Almost everyone has an opinion about securities enforcement. Many are disappointed (and even angry) that “few high level executives” have been prosecuted (criminally or even civilly) in connection with the 2008 financial crisis. Deep in their bunker, the SEC still has some diehards who maintain that fraud has been fully prosecuted, but, even there, attitudes are changing. The shift is much clearer at the Department of Justice (“DOJ”), which has just settled with JPMorgan for $13 billion and may be in hot pursuit of still unnamed defendants. Even if the SEC is presenting itself as a more aggressive enforcer under its new Chair, questions remain about whether its behavior has truly changed.
Although there is a surplus today of opinions about how enforcement should change, there is a paucity of facts. Why is it that enforcers have underperformed? What practical steps are possible? Provocative new proposals are being made, but they too need to be informed by better factual evidence as to how regulators actually behave. Last week, speaking before the New York City Bar’s Second Annual Institute on Securities Litigation and Enforcement as its keynote speaker, United States District Judge Jed Rakoff offered a bold proposal and a critique. After rejecting some frequently invoked explanations for prosecutorial inaction (such as the “revolving door” theory), he presented an alternative theory: namely, that federal prosecutors have relied too much on deferred prosecution agreements under which they permit independent counsel to conduct internal corporate investigations to establish the basic facts. These investigations, often headed up by a former U.S. Attorney or other eminent person, tend predictably not to find that senior executives behaved culpably. In the Judge’s view, this delegation of fact-finding to internal investigators has resulted in a loss of general deterrence that “far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window dressing.” Although the Judge carefully took no position on whether fraud was at the heart of the financial crisis, he concluded that, to the extent it may have been, “the failure of the government to bring to justice those responsible for such colossal fraud bespeaks weaknesses in our prosecutorial system that need to be addressed.”
The Judge’s words will resonate with many, particularly those concerned that we have quietly accepted a double standard for criminal justice under which banks (and their executives) have been treated as “too big to jail.” Nonetheless, there remains a missing factual foundation here. How is the government using its enforcement resources? Further, what is the alternative to internal investigations by counsel chosen by the corporation? How can the government investigate complex corporate misconduct when it largely lacks the manpower to conduct wide-ranging corporate investigations? How should the government prioritize among cases? To ask these questions is not to disagree with Judge Rakoff that financial executives should be subject to the criminal law, but it is to highlight the key empirical questions that usually wind up submerged and ignored in normative debates. A necessary starting point is to ask: How in fact does the government allocate its scarce enforcement resources? Invariably, the government asserts that it is tough and getting tougher. But what the government says and what it actually does can diverge significantly.
This column will limit its focus to the SEC, but that may be where the problem is most serious. To any knowledgeable observer, it is obvious that the SEC is more seriously resource-constrained than the DOJ (because even a conservative Congress is sufficiently “law-and-order” oriented that it will not cut the DOJ’s budget as severely as it may the SEC’s).
The SEC’s predicament is that, to justify a larger budget (which it clearly needs), the SEC must show a skeptical (and Republican) House of Representatives that it has done more. This need to improve on last year appears to have made the SEC very concerned with quantitative metrics (e.g., How many cases filed? How many settled in the fiscal year?) Much like a company approaching its IPO, the SEC has an incentive to inflate its numbers. At first glance, the SEC’s recent numbers do look much improved. In fiscal year 2012, the SEC brought 734 enforcement actions—a near record. Also in fiscal year 2012, the SEC entered into 714 settlements—up 6.6% from 2011 and the highest number since 2007.
But a closer look raises serious questions about whether these numbers have been padded. In an October, 2013 story, investigative reporters at the Wall Street Journal found that on the last day of its fiscal 2012 year, the SEC filed some 22 enforcement actions. Moreover, for the last month of that fiscal year (i.e., September 2012), the SEC initiated some 128 administrative actions—up 86% from the same month the preceding year. Many of these actions were simply “follow on” actions in which the SEC simply bars a broker or investment adviser from the industry based on a prior conviction or enforcement action.
Alone, this padding might not mean much. But there are other, more significant problems with many of the cases that the SEC brings. According to NERA Economic Consulting, from 2003 to 2010, slightly over 40% of SEC settlements included no monetary payment. In fiscal 2012, this percentage of “zero dollar” settlements fell to approximately 34% of individual settlements and roughly 24% of company settlements. Improved as that is, such bloodless settlements (particularly in the case of corporate defendants that are seldom impecunious) raise a puzzling question: Why does the SEC regularly sue defendants when it is willing to settle for nothing? Arguably, this looks like illusory enforcement.
