Mary Shapiro’s Securities and Exchange Commission is stepping up enforcement activities in an effort to counter criticism that it has not done its job, according to an August 11 article in the Wall Street Journal by Kara Scannell entitled “‘Urgency’ Drives SEC Crackdown.'” The SEC’s reputation as the dozing sheriff was battered by its failure to detect and/or take action against the Madoff Ponzi scheme and numerous other fraudulent schemes. Its inspector general is expected to release a critical report on the handling of the Madoff case. Former New York Attorney General Elliot Spitzer recently told Henry Blodget that the SEC does not need new authority, it just needs to stop going to lunch with Wall Street bankers every day and start issuing subpoenas.
This critical environment has created what Ms. Shapiro calls a “sense of urgency” and has led to the creation of at least seven specialized divisions and moves to speed up cases, according to the article. The SEC is looking to speed up cases by offering “cooperation points” to individuals who help uncover fraud, and eliminating a requirement that the five-member SEC leadership approve all formal orders of investigations and the issuance of subpoenas. That authority will apparently be delegated to senior staff attorneys. In addition, the SEC will no longer routinely grant extensions of time for firms to respond to Wells notices (essentially a notice to show cause why an enforcement action should not be brought).
Ms. Shapiro hired Robert Khuzami, a former federal prosecutor, as enforcement director. Mr. Khuzami hired Lorin Reisner as his deputy director and George Canellos to run the New York office, which would likely take the lead in investigating Wall Street firms.
Last week, the SEC got Bank of America, General Electric and former American International Group (“AIG”) chairman Maurice “Hank” Greenberg to agree to pay penalties of $33 million, $50 million and $7.5 million, respectively. All parties settled without admitting or denying any wrongdoing ? a practice that does not appear to have changed and one that sticks in the craw of some investor protection advocates.
On other fronts, the SEC has filed the first cases against “naked short selling,” a practice in which speculators who believe the price of a security will decline place sell orders for shares they don’t even own. Some say the practice is predatory and actually causes the price to decline. Others say we have to allow the “shorts” to vote, too ? not just the “longs.”
In May, the SEC brought its first case alleging insider trading through the use of credit default swaps, making good on its promise to regulate such products, which played a prominent roll in fall of AIG. Back in 2006, a former SEC commissioner told Congress that the agency had no regulatory authority over credit default swaps, a form of credit derivative contract in which the purchaser hedges other investments by betting that the underlying debt will default. The purchaser of a credit default swap (CDS) makes periodic payments to the seller, and if the collateral defaults, then the seller makes a large cash payoff to the purchaser which is analogous to an insurance policy although such contracts fall outside the purview of insurance regulators. While not regulated as insurance policies, however, credit default swaps clearly fall within the category of securities that have always been subject to SEC regulation. As credit default swaps grew to a $38 trillion share of the derivative market and abuses by traders became widespread, the SEC reversed its 2006 position and let Wall Street know that credit default swaps and other credit derivatives are on its enforcement radar.
The SEC is also undertaking a “targeted review” of older cases and those with little activity to determine whether continued investigation is warranted. Mr. Khuzami said that cases “worthy of continued investigation will remain open and active.
J. Boyd Page of Page Perry, observed “The recent flurry of activity by the SEC will be extremely positive for investors and our capital markets if it follows through on its commitment to protect the honesty and integrity of the market. I sincerely hope that this activity is not just short-term window dressing.”
In short, the new SEC seems to be taking a more determined stance, but it remains to be seen whether Ms. Shapiro will be as aggressive in investigating and rooting out financial fraud as Mr. Spitzer was.