The Citigroup Decision: The Director of the Division of Enforcement Responds

What is the Commission's reaction to the Citigroup decision?  There has been no official response.  Nonetheless, Robert Khuzami, the Director of the Division of Enforcement, gave a talk before the Consumer Federation of America's Financial Services Conference on December 1.  The entire talk is here and is worth a read. 

For now, we focus on his discussion of the "commentary" on the “neither admit nor deny” policy.  First, he had this to say about settlements. 

• When the Division of Enforcement recommends that the Commission settle a case, it is because our informed judgment tells us that what we are obtaining in settlement is within the range of outcomes we reasonably can expect to get after we prevail at trial, taking into account the strength of the case as well as the delay and resources required for a trial and the benefits of returning money to harmed investors quickly – not to mention the chances that we might lose at trial, or win but be awarded less than what the settlement achieves.

Refusing to approve such a settlement was in his view an "unwise policy."  As for the purported fear of going to trial, Khuzami noted that the Division was not "reluctant to try cases."  Cases were settled for "the right reasons."  To believe otherwise, he noted, it would be necessary to believe:

• That we established and funded an entirely new specialized unit directed solely at investigating fraud related to structured and mortgage-related products that gave rise to the credit crisis … that we staffed that unit with dedicated and talented SEC staffers, some of whom have spent their careers in public service, and all of whom are committed to uncovering fraud in these markets and transactions … we hired private sector experts with market experience to cut through the jargon and the complexities and help us zero in on the possible areas of misconduct … we set up extensive training programs to teach these staffers the complexities of structured products and the markets in which we operate; the staff then went out and spent years pouring over millions of pages of documents, e-mails and 500-page prospectuses and indentures and flow charts to find evidence of fraud … then spent months and years in conference rooms questioning witnesses about these transactions in painstaking detail … and then we put together our case, charging both the company and the persons who were responsible for the deal.

Given that the SEC was going forward with a trial against the individual charged, the idea "that we nonetheless intentionally settle the case against the company on the cheap because we just don’t like to try cases, or for other, even more ridiculous reasons" reflected a "fundamental misunderstanding about the professionalism and commitment of the SEC staff".

Khuzami's discussion reflects the complex considerations that go into settlements and the use the "neither admit nor deny" approach.  The discussion demonstrates why implementation ought to be left to the Agency and the parties and not be a matter of judicial fiat.

The Citigroup Decision and the Harm to Investors

The decision in Citigroup rejecting the $285 million settlement has resulted in plenty of critical commentary, much of it suggesting that the SEC was not tough enough on the large financial institution.  The problem in general with such criticism is that the trial court did not reject the settlement because it was not tough enough.  Indeed, the fact that Citigroup did not have to make factual admissions likely meant that the complaint was far more pointed and telling than it otherwise would have been.  In other words, it probably tells more of the truth than what would have emerged had Citigroup been forced to make factual admissions.

But more importantly, the reasoning of the case ultimately threatens to harm shareholders and investors by forcing the SEC to litigate more cases. 

Litigation is expensive and uses up resources.  The SEC has already had an exceptionally hard time getting an adequate budget out of Congress.  To the extent having to litigate more cases, this would likely require the Agency to strip resources from other areas and other projects.  Most logically, at least some of the funds would come out of the budget used to pay those who investigate possible violations.  In short, there will be fewer investigations and fewer resources seeking the next Madoff.

Yet there is another even darker implication of this approach.  Given that big financial institutions have an almost unlimited budget to pay attorneys, they can afford to litigate cases to the bitter end.  Smaller entities and individuals may not have the same ability.  The result might be fewer cases against large businesses. 

And, indeed, this is something the WSJ implicitly suggested ought to happen.  An editorial in the paper had this to say about the consequences of making the SEC litigate more cases. 

• we might learn whether these cases have legal merit or are merely easy attempts to extort a deep-pocketed target. The SEC knows companies want to avoid reputational and legal costs, not to mention the risk of a trial lawyer pile-on. But how many cases would the SEC bring if it knew it had to prevail in court?

To the extent that the SEC lost at trial, it might "cause the SEC to bring fewer of these grandstanding cases against the corporate villain of the moment—for now, it's Wall Street—and focus more on real financial criminals like Bernie Madoff."

In other words, by forcing more trials, the SEC would stop bringing cases against the "corporate villain of the moment." Instead, it ought to redirect its efforts not at Wall Street but at the Bernie Madoff's.  Of course, Bernie Madoff would probably be surprised to learn that he was not part of Wall Street.  But mostly the approach suggested by the editorial would result in fewer cases against large entities and more against smaller players in the securities markets.  And, indeed, this is a possible outcome of the decision in Citigroup. 

Citigroup Settlement Rejected (Part 3)

The decision to reject the settlement because it came without factual admissions throws a singificant potential wrench into the SEC's approach to enforcement. 

To some degree, the decision stands for the proposition that this type of language is never acceptable, at least where the relief is substantial.  The court itself all but said this.  See SEC v. Citigroup ("It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations?").  Of course, one could argue that injunctive relief enforced by contempt is always "substantial."  Were this to be the case, the SEC could no longer rely on settlements of this kind.  

This could significantly increase the number of cases that were litigated.  Particularly where the SEC sought to charge a scienter based claim, defendants would have considerable incentive to litigate, either in an effort to win or to provide delay.  Delay might, for example, give defendants time to settle any private litigation before there was a ruling in the SEC case.  Because the SEC has limited resources, more litigation would mean less money for other administrative activities.  The Commission could strip funds away from operating divisions and give them to Enforcement.  Or Enforcement would, within its own budget, be forced to spend more on litigation and less on investigations.  

Alternatively, the decision could paradoxically result in less protection for the public.  This could push the SEC to bring more settlements as administrative proceedings.  These proceedings are not subject to court approval.  Moreover, because violations are not enforceable through contempt proceedings, the public arguably gets less protection.

Certainly, the same court's opinion in SEC v. Gupta suggested that the SEC should have a strategic justification selecting an injunctive versus administrative forum.   Ease of negotiating and approving a settlement ought to qualify.  

Citigroup Settlement Rejected (Part 2)

The decision to reject the Citigroup settlement essentially entails a rejection of the Commission's practice of allowing defendants to neither admit nor deny the allegations in the complaint.

The decision poses numerous problems for the Commission.  For one thing, it is internally inconsistent. 

The court characterized these settlements as having little evidentiary or other value.  The criticism is overbroad.  SEC cases provide can provide plaintiffs with a roadmap for their own action, often involve obtaining relief that cannot be obtained by private parties (as the court noted, the SEC can recover amounts for negligent behavior, private parties cannot), and they may have some evidentiary value.  See THE ANSCHUTZ CORPORATION v. MERRILL LYNCH, 785 F. Supp. 2d 799, 821 (ND CA 2011)(declining to dismiss motion to strike references to various investigations and resulting settlements conducted by the New York Attorney General and the SEC because "regulatory investigations and settlements may be relevant to issues in this case"). 

