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From Securities Regulation Daily, October 15, 2014

Piwowar says focus on “broken windows” could harm markets

By Matthew Garza, J.D.

SEC Commissioner Michael Piwowar criticized Chair Mary Jo White’s “broken windows” approach to enforcement at the 2014 Securities Enforcement Forum, telling the audience that “if every rule is a priority, then no rule is a priority.” He said the Commission may be failing to uphold due process rights by increasingly bringing enforcement actions through administrative proceedings instead of federal court, and he called for an interpretative release to clarify the SEC’s 2006 statement concerning financial penalties.

Broken windows. Chair White explained the law enforcement theory at last year’s Securities Enforcement Forum. The theory posits that when a broken window is fixed, it is a sign that disorder will not be tolerated. When a broken window is not fixed, it is a signal that breaking more windows costs nothing. Commissioner Piwowar took exception to the application of the theory in the securities compliance context, saying that regulatory compliance is not the ultimate goal of the Commission.

“If you create an environment in which regulatory compliance is the most important objective for market participants, then we will have lost sight of the underlying purpose for having regulation in the first place. Rather than enabling vital and important economic activity, we will have unnecessarily shackled it,” he said.

Piwowar said that, after a period of adjustment to the new personalities, the SEC is now handling enforcement matters in a productive manner, crediting Chair White and Enforcement Director Andrew Ceresney. But the increase in the number of enforcement actions alone should not be a source of pride to the SEC, said Piwowar. “Most Americans would be outraged if we measured the effectiveness of traffic safety efforts primarily based on the number of tickets issued by police officers and the amount of monetary fines collected.” Instead the focus should be on outcomes, such as a decrease in traffic deaths, he said. He also said he was concerned that the focus on measuring the success of enforcement efforts by measuring monetary sanctions could lead to a “subconscious shift of efforts to pursue those types of cases” by the nearly 1,300 members of the enforcement division.

Piwowar said enforcement policy is especially troublesome given the fact that the laws and rules that govern the industry are numerous and increasingly complex. The CFR now dedicates three volumes to securities regulations, and does not include the interpretations of law expressed by the staff through no-action letters, compliance and disclosure interpretations, FAQs, and comment letters. When Commission orders, especially in settled administrative enforcement actions, create new interpretations or impose new requirements, he said “we fail in our duty to uphold due process.”

Enforcement activities should be closely aligned with priorities developed by the SEC’s policy-making divisions, he said, but instead the chair’s current approach serves as an independent source of policy. He considers the aggressive use of enforcement measures as an alternative to rulemaking and essentially an end-around of the Administrative Procedure Act, which mandates a notice and comment period in rulemaking, and implements key due process protections.

Penalties framework. The commissioner called for a review of the statement concerning financial penalties levied against corporations, adopted unanimously by the Commission in 2006. The statement was issued as part of an effort to increase the transparency of the penalties process, which he said was not only desirable, but “mandated by the Constitution’s due process clause.” The 2006 framework principally considers the presence or absence of a direct benefit to the corporation as a result of the violation and the degree to which the penalty will recompense or further harm injured shareholders.

Piwowar said he was concerned that the statement may no longer be applicable, and some have questioned the role it should play in enforcement decisions. “If one disagrees with the 2006 penalty statement, then we should consider making revisions,” he said. In recent months, an increasing number of staff recommendations have not included an analysis of the principal factors described in the 2006 penalty statement. “If we were a publicly-traded company, then we would likely be subject to an investigation if we knowingly permitted a misleading statement to remain outstanding without corrective disclosure,” said Piwowar.

Former directors respond. Six SEC enforcement directors, including Director Ceresney, expressed their views on current enforcement polices at a panel later in the day. William McLucas, who headed the division between 1989 and 1997 and is now a partner at WilmerHale, said that the industry perceives Chair White’s broken windows approach as a zero tolerance policy. He said his clients believe that “any violation and you’re in the soup.” Director Ceresney responded that the policy was intended to sensitize the industry to the need for across-the-board compliance, and emphasized that the agency is looking for patterns of violations to indicate bigger problems.

Linda Chatman Thomsen, who served as enforcement director between 2005 and 2009, said that she understood that the SEC prefers to get violations of the law before they cause significant harm, but the challenge of the broken windows policy is finding correlation between small violations and large crimes. Punishing modest violations with disproportionally large fines could cause the policy to backfire, she warned.

Retired U.S. District Court Judge Stanley Sporkin, who directed the enforcement division from 1974 to 1981, disagreed with the criticism from the other former directors, all now active members of the defense bar, saying “you can’t be a law enforcement agency unless you enforce the law.” McLucas jokingly chided the comment, saying that Director Ceresney “doesn’t need any encouragement.”

Admissions policy. Ceresney also touted the Commission’s new emphasis on extracting admissions of wrong doing in more cases, pointing out that it has led to twice as many trials as last year, and five times as many jury trials. He bristled when Thomsen said the admissions policy was being used as leverage in negotiations. Ceresney said that should not be happening, and that all decisions regarding when to seek an admission of wrongdoing are made by the director. After the decision is made, he said, it is non-negotiable.

Ceresney also said that the enforcement division is using technology to its advantage more than ever. The SEC has billions of lines of data available to it through blue sheet reports and is now able to examine that data more effectively to determine patterns indicating illegal trading. He dismissed the criticism levied by Piwowar in his morning speech about the SEC’s departure from the 2006 statement concerning financial penalties, noting that it was never binding on the Commission.

He was unapologetic about the increase in enforcement cases filed as administrative proceedings, and flatly rejected Piwowar’s view that the use of admins implicates due process concerns. He said the Dodd-Frank Act granted the SEC more powers to bring cases before ALJs, and he has to consider all the tools in his toolbox to prevent fraud. He pointed out that the choice to bring a case before an ALJ limits some remedies, such as injunctions, allows quicker resolution of some matters, and allows defendants to appeal cases. George Canellos, former co-director of enforcement and current partner at Milbank, Tweed, Hadley & McCloy, pointed out that 80 percent of the division’s docket is made up of technical violations that are “ripe” for resolution through administrative proceedings.

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