On November 28, 2011, SEC Chairman Mary Schapiro sent a letter to Senator Jack Reed, Chairman of the Senate Subcommittee on Securities, Insurance and Investment, requesting “statutory changes [that] would further enhance the effectiveness of the Commission’s enforcement program by expanding the Commission’s authority to seek monetary penalties for the most serious securities law violations.”  Despite “impressive” enforcement results in 2011, Schapiro says, legislative changes are needed to further deter securities laws violations.  To that end, she proposes increasing limits on civil monetary penalties and “substantially rais[ing] the financial stakes for securities law recidivists.”   

In order to deter – and in appropriate circumstances penalize – violators of the federal securities laws, Schapiro seeks to exponentially increase existing caps on civil penalties the SEC may recover in an enforcement action: from $150,000 per violation to $1 million per violation for individuals; and from $725,000 per violation to $10 million per violations for “entities.”  And in certain cases, Schapiro would like authorization to seek a penalty equal to the amount of investor losses caused by a securities law violation.   

Central to Schapiro’s request – and perhaps of more practical importance – is a proposal that would allow the SEC to prosecute more enforcement matters in administrative proceedings.  As Peter Henning of the NY Times reports:

There are a number of advantages for the S.E.C. to pursuing a case administratively, including limited discovery rights for the respondent in the action and a quicker hearing.  There is a perception among securities lawyers that the S.E.C. has something of a “home court” advantage in cases heard by an administrative law judge because the decision will be reviewed first by the full commission, which authorized filing the action, before it ever goes before a federal judge.

If approved, Henning says, the changes would allow the SEC to pursue enforcement matters outside of the federal courts, thereby “skirting the kind of scrutiny Judge Rakoff applied” in rejecting the SEC’s proposed settlement with Citigroup.  (Journalists for Bloomberg and Reuters, too, draw connections between Schapiro’s letter requests to Senator Reed and the rejected Citi settlement.)  

The requested changes, Schapiro argues, “would substantially enhance the effectiveness of the Commission’s enforcement program by addressing existing limitations that have resulted in criticism regarding the adequacy of Commission actions.”  If nothing else, the increased penalties contemplated would drastically change the stakes for regulated individuals and entities.  

Schapiro plans to prepare and submit to the Senate Subcommittee proposed language affecting the propose changes.  The fate of the draft legislation is yet to be determined, but companies should follow this space closely. 

The final 2011 installment of A Question of Ethics looks back at the year's big stories in government ethics.

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In November, the SEC’s Office of the Whistleblower released its Annual Report on the Dodd-Frank Whistleblower Program, detailing the quantity, quality and nature of the complaints it received during its first several weeks of operation, and describing the Commission’s responses to those tips.  The Report draws on only seven weeks of data and, therefore, provides limited insight into the goings on at the whistleblower office. 

According to the Report, the whistleblower office received 334 whistleblower tips from August 12, 2011 through September 30, 2011 (roughly seven per day).   The complaints received cover the waterfront in terms of the federal securities violations alleged.  As Emily Chasan of the Wall Street Journal’s CFO Report explains, however, “most of the complaints were related to market manipulation, offering fraud, insider trading, trading and pricing, unregistered offerings and market events.”  The following comprise the most frequently reported types of whistleblower allegations:

• 16.2% of the complaints alleged market manipulation;
• 15.6% of the complaints alleged offering fraud; and
• 15.3% of the complaints alleged problems with corporate disclosures and financial statements.

Many who read the Report were surprised to find that alleged FCPA violations made up only 3.9% of the tips received. 

At a December “SEC and DOJ Hot Topics” seminar in Washington, D.C., Sean McKessy, Chief of the SEC’s Office of the Whistleblower, emphasized that the available whistleblower data is a “small sample size,” and insisted that it is too early to identify overarching reporting trends.  Nevertheless, McKessy made several “observations” about the data:

• As compared with whistleblower complaints received in the past, the whistleblower office is experiencing a marked increase in the quality of tips received;
• Contrary to popular expectations, the whistleblower office has not been inundated with “an avalanche” of whistleblower complaints;
• The alleged violations cover “the full gamut” of securities laws violations, and the “most frequently litigated areas” are well represented;
• The whistleblower office is receiving “very detailed, very specific” tips, complaints, and referrals from whistleblowers;
• The whistleblower office is working with whistleblowers and their counsel to move complaints swiftly through “the triage process;” and
• The whistleblower office is actively reviewing tips and making referrals to the SEC Division of Enforcement. 

The whistleblower office has not yet made public – in its Report or elsewhere – the details of any bounty payment made to an SEC whistleblower, but Mr. McKessy noted that the Commission has received a number of applications for whistleblower awards.  He suggested that the whistleblower office is likely to publicize the amount of any awards paid (without identifying the whistleblowers), along with details of the related enforcement matter.  Until the Office of the Whistleblower releases another Annual Report next fall, its reports of awards may provide the best source of information regarding the nature of the complaints it receives, the tips the Enforcement staff are taking up, and the overall success of the program.

While it may be too early to spot themes in the whistleblower data, Mr. McKessy’s observations present one clear takeaway: Whistleblowers are coming forward to the Office of the Whistleblower with information about potential securities laws violations, and companies who have not yet made preparations for handling whistleblower complaints internally should act now. 

In a rebuke to the SEC, on Monday, November 29, 2011, U.S. District Court Judge Jed Rakoff (SDNY) refused to sign a consent judgment approving a $285 million settlement between the Agency and Citigroup.  At issue is a lawsuit filed in October 2011 by the SEC alleging that Citigroup created and sold mortgage bond investments without disclosing to investors that the people assembling the deal were betting against the performance of the securities.  As a result, Citigroup allegedly reaped a $160 million profit from the sale while investors lost more than $700 billion.  On the same day the Agency filed suit, the SEC filed a consent agreement whereby Citigroup agreed to disgorge the $160 million plus $30 million in interest, pay a civil penalty of $95 million, and undertake internal measures designed to prevent recurrences of the securities fraud alleged.  Under the agreement, Citigroup neither admits nor denies the SEC’s allegations, a longstanding practice by the SEC. 

Judge Rakoff’s opinion is significant because the SEC has routinely sought settlements similar to this one, whereby the defendant neither admits nor denies the SEC’s allegations of wrongdoing in exchange for a fine and/or injunctive relief.  Judges have generally signed off on such agreements as a matter of course.  However, it is precisely this practice that Judge Rakoff now finds offensive.  His 15-page opinion calls the entering into such an agreement, whereby a defendant neither admits nor denies allegations, “hallowed by history, but not by reason,” and ruled that he could not sign off on such an agreement because a judge must have some facts upon which to exercise “even a modest degree of independent judgment.”  Without such independent judgment, he refused to sign the consent agreement.

Traditionally, the SEC has arranged settlements such as the agreement with Citigroup because doing so allows the Agency to declare victory without having to devote the considerable time and money it would take to take the same matter to trial.  Requiring an admission of wrongdoing, which Defendants are reluctant to do, would decrease settlements and increase the number of trials.  Thus, if Judge Rakoff’s opinion gains traction, the SEC will have to dramatically shift how it uses its resources, with broad implications for the Agency and Defendants alike. 

In the meantime, as Kevin LaCroix at the D&O Diary notes, the SEC and Citigroup will likely have to work out a deal omitting the “admits or denies” language, and Citigroup will probably have to make a greater monetary contribution before a proposed settlement passes Judge Rakoff’s scrutiny.  Meanwhile, the clock is ticking; trial is scheduled for July 16, 2012.