Given the recent article in Bloomberg attributing the cause of the financial crisis of 2008 as being not due to the Securities and Exchange Commission’s lack of regulation and change in its net capital rule, but to the SEC’s poor job of monitoring Wall Street once it got its increased authority in 2004, its enforcement practices must be re-examined. Is the “watchdog” agency acting as a watchdog or a ruthless junkyard attack dog? When recently criticized by the New York Times for going after the little guys, and letting the big guys off the hook, Enforcement Director Robert Khuzami, in a letter to the Editor, attacked the article, citing that the agency has gone after large institutional defendants and that to just concentrate on the “big guys” would leave all kinds of financial fraud unregulated. While there is some truth to this theory, the real truth is that the big banks get waivers from injunctions and prosecution from the Commission and can afford to pay the settlement fines involved in an enforcement proceeding, then go about their business (which includes financial fraud on a large scale, as we can see from the proliferation of mortgage fraud suits and successful settlements), whereas the “little guys” are wiped out and prohibited from working by SEC proceedings, most of which settle, imposing huge fines and penalties, destroying reputations and putting people out of business who are less culpable than the financial giants. The taint of a civil proceeding brought by the SEC, even if you win it, can ruin an individual or small business.
In fact, Bloomberg also recently reported that the SEC’s office in Washington is actively litigating 50 percent more cases than last year, which they attribute to more complex cases form the 2008 financial crisis (caused in part by the SEC) and a related increase in lawsuits filed against individual executives who are defending themselves instead of settling. Hence the recent dismissal of most of the SEC’s claims against IndyMac executives.
But the critical problem with the SEC‘s enforcement policy is not their settlement policy, which has come under fire recently but has proven to be very effective in broad enforcement, but going after executives and attorneys for what amounts to alleged negligence in financial filings, instead of focusing on the wealth of fraud that is out there and more that is likely to occur with the upcoming crowd funding boom.
The Supreme Court, in its recent ruling of in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), limited liability in Securities Exchange Act 10(b) and Rule 10b-5 cases (the SEC’s most common enforcement filings) to the actual makers of the allegedly fraudulent statements, thus cutting out liability for ancillary participants such as accountants and lawyers, who are often sued by the SEC as aiders and abettors. The problem, however, is that Janus was a case involving private enforcement of 10(b) and 10b-5, not an SEC case, although it has been applied to Commission actions by one of the SEC’s own administrative law judges, In the Matter of John P. Flannery, 3-14081 (Oct. 28, 2011).
The SEC has been criticized for letting the big guys get away with murder and prosecuting the little guys for spitting on the sidewalk. By granting exemptions to laws and regulations that act as a deterrent to securities fraud, the SEC has let financial giants like Goldman Sachs and Bank of America continue to have advantages reserved for the most dependable companies, making it easier for them to raise money from investors, and to avoid liability from lawsuits if their financial forecasts turn out to be wrong and has, by contrast, punished companies like Dell, General Electric and United Rentals for misleading information in their disclosures.
According to the Times, JP Morgan Chase settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.” Bank of America and Merrill Lynch have settled 15 fraud cases and received at least 39 waivers. Citigroup is the only financial giant that the SEC no longer grants waivers to, after settling six fraud cases and receiving 25 waivers, although their recently launched investigation into JP Morgan may add the largest bank to the list, albeit for what is really trading losses and not the litany of mortgage fraud that it committed leading to the 2008 crash.
“The ramifications of losing those exemptions are enormous to these firms,” said David S. Ruder, a former S.E.C. chairman, in an interview. Without the waivers, agreeing to settle charges of securities fraud “might have vast repercussions affecting the ability of a firm to continue to stay in business,” he said.
But what should be the most troubling about SEC enforcement practices since it has increased enforcement since the crash has been the assault against lawyers. Lawyers are never popular until you need one, and they often place themselves at risk to protect their client’s confidentiality. Moreover, not only bad guys have attorneys, the good guys have them too. Khuzami, in a speech last June to a group of defense lawyers, criticized lawyers for their “questionable” behavior, citing multiple representation of witnesses with what appear to be adverse interests, multiple witnesses represented by the same counsel who adopt all the same implausible explanation of events, witnesses who answer “I do not recall” dozens of times in testimony, including in responses to basic and uncontroverted facts, counsel signaling to clients during testimony, and “questionable “tactics in document productions and internal investigations.
According to an article in the Wall Street Journal, the SEC is going after lawyers who examined certain mortgage bond deals before the crisis. More recently, they have prosecuted lawyers for writing legal opinions and, according to the SEC’s own head of the structured products enforcement unit, Kenneth Lench, the Commission is now questioning whether advice was given in good faith to determine whether to prosecute lawyers. The Commission has recently added more lawyers to its general counsel to take administrative actions against lawyers for “professional misconduct”.
An examination of recent filings and settlements leaves one with the distinct impression that the SEC has decided to go after not only the companies against whom they allege fraud or misinformation in filings, but their lawyers as well.
In the future, we may see on TV a new advisement of constitutional rights: “You have a right to an attorney and the right to have your attorney in the jail cell next to you during your sentence”.
By Kenneth Eade, Attorney at Law