Moreover, in FY 2012, NERA found that the median company settlement (in those cases where cash was paid) fell some 28% to $1 million, down from $1.4 million in FY 2011. In addition, there were 20 fewer settlements with companies in FY 2012 in comparison with FY 2011. Even the way these median values are computed seems dubious. Computing the median value by considering only those settlements in which some cash was paid (and ignoring the numerous settlements in which none was paid) is much like my computing my batting average by counting only the plate appearances in which I did not strike out. (By the way, on that basis, I look much better).
Perhaps more important than the declining number and median size of corporate settlements in FY 2012 is the fact that the number of “high value” corporate settlements has fallen way below where it was in the period from 2003 to 2005. “High value” settlements are best measured by looking to the 90th percentile of all SEC company settlements. The 90th percentile figure was $80 million in FY 2003, $50 million in FY 2004, and $72.5 million in FY 2005. Yet, by FY 2011, it had fallen to $16.4 million, while in FY 2012, it rose modestly to $18.9 million—still less than one quarter of the level in FY 2003. This fall in the size of the “high value” settlement means fewer “big” cases are being brought and likely measures the impact of resource constraints on the SEC. Unable credibly to threaten to go to trial, the SEC’s staff may have to settle at reduced amounts, as defense counsel (who usually are alumni of the agency) are well aware of the SEC’s logistical constraints.
The data that seems most inconsistent with the SEC’s claim to be a tougher, more aggressive enforcer has just been released by the Morvillo, Abramowitz, Grand, Iason & Anello law firm. They have tabulated the number of enforcement actions filed by the SEC between January 1, 2013 and September 30, 2013 and find that some 526 enforcement actions were brought in this interval. But the majority of these actions do not involve current investigations of fraud or other securities law violations. Rather, some 30% of these cases (or 159 out of 526) were “follow-on” cases—that is , administrative proceedings to revoke licenses that follow after earlier SEC or DOJ cases in court. Another 21% (or 113 out of 526) were “delinquent filer” cases in which a public company was late in making a required periodic filing. Only 48% of the SEC actions in this period alleged a substantive violation of the federal securities laws. Even in these “core” cases, one third of them (or 83 out of 259) did not allege scienter. This could mean either that these cases were relatively minor, or—more alarmingly—that the SEC did not allege scienter in order to facilitate settlement. Finally, even where scienter is alleged, the SEC may sue in an administrative proceeding (where the penalties tend to be lower and injunctive relief is not available). The SEC did so 27 times in the first nine months of 2013. Thus, out of the 526 cases brought by the SEC in 2013 (through September 30, 2013), only 144 cases (or 27.3%) were both brought in federal court and alleged fraud. Again, it is uncertain whether this reflects the lower gravity of these offenses or the SEC’s need to use administrative proceedings to facilitate settlement.
The composition of the cases brought by the SEC is also changing in a manner that suggests the SEC is moving away from the larger case. For purposes of its annual report, the SEC’s Enforcement Division annually groups the actions that it files into several generic categories. The two that have increased the most over recent years are: (1) broker fraud (“Misrepresentations to Customers and Misappropriation of funds by Financial Service Firms”), and (2) Ponzi Schemes. Both have risen dramatically in the years since Bernie Madoff’s fraud was uncovered in late 2008. Broker fraud has seen a two-thirds increase since 2008, and Ponzi scheme actions have more than doubled since 2008. That the SEC has shifted manpower to these areas is understandable as necessary self-protection, but these actions tend to be smaller cases involving broker/customer interactions.
More importantly, given that SEC resources are limited, an increase in one enforcement category necessarily implies a decrease in some other category. The category that has seen the largest decrease in the number of actions filed is that involving public company statements. These are the Enron and WorldCom style of cases that once elicited enormous settlements. FY 2011 saw the fourth straight year of decline in this category with only eleven actions being filed against public companies. Penalties also plummeted, as in these eleven cases against public companies, only six involved any monetary penalty (and four of these were for amounts under $1 million).
None of this proves that the SEC is consciously avoiding suits against large companies (and the Goldman Sachs and JPMorgan cases stand as counter-examples). But even if we look at the most recent cases filed this year in 2013, this pattern persists. According to the Morvillo, Abramowitz study, “public issuer disclosure” cases accounted for only 9% of the SEC’s enforcement actions filed in the first nine months of 2013. In contrast, “No Scienter” cases accounted for 26%.