But more importantly, even to the extent true, the court declined to approve the settlement because of its very importance.  Thus, the SEC was seeking "substantial injunctive relief, enforced by the  Court's own contempt power".  Or, said another way, the SEC was asking the court "to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt". In other words, it was the serious impact of the settlement (which presumably equated to a public benefit) that required the court to insist on factual findings. 

The court also effectively overstated the value of factual admissions.  The parties could, for example, renegotiate the settlement and agree to a thin list of admissions.  To the extent the SEC continued to charge Citigroup only with negligence under Section 17, private litigants would still have to prove scienter. To the extent the facts admitted merely established an aiding and abetting standard, private litigants would still have to prove a primary violation.  In other words, the mere elimination of the "neither admit nor deny" language does not automatically result in substantial benefit to private litigants. 

Citigroup Settlement Rejected (Part 1)

Yesterday, Judge Rakoff rejected the settlement between the SEC and Citigroup.  This was the one that involved a payment of $285 million by Citigroup but where the financial institution neither admitted nor denied the allegations in the 21 page complaint.

It is clear that Judge Rakoff does not like the settlement on substantive grounds.  He was unhappy with the amount (noting that investors lost $700 million) and viewd the settlement as inconsistent with the one reached in the Goldman case.  See note 7.  Nor was the court happy with the standard of fault charged in the complaint.  Although language in the separate action against an individual "would appear to be tantamount to an allegation of knowing and fraudulent intent ("scienter," in the lingo of securities law), the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence". 

The rejection of the settlement, however, was not on this basis.  Instead, the court rejected the settlement because it has not been provided with "any proven or admitted facts upon which to excercise even a modest degree of independent judgment." Said another way, the court did not approve the settlement because it allowed Citigroup to "neither admit nor deny" the allegations in the complaint (language that he suggested may violate the first amendment, see note 5).  As the court reasoned:

• Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that   a plaintiff dismiss his complaint.  But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable    judicial power of contempt, the court, and the public, need some knowledge of what the underlying     facts are:   for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated       on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of  obvious public importance.

In part the court based its reasoning on the perception that settlements involving the "neither admit nor deny" language had no public benefit.  They had "no evidentiary value".  They were often viewed by the business community "as a cost of doing business imposed by having to maintain a working relationship with a regulatory  agency, rather than as any indication of where the real truth lies."  This type of settlement served only the "various narrow interests of the parties."   Moreover, the settlement interfered with the public's right to know the truth.

• in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the  truth.    In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers.     Even in our nation,  apologists for suppressing or obscuring the truth may always be  found.  But the S.E.C., of all  agencies,  has a duty, inherent in its statutory mission, to see that the truth emerges;    and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial  enforcement to the agency's contrivances.

In effect, therefore, the court suggested that settlements, at least those involving "substantial relief", could not be approved where the defendant made no admissions of fact.  Indeed, the court itself asked rhetorically, "how can it ever be reasonable to impose substantial relief on the basis of mere allegations?"

We'll consider the implications of this case in the next post.  The opinion has been posted on the DU Corporate governance web site. 

Record Penalty in Rajaratnam Case

The SEC obtained a record penalty from Raj Rajaratnam, the hedge fund manager recently convicted of insider trading.  The SEC obtained a penaly of $92.8 million.  The penalty is the largest against an individual. 

The penalty was imposed in an order granting the SEC summary judgment in its civil suit against Rajaratnam.  An injunction was a foregone conclusion.  Given his criminal conviction, Rajaratnam "conceded that, because of the criminal conviction, he was collaterally estopped from contesting liability for insider trading on the five stocks here in issue, and that he did not oppose having an injunction entered against him based on this liability." 

Moreover, given the $53.8 million forfeiture in the criminal case, the SEC conceded that its "request for $31.6 million in disgorgement was moot."

The only real issue was the amount of the penalty.  Defendant essentially argued that, given the $38 million penalty imposed in the criminal case, "further civil penalties are unwarranted."  Judge Rakoff, however, disagreed.  Criminal penalties, according to the judge, were designed to address defendant's "moral blameworthiness."  In contrast:

• SEC civil penalties, most especial in a case involving such lucrativeive misconduct as insider trading, are designed, most importantly, to make such unlawful trading "a money-losing proposition not just for this defendant, but for all who would consider it, by showing that if you get caught, you are going to pay severely in monetary terms.

In calculating the penalty, the court agreed that the facts justified the highest possible penalty of three times the profit gained or loss avoided.  Moreover, the court declined to reduce the penalty by amounts attributed not to insider trading but to the market.  As the court reasoned:

• By its plain language, Congress instructed the Court not to eliminate from the calculation of "profit gained" or "loss avoided" any amount attributable to market factors other than the defendant's inside information. Rather, once the Court identifies the trading price of the security at a "reasonable period after public dissemination of the nonpublic information," the Court should simply calculate the difference between that price and the price the defendant paid for that security in order to arrive at the profit gained or loss avoided.

The profits/losses did, however, have to be computed based upon the trading price of the relevant shares "a reasonable period after public dissemination of the nonpublic information."  15 USC 78u-1(f).  Using 24 hours as a reasonable period, the Commission computed the gain/loss avoided as $33,512,929, while defendant came up with $30,935,235. 

The court refused to resolve the discrepancy.  The court simply determined that anything over $90 million was enough and, as a result, accepted the defendant's calculation since it yielded the requisite minimum penalty.

• the Court determines that it need not resolve these somewhat technical differences, since for present purposes the Court can accept the lower figure and still fulfill all the purposes of a civil penalty this case. Specifically, the Court determines that these purposes can all be achieved by a trebling of the base figure as long as that trebling results in a fine amount of at least $90,000,000.

As for paying the $92,805,705, the court noted that certified check, bank cashier's check, or United States postal money order made payable to the United States Securities and Exchange Commission would be sufficient. 

We will have Judge Rakoff's order posted shortly on the DU Corporate Governance web site.

SEC v. Peterson & Peterson: Denver Father and Son Plead Guilty to Insider Trading

In SEC v. H. Clayton Peterson and Drew Clayton Peterson, No. 11-CV-5448 (SDNY, Filed Aug. 5, 2011), the Securities and Exchange Commission (“SEC”) brought charges against Clayton Peterson and his son Drew Peterson (collectively “Defendants”) for insider trading under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-5.  Clayton Peterson was a CPA and former Managing Director of Arthur Anderson in Denver, Colorado.  His son, Drew Peterson, was a registered investment advisor in Denver. 

