Reforming the SEC: Relevancy and Reallocating Resources

Robert Khuzami, the Director of the Division of Enforcement, has wasted little time in disrupting the status quo.  He has proposed a series of reforms, many of them set out in a speech before the New York City Bar back in early August. 

One of the critical problems and goals is to increase the relevancy of the Commission.  To do that means getting in the enforcement game during the pendency of this crisis.  That is a surprisingly difficult goal.  In general, the staff at the Division is reactive.  Once fraud becomes known, it investigates to determine what happened and to assign culpability.  By definition this means working on scandals that are already over.  The investigative staff in the Division of Enforcement, therefore, must spend considerable time on cases that involve the ghosts of crises past.   

Thus, for example, the Commission in 2008 settled a case involving an audit partner with the defunct accounting firm, Arthur Anderson, over matters connected to Worldcom.  See Exchange Act Release No. 57662 (admin proc April 14, 2008).  Since the date of the behavior making up the violation, the backdating scandal has already come and gone and the current financial crisis is well into its second year.  

One way to assign investigators to the current crisis is to ask for increased appropriations and hire more lawyers.  The SEC was, in fact, given the right to make some additional hires.  But the real effort has been on redirecting existing resources.  In that regard, several things have happened.

First, according to the Washington Post, pressure has been placed on the staff to wrap up old cases.  See SEC Upsets Some as It Tries to Sharpen Teeth, Washington Post, July 17, 2009 ("Schapiro and Khuzami have pushed investigators to close old cases and focus more on those arising out of the financial crisis."). 

Second, Khuzami has announced that, absent exceptional circumstances, there would be no tolling agreements.  While this may cause discomfort to the practicing bar in some cases, the message is really aimed at the staff.  The Commission has a five year statute of limitations.  See 28 U.S.C. § 2462.  The message, therefore, was that cases must be completed within that time period. 

Most noticeably, however, has been the decision to eliminate branch chiefs.  These are the first supervisory level above investigative attorney.  The branch chiefs will be returned to the investigative pool, available to handle cases arising from the current crisis.  Moreover, having been promoted, they are in general talented and experienced investigators and likely to be a much better talent pool than new hires.

The change will likely affect morale, both from branch chiefs returned to the ranks of the staff attorneys and the assistant directors who now have to do more logistical supervision (attending depositions and the like).  The result will probably be increased turnover as soon as the economy improves and the job market loosens.  Moreover, the reform is essentially quantitative, ultimately resulting in an increase in the number of cases.  There will likely be some reduction in supervision.  The Inspector General at the SEC testified that in connection with at least one of the examinations of Madoff, there had been no branch chief involved, reducing the effectiveness of the efforts.  See Oral Testimony of David Kotz, Inspection General, Securities & Exchange Commission before SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, Sept. 10, 2009 ("For example, in one of the major examinations there was no branch chief on the exam, so the junior examiners were left kind of to their own devices, didn't get enough support. That was because they didn't have an available person."). 

Nonetheless, the short term impact will be more lawyers investigating current cases.  That appears to be the primary goal of the reform.  The long term effect is likely to be modest.