The Securities and Exchange Commission- the agency responsible for enforcement of the U.S. securities laws- has been under fire for its lack of regulation, contributing to the financial crisis of 2008 since the smoke has been settling on the crisis and its causes.
The latest debacle is the SEC’s slow reaction to Congress’ mandate to change one sentence in the agency’s Regulation D. The Jumpstart Our Business Startups Act or JOBS Act, is a law intended to encourage funding of United States small businesses by easing various securities regulations. It passed with bipartisan support, and was signed into law by the President of the United States on April 5, 2012. One of its provisions is to modify Regulation D to lift the ban on general solicitation and advertising of unregistered securities to accredited investors. Congress set a deadline for this rule change to take effect in July 2012, but the Commission did not even propose new rules until September. Even now, critics of the proposed rules, including one Commission member, urge that the SEC not enact the rules mandated by Congress.
The provision in the JOBS Act reads: “(1) Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission. Section 230.506 of title 17, Code of Federal Regulations, as revised pursuant to this section, shall continue to be treated as a regulation issued under section 4(2) of the Securities Act of 1933 (15 U.S.C. 77d(2)). (2) Not later than 90 days after the date of enactment of this Act, the Securities and Exchange Commission shall revise subsection (d)(1) of section 230.144A of title 17, Code of Federal Regulations, to provide that securities sold under such revised exemption may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer.”
Recent revelations include criticism of the SEC by the New York Times for going after the little guys, and letting the big guys off the hook. Enforcement Director Robert Khuzami, in a letter to the Editor, attacked the article, citing that the agency has gone after large institutional defendants and that to just concentrate on the “big guys” would leave all kinds of financial fraud unregulated.
Bloomberg also recently reported that the SEC’s office in Washington is actively litigating 50 percent more cases than last year, which they attribute to more complex cases from the 2008 financial crisis (caused in part by the SEC) and a related increase in lawsuits filed against individual executives who are defending themselves instead of settling. Hence the recent dismissal of most of the SEC’s claims against IndyMac executives and the paltry $80,000 fine paid by its ex-CEO.
On the flip side, the SEC has also been criticized for its lack of zeal in prosecuting the “too big to fail” banks, who receive small fines in proportion to large scale fraud and waivers from injunctions and prosecution from the Commission. According to the Times, JP Morgan Chase settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.” Bank of America and Merrill Lynch have settled 15 fraud cases and received at least 39 waivers. Citigroup is the only financial giant that the SEC no longer grants waivers to, after settling six fraud cases and receiving 25 waivers, although their recently launched investigation into JP Morgan may add the largest bank to the list, albeit for what is really trading losses and not the litany of mortgage fraud that it committed leading to the 2008 crash. “The ramifications of losing those exemptions are enormous to these firms,” said David S. Ruder, a former S.E.C. chairman, in an interview. Without the waivers, agreeing to settle charges of securities fraud “might have vast repercussions affecting the ability of a firm to continue to stay in business,” he said.
This is particularly alarming given the destruction of key evidence that could have been used against the mega banks within the SEC’s offices by its own employees. According to former SEC employee and whistleblower Darcy Flynn, also reported by Taibbi, the agency routinely destroyed thousands of documents related to preliminary investigations of alleged crimes committed by Deutsche Bank, Goldman Sachs, Lehman Brothers, SAC Capital, and other financial companies involved in the crisis that the SEC was supposed to have been regulating. The documents included those relating to “Matters Under Inquiry”, or MUI, the name the SEC gives to the first stages of the investigation process. The tradition of destruction began as early as the 1990s. This SEC activity eventually caused a conflict with the National Archives and Records Administration when it was revealed to them in 2010 by Flynn. Flynn also described a meeting at SEC in which top staff discussed refusing to admit the destruction had taken place because it was possibly illegal.