Clayton Peterson served on the board of directors for Mariner Energy Inc. (“Mariner”), a publicly traded oil and gas company.  Apache Corporation (“Apache”), also a publicly traded oil and gas company, was expected to announce its acquisition of Mariner on April 15, 2010.  The SEC alleged that Clayton Peterson gave his son material, non-public information about the acquisition prior to the announcement date.  The SEC noted that Clayton Peterson specifically told his son to purchase shares of Mariner for family members.  Acting on his father’s advice, Drew Peterson purchased Mariner’s securities for himself, relatives, the investment advisory firm where he was employed, and Blind Seven LLC, an investment club founded by Drew.  Drew purchased 1,200 shares of Mariner for himself, 5,000 shares for his relatives, 2,500 shares for Blind Seven, 500 shares for a friend, and 4,100 shares for four of his clients. 

Drew forwarded the tip about Apache’s acquisition of Mariner to a friend working as a portfolio manager at a registered investment advisor in Denver referred to as “Hedge Fund A Portfolio Manager” throughout the SEC’s complaint.  Hedge Fund A’s Portfolio Manager purchased 200,000 shares of Mariner stock valued at $3.3 million and 5,000 option contracts on Mariner just days before the announcement.  This was the first time Hedge Fund A had ever traded Mariner stock or options.  The portfolio manager also purchased 25,000 shares of Mariner and 400 options contracts for relatives and his personal accounts. 

Following the April 15^th announcement of the acquisition, Mariner’s stock increased from $18.09 per share to $25.68 per share.  Drew Peterson made over $100,000 in profits from his trades.  Hedge Fund A made $4.6 million in profits while the portfolio manager made $435,000 for his relatives and himself. 

The SEC claimed Defendants violated Section 10(b) of the Exchange Act and Rule 10(b)-5.  The SEC’s complaint stated that Clayton Peterson “recklessly disregarded, or should have known, that he owed a fiduciary duty” to Mariner and the information about the acquisition was material, non-public information.  The SEC applied this same standard to Drew Peterson and states that Drew “recklessly disregarded, or should have known” the tip his father gave him was inside information. 

The SEC sought permanent enjoinment against Defendants from violating Section 10(b) and Rule 10(b)-5 again, civil monetary penalties, and disgorgement of all profits that resulted from the insider trading, including those profits gained by Hedge Fund A and the portfolio manager for a total of $5.2 million.  The SEC also asked the court to bar Clayton Peterson from serving as an officer or director of any publicly traded company. 

Both Clayton Peterson and Drew Peterson pled guilty to insider trading charges.  Sentencing is on January 12, 2012.  The probation office has recommended Clayton Peterson not receive any jail time as reported here. 

The primary materials for this case may be found on the DU Corporate Governance website.

SEC v. Todd: The SEC Reclaims Victory

In SEC v. Todd, the SEC appealed the district court’s granting of Gateway Inc. officials John Todd and Robert Manza’s motions for judgment as a matter of law, which set aside the jury verdict against them on Section 10(b), Rule10b(5), and Rule 13b2-2 claims; they also appealed the district court’s granting of motions for summary judgment regarding alleged securities violations by Jeffrey Weitzen, Gateway’s CEO and president.  Sec. Exch. Comm’n v. Todd, 2011 U.S. App. LEXIS 12692 (9th Cir. June 23, 2011). 

The SEC claimed that Gateway’s CFO, Todd, and lead CPA, Manza, unlawfully misrepresented Gateway’s financial condition to meet earnings and revenue expectations in the third quarter of 2000. Their claims revolved around transactions between Gateway and Lockheed Martin, VenServ Inc., and AOL. 

In 2000, according to the SEC, Gateway entered into an agreement with Lockheed Martin to sell $47.2 million of fixed assets in the form of IBM and Sun Microsystems servers.  Gateway planned to then lease back the servers, booking the initial transaction as revenue.  This technique was not in accordance with revenue recognition under Generally Accepted Accounting Principles (“GAAP”).  Gateway booked this one time gain as revenue in its third quarter report.  During that same quarter, Gateway included $21 million from a transaction with Venserv.  However, when it was recorded, the Venserv sale was incomplete because Gateway did not fulfill the services stipulated in the contract.  Gateway also modified the AOL agreement to be able to book revenue sooner, creating a one-time revenue boost during the third quarter of $72 million.

The Lockheed transaction involved the defendants recording the sale of fixed assets as revenue; Manza and Todd argued that the Lockheed transaction did not violate a specific provision of GAAP while the SEC presented experts that disputed that claim.  However, Manza testified that while he did not believe their actions violated a specific GAAP provision, if he were the CFO he would not have recorded the transaction as revenue.    

The SEC alleged that the actions constituted securities fraud under Rule 10b-5.  Violations of § 10(b) of the Act require “a material representation, in connection with the purchase or sale of a security, with scienter, by means of interstate commerce.”  SEC v. Dain Rauscher, Inc., 254 F.3d 852, 855-56 (9^th Cir. 2001).   The SEC also claimed that Todd and Manza’s signing of the management representation letter sent to Price Waterhouse Coopers amounted to a violation of rule 13b2-2 for improper reporting to accountants.  Although the SEC prevailed at trial, the district court set aside the jury verdict, holding that the evidence was insufficient to establish scienter or the materiality of the alleged misstatements.   

On appeal, the Ninth Circuit reversed.  The appellate court found ample evidence in the Lockheed and VenServ transactions for the jury to have found a material misrepresentation.  In the Lockheed transaction, the jury heard expert opinions of how the transaction should have been recorded as well as testimony that Gateway had violated its own internal accounting policy by booking the transaction as revenue.  Both parties agreed that the Venserv transaction was not complete and improperly recognized.

With respect to scienter, the court held that the mental state embraced both an “intent to deceive, manipulate or defraud” and recklessness.  In the Lockheed transaction, Todd and Manza allegedly kept information from their internal auditors because Manza said “they wouldn’t go for it.”  In the Venserv transaction, evidence was presented which showed that the defendants knew the sale was incomplete at the time it was recognized.

A violation of rule 13b2-2 requires an officer to knowingly making a false or misleading statement to an accountant.  The Ninth circuit found that the same evidence sufficient for scienter with regard to Section 10(b) violations was sufficient to show Todd and Manza knew the financial documents were not accurate when they signed the management representation letters.

The Ninth Circuit reversed the trial court’s grants of summary judgment for Weitzen with regard to his liability under § 10(b), Rule 10b-5, and control person liability under §20(a) of the Securities Act of 1933.  Despite the nature of the transactions that were recorded in Gateway’s third quarter earnings report, Weitzen repeatedly referred to revenue growth as accelerated during conference calls with analysts.  The court drew from this a genuine issue of material fact regarding whether Weitzen materially misrepresented Gateway’s revenue and acted with scienter in doing so. The court again found a genuine issue of fact as to whether Weitzen could be considered a “control person” with regard to Gateway.  The control person must have power or control over the primary violator of the Act.

