SEC Should Not Prioritize Enforcement Over Other Parts of its Mission: Peirce
SEC enforcement is important and must continue, but has gone too far. While enforcement is necessary, agency staff should use it as a last resort and rein in the kind of enforcement-by-numbers philosophy that the SEC has been using over the past few years.
Those are the views of commissioner Hester Peirce, who spoke May 11 in Denver on why she sometimes votes "no" on approving enforcement actions brought by the Division of Enforcement. She cited an article in Bloomberg Law which she said noted that she casts a "no" vote 15 percent of time, a higher rate than any other commissioner.
"The SEC is not an enforcement agency, but enforcement is an important tool for the SEC," she said, noting that the Enforcement Division is currently the largest of the divisions and offices within the agency, with more than 1,100 personnel. Enforcement, however, should be viewed as part of the SEC, and "properly calibrated" into "part of the regulatory framework within which our capital markets operate. . . . To appropriately calibrate our enforcement program, we must spend our limited enforcement resources wisely."
Peirce also used her comments to urge the Commission to tread carefully when considering whether to impose liability on chief compliance officers. "CCOs advocate for compliance at registered entities," she said. "They implement and update compliance programs. They monitor for violations. We need to empower them, not dissuade them from taking the jobs in the first place."
What Peirce’s speech, as well as SEC chairman Jay Clayton’s stated goal of prioritizing capital formation, represents is a "swing of the pendulum back to how the SEC operated prior to the Bernie Madoff problem," said Buckley Sandler partner and former SEC Office of Market Intelligence chief Thomas Sporkin. "She comes from the same school as former agency commissioners Paul Atkins and Daniel Gallagher, as well as current commissioner Michael Piwowar, which is to pull back from the overly aggressive enforcement approach employed by the SEC since Madoff and the 2008 financial crisis and turn the SEC back into a regulatory and capital formation agency."
"As I consider enforcement matters before the Commission, one of the things I think about is whether we are using our enforcement resources wisely," Peirce said. "Was there a meaningful violation? Is this a matter that could have been handled by OCIE or that another foreign or domestic authority is already handling? Would a rulemaking, an interpretive release, or an investor alert be a more appropriate response to an issue?"
"When I believe that we ought not [emphasis Peirce] to have spent our Enforcement Division’s time and effort on a matter, I am likely to vote against it," she said.
Cleary Gottlieb partner and former SEC chief litigation counsel Matthew Solomon said that Peirce’s comments about a more calibrated approach to enforcement in view of resource constraints "is no surprise – they mirror statements made by Enforcement Division leadership which presumably reflect the chairman’s views. But she also noted that the vast majority of enforcement actions win unanimous Commission approval, and that the Enforcement Division plays a critical role in the Commission’s overall mission."
No more broken windows
In terms of more recent history, Peirce advocated a rollback of former SEC chair Mary Jo White’s "broken windows" approach to enforcement, although she did not mention her name. Under "broken windows," the agency investigated and prosecuted small violations, as well as large.
"In the past, we sometimes have taken a less resource-conscious approach – a more-is-always-better approach," Peirce said. "From 2013 to 2016, for example, the SEC embraced a ‘broken windows’ philosophy of enforcement. . . . Punishing every small violation, however, means casting discretion aside in favor of making the SEC look tough. Violations are not all equally serious." She noted Piwowar’s past statement that "if every rule is a priority, then no rule is a priority."
Peirce suggested that, during this time, "perhaps the SEC should have changed its name to the ‘Sanctions’ and Exchange Commission, because it acted like a branch of the U.S. Attorney’s Office for the Southern District of New York." That U.S. Attorney’s Office, coincidentally – or perhaps not-so-coincidentally – was the Office White headed as U.S. attorney. "Maybe this approach is natural for a prosecutor, although in the criminal context, discretion is important too," Peirce continued.
She then listed five "major problems" that she said occur with "an enforcement philosophy that pursues minor violations with the same vigor as it does major violations:"
Diverts resources from high priority issues. "The unsurprising result of the broken windows approach – one that aligned perfectly with our metrics of choice – was that the SEC brought a lot of enforcement actions with lots of penalties," Peirce said. "But the end goal is better functioning markets and investor protection."
Discourages contact with the SEC. "An enforcement-first approach sends the message to regulated entities and others that picking up the telephone to ask the SEC a question about how to comply is risky," she said. "Why draw attention to yourself by asking a compliance question of an agency that thinks every foot fault is enforcement-worthy?"
Provides bad incentives for Commission staff. "It rewards enforcement staff for the number, rather than the quality of cases," Peirce said. "It nudges staff to recommend charging some violation [emphasis Peirce] – even a minor one – rather than closing an investigation without bringing an enforcement action."
Contributes to an unhealthy capital formation environment. "Companies considering an initial public offering (IPO) have one more reason not [emphasis Peirce] to conduct an IPO," she said. "Why should companies expose themselves to a potential enforcement action based on a slight misstep in complying with the extensive public company ruleset?"
Imposes unwarranted costs on companies and individuals. "The effects of an investigation or proceeding on a private party can be devastating," Peirce said. She quoted from the SEC’s canon of ethics: "’The power to investigate carries with it the power to defame and destroy.’ This price is too high for violations that are minor."
The numbers game
"An enforcement program that pursues every minor violation might appear, at first glance, to be a successful one," Peirce said. "Under such an approach, the raw number of enforcement actions is likely to be high. A key metric to gauge success becomes the number of enforcement actions. By holding up raw numbers as the measure of success, the broken-window era SEC felt pressure to excel its previous year’s enforcement actions. It was an arms race as our lawyers rushed to settle a case or sprint to the courthouse – or the administrative law judge – to file the next action, especially as the SEC’s fiscal year end neared: our own version of earnings management."
She noted that in 2013, the agency brought 686 enforcement actions with monetary sanctions of $3.4 billion. Of these, however, 132 involved what she described as "simple filing matters, in which a company was deregistered for being delinquent in their Commission filings."
"Deregistering delinquent filers is important, but giving these types of matters the same weight as a complex accounting fraud in a count of enforcement actions is misleading," Peirce said.
In 2016, the final year of "broken windows," the SEC brought 868 enforcement actions with monetary sanctions of $4 billion, she said.
"Again, though, we have to delve deeper into the numbers to understand what happened. Of these 868 enforcement actions, 404 actions – 47 percent – resulted from the following: first, ‘follow-on’ administrative proceedings seeking bars based on the outcome of Commission actions or actions by criminal authorities; second, proceedings to deregister public companies that were delinquent in their Commission filings; and third, actions brought as part of the Commission’s voluntary, self-reporting program that targeted misstatements and omissions in municipal bond offering documents."
Today is different, Peirce said, with the SEC "no longer measuring its success by tallying up enforcement statistics." The agency instead is "making a more concerted effort to bring only meaningful enforcement actions . . . focusing its resources on key areas of concern, such as the protection of retail investors and cybersecurity."