U.S. Securities and Exchange Commission
February 9, 2007
Thank you, Linda [Thomsen, Director of the Division of Enforcement], for that very kind introduction. Now, ordinarily I would reciprocate, and take a few moments to say some nice things about you. That’s protocol. But instead of devoting the first few measures of my talk this morning to compliments directed toward Linda — such as what a professional, dedicated, and highly effective leader she’s been for the Division of Enforcement or what an outstanding job the Enforcement Division is doing for America’s investors and our markets — I’m going to devote the lion’s share of my remarks to that topic.
That’s because it’s my view that not only is the work of this Division absolutely critical to the mission of the Securities and Exchange Commission as a law enforcement agency, but never has the nation been blessed with a more professional team in enforcement in all of this agency’s history.
For virtually the entirety of the last 73 years, the SEC’s enforcement staff, and its inspectors and examiners, have been alternately praised and criticized. The very same efforts have been described, on the one hand, as tough discipline that keeps our markets honest, and on the other hand, as heavy-handed enforcement that suffocates our markets. And at the same time, just as incongruously, the agency has been alternately praised for exercising sound discretion, and lambasted for lax and inconsistent enforcement. Much of this, of course, is in the eye of the beholder, but all of it comes with the territory.
For starters, people don’t like to be accused of securities fraud — especially when it’s true. So the fraudsters fight back. Sometimes they are rich and powerful. Sometimes they have friends in high places, in the government and in the media. And when they fight back, the more clever among them cloak their true motives by appropriating the high-minded concerns of the free market economist or the civil libertarian. We can never have enough economists at the SEC, or vigilant protectors of our civil liberties. But there is nothing about securities fraud that is consistent with either.
Throughout the inevitable and enduring public debate about just how tough to be, and just how to be tough, the job of law enforcement is to stay the course. That’s because our entire free enterprise system depends upon the rule of law that the SEC upholds.
So this is going to be the topic that I’ll talk with you about briefly this morning. But having shortchanged the pleasantries at the outset, I do want to say what a pleasure it is to be here again for SEC Speaks — though it is hard to believe a year has passed already since we were last here. And as always, this is a truly impressive group. There are over 800 people with us here this morning in Washington, D.C., and hundreds more joining us across the country via the Internet. And it’s not surprising, because SEC Speaks is truly a unique gathering — and it gets better every year.
On behalf of all of us at the Commission, I want to thank the Practising Law Institute, and its Board of Trustees, for putting this conference together again this year. And I’d particularly like to thank Loula Barkas for her leadership role. The PLI’s mission of continuing legal education is enormously important, and you’ve made the SEC Speaks Series, now in its fourth decade, the premier opportunity for Commissioners, senior staff, SEC practitioners, and the regulated community to come together to discuss our regulatory program.
I can’t think of a better way to open this conference than to express my appreciation not just for the Enforcement staff — a topic I’ll return to — but to the entire staff of the Commission. At SEC Speaks some years back, David Martin, who was then Director of the Division of Corporation Finance, asked each member of the staff to stand and be recognized. We’ve carried on that tradition ever since. So just as I did last year, I’d like to continue that tradition today and ask every one of our professional staff who is here this morning to stand and take a bow.
Thanks to each of you for your hard work, and for your dedication to America’s investors.
And to the many SEC alumni here, let me say that to my mind, there is no better confirmation that the agency is a great place to work than your constant participation in our shared efforts. Thank you, too, for all that you do.
On Monday, I began my 80th week as Chairman of the Securities and Exchange Commission. And at times I’ve felt just like Phileas Fogg going Around the World in 80 Days. The breadth and variety of territory the agency has covered during my 80-week tenure is truly remarkable.
For starters, we’ve been through the most comprehensive overhaul of the executive compensation rules in over a decade. And that has certainly been a daunting task. It has involved contributions from every Division and Office of the Commission, and generated over 20,000 comments from the public. That’s by far the greatest number of comments the SEC has ever received on any issue in our 73 year history. In arriving at our final rule, the staff and the Commissioners devoted thousands of hours to the review and consideration of these comments, which in the main were exceptionally thoughtful, and very much improved the final product.