 The Ninth Circuit upheld summary judgment for Weitzen with regard to the rule 13b2-2 claim of improperly reporting to accountants.  The court also affirmed the district court’s order denying defendants Todd’s and Manza’s motions for a new trial and motions for judgment as a matter of law on aiding and abetting claims.

Further posts on SEC v. Todd can be found here.

The primary materials for this case may be found on the DU Corporate Governance website.

SEC Opts not to Appeal Shareholder Access Rule

 The SEC won't seek en banc consideration of the DC Circuit's decision with respect to Rule14a-11 or review in the Supreme Court.  It would have been a very difficult case to win in the DC Circuit since three of the nine judges could be counted on to oppose Commission efforts.  Yet it leaves in place a very bad precedent that will come back to haunt the SEC with respect to future rulemaking efforts, particularly in the corporate governance area.  We have a few more posts on the DC Circuit's decision and the extent to which it went beyond any other court in imposing cost-benefit burdens on the SEC.

As we have written before on this blog, this is access delayed, not access defeated. 

The SEC and Business Roundtable: The Views of the CII (and 14 Member Funds)

The Council for Institutional Investors sent a letter to Mary Schapiro indicating that the Commission ought to seek en banc review of the panel's decision in Business Roundtable.  The letter is here.  As the letter noted:

• the panel explicitly rejected the Commission’s conclusions about the benefits to shareowners of Rule 14a-11 because, in the Court’s view, the empirical evidence was “mixed.” But it is precisely the role of expert agencies like the SEC—not the courts—to reach reasoned conclusions based on such “mixed” evidence. So long as the agency considers the relevant factors and articulates a reasoned basis for its decision—a standard plainly met by the final rule—the agency’s determination should not be disturbed.

In addition, as we will note in later posts, the court erred in its analysis of the types of "costs" that the SEC must examine.  The court assumed, wrongly, that boards had a duty to resist access candidates, equating the boards fiduciary obligations in those circumstances with those applicable during a proxy contest.  The court also incorrectly required the SEC to assume that union pension plans would violate their fiduciary obligations by using access to benefit workers rather than plan beneficiaries.  There is no support in the case law for either proposition. 

A Tempest in a Teapot and Allegations of Document Destruction at the SEC

The SEC cannot get a break.  The latest is a set of allegations that the SEC is destroying documents collected during investigations. 

The allegations came from an attorney in the SEC but gained traction when Senator Grassley sent a letter to the Commission asking for information on the matter.  The letter is here.  The letter indicated that the SEC had destroyed documents in 9000 files (apparently over a 17 year period) and some of the filed involved high profile companies or persons (Madoff, a bunch of financial institutions).

In discussing this, lets first get the facts on the table.  The destruction is alleged to have occurred with respect to Matters under Investigation or MUIs.  What are these?  They are preliminary examinations of tips and other allegations designed to determine whether the Division of Enforcement should engage in a full scale investigation.

The MUI process is informal.  Staff engaging in a MUI does not have subpoena authority so the investigation cannot involve compelled production of documents or testimony (that only comes with a formal order).  Moreover, the period of time for MUIs is brief.  Under the internal policies of the SEC, a MUI is automatically converted into a full scale investigation after 60 days.  See Enforcement Manual, at 17 ("The internal system will convert a MUI to an investigation when the MUI has been open for sixty days."). 

The staff must, therefore, decide whether to terminate the preliminary investigation or upgrade it into a full investigation in a relative quick fashion.  To the extent terminated, the staff must provide a written explanation for the reasons.  Again, as the Enforcement Manual notes: 

• If the assigned staff, in consultation with the assigned Associate Director, determine that the investigation does not have the potential to address violative conduct, or there is another reason that the investigation would be an inappropriate use of resources, then the assigned staff, in consultation with the assigned Associate Director, should close the MUI before it converts to an investigation. To close the MUI, the assigned staff should contact their Case Management Specialist, request to close the MUI, and provide an explanation for closing the MUI. Please refer to the internal system instructions for the closing MUI codes. If the MUI is not closed before its conversion to an investigation, then the investigation closing procedures must be followed (see Section 2.6 of the Manual).

Enforcement Manual, at 19 (emphasis added).  So the documents in the file may be destroyed but the file itself and an explanation for the decision to close the matter apparently remain in place.

Second, the US government requires the implementation of a "selective retention" policy.  See 44 U.S.C. § 2905.  Thus, not everything has to be retained.  The Archives indicated that the records shouldn't have been destroyed but only because there had been no disposition schedule. 

• "Because a NARA-approved disposition schedule did not exist for these records, the SEC did not have authority to dispose of them per the Federal Records Act, 44 USC 3314 and 36 CFR 1220.18,"

Third, in deciding what to retain, it bears recalling that the SEC receives a massive number of tips and referrals each year, somewhere around 30,000 a year (which are screened through the newly minted TRC database).  It must first sift through these allegations and decide which ones require further attention.  A certain number of them are investigated further and become MUIs.  Within 60 days, a small percentage of the total become active investigations, somewhere around 500.  Some percentage of the investigations result in actual cases.  Somewhere along the spectrum of tips to cases, the SEC has to decide (in conjunction with the Archives) what to retain.  Not retaining file documents in matters that never made it to a full scale investigation does not seem unreasonable.   

Moreover, to the extent put in place 17 years ago, the policy arose before documents in electronic format became universal.  As a result, retention meant hard copies.  To keep all documents would have resulted in warehouses bursting with paper.  Some type of cost-benefit analysis had to be made in determining what was retained.

Fourth, it is no great surprise that some well known names (Maddoff) or well known entities would appear in a list of closed MUIs.  After all, there were 9000 of them.  Presumably the larger the institution the greater the likelihood someone will complain to the SEC (and a MUI opened).  But that inevitability is not a reason to suddenly retain all of the documents in 9000 files.

Apparently the SEC has now decided to retain documents obtained in MUIs that are later closed (as opposed to becoming full blown investigations).  It is in fact the case that this may be appropriate, particularly given shifts in the cost-benefit analysis.  In an era where electronic retention is prevalent, the cost of storage has gone way down.  But to the extent the current criticism of the Commission provides an incentive (by the SEC and all other government agencies) to retain everything, without undertaking a cost-benefit analysis, the result will likely be a government wide retention policy that is overbroad and, in the aggregate, costly.

Commissioner Casey Steps Down

Commissioner Casey stepped down from the Commission on Friday.  The press release is here. 

Gupta, the SEC and the Termination of the Administrative Proceeding

According to the WSJ, the SEC has decided to terminate its administrative proceeding against Rajat Gupta. 

