Introduction
The recent financial crisis has led to much regulatory ferment, along with public outrage at the apparent lapses of market oversight by the U.S. Securities and Exchange Commission (SEC or the Commission). One outgrowth of this phenomenon is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which (in part) required the SEC to hire an independent consultant to assess its internal operations, structure, funding, and relationship with Self-Regulating Organizations (SROs) in an effort to identify "improvements" to the Commission.1 The assessment was conducted by the Boston Consulting Group, which spent six months reviewing documents, analyzing data, and interviewing hundreds of current and former SEC officials, regulated entities, peer regulators, SROs, and industry groups. The result is a 263-page BCG Report (Report), published on March 10, 2011, and setting forth 16 specific recommendations in four categories.2
Of particular interest to issuers and regulated entities is whether and how any of these recommendations — if implemented — will affect the SEC's Division of Enforcement (Enforcement or the Division). Ironically, although Enforcement is included in the Report, it appears that this SEC Division's own damage-control steps at reorganization in the wake of the Madoff scandal spared it from being the subject of any material criticism or recommendations in the Report. Indeed, Enforcement will benefit from recommendations involving more rational allocation of cases among regional offices, personnel enhancements, and additional co-opting of SROs' resources, and these benefits do not appear to require any diversion of resources or funds from Enforcement's budget. Accordingly — and ironically — it appears that Enforcement will emerge a winner under Dodd-Frank.
Pre-BCG Report Efforts To Improve Enforcement
The SEC's own reorganization of Enforcement, which began in 2009, provides important context for the Report. Heralded in the Report and elsewhere as an SEC success story, the restructuring of Enforcement was initiated by the SEC with the goal of increasing the efficiency and expertise with which the Division handles its case. Of chief impact, a new "Managing Executive" position was created and charged with project management and division-wide operational workflow, and a new "Office of Market Intelligence" was made responsible for collecting, risk-weighting, triaging, and referring tips, complaints, and referrals. In addition, five new national units were dedicated to highly-specialized and complex areas of the securities industry (Asset Management, Market Abuse, Structured and New Products, Foreign Corrupt Practices Act, and Municipal Securities and Public Pensions), a move that has already proven successful. Although only approximately 25 percent of Enforcement personnel are assigned to specialized units, which draw upon all of the regional offices,3 the result has been a flexible network of experts that has brought the entire Division closer together.
This increase in cooperation among the 11 regional offices has been one of the most positive side-effects of the reorganization. The 11 Regional Directors and their Associate Directors now have weekly meetings by videoconference, and a Cooperation Committee was established to assist with cooperation between Headquarters and the regional offices.
Notably, former SEC General Counsel and Chairman Harvey Pitt recently testified before Congress about the Report and pending legislation aimed at reforming the SEC.4 Along with chastising Congress for broadening the SEC's mandate without increasing its budget, Mr. Pitt praised the reorganization of Enforcement. He noted that, to date, the reorganization has eliminated a full layer of management to streamline the Division's internal management and processes, creating immediate efficiencies. Mr. Pitt also observed that the ongoing success of Enforcement's reorganization, and the fact that the SEC voluntarily undertook that process, demonstrates that the Commission can be relied upon to respond intelligently and effectively to its responsibilities. Criticizing Dodd-Frank, Mr. Pitt further commented that it has undermined the SEC's impetus to improve itself, by mandating the creation of new divisions and by dictating the manner in which those new divisions are worked into the chain of command. Only time will tell whether Mr. Pitt's opinions will prove correct, but it is clear that the reorganization of Enforcement at least blunted the impact of the Report, given that its recommendations do not directly involve — but secondarily benefit — Enforcement.
Recommendations of the Report and Their Likely Effects on Enforcement
The Report contains information, analysis, and commentary on nearly every aspect of the SEC. Overall, the vast majority of its recommendations relate to the organizational structure and regulatory activities of the SEC other than Enforcement, although the implementation of these recommendations will have ripple effects on Enforcement. As described by the Report, its 16 "optimization initiatives" fall into four self-described categories: (1) reprioritizing regulatory activities; (2) reshaping the organization; (3) investing in infrastructure; and (4) enhancing the SRO engagement model.
To Reprioritize Regulatory Activities, the Report tasks the SEC with undertaking a "rigorous" assessment to identify its highest-priority needs in regulatory policy and then reallocate its resources accordingly. This category is at least partially a result of the Report's overarching conclusion regarding the chasm between the SEC's resources and its responsibilities. Because the SEC cannot make every recommendation its first priority, this first initiative lays out an internal, "reprioritizing" approach to improving regulation. This is particularly important as the SEC's market oversight (or perceived lack thereof) has been the subject of much intense public criticism, particularly in the wake of the Madoff and Allen Stanford scandals. The Report breaks this initiative into four subcategories: (1) high priority activities that SEC management deems critical to strengthen commerce; (2) activities that the SEC could, if necessary, scale back or stop entirely; (3) activities where the SEC could consider delegating responsibilities externally (e.g., to SROs like FINRA); and (4) congressionally-mandated activities where SEC management could request implementation flexibility. Although regulation is the flip-side of enforcement — the law-making counterpart to Enforcement's prosecution of law-breaking — this initiative does not appear to portend any direct, near-term effects on Enforcement's activities, given the Division's already high priority at the SEC.