As a result, this spring, America’s investors will find in their proxy statements the most clear, understandable, and comprehensive presentation of executive compensation that has ever been provided at any time, in any country on earth.
And of course this initiative could not have been more timely, since it was undertaken just as what we all know now as the options backdating scandal was coming to light. That scandal has highlighted the importance of meaningful and straightforward disclosure of how executives are compensated. And here, the Enforcement Division has played the leading role. To quickly extinguish what appears to have been a pandemic of crooked accounting, the Enforcement Division has brought backdating cases against executives at Brocade, Comverse, and Engineering Support Systems, and initiated investigations in more than 130 other cases.
To help honest companies account properly for their options going forward — so that this problem can be laid to rest once and for all — this past September the Office of the Chief Accountant issued guidance on how to account for backdated stock option grants, and when restatements are and aren’t necessary.
It is fascinating to consider that the SEC’s investigations of backdating provide a dramatic illustration of the value of a very new bit of technology called interactive data.
Prior to 2003, the form that issuers and executives use to report their stock option exercises, Form 4, was filed with the SEC the old-fashioned way — without using computer tagging, or what I call interactive data. And so in order to analyze the data, all of the numbers and dates had to be manually re-typed before they could even be used within databases or spreadsheets. Not surprisingly, for all of that time, the backdating phenomenon was never uncovered.
Starting in 2003, however, the SEC began collecting the information on the Form 4s in interactive data format. With the help of interactive data, understanding this information suddenly became much easier and cheaper — not only for investigators at the SEC, but also for academics, analysts, and financial detectives throughout the economy. They could now systematically sift through the data and look for patterns and anomalies. And not only was all of the new information available in interactive format, but the Commission also began tagging the old data in the archival Form 4s using the XML computer language.
It was especially fortunate that this real-time interactive data technology was adopted just as the SEC put into effect new rules requiring real-time reporting of option awards within two days of the grant. Before the Sarbanes-Oxley Act, of course, option awards weren’t reported in anything close to real time, so a grant in January might not have to be disclosed until more than a year later.
Not surprisingly, once real time disclosure was combined with interactive data to give the Commission and the public almost instant access to information about stock option grants in immediately analyzable form, we began to find clues that had previously gone undetected. That led directly to the discovery of what we now know were billions of dollars of backdated stock option awards.
It’s because of the potential interactive data holds to give investors and analysts remarkable new insights into the disclosures we already mandate that the SEC has recently committed to a $54 million initiative to convert all of our filings, and the entire EDGAR system, to this new interactive format.
It is, after all, the 21st century. And it’s high time we tap the computing power of today’s technology, and take advantage of the real-time speed of the Internet.
So our new technology investments don’t stop there. Beyond our interactive data initiative, we’ve allocated significant new resources to the development of software tools that will help manage the SEC’s enforcement caseload. Later this month, we’ll deploy our new Phoenix system to help us more accurately track, collect, and distribute the billions of dollars in penalties and disgorgements that flow from our enforcement work.
And to see to it that the SEC meets the gold standard for disaster preparedness, we’re deploying new software systems to ensure the agency will be able to continue its mission-critical work in the event of an emergency.
In the end, of course, technology is just a tool. No matter how sophisticated the technology, it is only as good as the people who are using it. And so we are redoubling our efforts to sharpen our own professional skills, and to reach out to collaborate with and learn from the regulated community. To this end, we instituted the Chief Compliance Officer Outreach program, sponsored jointly by the Office of Compliance, Inspections, and Examinations and the Division of Investment Management. It’s designed to improve compliance by opening the lines of communication between CCOs of registered investment advisers and companies, and SEC staff. It provides a forum to discuss compliance issues in a practical way, to share experiences, and to learn about effective (and not so effective) compliance practices.