The Commission did so only after Judge Rakoff allowed Gupta's case challenging the SEC's decision to bring an administrative rather than injunctive proceeding to go forward.  The case likely gave Gupta and his counsel the opportunity to depose the staff at the SEC about their motivations for bringing the administrative proceeding, something that would potentially provide evidence useful in the administrative proceeding.  We wrote a number of posts on this case. 

The WSJ indicated that Gupta also intends to terminate his case against the SEC.  As part of the settlement, the SEC agreed not to bring an administrative proceeding against Gupta.  SeeWSJ ("As part of an agreement between the sides, the SEC said it wouldn't bring any administrative or cease-and-desist proceedings in the future against Mr. Gupta based on the allegations.").  

To the extent the SEC wants to bring an action against Gupta, it will be limited to an injunctive proceeding in federal district court (apparently in Judge Rakoff's court).  The Commission in dismissing the administrative proceeding left open this possibility.  See Exchange Act Release No. 65037(August 4, 2011) ("The Commission has determined that it is in the public interest to dismiss these proceedings. Dismissing these proceedings will not prevent the Commission from filing an action against Mr. Gupta in United States District Court."). 

The SEC terminated the administrative proceeding for one of two reasons.  The SEC either viewed the case as weak (as Gupta asserts) and decided not to waste the resources on the matter, or terminated the administrative proceeding only to end Gupta's litigation.  The reason will eventually become clear.  Should the SEC file in federal district court, it will suggest that the agency viewed the case as strong on the merits but switched forums to end Gupta's litigation.

Whatever the reason for the termination of the administrative proceeding, the outcome of the case provides future defendants with an incentive to litigate against the agency in order to control the forum decision.  In addition, the staff will likely have to take this possibility into consideration when selecting the forum.  This is an unnecessary complication to an already complicated process.

Judicial Hobbling of the SEC: Gupta v. SEC (Part 5)

What are the implications of this decision?

The trial court in Gupta v. SEC essentially validated equal protection claims by all parties dissatisfied with administrative proceedings.  The court all but held that the SEC has no competency to resolve such challenges and that anyone consigned to the administrative process will be subject to an inferior forum.  This went well beyond the analysis in FEF v. PCAOB.  Nothing in that case suggested such a broad exception to the language in APA 703.  Its one thing to allow a claim in a separate preceding that challenges the constitutionality of the relevant agency and another to allow a claim whenever a party alleges discrimination. 

The analysis, therefore, provides an open invitation for any party with the resources to bring a parallel action in federal court.  Moreover, while Gupta v. SEC involved a suit alleging unfairness in bringing an administrative proceeding, there is nothing in the court's analysis that prevents a party from alleging that the SEC's decision to bring a case in federal district court was also unfair.  After all, there are advantages to the administrative process (inapplicability of the rules of evidence, a decision maker with substantive expertise, a typically quicker process, the lack of D&O bars, the inability to bring an action for contempt for violations). 

The district court understood this implication and tried to sidestep it.

• To be sure, it would not be prudent to allow every subject of an SEC enforcement action who alleges "bad faith" and "select prosecution" to be able to create a diversion by bringing a parallel action in federal district court. But such diversionary tactics can be quickly disposed of in the ordinary case through dismis for lure to plead a plausible claim. See Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009). Here, by contrast, we have the unusual case where there is already a well-developed public record of Gupta being treated substant ly disparately from 28 essentially identical defendants, with not even a hint from the SEC, even in their instant papers, as to why this should be so. A fear of abuse by litigants in other cases should never deter a federal court from its unfailing duty to provide a forum for vindication of constitutional protections to those who can make a substantial showing that they have indeed been denied their rights.

The analysis is weak on a number of counts.  First, as a practical matter, the SEC never has and should not be required to justify the selection of a particular forum. 

Second, requiring such a justification runs headlong into the confidentiality normally accorded the SEC's actions.  When a proceeding against a party is announced, the SEC rightfully maintains confidentiality about non-public aspects of the case.  The court is, however, suggesting that when the SEC announces what appears to be a different approach with respect to a party, it should give an explanation.  The explanation will presumably involve a description of differences in the particular case, something that may require a violation of the traditional rule of confidentiality.

Third, the court is trying to limit the analysis to a case where there are other defendants treated differently.  Yet many cases involve multiple defendants who are subjected to actions in different forums.  Moreover, there is nothing that prevents parties from claiming that they were treated unequally when compared with parties in different actions.  Thus, if the SEC ordinarily brings insider trading cases as injunctive proceedings, a party sued in an administrative action for insider trading can argue that he or she was treated unequally.

Fourth, the "harm" to Gupta (lack of a jury, lack of the rules of evidence, etc), applies in every administrative proceeding.  To the extent the court truly thinks that Gupta is disadvantaged by being forced to litigate in an administrative forum, it is surely an argument that can be made in every single administrative case.

As a result of this reasoning, there are two likely outcomes.  First, the number of parallel suits will increase dramatically.  Why not?  You can obtain discovery against the agency and explore the staff's motivations for bringing the relevant administrative proceeding.  Even if the case is ultimately a loser, its possible that it will make available plenty of information useful in the administrative proceeding (and the eventual appeal to the US Court of Appeals).  The increase in the number of suits will require the SEC to reallocate attorneys from the Division of Enforcement to the Office of the General Counsel, the office that defends actions filed against the Commission.  Thus, the SEC will have to reduce resources used to investigate and enforce the securities laws.

The most important outcome, however, will likely be a further decline in moral at the SEC.  After working hard on a case and deciding on a forum, attorneys in the Division of Enforcement will need to be prepared for litigation over the forum choice, including depositions and review of their emails and other internal records. 

Leave the SEC to go work in the private sector and be investigated.  Bring an action that results in a $550 million settlement and be investigated.  Bring an action in a particular forum and be investigated.  This can't be good for moral. 

Primary materials in this case, including the court's opinion, can be found at the DU Corporate Governance web site.

Judicial Hobbling of the SEC: Gupta v. SEC (Part 4)

So what was the constitutional claim?

The case is not always clear but the trial judge apparently treated the retroactivity issue as one of constitutional dimension.  As the opinion noted:

• His claims as to the constitutional violations he will suffer from the allegedly improper retroactive application of the Dodd-Frank Act are not peculiarly within the SEC's competence or expertise.

But the retroactivity issue goes to the relief, not the forum.  To the extent that the court finds that the SEC cannot obtain penalties against Gupta, it does not preclude the SEC from bringing an enforcement action.  Indeed, in the complaint, Gupta mostly argues that the application of the penalty provision is further evidence of his other constitutional claim, that he is being treated differently from the other defendants arising out of the same basic set of facts who have been subjected to proceedings by the SEC. See Gupta Brief ("The impact of this 'first use' is to single out Mr. Gupta as the only Galleon-related defendant being pursued by the Commission administratively in contrast to more than two dozen other Galleon-related defendants named in Commission complaints filed in this Court.").

