How the New SEC Enforcement Director Can Help Restore Investor Confidence

by Bruce Carton
Robert Khuzami began his new job as director of the Enforcement Division at the Securities and Exchange Commission on March 30. His arrival marks the first change in leadership for the Enforcement Division since 2005.

Khuzami joins the SEC from Deutsche Bank AG in New York, where he was a top lawyer on its staff. Prior to that, he was a well-known and respected assistant U.S. attorney in the Southern District of New York, where he served as the chief of the securities fraud unit.

Following the avalanche of criticism the SEC has received in the wake of the Bernard Madoff case (some fair, some unjustified), Khuzami steps into an extremely challenging and high-profile situation. It will immediately require every bit of his legal, management, and public relations skills. He’s going to need to hit the ground running and perform at the highest level from Day 1.

From my perspective—which, as will be demonstrated below, is not necessarily shared by everyone—the most significant problem the Enforcement Division now faces is a public relations problem. The SEC admittedly botched its investigation into what turned out to be the largest Ponzi scheme in history (Madoff), and has been properly skewered for that failure. The SEC has also had some bad press resulting from recent inspector general reports on its handling of isolated enforcement matters. The combination of these recent matters, as well as the perception that the SEC somehow failed to prevent the sub-prime crisis from occurring, has left the agency looking weak and ineffective in the eyes of many. The constant, often over-the-top criticism from Congress and the financial press, which are both hungry for scapegoats and headlines in the financial crisis, has only intensified this perception.

Although its processes and resources can certainly be improved, I don’t believe the Enforcement Division is broken. It continues to bring significant cases. It still consists of, and is led by, many of the same people who have been there for years, people who were there just a couple of years ago when the Division was routinely held up as an example of lean, effective government at its finest.

The lessons of the Madoff case—which include the need for better training of the staff and better evaluation and follow-through on tips from outsiders—must be learned and institutionalized. More than anything, however, the Enforcement Division needs to take action designed to demonstrate to a now-skeptical public that the change in leadership has brought a renewed commitment to pursuing securities fraud aggressively, effectively, and fairly.

On this very point, SEC Chairman Mary Schapiro stated shortly before Khuzami’s arrival that he “is coming with a new commitment to the SEC’s focus on bringing the most important cases, the most meaningful cases, in the quickest time possible in order to protect investors more effectively.”

How can that best be accomplished? What should Khuzami prioritize and pursue upon his arrival? He’s already being flooded with suggestions on this front, from within the SEC and from the outside. Less than two weeks before Khuzami’s arrival, Commissioner Luis Aguilar delivered a speech to the Washington, D.C. Bar Association in which he detailed his own vision to “unshackle and empower the SEC Enforcement staff.” Aguilar stated that the SEC should:

• promptly streamline the “formal order process” by which the enforcement staff obtains subpoena power;
• improve and expedite the process by which SEC settlement funds are distributed to investors;
• implement a risk-based data analysis system that feeds all information into modern surveillance and analysis programs to flag signals of possible misconduct; and
• revise corporate penalty guidelines significantly.

The day after Aguilar’s speech, fellow Commissioner Troy Paredes weighed in with his own four-point plan for how best to allocate the Enforcement Division’s resources. In a March 19 speech at the Southeastern Securities Conference in Atlanta (a speech that Paredes said he planned to share with Khuzami upon his arrival), Paredes emphasized the Enforcement Division’s need for:

• better case selection, including analysis of the impact and deterrent effect a case will have and whether the alleged wrongdoer will be meaningfully sanctioned through other sources such as state or federal criminal authorities;
• development of a more robust centralized case tracking system, to provide a comprehensive look at the range of ongoing and potential investigations and cases and to help identify synergies;
• doing more to encourage parties to self-report violations and otherwise cooperate with SEC investigations; and
• a frank and demanding self-assessment by the SEC that measures the Enforcement Division’s progress in a meaningful way—beyond simply “overemphasizing the number of cases brought or the monetary sanctions imposed.”

The suggestions hardly stop at the commissioner level, though. Numerous former SEC enforcement attorneys who now defend clients in SEC matters were quick to provide me with their thoughts on what Khuzami should do in the short term and longer term to be successful.

Philip Khinda, now a partner with the law firm Steptoe & Johnson, believes that the most important thing Khuzami can do to help the SEC restore investor confidence is to bring high-impact cases in a timely manner. He observes that Khuzami might do well in taking a cue from predecessor Richard Walker, the SEC’s enforcement director from 1998 to 2001 and Khuzami’s boss at Deutsche Bank until Khuzami left for the SEC.

Khinda believes that the Division’s use of enforcement “sweeps” under Walker—where the SEC announced several thematically linked cases all at once—was very effective in punishing and deterring many forms of misconduct and, as important, conveying that the SEC was hard on the prowl. Khinda also expects that another benefit of Khuzami’s influence, borne of his time as a federal prosecutor, will be the earlier involvement of the agency’s trial lawyers, and perhaps the Office of General Counsel, in its investigative process. Khinda believes that such earlier involvement may be a means of weeding out cases based on weaker evidence or theories and focusing on those where enforcement action is “important and imperative.”

Bill Thomas, a former Enforcement Division branch chief, emphasizes that Khuzami’s actions need to be highly visible during this turbulent financial time. The public needs to see that the SEC is acting, and not just considering actions for the future, he says. Thomas suggests that Khuzami appear on a show like “60 Minutes” as part of an aggressive campaign to reinforce that positive steps are being carried out by the Enforcement Division.

Russ Ryan, a former assistant director in the Enforcement Division who is now a partner at King & Spalding, believes that because Khuzami was recruited from outside the agency by a new chairman, he has the best opportunity in recent memory to take a hard look at some of the Enforcement Division policies and practices that many have come to accept as immutable. For instance, Ryan hopes Khuzami will question whether the SEC “really needs to seek permanent injunctions in every single case it files in federal court, whether those injunctions might be something other than the standard ‘obey the law’ injunctions, and whether there should be a more uniform presumption of ‘open jacket’ during the Wells process.”

Michael MacPhail, the former deputy assistant director of the SEC’s Denver office who is now a partner at Holland & Hart, says Khuzami should keep his focus on the malfeasance underlying the economic crisis, including improper valuation of mortgage-backed securities and accompanying inaccurate disclosures. Like Ryan, he too believes that Khuzami should change problematic enforcement policies, including the lack of incentives for individual cooperators and inconsistent application of policies governing access to the staff’s investigative files.

Christopher Cooke, a former Enforcement Division branch chief who is now a partner at Cooke Kobrick & Wu, suggests that the SEC should re-emphasize the risk analysis program started by former SEC Chairman William Donaldson (the Office of Risk Assessment). Cooke believes that currently the SEC Enforcement “waits for something to blow up, or come to them, rather than going out and finding the frauds and stopping them before they become too big and do too much harm.”

Finally, Mark Perlow, a former member of the Enforcement Division who is now a partner with K&L Gates, believes that Khuzami’s first order of business must be to re-establish morale among the enforcement staff and show them that the leadership of the Division supports them.

So, suffice it to say that there is no shortage of opinions on what Khuzami should pursue as he helps launch this new, critical era for the SEC’s Enforcement Division. He undoubtedly has his own views, as well. Whichever paths he chooses, he will have performed an enormous public service if he can help restore investors’, securities markets’, and the world’s confidence in the SEC as a zealous and effective enforcer of the securities laws.

Originally published in Compliance Week. Reprinted with permission. © 2009 Financial Media Holdings Group, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.

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