In Reshaping the Organization, the Report recommends systematically redesigning the structure, roles, and governance of the SEC's many divisions in light of its reprioritized regulatory activities (noted above). Of particular interest to Enforcement is the recommendation that the SEC review its regional model because there appears to be no articulated strategy for the location, activities, or roles of the 11 regional offices. Enforcement is one of several divisions that likely suffers from a lack of clarity and duplication of roles among the offices. For example, cases are currently assigned based on the geographic nexus of the activity underlying the case; but because headquarters (in Washington, DC) has no assigned geographic jurisdiction, there are often turf battles over the assignment of cases, plus duplication of work, before the official assignment occurs. A review of the strengths and expertise of regional personnel could go far in ensuring that cases are quickly and appropriately assigned. Separately, the Report recommends seeking flexibility from Congress on certain new Dodd-Frank mandated "offices" — four of which are supposed to report directly to the Commissioners — which the Report finds will be less efficient than incorporating these new divisions into the existing hierarchy. Whether any of these "offices" might be rolled into Enforcement is not yet determined. It is clear, however, that a more rational approach to regional office utilization will benefit Enforcement by improving efficiency and decisiveness in enforcement matters.
In Investing in Enabling Infrastructure, the Report encourages the SEC to enhance its existing technology to improve the availability and sharing of information, and to execute a redesign of the Office of Human Resources. If the recommended Technology Center for Excellence is implemented, this could greatly aid Enforcement in the fact-finding and market analysis aspects of their cases. Additionally, the Report recommends a redesign of the Office of Human Resources, an enhanced role for the HR manager, a centralized training program for SEC personnel, and the roll-out of a new performance management system. The Report also discusses the SEC's need to hire and retain personnel with certain high-priority skills. For Enforcement, this could be experienced trial attorneys, as well as top-tier candidates from the private sector with experience in securities litigation. Accordingly, it is likely that this initiative will result in an enhancement to the quality and effectiveness of Enforcement's legal personnel.
Fourth and finally, the Report describes an initiative dedicated to Enhancing the SRO Engagement Model. SROs are endowed by statute with regulatory authority over specific segments of the market and the power to make policy, survey markets, mandate registration of market participants, and coordinate peer regulators. Examples of SROs include the stock exchanges (NYSE, NASDAQ), market oversight organizations (FINRA, FASB), and clearing corporations (National Securities Clearing Corporation, Options Clearing Corporation). The SEC oversees these activities through inspections or approving SRO rule proposals, and may also regulate alongside them when pursuing joint enforcement actions. The Report notes that the SEC has come to rely heavily on SROs as the financial markets have become more technical and the volume of trading has greatly outpaced the increase in SEC funding. While this is to be expected, and may in fact be a good way to stretch the SEC's budget, the Report suggests the creation of a central coordinating body to oversee the SROs, ensure their compliance with certain regulations, and also ensure that the SEC fully benefits from their expertise. If unfunded, of course, this mandate could divert some portion of SEC resources away from Enforcement. Otherwise, it is likely to benefit Enforcement because greater co-opting of SRO personnel and expertise could improve the reach and scope of Enforcement's activity.
Conclusion: What Lies Ahead for Enforcement and the SEC?
The SEC has formally responded to the Report,5 as required by Dodd-Frank, and Mary Schapiro, current Chairman of the SEC, has testified before the U.S. House of Representatives Committee on Financial Services regarding the SEC's response.6 In general, the SEC's reaction has been positive and the Commission is well under way executing some of the Report's more urgent recommendations.
One point the Report makes, and one that both Mr. Pitt and Chairman Schapiro emphasized in their remarks before Congress, is the need to close the ever widening gap between the SEC's congressional mandate and its funding. The Report flatly challenges Congress to either give the SEC the resources it needs to fulfill its extensive list of responsibilities (a list that is only lengthened by Dodd- Frank), or to narrow its responsibilities in light of its current level of funding. Dodd-Frank requires the SEC to write and enforce over 100 new rules and expands the SEC's regulatory and enforcement activities to cover managers of private funds, derivatives, credit rating agencies, asset-backed securitization, and corporate governance reform.
Although Enforcement is the indirect beneficiary of the Report's recommendations, the increased responsibilities imposed on the SEC by Dodd-Frank — if left unfunded — could strain Enforcement resources as a trickle-down effect of strains on the Commission overall. Given the prominent public role of Enforcement, however, it seems certain that Congress (and the SEC itself) will do all they can to prevent this situation. Accordingly, in all likelihood, it appears that Enforcement will emerge from Dodd-Frank a winner — despite the fact that its own lapses were a primary impetus for Dodd-Frank and the Report in the first place.
Footnotes
1 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 967, 15 U.S.C. § 78n (2010).
2 The full text of the BCG Report is available at www.sec.gov/news/studies/2011/967study.pdf.
3 In addition to its headquarters in Washington, D.C., the SEC has regional offices in Atlanta, Boston, Chicago, Denver, Fort Worth, Los Angeles, Miami, New York, Philadelphia, Salt Lake City, and San Francisco.
4 Written Testimony of Harvey L. Pitt, "Fixing the Watchdog: Legislative Proposals to Improve and Enhance the SEC," before the House Financial Services Committee (September 15, 2011), available at: http://financialservices.house.gov/UploadedFiles/091511pitt.pdf.
5 The SEC Report on the Implementation of SEC Organizational Reform Recommendations was made public on September 9, 2011 and is available at: www.sec.gov/news/studies/2011/secorgreformreport-df967.pdf.
6 Chairman Schapiro testified before the Committee on September 15, 2011, full remarks available at: www.sec.gov/news/testimony/2011/ts091511mls.htm.
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