The main constitutional claim discussed in the opinion is a violation of the equal protection clause.  This arises out of the fact that Gupta was allegedly treated differently from other similar defendants.  The difference in treatment, according to Gupta, resulted in considerable harm.  He would be deprived of certain constitutional rights such as a right to a jury and certain other prophylactic safeguards such as the Federal Rules of Evidence.  He is subjected to a short trial date.  As the court noted:

• Ultimately, the Complaint alleges, the SEC's plan is to gain an unfair advantage by depriving Gupta of the protections he would have had if the case were brought federal court, including full discovery, application of the federal rules of evidence, the ability to assert third-party claims for indemnification and contribution, the ability to bring counterclaims against the SEC, and, most importantly, a right to a jury trial: all of which rights are being accorded to every other Galleon-related defendant except Gupta.

But even if Gupta was singled out, that does necessarily establish a violation of the equal protection clause. The complaint does not allege that Gupta was treated differently because of race, gender, ethnicity or other categories that warrant some type of heightened review. Under traditional analysis, the SEC need only have a rational basis for any decision.

Moreover, this is not a case of selective prosecution.  With 28 other persons having been sued based on similar allegations, the parties and the trial judge implicitly concede that the action could have (indeed, they suggest, should have) been filed in federal district court.  Thus, the only issue is whether the SEC could have violated the equal protection clause by filing an action in a particular forum (in this case an administrative one).  

In explaining the choice of forum, Paragraph 16 of the complaint states that the "only plausible inference is that the Commission is proceeding how and where it is against Mr. Gupta for the bad faith purpose of shoring up a meritless case by disarming its adversary."   Stripped down to its essence, this is basically a claim that the SEC brought the action as an administrative proceeding because it thought it had a better chance of winning than in district court.  It is, in short, a rational basis for the decision.  

First, parties invariably consider the likelihood of victory when deciding on the forum.  This can be true, for example, with respect to venue decisions.  It is an ordinary part of the litigation process and hard to see as bad faith or irrational behavior.  

Second, while the SEC did get to choose the forum, that does not mean it is able to shore up a meritless case.  The Defendant can defend against the allegations and some of the matters mentioned (the inapplicability of the rules of evidence) may benefit Defendant more than the SEC.  He also gets to  appeal to the Commission (which is not united and therefore cannot be viewed as automatically willing to uphold an ALJ decision) and to the court of appeals.  Presumably, these steps will weed out any "meritless cases."   

Third, it is Gupta who gets to determine the relevant appellate court.  He has the choice of bringing the appeal in the DC Circuit or the Circuit where he resides.  See 15 U.S.C. § 78y(a) (1).  Thus, while the SEC determines the initial forum (an administrative proceeding), Gupta can determine the relvant appellate court.  Moreover, with the DC Circuit among the choices, he has available a court that has shown considerable willingness to overturn decisions of the Commission.

But mostly the claim has to fall because the case has not been made that an administrative proceeding is somehow inferior to an action in federal district court.  Defendant's argument seems to be premised on the view that the procedures involved in administrative cases do not adequately protect against "meritless cases." In other words, those consigned to the administrative process have a greater likelihood of being wrongly convicted.  But there is simply no evidence of this.  Thus, while Gupta was consigned to a forum with a different set of procedures and requirements, it is not at all established that this somehow resulted in a greater risk that the SEC would prevail on a meritless case.   

This claim falls squarely into the category of cases where the agency has almost unlimited discretion to make decisions about enforcement proceedings.  See Heckler v. Chaney, 470 U.S. 821 (1985).  For the most part, decisions about whether to bring an action or about whom to bring an ation against are unreviewable.  Id.  ("an agency decision not to enforce often involves a complicated balancing of a number of factors which are peculiarly within its expertise. Thus, the agency must not only assess whether a violation has occurred, but whether agency resources are best spent on this violation or another, whether the agency is likely to succeed if it acts, whether the particular enforcement action requested best fits the agency's overall policies, and, indeed, whether the agency has enough resources to undertake the action at all.").  The decision by the SEC to bring an administrative proceeding, even if motivated by a desire to increase the likelihood of winning, is not a violation of the Equal Protection Clause.

The trial court did try to strengthen Defendant's argument by reading into the complaint the allegation that the SEC singled Gupta out for unequal treatment "in retaliation for his strenuous assertion of his innocence". See Complaint at P 16.  The argument, however, is still premised on the idea that an the SEC chose to "punish" Gupta by selecting a forum where it believed it had a greater chance of winning.  Such a justification is rational.  

Primary materials in this case, including the court's opinion, can be found at the DU Corporate Governance web site.

Judicial Hobbling of the SEC: Gupta v. SEC (Part 3)

Counsel for Gupta filed a strong brief and the court sided with the Defendant, concluding that he had a right to litigate the constitutional claims in federal district court.

In considering whether to dismiss the case, the court had concerns over the SEC's motive in bringing the administrative proceeding, particularly given the different treatment afforded other defendants in similar circumstances.  As the court noted:

• A funny thing happened on the way to this forum. On March 11 2011 1 the Securities and Exchange Commission (the "SEC" or "Commission") - having previously filed all of its Galleon related insider trading actions in this federal district decided it preferred its home turf. . . .In language substantially similar to its complaints filed in this Court against some 28 other persons and entit accused of Galleon-related insider trading the SEC alleged that by virtue of such conduct, Gupta willfully violated Section 17(a) of the Securit s Act of 1933 and Section 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act"), including SEC Rule lOb-5 promulgated thereunder.

In other words, as the court described, the behavior was a "seeming exercise in forum-shopping".  The court also had concern over the retroactive application of the penalty provision in Dodd-Frank.  As the opinion noted:

• It appears undisputed that, prior to the enactment of the Dodd-Frank Act on July 21, 2010, the SEC had no power to impose such penalties in an administrative action against a nonregulated person like Gupta. Accordingly, since the conduct here complained of occurred in 2008-09, the OIP in effect seeks to apply Dodd-Frank retroactively, in seeming violation of the well established rule that a statute will be presumed not to impose penalties retroactively unless it expressly so states.

But whatever concerns the trial judge had over these issues, the case was supposed to be about the appropriate forum.  Under the traditional approach, Gupta would raise any legal issues in the administrative proceeding.  If unhappy with the outcome, he could appeal first to the Commission then to the US court of appeals.  One way or another, he would obtain judicial review of any relevant issue.

The court, however, concluded that Gupta had standing to raise his constitutional claim in a separate action.  Id.  ("Actually, however, since Gupta has alleged constitutional violations, the Court has jurisdiction pursuant to 28 U.S.C. § 1331, which grants district courts 'original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States.'").  To allow the case to go forward, however, had to overcome limitations set out in the APA.  Under Section 703 of the APA, actions are ordinarily limited to those "specified by statute".  5 U.S.C. § 703.  The SEC argued that the Exchange Act specified the form of proceeding (appeal of an administrative proceeding to the SEC then to the US Court of Appeals) and that Gupta was precluded from litigating the issues in any other forum.  See 15 U.S.C. § 78y(a) (1).  

