Regional Director Addresses Enforcement Issues

The SEC must speed up its investigative process, said Merri Jo Gillette, regional director of the SEC's Chicago regional office. According to Ms. Gillette, the Enforcement Division must bring more meaningful cases in a timely fashion to maximize the impact of the division's limited resources. She made her remarks at the 29th Annual Ray Garrett Jr. Corporate and Securities Law Institute presented by Northwestern University.

She reviewed several recent changes made with regard to enforcement procedures under Chairman Mary Schapiro. Initially, the Commission discontinued its two-year "penalty pilot" program which required the staff to obtain Commission approval before negotiating settlements involving civil monetary penalties. Ms. Gillette noted that the restrictions of the program precluded the staff from engaging in even very preliminary discussions on settlements without obtaining Commission approval. She also noted that the SEC had expedited the process for requesting formal orders of investigation. Previously, such requests had to go before the full Commission at a formal meeting for consideration, a process which could which could take several weeks. These orders, necessary for subpoena power and the authority to compel document production, may be issued by one commissioner acting as the agency's duty officer. The Commission is also working to improve its relationships with other oversight and law enforcement entities, such as state authorities, the Department of Justice and the TARP inspector general.

According to Ms. Gillette, a key enforcement priority is to assess and revamp the Commission's approach to dealing with complaints and tips from the public and referrals from other authorities. The SEC receives nearly 1.6 million such communications a year, she said. This information comes into the SEC through many different portals, however, and according to Ms. Gillette, the agency has only a "rudimentary" ability to track and monitor this data. The SEC has retained a private vendor to review its handling of incoming information.

Another priority is staff training and the development of new skill sets among the staff. Traditionally, the Enforcement Division has relied on lawyers and accountants, but according to Ms. Gillette, the SEC needs to develop its expertise in technology, financial analysis, trading strategies and complex financial products. A possible option for the division, she noted, is the development of enforcement teams, with specialized expertise and embedded resources. The SEC received an additional $20 million appropriation targeted for enforcement this year for these and other
projects.

In a brief review of the agency's enforcement docket, Ms. Gillette noted that there are currently over 150 hedge fund investigations currently open. These investigations involve matters such as alleged Ponzi schemes and misappropriations. More than 20 municipal bond offerings are under investigation, including possible offering and arbitrage fraud as well as public corruption. A similar number of cases involving subprime mortgages are under investigation, while more than 50 cases involving various derivatives are under investigation. A possible option for the division, she noted, is the development of enforcement teams, with specialized expertise and embedded resources.

The limited resources of the division require the SEC to adopt a strategic approach to its enforcement policy. A panelist, Steven F. Molo of Shearman & Sterling LLP, asked if the apparent focus on hedge funds and new financial products suggested a shift of enforcement priorities away from "traditional" concerns such as earnings management. Ms. Gillette strongly cautioned against any such assumption.

Ms. Gillette described how there are two categories of division actions involving potential violations of the securities laws. The first is the opening of a "matter under inquiry." MUIs are preliminary in nature and typically involve incomplete information. According to the division's enforcement manual, the threshold determination for opening a new MUI is low because the purpose of a MUI is to gather additional facts to help evaluate whether an investigation would be an appropriate use of resources. The next phase, an investigation, connotes more serious issues and are generally opened after the assigned staff has done additional information-gathering and analysis. Investigations may be either informal, with no compulsive authority, or formal, with the power to subpoena witnesses and compel document production.

She asserted that the SEC does understand the impact that the investigative process has on targets. However, she cautioned, in light of the agency's experience with the Madoff affair, that closing an inquiry or investigation too quickly can be "disastrous."

Mr. Molo stated that it is advisable once the SEC has given notice of its interest for counsel to meet with the staff. A key question is the conduct of the internal investigation. Mr. Molo suggested that the SEC may not be comfortable with an investigation conducted by the firm's regular counsel. An independent investigation may be appropriate, and board members may wish to retain independent counsel with regard to their involvement in the case. While it is not essential for the company to furnish the SEC with a report of the investigation, Ms. Gillette said that access to witnesses reinforces the division's sense of confidence and cooperation with regard to the company.

She strongly cautioned, however, against any attempt by the company to misrepresent the facts of the case or its involvement with any alleged wrongdoing. Communications in bad faith will bring any cooperative approach to a "screeching halt," she warned.

Finally, Ms. Gillette advised on the use of Wells submissions. The Commission does read and consider these statements, she stated. She cautioned, however, that respondents should not argue factual questions. Facts may be challenged later in the process, barring a clear mistake by the staff on factual matters. The commissioners want to see arguments of law and policy rather than facts at this stage. She also advised counsel to refer to the division manual and adhere to the page limits for Wells submissions (usually 40 pages) set forth in that publication.