Because of the importance of deterrence to our overall mission, we are also working to lever our resources by collaborating with our counterpart regulators and private organizations. This past summer, in coordination with state securities regulators, the NASD, and the AARP, we held the agency’s first Senior Summit. This is one part of the Commission’s overarching initiative to protect the nation’s senior investors, which includes aggressive enforcement, targeted examinations, and investor education and outreach programs.
With over 75 million Americans turning 60 in the next two decades, protecting the assets and financial security of our seniors has never been more important — and it will remain a top priority for the Commission in the coming year.
We have also worked with the Public Company Accounting Oversight Board to improve the implementation of section 404 of the Sarbanes-Oxley Act for all issuers, and in particular for smaller public companies. Together we will continue our efforts in this area in 2007.
We really have covered a lot of ground in the last year and a half — so much so that it’s hard to remember what I expected 80 weeks ago. I do know I expected the staff to be smart, tough, and aggressive, and I haven’t been disappointed. No one who knows the record of the Enforcement Division could expect anything less.
The history of the Enforcement Division, a history built by many in this room, is one of zealous protection of the nation’s investors. The names Drexel Burnham Lambert, Michael Milken, and Ivan Boesky are as familiar to this history as Bonnie and
Clyde are to the history of Hollywood. Of course Enron, WorldCom and Adelphia have also become infamous accounting frauds, and each has added an important chapter to the history of the Enforcement Division.
Those who have been on either side during the course of a major fraud investigation know that even in cases of this magnitude, it is not uncommon for a team of two or three SEC staff to go up against a team of a dozen or more joint defense counsel – classic David and Goliath. But, as in the biblical tale, giants fall. The SEC has often been outmatched in strength, numbers, and tactics — but never outwitted. We’re an agency built on intellect and professionalism.
This rich history is exemplified by this year’s recipient of the Association of SEC Alumni’s William O. Douglas Award, my friend and predecessor as Chairman of the SEC, David Ruder. I hope you will be able to join later this evening to celebrate with David and to honor him. As you know, this prestigious award is conferred annually on a single SEC alumnus who has made significant contributions to the field of securities law.
It is certainly merited in David’s case. During his tenure as Chairman, the agency brought the now-legendary actions against Drexel Burnham Lambert and its principals, and stabilized the capital markets in the aftermath of Black Monday during the October 1987 stock market crash.
Of course, the proud history of the Enforcement Division, in which Professor Ruder played such a key role, continues to this day. And in a moment I’ll highlight a few of the Division’s major accomplishments since we gathered here last spring. But first, I’d like to say a few things about what we see every week inside the SEC in addition to intelligent, tough, and aggressive enforcement.
We see fairness. We see process. We see great care. We see an appreciation of subtlety and nuance. And always a concern about doing the right thing, and getting to the right result.
Those of you who have participated in our weekly closed meetings, where enforcement recommendations are presented to the Commission, know that ours is a lively process. As Commissioners it is our job to question the recommendations that come before us. And we do – often down to the last footnote. Invariably, we find the staff has already thought through every potential issue, and has wrestled with great care with the many implications both of the recommendations it is making and the recommendations it is not making.
Our enforcement process is very powerful, not because the Commission itself is powerful, but because of the power of facts and evidence. And that is where the first level of process comes in: put most simply, the process of figuring out what actually happened. But this process is anything but simple.
This process almost always involves an exhaustive review of documents as well as extensive witness interviews and depositions, for the purpose of identifying the facts, determining which are relevant, and understanding who is telling the truth and who is lying.
Then there is a second level of process – one well known to those of you in the defense bar. The Wells process is our agency’s tradition of pausing before a recommendation is made to hear and to address all counter-arguments. It is one of the most striking models of fairness that exists in the federal system.
Next comes a third level of process, which involves careful review by every level within the Division of Enforcement itself, as well as by the General Counsel’s Office, and by every other Office and Division that has a stake.
And if all of that were not ample due process, it is all but prelude to the weekly process in which my four colleagues and I sit opposite the Division in our Closed Meeting Room and begin the discussion and analysis of the case that eventually will lead to a Commission vote.
