The recent fiery criticism leveled by U.S. Representatives and Senators at the Securities and Exchange Commission for allegedly dropping the ball on investigating Bernard Madoff and mishandling the financial crisis has prompted lawyers to dream big dreams about boosting SEC prosecutions of corporate and financial fraudsters.
The installation of Mary Schapiro as chairman of the commission and the Obama administration’s seeming taste for regulatory reform have also whetted legal appetites for the blood of greedy investment bankers. At a conference on the future of financial regulation last Wednesday, for instance, Donald Langevoort, a prominent securities-law professor at Georgetown, recommended that the SEC “has a lot to learn” from the Central Intelligence Agency’s methods of gathering information.
Recalling that an effort a few years ago to install a risk regulator at the SEC failed for political as well as practical reasons, he contended that the commission’s probes needed to rise to a “higher level of financial sophistication.” Langevoort conceded that for the SEC, a CIA-style investigation would be “a task that’s very difficult. It involves contacts; it involves people who are pouring over data, who are meeting with sources in the field.”
Still, given the crisis the country is in, such investigations are “going to be absolutely necessary going forward,” he said, noting that “the SEC as a financial intelligence agency [is] a theme I want to put on the table.”
Other participants found humor in the analogy. Jay Eisenhofer, an attorney who represents corporate shareholders, noted that “the idea that the SEC should become more like the CIA would have a lot of popular appeal” because it might involve “the rendition and torture of investment bankers.”
A member of the audience at conference, which was cosponsored by the Columbia Law School and the American Constitution Society for Law and Public Policy, suggested waterboarding as a proper punishment. Later, shareholder advocate Nell Minow added that although she wasn’t in favor of rendition for erring financial executives, she favored the old torture method of putting them in the stocks. “Let’s throw tomatoes,” she added.
Short of such extreme practices, Langevoort had some other suggestions for putting teeth into the SEC’s prosecution of securities laws. For years, he asserted, the commission’s might has been weakened by the “settlement culture” of its enforcement division. “The percentage of cases that are settled and that leave a lot on the table for both sides is far too great,” the professor said. “On issues of substantial investor-protection importance, the SEC has to be willing to go to trial.”
Within her first few days in office, Schapiro made it easier for the commission’s staff to launch formal probes of corporations. She also overturned her predecessor’s policy of requiring commission approval for levying fines against public companies. While Langevoort acknowledged that there was value in such moves, he suggested that a more important change would be for the SEC to “go much more heavily after individuals, as opposed to firms.”
Too often, he argued, “the commission has been willing to settle cases for fairly headline-making fines against the firm and then the executives get off sort of cheap.” To be sure, he added, “If you want to settle a case, that’s how you do it. The people in charge are much more willing to settle if they don’t have to pay out of their own pocket.”
A more basic problem, according to Langevoort, is in Section 304 of the Sarbanes-Oxley Act, which requires CFOs and CEOs to reimburse their companies for the bonuses and stock compensation they earned in the year following a restatement made because of misconduct. Calling it “a horribly drafted provision,” he said that it was on his “wish list that Congress rewrite 304 to make it both enforceable and sensible.”
In a paper he published in 2007 in the Wake Forest Law Review, he noted that under 304 as it exists now, company managers are motivated to resist making restatements — “or at least restatements that might be characterized as involving misconduct” — in order to avoid having their compensation clawed back. The SEC should “look to bring cases against both managers and auditors where companies apparently avoided restating in order not to trigger Section 304,” he wrote.
Not unexepectedly, Eisenhofer, the shareholder lawyer, argued that individuals, as well as the SEC, should be able to sue for executive clawbacks under Sarbox 304. “If persons received compensation because they have delivered returns which are supposedly in excess of market return, and it turns out those returns are illusory and eventually have to be written off and given back, why should they be entitled to receive or keep those bonuses and compensation?” he asked.
Minow agreed, arguing that more corporations should have clawback provisions in their bylaws. She cited a July 2008 report by The Corporate Library, the research organization she heads, that found that just 13 percent of 2,500 U.S. and Canadian companies have clawback provisions.