The successful evolution of the SEC
By Douglas Shulman, Director, Regulatory Compliance, Kinetic Partners – The Madoff fraud was a turning point for the regulatory environment and the US Securities and Exchange Commission (the “SEC” or the “Commission”).
The Commission suffered great damage to its reputation, as it was roundly criticized in the media for missing the long-standing Madoff fraud.
The frustration of the public grew as Madoff’s firm was: (i) registered with the SEC, (ii) the subject of several complaints and tips regarding the Ponzi scheme and (iii) had undergone an SEC examination. Questions abounding in the news media included: How could the SEC miss the fraud? What happened during that SEC examination? Should the SEC be dismantled; or lose regulatory authority to another agency?
The SEC recognized the need for imminent action and their Office of Investigations shortly thereafter published a 456 page report titled “Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme” that reviewed, in great detail, the issues behind missing the fraud, as well as the errors that occurred throughout the examination of Madoff’s firm. To the SEC’s credit, they recognized the need for improvement and have spent the last several years enhancing its infrastructure and enforcement capabilities.
Recent developments show that the SEC has not only been successful in strengthening itself on a substantive level, but has also strengthened its reputation in the public eye.
A New and Improved SEC
Post Madoff, the SEC set out to improve its examination program and strengthen its enforcement capabilities. It has succeeded on both fronts.
The SEC announced in a press release on January 13, 2010 that its Enforcement Division had “named leaders of national specialized units it has established in five priority areas dedicated to particular highly specialized and complex areas of securities law. The Division also has created a new Office of Market Intelligence that is responsible for the collection, analysis, and monitoring of the hundreds of thousands of tips, complaints, and referrals that the SEC receives each year.”
These five priority areas are (i) Asset Management, (ii) Market Abuse, (iii) Structured and New Products, (iv) Foreign Corrupt Practices and (v) Municipal Securities and Public Pensions. The Commission noted in the press release that the SEC Enforcement Divisionwas undertaking the most significant reorganization since its establishment in 1972.
The focus on building skill sets of the SEC Staff was made clear in separate remarks by the then SEC Enforcement Director, Robert Khuzami, as he stated, “These specialized units address both challenges through improved understanding of complex products and markets, earlier and better capability to detect emerging fraud and misconduct, greater capacity to file cases with strike-force speed, and an increase in expertise throughout the Division.”
Further, the SEC’s Office of Compliance Inspections took steps in 2012 to strengthen their technology knowledge and skill sets by forming the Quantitative Analytics Unit (the “QAU”). The QAU is staffed with highly-skilled employees (including PhDs) with trading knowledge and a strong understanding of mathematical models used to make trading decisions.
The QAU uses quantitative analytics to understand how firms manage risks posed by technology and trading models. It is targeting quantitative, model-based firms and is taking a long, hard look at the compliance controls surrounding these models.
The SEC is clearly a much stronger agency than in 2008 – and the enforcement statistics evidence their tremendous progress.
Recent Enforcement Statistics
The SEC has continued to increase the number of enforcement actions over the last several years. As noted in the SEC press release 2012-227, the Commission announced it filed 734 enforcement actions in year-end September 30, 2012 (one short of the 735 filed as of year-end September 30, 2011.).
A number of additional statistics from the press release include:
- The SEC filed 147 enforcement actions in 2012 against investment advisers and investment companies, one more than the previous year’s record number.
- The SEC filed 134 enforcement actions related to broker-dealers, a 19 percent increase over the previous year.
- The SEC filed 58 Insider Trading cases for year-end 2012 and 57 Insider Trading cases for year-end 2011.
- For 2011 and 2012, the SEC obtained orders for USD5.9 billion in penalties and disgorgement.
As stated in the press release, “The results in 2012 were aided by many of the reforms and innovations put in place in the past two years, such as increased expertise in complex and emerging financial markets, products, and transactions, including through enhanced training, the hiring of industry experts, and the creation of specialized enforcement units focused on high-priority misconduct...”
To sum, the SEC has continued to make enforcement a focus. The SEC of 2013 has highly-skilled staff with a clear directive to ensure each examination gets the proper attention before it is completed. The inevitable result is longer and focused examinations, with more enforcement actions being filed against firms.
The message is clear – the pendulum has swung and firms would be well-suited to ensure their compliance program and employees are adequately prepared to meet this heightened regulatory scrutiny.
 SEC Office of Investigations, Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme, Report No. OIG-509 (August 31, 2009).
 SEC press release 2010-5 titled “SEC Names Specialized Unit Chiefs and Head of New Office of Market Intelligence.” (January 13, 2010).
 Speech by SEC Staff: Remarks at News Conference Announcing Enforcement Cooperation Initiative and New Senior Leaders (January 13, 2010).
 SEC press release 2012-227 titled “SEC’s Enforcement Program Continues to Show Strong Results in Safeguarding Investors and Markets. (November 14, 2012).
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