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Unfair claims, untenable solution
The National Law Journal
In his December 3, 2012, column, "SEC enforcement: What has gone wrong?," Columbia Law School professor John C. Coffee Jr. makes a series of claims about U.S. Securities and Exchange Commission enforcement cases. These claims are inaccurate and paint a distorted picture of an enforcement program that has achieved record results in recent years. As a solution to the problems he sees, Coffee proposes that the SEC outsource its biggest cases to private contingency-fee lawyers a suggestion that ignores critical differences between the SEC's goals as a regulator and those of a litigant seeking monetary damages.
Coffee casts his solution as a response to the emergence of a "disturbingly persistent pattern" in recent SEC enforcement cases. However, his description of this perceived pattern turns on its head the SEC's actual record.
First, Coffee has his facts wrong when he states that "the penalties collected by the commission…are declining" and "the median value of SEC settlements with corporate defendants" in 2011 and 2012 "are well below the median corporate settlements a decade ago." Far from declining, the median value of SEC settlements is at or near record levels.
His suggestion to the contrary seems to be based on a simple apples-to-oranges error in reading a chart. He inaccurately states that the median settlement with a corporate defendant dropped from "well over $50 million" in 2003 through 2005 to $1.5 million in fiscal year 2011 and $800,000 during the first half of FY 2012.
Coffee's source a study of SEC settlement trends published by the NERA Economic Consulting group actually reveals just the opposite. It states that the median corporate settlement in the period from 2003 to 2005 ranged from a low of approximately $600,000 to a high of approximately $1.3 million. Therefore, the $1.5 million median value obtained in 2011 was not only greater than the median in the 2003-2005 time frame from which Coffee cites a decline, but also was close to an all-time high. And the 2012 figures were well within the range for recent years. See NERA Economic Consulting, "SEC Settlement Trends: 1H12 Update," June 27, 2012, at 6. Also, given that the first three months of FY 2013 already have seen a $525 million penalty and two additional settlements well above $100 million each, the median may well continue to rise.
Second, Coffee is wrong to suggest that the SEC "rarely sues" individuals, "settling instead with the entity only." The NERA study reveals that in the first half of FY 2012, the SEC was on pace to hold a larger number of individuals accountable than at any time since 2005, and the median value of settlements with individual defendants has been increasing steadily in recent years.
Specifically, NERA writes, "The SEC's promise to hold more individuals accountable was realized in [the first half of FY 2012] in a 20% jump in the number of SEC settlements with individuals." On the point of the SEC's record of holding individuals accountable, Coffee's criticism of the handling of cases arising out of the 2008 credit crisis is especially misleading. He asserts that "the only senior executive at a truly major bank named as a defendant by the SEC in a case growing out of the 2008 crisis appears to be Angelo Mozilo," the former chief executive officer of Countrywide Financial Corp. However, in credit-crisis cases, the SEC has charged a total of 102 individual defendants (along with 51 corporate defendants), including more than 65 CEOs, chief financial officers and other senior corporate officers. By our count, there have been only eight cases relating to the credit crisis in which the SEC did not charge individual defendants.
Even assuming that the number of executives at "truly major bank[s]" the SEC has sued is the yardstick for measuring enforcement performance, Coffee's definition of "truly major bank" apparently excludes institutions such as Citigroup Inc. (whose former CFO and former head of investor relations were charged by the SEC with causing the company's misleading disclosures to investors about its exposure to subprime mortgage-related assets), New Century Financial Corp. (whose former CEO, CFO and controller were charged for similar conduct), American Home Mortgage Investment Corp. (whose former CEO, CFO and controller were also charged) and State Street Bank and Trust Co. (whose chief investment officer for the Americas was charged with misleading some investors).