Breaches of the law by the large Wall Street brokers also go unpunished. According to a recently published study by Berkeley Law professor Stavros Gadinis, at the Harvard Law School Forum on Corporate Governance, it has been three decades since any academic analysis of SEC enforcement actions against broker-dealers. In that time, Gadinis wrote, the information vacuum has been filled with complaints about the commission’s perceived foot-dragging and questions about the so-called revolving door between the SEC and private law firms. To add some substance to the discussion, Gadinis undertook what he said was the first systematic examination of SEC enforcement actions against broker-dealers — a category that includes major financial institutions — in 30 years, analyzing more than 400 cases finalized in 1998 and 2005-2007. (Gadinis added 1998 to the study so it would include cases brought in a Democratic administration.) His overall conclusion: Size matters, at least when you’re a broker-dealer facing off against the SEC. According to the prof’s data, firms with more than 1,000 employees fared much better than their smaller counterparts in terms of whether cases are brought against individual defendants; whether the SEC brought cases as administrative proceedings; and what kind of sanctions the SEC extracted. ”
Big firms and their employees were also likelier to face administrative proceedings — and not federal-court litigation — than their small-firm counterparts, according to the study. (Seventy-one percent of big-firm cases, compared to 41 percent of small-firm suits, were handled administratively.) There has been academic speculation that the SEC has been filing tougher cases as administrative proceedings, which are perceived to favor the commission, but Gadinis’s study discounted that theory. Instead, he considered it a benefit to defendants to resolve their cases in administrative proceedings, which generally involve less negative publicity.
But the critical problem with the SEC‘s enforcement policy is not their settlement policy, which has come under fire recently but has proven to be very effective in broad enforcement, but going after executives and attorneys for what amounts to alleged negligence in financial filings, instead of focusing on the wealth of fraud that is out there and more that is likely to occur with the upcoming crowd funding boom.
The SEC has been criticized for letting the big guys get away with murder and prosecuting the little guys for spitting on the sidewalk. By granting exemptions to laws and regulations that act as a deterrent to securities fraud, the SEC has let financial giants like Goldman Sachs and Bank of America continue to have advantages reserved for the most dependable companies, making it easier for them to raise money from investors, and to avoid liability from lawsuits if their financial forecasts turn out to be wrong and has, by contrast, punished companies like Dell, General Electric and United Rentals for misleading information in their disclosures.
But what should be the most troubling about SEC enforcement practices since it has increased enforcement since the crash has been the assault against lawyers. Lawyers are never popular until you need one, and they often place themselves at risk to protect their client’s confidentiality. Moreover, not only bad guys have attorneys, the good guys have them too. Khuzami, in a speech last June to a group of defense lawyers, criticized lawyers for their “questionable” behavior, citing multiple representation of witnesses with what appear to be adverse interests, multiple witnesses represented by the same counsel who adopt all the same implausible explanation of events, witnesses who answer “I do not recall” dozens of times in testimony, including in responses to basic and uncontroverted facts, counsel signaling to clients during testimony, and “questionable “tactics in document productions and internal investigations.
According to an article in the Wall Street Journal, the SEC is going after lawyers who examined certain mortgage bond deals before the crisis. More recently, they have prosecuted lawyers for writing legal opinions and, according to the SEC’s own head of the structured products enforcement unit, Kenneth Lench, the Commission is now questioning whether advice was given in good faith to determine whether to prosecute lawyers. The Commission has recently added more lawyers to its general counsel to take administrative actions against lawyers for “professional misconduct”.
By Kenneth Eade, Attorney at Law

About Ken Eade

Best selling author Kenneth G. Eade (Ken Eade, Kenneth Eade) is an international business lawyer, based in Los Angeles, California, specializing in international law, transactional and corporate law, complex business litigation, securities litigation, Contract Law, General Commercial and Business Law Matters, Licensing Agreements, and Mergers & Acquisitions. He is a member of the Bar of California, the federal District Court for the Central District of California, and the Ninth Circuit Court of Appeal. His previous experience over the past 30 years includes licensing, mergers and acquisitions, securities, collections, real estate, and bankruptcy. He holds a Juris Doctor in Law from Southwestern University School of Law, and a B.A. in Liberal Studies from California State University, Northridge. Mr. Eade is a member in good standing of the California State Bar, the federal Bar of the United States District Court for the Central District of California and the Ninth Circuit Court of Appeal. He is also an accomplished filmmaker and a free lance writer for the Los Angeles Daily Journal. Mr. Eade was recently presented with a plaque by Martindale Hubbel for his 30 years of service to the community as a California lawyer. In his 30 years' of practice, Mr. Eade has championed thousands of causes for individuals for their civil liberties and freedoms, and advocated the rights of small businesses and individuals against large special interest groups.
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