Planned or unplanned, a shift in the nature and composition of the SEC’s cases appears to be occurring. First, the Enforcement Division appears to be moving towards the “retailization of enforcement,” bringing more cases involving broker/customer disputes or small frauds and less involving larger corporations. Second, the Enforcement Division seems to be emphasizing quantity over quality, bringing more actions in total (734 enforcement actions in FY 2012), but fewer against large public corporations (or their executives).
Why would the SEC move in this direction? Several reasons seem plausible. First, some in Congress have pushed it to show more attention for the problems of the retail customer. Second, logistical constrains may make it nearly impossible for the SEC to pursue a large case involving multiple senior executives. Although the SEC won a hard fought victory against Fabrice Tourre (a/k/a the “Fabulous Fab”), that was a factually narrow and contained case, modest in its overall scope. A much bigger case alleging that multiple executives designed portfolios to fail may have been beyond it. Some also doubt the SEC staff’s depth of trial experience (for example, the SEC attorney who won the Tourre case has already moved on to greener pastures in the private sector).
Beyond these reasons, two more context-specific reasons for this shift to smaller cases strike me as more important and alarming. First, bringing many smaller cases (instead of fewer larger cases) enables the Enforcement Division to show quantitative improvement that may justify a larger budget request. If the House of Representatives wants more cases brought to justify a larger budget for the SEC, the SEC can give them that, but only by inflating its numbers (as the Wall Street Journal has alleged), bringing smaller cases, and settling them more easily. But with this shift comes a likely loss in general deterrence.
Second, avoiding the large, highly public case may be a product of risk aversion, because with greater publicity comes a greater risk of an embarrassing failure that the post-Madoff SEC can ill afford. The SEC’s reputation was at risk in the Tourre case, and the SEC suffered a prestige-damaging defeat in the Mark Cuban insider trading case. Neither case will incline it to take the high risk in going to trial in a much publicized matter. This suggestion that the SEC has become highly risk averse is more than an intuitive speculation on my part. A July 2013 study by the Government Accountability Office (“GAO”) asked SEC staffers if they agreed or disagreed with the statement that “fear of public scandals has made the SEC overly cautious and risk averse.” 62.8% of the SEC senior officials, 57.4% of its supervisory officials, and 54.7% of its non-supervisory staff either “agreed” or strongly agreed with this statement. To the extent that the SEC is risk averse, it might be reluctant to pursue senior executives (who would predictably not settle, at least in a scienter-based case because the reputational damage could be career-ending). A risk averse SEC might still be prepared to sue large banks (who would generally prefer to settle than engage in a trial that would subject them to unfavorable publicity day after day in the national media).
SEC staffers have strongly objected to my hypothesis that the SEC has opted for a low-risk policy of emphasizing quantity over quality because such a policy is contrary, they insist, to all the Commission’s expressed policies. Perhaps it is, but this then poses the ultimate question: in assessing an agency, should we look to what it says, or what it does? Whatever the SEC says its policies are, it has not pursued cases against notable senior financial executives (with the possible exception of its action against Countrywide CEO, Angelo Mozilo). This can be explained based either in terms of resource constraints or risk aversion (or both), but not in terms of preferring quality to quantity.
If resource constraints and risk aversion better explain the SEC’s failure to pursue senior executives, what policy reforms would work? To deal with its resource constraints, the SEC could economize by bringing most of its smaller actions in administrative proceedings. At present, the SEC sometimes does the reverse, bringing, for example, its London Whale case as an administrative proceeding (probably to avoid any need for judicial approval). Moving smaller cases in house might free up resources for larger cases against senior executives. Last month, the SDNY U.S. Attorney showed that winning such a case is not impossible, as a jury found both Bank of America and the executive who headed its mortgage securitization program (Rebecca Mairone) liable under FIRREA. That was an important precedent that makes SEC inaction even more conspicuous.
In the last analysis, for the SEC to undertake the truly complex case, it probably needs to retain outside counsel (possibly on a contingent fee basis)—much as the FDIC and FHFA already do with considerable success. Within the SEC, this idea is still seen as treasonous, and SEC staffers respond that use of private counsel would sacrifice the prosecutorial discretion that is the hallmark of public enforcement. This is nonsense! Large corporations maintain significant in-house legal departments, but still rely on outside counsel for “you-bet-your-company” cases. In those cases, outside counsel are closely monitored by the corporation’s general counsel, who retains the ultimate decision-making discretion. Economically, the decision whether to rely on in-house staff or to hire the best available “stars” in the legal market is a classic “make-or-buy” decision, and there is no per se superior policy.