The court, however, disagreed, relying on Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd, 130 S. Ct. 3138, 3150 (2010).  In that case, the Supreme Court allowed plaintiffs to challenge the constitutionality of the PCAOB without first having to raise the issue in a case before the SEC.  As the Supreme Court noted:

• But we presume that Congress does not intend to limit jurisdiction if "a finding of preclusion could foreclose all meaningful judic review"; if the suit is "wholly collateral to a statute's review provisions"; and if the claims are "outside the agency's expertise."

In applying the test, the district court in Gupta v. SEC mostly viewed the constitutional question at issue to be a matter that was not within the competency of the SEC.  Id.  (with respect to the equal protection claim, it would, "if anything, . . .be inherently difficult for the Commission, which will have to approve any final order against Gupta, to be deciding whether it itself engaged in unequal protection in bringing its charges against Gupta.").  As a result, the court agreed that Gupta could raise the claim in a separate action.

Whatever the validity of the reasoning, the case really turned on the strength of the constitutional claim brought by Gupta.  In FEB v. PCAOB the issue was the constitutionality of the entire body.  In this case, the issue was whether Gupta was somehow singled out in an unconstitutional fashion with respect to the administrative proceeding.  The two claims are very different and it is not at all clear that FEC v. PCAOB supports the district court's view.  Nonetheless, we will look at the constitutional law claim in the next post. 

Primary materials in this case, including the court's opinion, can be found at the DU Corporate Governance web site.

Judicial Hobbling of the SEC: Gupta v. SEC (Part 2)

The SEC chose to bring an action against Rajat Gupta as an administrative proceeding.  What is the consequence of this determination? 

Administrative proceedings are litigated before administrative law judges at the SEC.  These decision makers have relative independence but any appeal from their determination goes to the Commission.  For some, therefore, the administrative process is skewed toward the agency.  Only when the matter is appealed from the agency to the US Court of Appeals will there be a review that is entirely outside the agency.  Administrative actions do not provide for the use of juries or the rules of evidence. 

What ever issues exist with the administrative process, it is a system put in place by Congress.  Traditionally with respect to the SEC, there were plenty of reasons why administrative proceedings were not the preferred route in bringing an action.  For one thing, violations (unlike injunctions), are not subject to contempt proceedings.  As a result, the actions have less teeth.

In addition, traditionally, administrative proceedings did not permit the full range of remedies that the agency might seek.  Director bars are not permitted in administrative proceedings.  And, until Dodd-Frank, the SEC could not seek penalties against persons associated with non-regulated industries. 

Dodd-Frank, however, took away one of the disadvantages to administrative proceedings.  See Section 929P of Dodd Frank (amending Section 21B(a) of the Exchange Act).  The Agency can now seek penalties in the proceedings against persons who are not associated with regulated entities.  Indeed, the administrative proceeding against Gupta is the first to seek penalties under this authority.  See Remarks at SIFMA’s Compliance and Legal Society Annual Seminar, Director of Enforcement Robert Khuzami, March 23, 2011 (case against Gupta was “the first use by the SEC of its new authority under Dodd-Frank to obtain penalties in an Administrative Proceeding against persons not associated with a regulated entity.”). 

Gupta was, however, unhappy with the choice of forum and brought a separate action challenging the SEC's decision.  The Complaint alleged that, by bringing the action as an administrative action, the SEC was violating his statutory and constitutional rights.  Gupta essentially argued that he was subject to unequal treatment since all of the other persons involved in the same general fact pattern had been sued in federal court and not subjected to an administrative proceeding.  In addition, he argued that the SEC was seeking retroactively to apply Section 929P from Dodd-Frank by imposing penalties on behavior that occurred prior to the adoption of the Act.

The SEC moved to dismiss the case, essentially arguing that Gupta should raise any legal issues in the administrative proceeding.  The district court disagreed.

Primary materials in this case, including the court's opinion, can be found at the DU Corporate Governance web site.

Judicial Hobbling of the SEC: Gupta v. SEC (Part 1)

One can only imagine the morale of the staff at the SEC these days, particularly in Washington. 

The Agency traditionally had been built around hard working and generally underpaid staff who believed in their mission, particularly ensuring the integrity of the securities markets and the protection of investors.  Moreover, a stint at the SEC could be used to obtain a position in the private sector.  Look at the number of prominent securities attorneys who started in the SEC.  The turnover also benefited the Agency by providing constant room for new energy and invigoration.  

These days, though, a position outside the Agency can get you subjected to a congressional request for an investigation by the Office of the Inspector General.  Bring a big case like the one against Goldman (which settled for $550 million) and you get investigated to see if the matter was timed to coincide with financial reform (charges eventually found to be baseless).  Whenever anyone wants to criticize the staff (say Congress at budget hearings), they need only trot out Madoff and the lease on the Constitution Center, ignoring all of the other work performed by the Agency (not the least was the SEC's participation in the conviction in Galleon).

In all of this, it seems as if the courts have also increasingly played a role in hobbling the SEC.  The DC Circuit has taken an activist role in striking down SEC rules, with shareholder access another potential candidate.  Law from the US Supreme Court has contributed.  When the staff members get criticized for not bringing actions against individuals in securities fraud cases, they will have Janus Capital as an explanation, a case that has the potential to sharply curtail the individuals under the federal securities laws. 

An example of this approach occurred in Gupta v. SEC.  The case involves a challenge to the SEC's decision to bring an action against Rajat Gupta as an administrative rather than an injunctive proceeding in federal district court.  Broadly speaking, the case seeks to explore the staff's motive for the choice of forum.  Allowing the case to go forward has the capacity to disrupt the enforcement process, subject staff members to depositions and other litigation risk every time they select a forum for bringing a case, and cost the SEC considerable resources in defending cases everytime a well funded defendant wants to challenge the choice of forum. 

We will look at the case over the next few posts.   Primary materials in this case, including the court's opinion, can be found at the DU Corporate Governance web site. 

The SEC and Investor Protection (Part 1)

The Commission has a tough mission.  Protecting investors and ensuring the integrity of the capital markets is a continuous struggle that must overcome constant impediments.  They include new regulatory burdens and inadequate resources.  But some of the harm to the agency comes from within.  

Commissioner Aguilar, who was recently nominated for a second term at the SEC, noted some of these issues in a recent speech before the Social Investment Forum.  As he described: 

• In the near term, the Dodd-Frank Act requires the SEC to promulgate over 100 new regulations, create five new offices, and undertake about 20 studies. To say this is a significant undertaking is a massive understatement. The SEC is currently right in the middle of this process.