His definition of "senior executive" appears similarly limited, since he makes no mention of the SEC's actions against high-ranking managers at such firms as Credit Suisse and Bear Stearns for misconduct related to the credit crisis. Finally, Coffee ignores the SEC's many actions against senior officers of nonbank financial institutions such as mortgage giants Fannie Mae and Freddie Mac, whose top corporate officers have been charged with fraudulently concealing the companies' exposure to risky mortgage assets.
A WINNING RECORD
Third, Coffee's suggestion that the SEC "frequently loses" cases against individual defendants is dramatically at odds with the facts. During FY 2012, the Enforcement Division won its cases against 23 out of 24 defendants who went to trial. These include cases tried in both district and administrative courts and before both judges and juries. We count the case as a "win" only if the SEC prevails on the most serious charge against the defendant. Most of the defendants were individuals (17 out of 24), including senior officers of public companies and investment professionals; and the cases against them include a broad range of complex fraud charges. These unusually strong results follow three consecutive fiscal years in which the SEC notched an enviable record in the courtroom, winning about 80 percent of its cases at trial.
Instead of discussing this successful record of performance, Coffee points to just three cases that are exceptions to the general rule: the one case the SEC lost at trial in FY 2012 (against a midlevel manager at a Citigroup unit for alleged lapses in disclosure in the offer and sale of a collateralized debt obligation); a more recent case in which the SEC experienced a mixed verdict (relating to disclosures made on behalf of the Reserve Primary Fund after it "broke the buck" due to the collapse of Lehman Brothers); and a third in which the SEC decided to dismiss charges against a midlevel investment adviser during discovery. But given that the SEC has brought charges against 153 individuals and entities in financial-crisis cases and hundreds of defendants in other complex cases, the results of three cases are not a valid basis for generalization about the SEC's overall ability to prevail in litigation.
Furthermore, Coffee's suggestion that SEC trial attorneys may be outmatched by defense counsel does not consider the overall pattern of courtroom success. While the SEC may be "an overworked, underfunded agency that is subject to severe resource constraints," it is also staffed by some of the most talented, experienced and dedicated securities lawyers in the country. Many of its trial attorneys are former litigation partners at top law firms, former federal criminal prosecutors and other highly credentialed and experienced attorneys equal to the challenge of any case. While these facts suggest that Coffee is casting for solutions to a nonexistent problem, his proposed solution to replace government attorneys with private contingency-fee lawyers raises serious concerns.
He proposes that for big litigation matters the SEC engage private lawyers compensated based on a percentage of the monies they collect. However, that solution assumes that the SEC's general goal is to sue as many deep-pocketed parties, and collect as much in penalties, as possible. But, as enforcer of the nation's securities laws, the SEC's goal is aggressively to uphold the law and serve the interests of justice. That means evaluating each case fairly, suing only those whom the evidence shows violated the law, assessing relative culpability of different participants, and assessing a penalty that is appropriate for the particular violation which could be anything from a serious fraud to an unintentional violation of a more technical requirement.
Moreover, assessing penalties is by no means the only objective of the SEC. In cases against individuals, other forms of relief can be of great importance, such as banning a violator from the securities industry or from serving as an officer or director of a public company. Similarly, in cases against companies, the SEC frequently seeks to achieve meaningful corporate reform, such as effecting changes in management, improving the company's culture of compliance and enhancing the company's policies and procedures.
A bipartisan pair of U.S. senators, Jack Reed (D-R.I.) and Charles Grassley (R-Iowa), recently introduced a bill that would substantially increase specified statutory limits, improving the SEC's ability to punish recidivist offenders and to assess penalties that take into account the magnitude of investor losses. No action has yet been taken on this bill. The existing limits on the SEC's authority may help to explain why Coffee views some SEC penalties as inadequate and believes that significant policy changes are warranted.
While debate about these issues should be encouraged, any debate should start with a fair and complete description of the facts. Coffee does not do the SEC's enforcement record justice.
Robert S. Khuzami is director, and George S. Canellos is deputy director, of the Enforcement Division of the U.S. Securities and Exchange Commission.