Ultimately, risk aversion can cut both ways. Today, the SEC’s staff fears losing the big case and so may settle cheap. But the Commission’s decision in the Philip Falcone case to reject an embarrassingly weak settlement could begin to convince senior staff that there are dangers in being too soft and accommodating. Today, such a prediction may still be highly optimistic. But the SEC’s new Chair could prove tough enough to convince her staff that “settlement at all costs” is not the safest policy. This will require, however, some changing of the institutional culture. The SEC is today talking the talk of tougher enforcement, but only actions against executives will show that it is walking the walk.
 This was the phrase used by Judge Rakoff in his speech last week before the New York City Bar at its Second Annual Institute on Securities Litigation and Enforcement. See Jed S. Rakoff, “Why Have No High Level Executives Been Prosecuted In Connections With the Financial Crisis?” (November 12, 2013).
 At a conference held at Columbia Law School on November 15, 2013, Lorin Reisner, Chief of the Criminal Division in the Southern District of New York’s U.S. Attorney Office, observed that the DOJ’s response to the 2008 crisis was “still a work in progress.” That may hint that prosecutions are still possible at the DOJ, but corresponding SEC actions are unlikely, given the expiration of its shorter, five-year statute of limitations.
 See Rakoff, supra note 1, at 15–18.
 Id. at 18.
 Id. at 19.
 See Morvillo, Abramowitz, “SEC Enforcement Data Analysis: Analyses of Cases Filed between January 1, 2013 and September 30, 2013” at p. 5 (hereafter, “Morvillo, Abramowitz Study”).
 See Jorge Baez and Dr. James A. Overdahl with Dr. Elaine Buckberg, “SEC Settlement Trends: 2H12 Update” (NERA January 14, 2013) at p. 1. This figure is up by 44 settlements from both FY 2011 and 2010 and 108 more than FY 2009. Id. at 4.
 See Jean Eaglesham, “Easy Prey Pads SEC Numbers,” Wall St. Journal, October 18, 2013 at C-1.
 Id. In an established bureaucracy (such as the SEC), an 86% shift in a single year suggests that the SEC is responding to new pressures (such as possibly a Republican House).
 See Baez and Overdahl, supra note 7, at 7.
 . Id. The overall rate was thus that 31.2% of all settlements in FY 2012 lacked a monetary component. . Id.
 . Id. at 1.
 . Id. at 4.
. Id. at 6.
 See Morvillo, Abramowitz Study at 1.
 Id. at 3.
 See Baez and Overdahl, supra note 7, at Exhibits 10 and 13.
 Id. at Exhibits 10 and 13.
 NERA has not published data for this category in its 2012 study, and thus I here rely on its 2011 study. See Dr. Elaine Buckberg and Dr. James Overdahl with Dr. Max Gulker, “SEC Settlement Trends: 2H11 Update,” at p. 16 (Exhibit 14).
 Id. at p. 17 (Exhibit 15).
 See Morvillo, Abramowitz Study at p. 2 (pie chart of all SEC actions by category). Similarly, the Buckberg, Overdahl and Gulker study shows this category as having “declined” to 10.4% in FY 2011. See Buckberg, Overdahl and Gulker, supra note 24, at p. 6 and Exhibit 4. These two figures are very close and thus reinforce each other.
 Most recently on September 12, 2013, the Chairman of the House Committee on Financial Services (Job Hensarling R-Tex.) and the Chairman of the Subcommittee on Capital Markets (Scott Garrett R-N.J.) wrote to SEC Chair White to question whether the SEC was spending too much time on oversight of private equity funds and not enough in protecting the small investor.
 See United States Government Accountability Office, “Securities and Exchange Commission, Improving Personnel Management is Critical for Agency’s Effectiveness” (July 2012).
 For a quick summary of this case, see “U.S. seeks $864 Million From Bank Over Peer Loans,” N.Y. Times, November 10, 2013 at A-27.
 I do not address in this column the legal authority of the SEC to hire private counsel, which will be debated.
 The Philip Falcone settlement has a two-sided significance. It shows both that the Commission can sometimes reject a weak settlement but also that the Enforcement Division can accept one.