By Bruce Carton
In a column last month, I noted the arrival of a new Securities and Exchange Commission enforcement director, Robert Khuzami (pictured below). I suggested that Khuzami had to hit the ground running and discussed the flood of suggestions from within the SEC and from the outside that Khuzami had already received as to what he should prioritize and pursue upon his arrival.
Less than one month later, details of big changes in the Enforcement Division have begun to emerge. From my perspective, the changes now being introduced are smart, high-impact moves that will help the Enforcement Division perform at a higher level.
On April 29, Khuzami confirmed to the Wall Street Journal that the SEC is working on a plan to completely reorganize the Enforcement Division by splitting it up into teams that specialize in investigating specific kinds of fraud. “Specialization is a fancy term for being as smart as we can about how we do our job,” he said. “By better understanding products, markets, and transactions … we can better identify trends and patterns.”
An organization of specialists, while common in U.S. attorney offices (which is Khuzami’s background), has not been the model at the Enforcement Division. There, the staff has traditionally taken on the SEC’s entire range of cases as generalists. Indeed, given that the Division has operated for decades under a generalist model, the plan has been described by some as the SEC’s “biggest overhaul since the 1970s” and a “radical departure” from past practices. Under the new plan, the Enforcement Division will create specialized groups focusing on areas such as structured financial products, fixed-income and municipal bonds, and hedge funds.
News of many other significant changes on the way has also emerged recently. In a Securities Docket Webcast on April 28, George Curtis, deputy director of the Enforcement Division, noted the intense scrutiny and pressure on the SEC to re-examine its processes, and stated that the SEC wanted to re-think and generally expedite components of its enforcement program on several levels. The subjects of this re-examination, he said, were primarily internal Enforcement Division processes falling under Khuzami’s “universe”—that is, not requiring Commission approval.
One of the most important changes on the way is streamlining and providing further guidance to the SEC staff on the “Wells process.” At the conclusion of an investigation, if the enforcement staff intends to recommend that the Commission authorize a lawsuit, the staff will make a “Wells call” to the potential defendants advising them of this decision. This call triggers the Wells process, which allows the potential defendant to provide the staff and the Commission with information that might cause them to decide against bringing the case. Curtis said that one of the Enforcement Division’s first changes will be to expedite the entire Wells process, imposing tighter and stricter deadlines to avoid delays.
Specifically, Curtis stated, the Division is concerned about the significant amount of time that the Wells process has evolved to consume. The present Wells process typically includes the initial call conversation, a written white paper-type “Wells submission” by the defendant, a meeting with lower-level enforcement staff, and then a request for another meeting in Washington with high-level members of the Enforcement Division that is often delayed by calendar conflicts and travel schedules.
In the future, Curtis said, the Enforcement Division will not hesitate to decline the Washington meeting if it considers the matter to be fully briefed and discussed. Instead, high-level officials such as Curtis may attend the first (and only) meeting. The watchword for the various expected changes to the Wells process, Curtis said, will be “timeliness.”
On the other hand, defendants may soon receive much clearer guidance on their rights to access and review the SEC’s investigative file during the Wells process. The SEC has been criticized recently for the uneven manner in which this access has been granted between its various offices. Indeed, Mike MacPhail of the law firm Holland & Hart recently wrote that based on his research, eight of the SEC’s 11 regional offices, and certain associate director groups within the main office, are willing to grant access to the investigative file during the Wells process unless there is a compelling reason not to do so. But the New York, Philadelphia, and Los Angeles regional offices, and certain other associate director groups routinely deny such access.
Curtis says the SEC is aware of this criticism, and wants to do what it can to provide access to its files so that potential defendants have the ability to respond intelligently to the SEC’s concerns. He said that the SEC recently established a focus group to examine Wells access practices in all of the offices, and to arrive at some core principles for granting access. He anticipates that the SEC will revise the procedures in its Enforcement Manual to provide further guidance to the staff on this subject, with the goal not necessarily being “complete uniformity” but rather a common approach and philosophy on how to exercise its discretion on allowing access while maintaining a focus on timeliness.
Overarching Khuzami’s plan for specialization in the Enforcement Division is the broader issue of “allocation of resources.” Curtis stated that the SEC is looking hard at its current limited resources and reduced headcount and is trying to review how people should allocate their time. It is likely, he believes, that resources will be allocated in the future to focus more on matters that pose risks to the market. He emphasized that while this doesn’t mean the end of enforcement for basic fraud such as insider trading, he expects to see a much greater focus on areas such as the sub-prime market.
As an example of things to come, Curtis offered the April 28, 2009, case in which the SEC charged two former executives at American Home Mortgage Investment Corp. with accounting fraud and making false and misleading disclosures to conceal the company’s worsening financial condition in early 2007, including the riskiness of the mortgages originated and held by the company.
Curtis also shared that the SEC will seek to preserve its resources by deferring more often to self-regulatory organizations, state regulators, the New York Stock Exchange, the Financial Industry Regulatory Authority, and even foreign regulators (as in the Siemens bribery case, in which the SEC worked closely with German regulators).
Curtis also indicated that while an increase in funding for the SEC proposed for 2010 should allow it to increase the Enforcement Division headcount, the new additions will likely bring a noticeably different mix of talent than in the past. Curtis expects that the Enforcement Division will look to bring on fewer general legal investigators and more people with significant experience in industry, such as chief compliance officers, broker-dealers, investment advisers, and investment bankers.
Indeed, the SEC announced on April 30, that its Office of Risk Assessment is seeking to hire highly seasoned financial experts as “Industry and Markets Fellows” to help “oversee complex industry practices and products in today’s markets.” The Enforcement Division will apparently be following this lead as well.
One final move that has been widely discussed both inside and outside of the Enforcement Division is a plan to eliminate the “branch chief” position altogether. Branch chiefs are the lowest level of management in the Enforcement Division, typically supervising a handful or more staff attorneys on cases. According to Khuzami, the elimination of this position is under consideration to allow the Division to “have all the management that you need but no more than necessary, so you can free people up to do what’s our first and foremost priority, which is to make cases.”
I believe that all of these moves are steps in the right direction. Based on my own experience at the SEC, and from recent accounts of the SEC’s failings in the Bernard Madoff fraud case, I believe the move to specialization is a particularly important one. The plain truth is that not every investigator in the Enforcement Division has the background or experience to handle a complex accounting fraud case properly, or to recognize a fraud such as that perpetrated by Madoff. Others, however, truly excel in those areas.
This is not a criticism, just reality, and not much different than saying that it makes more sense to have an orthopedic surgeon, not a general practitioner, reconstruct your injured knee. In my view, re-examining and re-allocating the SEC’s resources so that they are used in the areas where they will be the most effective and make the greatest impact is a smart way to make the Division more successful overall.
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.