Legal Issues

ADMINISTRATIVE INVESTIGATIONS AND THE SEC

By:

AUGUST BEQUAI, ESQ.

     XYZ Corp.’s investors suffered a shock when their company’s shares plummeted after a bogus press release made its way through the Internet.  The release falsely stated that the U.S. Securities and Exchange Commission (”SEC”) had launched an investigation into the company’s accounting practices.  The bogus news had been distributed over a web-based news dissemination service and had quickly spread after being picked up by the wire services and a multitude of chat rooms. 

     An arrest by the FBI followed, and a college student with inside knowledge on on-line news services was indicted on 11 counts of securities and wire fraud.  The incident served to illustrate the ease with which frauds can be committed over the Internet, and the need for the SEC and other financial regulators to upgrade their policing efforts in the age of cyber-space.             

     Over the years, the SEC has been criticized for letting off criminals too lightly; as well as allowing them to continue working, while under investigation by its staff.  Whatever the merits of the criticisms, they should not obscure the SEC’s performance over the years; nor the fact that it labors under outdated and cumbersome procedures laid down in the ticker-tape era. 

     Experts in security and cyberspace have, over the years, criticized the in-house investigative procedures of the SEC, which some have compared to a Byzantine maze.  Highly centralized and controlled by a five-member Commission, with SEC staff investigations often dragging out for several years before finally making their way to the courts. Which in large part explains the Enron and related financial debacles.

     Consider what a typical SEC investigation entails.  It begins with an informal inquiry, after the staff has received information about a potential violation of the federal securities law.  If the staff determines that a serious violation exists, it then forwards to the Commission a written request for a Formal Order of Investigation.  Without such an Order, the staff lacks the legal authority to issue subpoenas and take sworn testimony from witnesses. 

     However, since the Commission has numerous other matters on its agenda, many of which are unrelated to its enforcement authority, the staff’s request for a formal investigation often takes several months to approve.  But in the process of conducting its inquiry and interviewing brokers, market analysts and others, the staff can hardly help but alert the target(s) of its interest.  Hence, the target(s) often has ample time to destroy damaging evidence - which has become much simpler in the age of cyber-space - and divert ill-gotten gains.

     Even after it is authorized to issue subpoenas, the staff faces additional bureaucratic hurdles.  If a witness refuses to comply with its subpoena, the staff must go back to the Commission and request subpoena enforcement authority.  This entails writing a memo to the Commission detailing the reasons why the subpoena was issued, and why it is necessary for the staff to obtain a court order directing the witness to comply.  Once again, the Commission may take several months to decide; after which time, the witness may make him or herself scarce and vital records may be destroyed.

     A potential SEC target can also hamstring the staff’s efforts by filing an internal motion with the Commission, requesting it to quash the staff’s subpoena.  Even if the Commission supports the staff, a witness or potential target may appeal that decision in federal court; once again tying up the staffs efforts in complex appeals that can span out for years. 

     Since the SEC, by law, must defer the prosecution of all criminal securities frauds to the U.S. Department of Justice, red tape and rivalry between their staffs can serve to hamper the criminal prosecution of securities offences. Thus, it can take several years for a criminal securities case to make its way to the courts; by which time, the culprits may have skipped the coop.

     The SEC gets little credit for bringing criminal cases to fruition.  That limelight goes to the U.S. Department of Justice.  The SEC defends its budget requests before the U.S. Congress on the basis of the number of civil cases that it brings.  All of this may explain why more than 90 percent of all SEC’s civil prosecutions culminate in consent decree settlements.  (A consent decree is a civil agreement in which the offender neither admits nor denies guilt, agreeing merely not to engage in any future illegal conduct).

     Under the SEC’s investigative procedures, it is a simple matter for attorneys versed in the agency’s workings to bottle up cases for many years; watering them down to consent degrees.  The threat of such tactics by wealthy targets frequently accounts for the SEC’s willingness to settle for cosmetic victories and light penalties.  In the age of cyber-space, these failings can prove costly.

     With the SEC stymied by its own internal inertia, the agency is not likely to reform itself.  Pressure for reform must come from outside.  The U.S. Congress can do a number of things to streamline the SEC’s enforcement procedures.  Among these:

•   Decentralize the decision-making process by taking some of the power away from the five-member Commission; thus, relieving the bottleneck and expediting the enforcement process. When federal prosecutors want to enforce a subpoena, they go directly to court and not to the Attorney General for permission. SEC attorneys should have similar powers and flexibility.

•   Lift the shroud of secrecy in SEC investigations. Secrecy does little to protect the victims of securities frauds. By keeping the enforcement process under tight veil, the investigative process lends itself to manipulation by powerful interests. The secrecy provisions also stymie SEC investigators form exchanging information with their counterparts in other government agencies, slowing their progress and leading to duplications in efforts.

•   Give the SEC authority to prosecute its own criminal securities fraud cases. There is no reason why SEC lawyers, well versed in securities law and frequently recruited from the top layers of the legal profession, should defer to local U.S. attorneys, who, while well versed in drug prosecutions, may not be familiar with the intricacies of securities frauds. At the very least, this step would end the counter-productive rivalry between the SEC and U.S. Department of Justice.

     In the fast-moving world of cyber-space, the SEC’s staff deserves better tools to enforce the Federal securities law.  Faced with the rapidly evolving world of the Internet, investors, more than ever, need an effective cop on the beat.  Sadly, the SEC and its sister regulatory agencies are not up to par in this regard.