On January 14, Robert S. Khuzami and George S. Canellos published their response in the National Law Journal to my earlier column, “SEC Enforcement: What Has Gone Wrong?” Their column—“Unfair Claims, Untenable Solution”(available here)—minces no words, but in my judgment continues to miss the forest for the trees. In responding, I want to emphasize that I am criticizing policies, not individuals. I have no doubt that both men are able lawyers who have worked hard to improve the SEC’s performance.
In their response, Khuzami and Canellos focus primarily on whether the median value of SEC settlements has declined. Although much depends on what years are compared, the data does not truly permit anyone to give an accurate answer because, as the attached PowerPoint slides show, the reported numbers (between 2003 and 2010) ignore the roughly 40% of individual settlements and the approximately 44% of company settlements in which the SEC settled for no monetary payment by the defendant. This pattern continued into 2012. It is meaningless to focus on the settlement in those cases where the SEC obtained a monetary recovery but ignore both the cases in which the SEC did not and whether the percentage of non-monetary recoveries is increasing or decreasing. Moreover, the high percentage of cases that the SEC settles without any monetary contribution by the defendant is striking and requires some explanation.
Khuzami and Canellos do not dispute that the median SEC settlement fell in the first half of FY 2012 (from $1.5 million in FY 2011 to $800,000), but they respond that they are doing better in 2013. Good for them, but the greater problem surrounds their failure to take on senior executives at major financial institutions. Here, they point out that the SEC is suing more individuals than in the past. True, but actions against high-ranking senior executives of financial institutions remain conspicuous by their absence. Their attempt to list senior executives at major institutions ignores that no senior executive at Lehman, Bear Stearns, AIG or the other major players in the 2008 financial collapse were named.
Overstrained and underfunded, the SEC is faced with an often hostile Congress that will only increase its budget if the SEC can show improved results. This creates an unfortunate incentive to proclaim weak and equivocal settlements to be significant “victories.” Such illusory victories may allow the SEC to stage a victory parade and request increased funding (as other agencies also do), but they mislead.
The most important claim I make is that the nature of corporate litigation has changed, partly as a result of “ediscovery” and the often millions of emails and related documents in the typical large case. It is no longer feasible for a handful of SEC attorneys (even if all are diligent and able) to litigate effectively against the squadrons of associates that a large firm can throw at a complex case. The result is a mismatch. Hence, when facing a major financial institution, the SEC tends out of necessity to settle cheaply or not sue at all (as in Lehman). My proposed answer to this problem is that the SEC should do what other financial regulators are already doing (including the FDIC): namely, hiring independent counsel on a negotiated contingent fee basis. Khuzami and Canellos object that I would cause the SEC to abandon prosecutorial discretion. Nonsense! The SEC would conduct the initial investigation and decide whether a suit was justified. But, it would now hold increased leverage in negotiations because it could credibly threaten suit by independent counsel (who would only take the case only if they judged it to be promising). SEC discretion would remain because the case would go forward only if the SEC’s staff decided that it had merit. Such an approach would go far towards solving the SEC’s budgetary crisis, because attorneys’ fees would be earned only if a recovery was obtained and only out of the recovery (thus not depleting the SEC’s budget).
Although 2012 may have been a near record year in terms of the number of cases that the SEC settled, this increase may be more part of the problem than part of the answer. This is because the cost of maximizing the number of settlements (as the SEC is doing) may be to minimize their deterrent impact (if the penalty does not cancel the expected gain). This is where I most disagree with Messrs. Khuzami and Canellos. They claim that my approach “assumes that the SEC’s general goal is to sue as may deep-pocketed parties and collect as much in penalties as possible”, while they assert that their goal is “to uphold the law and serve the interests of justice.” That is only rhetoric. Major SEC actions continue to be settled for what several prominent federal judges have described as “pocket change.” Recovering many small settlements may only amount to issuing parking tickets for securities fraud. In the past, the SEC’s greatest victories came when it took on major foes, such as Michael Milken and Drexel. To restore its reputation, the SEC needs to remember its history. But the SEC probably cannot do significantly better without obtaining additional resources (and the use of private counsel may be the most feasible route to this end).
Because the facts are in dispute between Messrs. Khuzami, Canellos and myself, I attach the PowerPoint slides from my recent keynote address—Securities Enforcement: What Has Happened? Why Are Folks Upset? What Can Be Done?—at the First Annual Securities Regulation and Enforcement Institute on December 11, 2012. Here. It should allow readers to decide for themselves whether there is a problem.