by Bruce Carton
In December the U.S. House of Representatives passed a key financial reform bill, the Wall Street Reform and Consumer Protection Act of 2009, which would provide sweeping new oversight of the financial sector. The bill, which passed the House narrowly and without a single Republican vote, includes new regulations in a host of areas of interest to Compliance Week readers, such as exempting certain filers from compliance with Section 404(b) of the Sarbanes-Oxley Act. It also creates a new Consumer Financial Protection Agency to regulate financial products sold to the public, and a Financial Stability Council to identify and regulate particularly risky financial firms.
Mixed in the House bill with these broader structural changes, however, is a separate section called the Investor Protection Act that lays out many important enhancements to the enforcement powers of the Securities and Exchange Commission. The Investor Protection Act (which is the legislation that ultimately flowed from the Obama Administration’s June 2009 white paper on financial regulatory reform) includes quite a few provisions that could bring meaningful change to SEC enforcement and securities litigation. Let’s take each one in turn.
Whistleblower bounties: Section 7203 of the House bill establishes the rules for the much-discussed “bounty” program to compensate whistleblowers who provide original information to the SEC. If the whistleblower’s information leads to a successful enforcement action with a monetary sanction exceeding $1 million the SEC “may” pay a bounty award of up to 30 percent of the sanction imposed.
It will be interesting to see how the SEC exercises its discretion here. The legislation gives the SEC sole discretion to determine the amount of the award, after considering factors like the significance of the whistleblower’s information to the success of the enforcement action or the degree of assistance provided. Of course, remember that the SEC has had a bounty program in place for insider-trading cases since 1988, and it has gone virtually unused. My research on the insider-trading bounty program shows that only four awards have ever been doled out, for a grand total of $67,570.
That said, the monetary sanctions involved in financial fraud cases are typically much larger than those in insider-trading cases, and may well be enough to encourage whistleblowers to step forward. In addition, financial fraud cases often involve lower-level employees who are pressured into doing illegal things to support the fraud. A sizable prize might be all the incentive these workers need to reject the pressure and turn over evidence to the SEC.
Aiding and abetting liability: Sections 7207 and 7208 of the House bill would amend the Securities Act of 1933, the Investment Company Act of 1940, and the Investment Advisers Act of 1940, to subject aiders and abettors of securities law violations to the same liability as primary violators for purposes of SEC enforcement actions.
Right now, the SEC can only impose such liability under the Securities Exchange Act of 1934, so the number and types of cases where the SEC would have a viable claim would increase. The House bill doesn’t seek to overturn the U.S. Supreme Court’s decision in Central Bank of Denver v. First Interstate Bank of Denver, which held that private parties may not pursue an aiding and abetting suit under the Exchange Act. Accordingly, the SEC would remain the only plaintiff able to bring aiding and abetting claims in securities cases.
New enforcement deadlines: Section 7209 of the bill would amend the Exchange Act to impose a new deadline on SEC enforcement actions. Within 180 days of providing a Wells notice to a potential defendant (that is, a notice that SEC staff intends to recommend that the Commission authorize it to file a lawsuit), the SEC would be required to either file the case or notify the Director of Enforcement of its intent to not file the case. The legislation also provides a mechanism for the SEC to obtain an extension in “sufficiently complex” maters.
Putting a time limit on the SEC’s decisions would help ensure finality in the end-game of SEC investigations, which is occasionally lacking. But in my view, this isn’t really a major problem that needs correcting by Congress. In fact, Section 7209 appears to be an odd type of compromise provision: An earlier version contained the much more dramatic provision that the SEC “shall complete any examination, investigations, or enforcement action initiated by the Commission not later than 180 days after the date on which such examination, inspection, or enforcement action is commenced.” A 180-day deadline for the SEC to complete a case from start to finish would have been a revolutionary change from the current process, where cases commonly take years to complete.
Right to seek grand jury materials: Section 7214 of the bill would allow a court, upon a finding of a “substantial need in the public interest,” to disclose criminal grand jury materials to the SEC. That would be a significant change in current practice. Currently the SEC shares information with the Justice Department when there are parallel proceedings, but not the other way around.
Extraterritorial jurisdiction: Section 7216 amends both the Securities Act and the Exchange Act with respect to extraterritorial jurisdiction. It adds to both statutes that the federal courts’ jurisdiction includes “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”
This question of the federal courts’ jurisdiction in securities cases involving foreign companies has been the subject of high-profile litigation recently in the Second Circuit (Morrison v. National Australia Bank) and is now pending before the U.S. Supreme Court. Section 7216 would effectively resolve that issue by mandating a jurisdictional standard for extraterritoriality that is broader than that argued for by the defendants in the NAB case. Under Section 7216, the U.S. courts would have jurisdiction over so-called “F-cubed” claimants (foreign purchasers who purchased their shares of foreign companies on foreign exchanges) if there was any conduct within the United States.
SEC Funding: Section 7301 provides for an unprecedented burst of funding for the SEC over the coming five years. The SEC budget would steadily increase from $1.12 billion today to $2.25 billion by 2015—doubling the budget in just five years.
To place these numbers in some context, from 2006 through 2009 the SEC’s budget hovered around $900 million. The Obama Administration proposed an increase to $1.02 billion in FY 2010, but SEC Chairman Mary Schapiro said that was not enough and raised many eyebrows in mid-2009 when she requested a massive 20 percent increase to $1.2 billion for FY 2011. Section 7301 would take SEC funding to levels never contemplated before.
Odds and ends: Finally, the House bill contains three other interesting provisions. First, the House bill requires the SEC chairman to appoint an “ombudsman” who will report directly to the chairman. This new position will serve as a liaison between the SEC and any person who encounters a problem resulting from the regulatory activities of the Commission. Second, to ensure that the various post-Madoff reforms promised by the SEC are carried out, the SEC is required to provide a report on its progress in this area to Congress (also to be posted on the SEC Website) within six months of the bill’s passage.
Third, the bill requires the Government Accountability Office to conduct what should be an interesting “Study on SEC Revolving Door,” a response to those who contend that the practice of SEC enforcement attorneys moving on to high-paying Wall Street jobs blunts the SEC’s intent to work hard and penalize malfeasance. Some commentators (and Congressmen) contend that regulators should not be permitted to take such jobs for some meaningful amount of time after they have left the SEC. So the House has attached at least a few strings to the enhanced powers and budget that may be coming to the SEC under the bill.
Of course, none of the above will come into play unless the U.S. Senate also passes some version of the House bill, and the most recent reports from Washington, D.C. are that financial reform legislation may not pass the Senate until late July 2010. Now that Sen. Chris Dodd, chairman of the Senate Banking Committee, has announced that he will retire this year, that only clouds the picture still more. If the key SEC enforcement and operations provisions discussed above make it into the final bill that becomes law, they are certain to shake up SEC enforcement a bit in the coming years.
Originally published in Compliance Week. Reprinted with permission. © 2009 Haymarket Media, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.