that creating resilient markets should be the ultimate goal of a regulation, not regulatory compliance. Cranking up on penalties could only hurt shareholders whom the agency should be protecting, he added.  “Historically, the SEC’s enforcement program has been prospective, remedial and prophylactic,” echoed Ralph Ferrara, a partner in the Washington office of law firm Proskauer Rose LLP. “Currently, it is retrospective, retributive and penal.”

In 2006, then former SEC chair Chris Cox created guidelines that laid out the factors to consider when imposing penalties. The severity of a violation and the harm a fine might bring to shareholders are major considerations in the guidelines.  This is in line, it seems, with Piwowar’s suggestion that the Commission to put more emphasis on elder financial abuse.

SEC’s penal-driven approach is expected to continue following the agency’s announcement of its 2015 examination priorities earlier this month.

According to the statement, the agency will focus on three areas including products offered to retail investors, like private funds and illiquid investments.  The agency is also expected to focus on structural risks and trends that involve multiple firms or entire industries, like broker-dealers’ compliance. Data analytics for efficient and effective oversight of registrants and registered representatives who may be engaged in illegal activities is also a priority.

Leave a Comment: