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Speech by SEC Staff:
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| The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or the staff of the Commission. |
Good afternoon, and thank you for that kind introduction. It's a pleasure to be here with you this year.
Despite my pleasure at being here, I realize there is a dark cloud hanging over all of us these days. Practically overnight, a system we'd all come to believe in has been exposed as plagued with weaknesses. As a result, we are being forced to grapple with difficult issues of fairness and integrity that we never anticipated. I'm sure you all would agree with me that, until we regain our trust and confidence in the judging of competitive figure skating, none of us will sleep well at night.
As you might have guessed, despite all the activity at the Commission these days, I've made a point of trying to catch at least a glimpse of the ongoing Winter Olympics. One of the things I've noticed is that in some of these sports, cutting a tenth of a second, or even a hundredth of a second, from your time can be viewed as groundbreaking, even revolutionary. With that in mind, I'm considering asking Chairman Pitt to grade my execution of his real-time enforcement initiative on the same scale.
Turning now from the Olympics to another symbol of national pride - our securities markets, today I would like to share with you my views, and they are only my views and not necessarily those of the Commission or its staff, on how, in the current climate of concern, the SEC's enforcement program can, and will, effectively respond to the seeming rash of financial fraud and reporting problems plaguing our markets.
There is no denying that for investors, this is an anxious time to participate in the securities markets. Each day seems to bring a new restatement, revelation, or allegation that calls into doubt the accuracy or completeness of another company's financial statements or disclosures. Those who have expressed grave concern about maintaining investor confidence in U.S. markets are not merely crying wolf. Certainly, in my view, there has never been a better time to consider wide-ranging and meaningful policy reform. But investor confidence also requires swift and sure enforcement action against those who have broken the law. I believe we must, more than ever before, respond swiftly and vigorously to abuses of the financial reporting system. Effective enforcement of our federal securities laws is a critical component of restoring -- and maintaining - investor confidence in the fairness and transparency of our securities markets. And I think we're well positioned, at this moment in time, to do that.
As tragic as the consequences of Enron's collapse have been, surprisingly, at least some small benefit has flowed from it. The public's sensitivity to and understanding of the risks from financial reporting failures have become extraordinarily heightened. Whether due to investor education efforts, like those undertaken by the Commission and other public and private groups, or the glut of newspaper and other media reports, investors in, and employees of, public companies are increasingly alert to possible financial misconduct. As a result, they are contacting the SEC with potential investigative leads in unprecedented numbers. Of course, the Commission's own Division of Corporation Finance is a great source of leads - and as you know, they are monitoring the annual reports filed by the Fortune 500 companies.
But as you also undoubtedly know, many of our investigations flow from complaints or other submissions by members of the public. And on that score, just listen to what has happened as of late:
Because of this phenomenon, among other reasons, we are learning of potential securities law violations earlier than ever before. If we can stop frauds in their tracks or, better yet, even before they occur, this will go a long way towards restoring investor confidence in our markets. So, all I can say is, keep those cards and letters, not to mention emails, coming.
The second reason I'm optimistic about our ability to respond to this perceived crisis of confidence in our markets is Chairman Pitt's real-time enforcement initiative. The goal of real-time enforcement is to protect investors. It achieves that goal three ways: (1) by stopping illegal conduct expeditiously and preventing dissipation of improperly obtained investor funds; (2) by compelling disclosure of questionable conduct on a timely basis so that the public can make informed investment decisions; and (3) by deterring future misconduct through imposing swift and stiff sanctions on those who commit egregious frauds, repeatedly abuse investor trust, or attempt to impede the Commission's investigatory processes. Let me expand on each of these points.
The primary tool available to the Commission to stop an ongoing securities fraud is to obtain an emergency court order halting the misconduct. Simultaneously, we can ask the court to freeze the assets of the wrongdoers to prevent their continued use of investor funds obtained through fraud. This is the first step toward returning such ill-gotten gains to defrauded investors. I am pleased to say that we now are using these two tools - temporary restraining orders (TROs) and asset freezes - to protect investors at an extraordinary rate. The following statistics tell the tale:
The second means by which real-time enforcement enhances investor protection is by disseminating information about questionable conduct by public companies as quickly as possible. This helps ensure that individual investors are not at an informational disadvantage compared to company insiders. The Commission's enforcement program accomplishes this goal through a variety of means. Among them is suspending trading in the stock of a public company about which there is inaccurate material information in the marketplace. In all of fiscal year 2001, the Commission utilized this tool just twice. In contrast, in the first four months of fiscal year 2002, the Commission has suspended trading in the securities of 4 public companies.
Despite this increase, rest assured that we do not seek trading suspensions lightly. We recognize that they severely constrain liquidity, and can frustrate existing shareholders. However, these actions serve an important investor protection purpose, and we won't hesitate to use them where appropriate.
For the same reason, real-time enforcement focuses on conducting investigations and bringing enforcement actions more quickly than ever before. By filing an action promptly, the Commission causes its findings or allegations of wrongdoing to become public in a timely fashion, thus enabling investors to consider this highly relevant information when making investment decisions. Of course, doing this in the financial reporting area is a real challenge. Investigations of financial reporting misconduct are among the most complex, labor-intensive, and time-consuming investigations we do. There are invariably limits to how fast we can go, and we're not going to sacrifice getting it right in favor of doing it quickly. In addition, parallel criminal investigations often result in delays to our actions, but we're willing to live with the delays because criminal prosecutions are, in our view, terribly important to achieving deterrence, and, in the long run, investor protection. In fact, for just that reason, we've made a concerted effort to increase criminal prosecutions of securities fraud.
Certainly one of the ways to speed things up - even in the context of financial fraud investigations -- is to become less tolerant of delaying tactics by those we investigate. The staff will insist on, and enforce, tighter deadlines for production of documents and appearances for testimony. When these deadlines are unreasonably disregarded, we will seek to enforce our subpoenas in federal court. Already this fiscal year, the Commission has brought ten actions to enforce subpoenas for documents or testimony. In all of fiscal year 2001, we employed this tool only thirteen times. Because our goal is to uncover the facts and bring possible misconduct into public view as quickly as possible, you can expect more of these actions in the future. I have delegated authority to approve the filing of subpoena enforcement actions, and I'll let you in on a little secret: I haven't seen one yet that I've been tempted to reject.
I also anticipate that the Commission will be more willing than ever to seek civil penalties against public companies that drag their feet during the course of an investigation. Historically, there has been a reluctance to impose civil money penalties on public companies in financial fraud cases, on the theory that their cost would be passed along to shareholders who already had suffered as a result of the issuer's securities violations. When confronted with recalcitrance by company management, however, I believe we would be justified in seeking penalties. To those who say this results in costs to shareholders, I say, they are costs imposed by wrongheaded management, not by the SEC.
Another means we're employing to bring our actions more quickly is breaking cases into pieces, so that we sue categories of wrongdoers - the company, its officers, the auditors -- separately. For example, in our case involving Waste Management's financial statements, we sued the company's auditor, Arthur Andersen, last year, but our investigation of the matter is continuing.1 Similarly, we already have brought actions against the former senior officers of McKesson HBOC in connection with a massive financial fraud at HBOC; that investigation is continuing as well.2
Real-time enforcement also aims to get important issuer information to the investing public expeditiously by rewarding cooperation. The Commission's policy on rewarding cooperation was articulated in a recent 21(a) report, which has received considerable attention.3 Those of you who are familiar with it know that to receive maximum credit for cooperation, a public company must, among other things, promptly disclose, both to the regulators and the public, the wrongdoing it discovers. This critical component of the Commission's cooperation model clearly illustrates the premium it places on forcing significant news into the public domain quickly, so that individuals can make the most informed investment decisions possible.
The third facet of real-time enforcement that results in enhanced investor protection is the approach it prescribes for dealing with those who attempt to impede the Commission's investigatory processes, violate the securities laws on multiple occasions, or engage in deliberate wrongdoing. This is an aspect of real-time enforcement that may have been somewhat overlooked by the defense bar. Real-time enforcement, as embodied in the 21(a) report, is not only about offering a more enticing carrot. Let me assure you, it also calls for brandishing a bigger stick.
As I alluded to, there are three categories of violators, in particular, against whom, I think, the Commission will be seeking stiffer sanctions: (1) those who interfere with Commission processes, (2) recidivists, and (3) deliberate wrongdoers. We also will work with criminal authorities in these categories of cases. Let me give you some examples of the success we're already having with the first two categories.
The third category of securities law violators against whom the Division will seek tougher sanctions are those who engage in deliberate and egregious misconduct, particularly when they abuse positions of shareholder trust. Recent accounting scandals have focused attention on the critical responsibilities and obligations of officers and directors of public companies, and the consequences that follow when they place their own interests ahead of those of the company or its shareholders.
For several reasons, the need for public companies to have well qualified, deeply-engaged, fundamentally honest officers and directors has become more critical than ever. First, as participation in our markets has grown over the last several years, more and more people have, indirectly, put their savings, and their trust, in the hands of officers and directors of public companies. A total of 78.7 million individuals owned equities in early 1999, a level 85.6 percent higher than in 1983.7 Put another way, as of 1999, 48% of all U.S. households owned equities directly or indirectly through stock mutual funds.8
At the same time, companies are developing ever more complex products, services, and business models, making it more difficult for the average investor to readily understand and analyze a company's operations. Finally, the complicated nature of required public disclosures, including financial statement disclosures, guarantees that investors frequently cannot detect from publicly available information whether a company is experiencing difficulties. As an aside, I think the Commission's statements on MD&A and accounting principles disclosures and the rule proposals outlined earlier this week, if adopted, should help immensely in this area.9 These factors, in combination, suggest that investors, in growing numbers, have little choice but to rely on the competence and integrity of public-company officers and directors, and they have more to lose than ever, should their reliance prove unfounded.
In this environment, it is essential that the Commission find ways to deter wrongdoing by individuals who hold these positions of public trust. One way of doing so is to heighten the personal accountability of officers and directors who elect to place their own interests ahead of those of the company or its shareholders. Criminal sanctions are the ultimate means of achieving this effect, and we will work closely with U.S. Attorneys' Offices to obtain such sanctions as appropriate. But not every case is criminal, of course. In our own cases, the concept of personal accountability dictates that the Commission seek substantial civil penalties against officers and directors who commit serious fraud. Indeed, there has been a concerted effort to ratchet up the penalties we seek from corporate wrongdoers. You may recall that when the Commission brought its actions against MicroStrategy and three of its executive officers, the individual defendants agreed to pay civil penalties of $350,000 each.10
However, monetary penalties -- often paid by O and D insurance policies or otherwise insignificant to wealthy wrongdoers -- are not always sufficient to achieve the deterrence we seek. Accordingly, the Division intends to expand its use of a remedy that, in my view, has been sought too infrequently by the Commission, has been imposed on too limited a basis by Courts, and is needed now, more than ever to respond to large financial frauds, which no longer seem rare. That remedy is the officer and director bar.
Congress provided the Commission explicit authority to seek officer and director bars in 1990, as part of the Securities Enforcement Remedies and Penny Stock Reform Act (Remedies Act). However, even prior to 1990, the SEC had requested that courts use their general equitable powers to bar future service as an officer or director, and successfully obtained such bars against approximately 100 individuals. The statutory authority provided by the Remedies Act enables the Commission to seek an officer and director bar against any individual who violates Section 10(b) of the Exchange Act or Section 17(a)(1) of the Securities Act, and whose "conduct demonstrates substantial unfitness to serve as an officer or director" of a public company. Unfortunately, this second prerequisite - that a person be substantially unfit, a requirement that one might suppose was implicit in the first requirement, that the person have committed scienter-based fraud -- has spawned a burdensome and overly restrictive test for imposing officer and director bars.11
The Remedies Act does not explain what is required to demonstrate "substantial unfitness to serve as an officer or director." As we all know, however, law professors, like nature, abhor a vacuum. Thus, in 1992, one professor authored a law review article that proposed a multi-part test for establishing "substantial unfitness,"12 and this article has proven to be influential. Several courts latched onto the test proposed in this article,13 and, unfortunately, that test now seems to have taken on a life of its own.
The six-part test, which requires, among other things, a showing that the misconduct at issue is likely to recur, has created an unreasonably high standard for obtaining a bar. The result has been, unbelievably, that in some cases courts have refused to impose permanent officer and director bars on individuals who have engaged in egregious - even criminal- misconduct. It is hard to imagine that this is what Congress had in mind when it adopted a provision that surely was intended to facilitate the Commission's ability to obtain O and D bars.14 Let me give you three examples of what I'm referring to:
"Based upon the record, a permanent officer or director bar is not appropriate. Farrell's securities violations were serious and he did engage in fraudulent conduct in the hopes that his illegal activities would not be discovered. However, upon release from prison, he should not be barred from holding any other officer or director positions . . . Farrell is a talented executive and a permanent bar would effectively prevent him from using those talents to rebuild his life."16
When confronted with these cases, it is hard for me, at least, to avoid the conclusion that, when it comes to O and D bars, the courts have simply lost their way. And because the Commission is compelled to seek in court only what it realistically can expect to obtain, the Commission has become a victim of this misdirection as well. Now is the time to reverse this course, however. I am steadfastly determined to be more aggressive in seeking officer and director bars. Indeed, despite our limited success to date in obtaining O and D bars in insider trading cases, the Commission recently filed such an action against two brothers, George and Peter Matus, for trading on inside information that George obtained as an officer of Carreker Corporation. In that case, the Commission is seeking a permanent O and D bar against George Matus.21
While obtaining more officer and director bars may be an uphill battle, the trends suggest we are moving in the right direction. In fiscal year 2000, the Commission sought 14 officer and director bars in financial fraud and reporting cases, whereas last year, in FY 2001, we sought more than twice that number, for a total of 33. I wouldn't anticipate a reversal of this trend.
The role of officers and directors is far too important to allow those with a questionable commitment to the interests of shareholders to serve. There is nothing preventing the courts - certainly not the statutory language of the Remedies Act - from viewing a finding that a person engaged in scienter-based securities fraud as a basis for deeming him or her substantially unfit. Don't get me wrong; I'm not proposing that an O and D bar be imposed in every case where there's a violation of Section 10(b) or Section 17(a)(1). Clearly that was not what Congress intended or what the Commission said it wanted when the Remedies Act was proposed. But, assuming there was ever a time that it was rational to view a corporate officer who was a central participant in a substantial securities fraud as qualified to serve as an officer or director, that time has certainly passed. In today's complex economy and volatile markets, a single, serious breach of the public trust, in my view, undeniably renders one "substantially unfit" for service as an officer or director. The layering on of additional tests simply frustrates the goals of the statute and endangers the interests of the investing public.
Congress could also help in this area by granting the Commission the authority to impose officer and director bars in administrative proceedings. Such an expansion of Commission authority would help make imposition of officer and director bars swifter and more certain. This greater flexibility would not only reinforce the O and D bar's deterrent effect, it also would provide the Commission a wider array of tools with which to combat financial fraud. With or without this additional authority, however, by subjecting corporate wrongdoers to restrictions on their ability to serve in high-paying positions of authority and respect, I believe we will succeed in causing others to think twice about crossing the line.
I hope you no longer view my confidence in the Commission's ability to respond to the current circumstances as a product of cock-eyed optimism, but rather as the view of a determined realist. The results we are achieving under real-time enforcement already provide evidence that the Commission, through its enforcement program, has the tools and the will to make enhanced investor protection not just its aspiration, but a reality. By acting quickly to halt misconduct and preserve investor assets, forcing material information into the public domain in a timely manner, and seeking the harshest sanctions, including officer and director bars, against deliberate wrongdoers, the Commission will help ensure that the U.S. markets continue to be the envy of the world.
Thank you.
| 1 | SEC v. Arthur Andersen LLP, Robert E. Allgyer, Walter Cercavschi, and Edward G. Maier, Litigation Rel. No. 17039, June 19, 2001. |
| 2 | SEC v. Jay Lapine and SEC v. Michael Smeraski, Timothy Heyerdahl, Deborah Mattiford, Elaine Decker, and David Held, Litigation Rel. No. 17189, Oct. 15, 2001; SEC v. Jay Gilbertson, Albert Bergonzi and Dominick Derosa, Litigation Rel. No. 16743, Oct.2, 2000. |
| 3 | "Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions," Securities Exchange Act Release No. 44969, Oct. 23, 2001. |
| 4 | United States v. Patrick H. McCarthy III, Litigation Rel. No. 17275, Dec. 17, 2001. |
| 5 | United States v. Steven H. Adler, Litigation Rel. No. 17238, Nov. 16, 2001; In the Matter of Vector Index Advisors, Inc. and Steven H. Adler, Securities Exchange Act Release No. 45064, Nov. 15, 2001. |
| 6 | SEC v. Mustang Development Corp., Tower Operating Company, Neal B. Stein, Cary S. Greene and Samuel Embras, Jr., Litigation Rel. No. 17224, Nov. 7, 2001. |
| 7 | "Equity Ownership in America," Investment Company Institute and the Securities Industry Association, at 5, Fall 1999. |
| 8 | "Equity Ownership in America," Investment Company Institute and the Securities Industry Association, at 5, Fall 1999. |
| 9 | "Commission Statement about Management's Discussion and Analysis of Financial Condition and Results of Operations," Securities Act Rel. No. 8056, Jan. 22, 2002; "Cautionary Advice Regarding Disclosure About Critical Accounting Policies," Securities Act Rel. No. 8040, Dec. 12, 2001; "SEC to Propose New Corporate Disclosure Rules," Press Rel. No. 2002-22, Feb. 13, 2002. |
| 10 | SEC v. Michael Jerry Saylor, Sanjeev Kumar Bansal and Mark Steven Lynch, Litigation Rel. No. 16829, Dec. 14, 2000. |
| 11 | See Donald C. Langevoort, "Seeking Sunlight in Santa Fe's Shadow: The SEC's Pursuit of Managerial Accountability," 79 Wash. U. L.Q. 449, 466-67 (Summer 2001) ("[W]ith respect to the officer and director bar authority that Congress granted the SEC in 1990, one can readily assume that any CEO who deliberately engineers a significant securities fraud deserves for that reason alone (absent some strong shareholder-oriented justification) to be removed from his job. However the courts have superimposed additional requirements that make such an order far more difficult to obtain. What would have been a strong threat becomes much more muted.") (citation omitted) |
| 12 | Jayne W. Barnard, "When Is A Corporate Executive Substantially Unfit to Serve'?" 70 N.C. L. Rev. 1489 (1992). |
| 13 | See e.g., Securities and Exchange Commission v. Shah, 1993 WL 288285, *7 (S.D.N.Y. July 28, 1993) ("To date, no court has construed the meaning of substantial unfitness.' A framework for interpreting substantial unfitness' is proposed in a recent article by Professor Jayne Barnard.") |
| 14 | "Congress' express purpose in empowering the federal courts to issue such bars was to combat recidivism and protect investors' and to strengthen the remedial effect of the SEC's enforcement program.'" Securities and Exchange Commission v. Drexel Burnham Lambert Inc., et al., 837 F.Supp. 587, 613 (S.D.N.Y. 1993), citing S.Rep. No. 337, 101st Cong., 2d Sess. 1-2 (1990). |
| 15 | 1996 WL 788367 (W.D.N.Y. Nov. 6, 1996) |
| 16 | SEC v. Farrell, 1996 WL 788367 at *8 (citation omitted). |
| 17 | 2001 WL 1029053 (S.D.N.Y. Sept. 6, 2001). |
| 18 | SEC v. McCaskey, 2001 WL 1029053 at *6-*7. |
| 19 | 63 F.3d 137 (2d Cir. 1995). |
| 20 | SEC v. Patel, 63 F.3d at 142. |
| 21 | SEC v. George P. Matus and Peter T. Matus, Litigation Rel. No. 17259, Dec. 5, 2001. |
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