More than a spate of additional rules, the Commission was tasked with additional areas of oversight.

• Dodd-Frank Act charges the Commission with on-going oversight responsibilities on the previously unregulated over-the-counter derivatives market. The Commission’s new responsibilities include direct regulation of participants such as security-based swaps dealers, venues such as swap execution facilities, warehouses such as swap data repositories, and clearing agencies set up as central counterparties. In addition to regulating the derivatives market, the Commission has also been given the responsibility for the oversight of hedge fund advisers, and new responsibilities for the registration of municipal advisers.

Despite these responsibilities, a much needed budget increase was voted down in the House.  Why?  In part it was punishment.  The report accompanying the decision "faulted the SEC’s handling of Ponzi schemes.  The agency failed to stop Bernard Madoff's fraud, despite repeated warnings over the years.").  So to punish the SEC for not protecting investors, the House will deny the SEC the funds it needs to protect investors.

The main explanation, though, was essentially financial mismanagement.

• Accusing the agency of shortcomings in its handling of information technology contracts, a major office lease and preparation of its own financial statements, the panel said it was reluctant to provide more funding until the SEC achieves efficiencies recommended by an outside consultant.   “The Committee believes that these lapses demonstrate a concerning lack of ability to manage funds,” the report said.

No doubt there could be improvements in this type of management.  But the sense of financial mismanagement at the Agency was unnecessarily stoked by what looks to be gratuitous criticism by the SEC's Office of the Inspector General (OIG). 

The OIG conducted an investigation into the execution of a large lease by the SEC.  Apparently, the  lease proved to be unnecessary but saddled with SEC with excess space.  Certainly the OIG ought to look into these sorts of matters.  Investigations might reveal deficiencies in the internal process used for approving leases and result in appropriate reforms. 

But rather than focus on the lease, the OIG chose to lump in practices that had occurred at eaerlier dates.  As the report noted:

• The OIG investigation found that the circumstances surrounding the SEC's entering into a lease contract with David Nassif Associates ("DNA") for 900,000 square feet of space at the Constitution Center facility in July 2010 represents another in a long history of missteps and misguided leasing decisions made by the SEC since it was granted independent leasing authority by Congress in 1990. We found that notwithstanding this significant authority, the SEC had not even established a Leasing Branch until April 2009 and did not put into place leasing policies and procedures until August 2010.

The report, therefore, suggested that there have been problems with leasing decisions since the 1990s.  In other words, the OIG chose to put the Constitution Center lease in a broader context.

Fair enough.  To the extent there is a bigger problem, it should be addressed.  Only the report doesn't support this contention.  While suggesting that problems have taken place since 1990, the first "misguided" decision it mentions occurred in 2005.  Second, while emphasizing "misguided leasing decisions" (the Constitution Center after all involved a lease), it gives as additional examples two events that do not really involve leases.  

The problem in 2005 involved cost overruns for the new building ("In May 2005, the SEC disclosed to a House Subcommittee that it had identified unbudgeted costs of approximately $48 million attributable to misestimates and omissions of costs associated with the construction of its headquarter facilities near Union Station") and the one in 2007 involved a reconfiguration of the building once it was finished.  ("In 2007, merely a year after moving into its new headquarters, the SEC embarked on a major "restacking" project in which various SEC employees were shuffled to different office spaces at a cost of over $3 million."). 

In addition to selecting what appears to be inapposite transactions, the basis for criticizing them was noticeably thin.  Take the restacking project.  OIG's criticism was based upon a "review" of the project.  The review found "serious questions" about whether the project was necessary.  Here is what the report had to say:

• The OIG's audit unit conducted a review of the project and found that there were serious questions about whether the restacking project was necessary and whether it had any meaningful impact on communication among or productivity of the staff. !d. at iv. The OIG found that there was no record of a cost benefit analysis having been conducted before embarking on this restacking project. !d. at iii. Moreover, an OIG survey of Commission staff found that only 34 percent of staff surveyed believed that the restacking project would improve effectiveness or efficiency oftheir office or division. !d. at iv, 13. This OIG survey also found that 89 percent of the responding staff had been satisfied with the location of their workspace before the restacking project was initiated, and 81 percent of the responding staff did not believe the restacking project benefits were worth the cost and time of construction, packing, moving, and unpacking. Id. at 11, 15.8

In other words, the "review" doesn't appear to be much of a review at all.  Apparently the file on the project was opened (there was no piece of paper undertaking a cost benefit analysis) and some attempt was made to survey employee views.  But restacking was designed to configure the operating divisions in a particular manner in an effort to make them more effective.  That doesn't mean that it was a correct decision.  The old building for the most part organized divisions on a single floor.  But it does mean that the "serious questions" posed by the OIG were not administrative inefficiencies like the Constitution Center lease but policy questions about how to maximize efforts by employees.  Had the OIG examined the way that contracts had been executed for the restacking project, it would have been more in line with the lease issue.  But commenting on and disagree with policy decisions was not.

Yet by expanding the discussion from the lease to past practices and giving an impression that these issues had been around since 1990, the report potentially harmed the SEC by providing an inappropriate impression about the degree of administrative mismanagement at the agency. 

Moreover, while the report may have harmed the SEC, the OIG may well come out of the budget battle better off than the agency as a whole.  As the article in the Washington Post notes:

• The committee made a point of guaranteeing a minimum level of funding — almost $6.8 million — for the office of the SEC inspector general, whose probes have criticized the agency and given its critics ammunition. 

An active and vigorous OIG is an important component of accountability.  The SEC probably needs to change its practices with respect to executing large leases.  But unnecessary criticism of under investigated topics takes away from the credibility of the office and should be avoided.     

The Renomination of Commissioner Aguilar

The Washington Post revealed that the Obama Administration has now sent two names to Congress with respect to membership on the Securities and Exchange Commission:  Commissioner Aguilar for reappointment and David Gallagher to fill the position that will be vacated by Commissioner Casey.  The appointments will maintain the political balance on the Commission with three democrats (although the Chair, Mary Schapiro, is actually an independent) and two republicans (Commissioner Paredes is the other).  Both still must be approved by the US Senate.  Nonetheless, with a republican and democrat paired, there is little reason to think that the nominations will encounter any difficulty. 

Commissioner Aguilar has been a solid, pro-investor, pro-enforcement vote.  Most noticeably, he has taken on the issue of diversity, both with respect to corporate boards and the Commission itself.  Improving diversity in both areas takes time and a second term at the Commission provides Commissioner Aguilar with greater opportunity to see progress on the issue.  In particular, he will be in a position for at least several more years to make sure that the new SEC disclosure requirements on diversity result in meaningful disclosure.  These are the kind of disclosure requirements that will slip into boilerplate oblivion unless companies get the message that the Commission is looking at them closely.  And for that to happen, there needs to be leadership at the top.  That leadership has just been renominated.