I confess that these spirited meetings are one of my favorite duties at the Commission. Yes, they can be long, tedious, and occasionally contentious. But it’s worth it. The challenge and privilege of considering such difficult issues with colleagues of such caliber is both honor and pleasure.
At one recent closed meeting, one hard working staff attorney – an attorney, by the way, who joined the staff straight out of law school and has been with us a little over a year – described his first in-person encounter with a witness. The witness had previously spoken to us by phone and had initially lied to us. Ultimately the witness saw the error of his ways. When the two met in person the witness said to this mild mannered, staff member:
“You don’t look anything like the way you look in my nightmares.”
While that’s a great story, and a good line for next week’s episode of Law and Order, the simple truth of the statement is even more striking. And that is where yet another level of protection for investors comes in. The enforcement staff is some 1,100 smart, thoughtful, hardworking, measured individuals who come to work each day looking for the right answer. They are honest people who are committed to fairness. That intangible but powerful ingredient is an exceptionally strong guarantor of due process in all of the agency’s proceedings.
So with that said, let me highlight the Division’s major accomplishments since we last gathered here at SEC Speaks.
In the last year, we’ve brought a number of significant hedge fund cases, alleging insider trading abuses, inappropriate fund valuation schemes, failures to supervise, disclosure issues, and garden variety fraud on the customer. In addition, we recently brought a number of high profile cases against hedge funds and other professional traders alleging that they engaged in illegal trading schemes using Private Investments in Public Equities, or PIPEs. Among these were cases against Gryphon Partners, SG Cowen, Langley Partners, Spinner Asset Management, and Spiegel.
One action that we can all be particularly proud of, because it goes to the heart of our efforts to protect individual investors, was our enforcement action against American Amicable. That company specifically targeted military personnel and their families by making false and misleading statements about an investment opportunity bundled with an insurance product.
The company suggested it would make investors into easy millionaires. Our civil action resulted in the return of $10 million to our servicemen and women who had been defrauded. That was a 100% recovery of their losses, when combined with claims brought by state ins regulators and the U.S. Attorney’s Office for the Eastern District of Pennsylvania.
In addition, during the past year the Commission charged the City of San Diego with making fraudulent representations about the funding — or more accurately, the multi-billion dollar under-funding — of its pension plans. We also brought several important cases in connection with the misuse of finite insurance and reinsurance products, including actions against AIG, MBIA, and Renaissance Re.
And we moved quickly against the latest wave of market manipulations, so-called “account intrusions.”
When you hear the term “account intrusion,” it might sound like an arcane auditing term. But there’s nothing arcane about it — what it really amounts to is bank robbery in cyberspace, without the guns and the getaway car, but every bit as dangerous for the account holders. And because there are no exploding dye packs, the money doesn’t even need to be laundered.
In several recent account intrusion cases, we’ve charged that the defendants illegally hacked into the brokerage accounts of individual investors, and liquidated the investors’ holdings. They then used the investors’ money to buy large quantities of shares in small, thinly traded companies that the fraudsters already owned. The fraudsters then sold their own shares at the inflated prices they’d just managed to manipulate.
This has become a major concern for brokerage houses nationwide, because thus far they have absorbed the losses that would otherwise be borne by their individual customers.
Financial fraud, too, remains a staple of our enforcement program. In the past year the Commission’s notable actions include cases against Fannie Mae, Tyco, McAfee, Applix, Raytheon, Doral, and Endocare.
In the area of securities offering fraud, and broker-dealer and investment advisor abuses, the Commission took enforcement actions against Jefferies & Co. and the head of its equities trading desk in connection with gifts and entertainment that were offered in exchange for directed brokerage. We secured substantial settlements in market timing and late trading abuse actions against Prudential, Bear Stearns, and Fred Alger Management. And the Commission recently sued BISYS Fund Services in connection with improper marketing arrangements with 27 mutual fund advisors. Not surprisingly, when fraud occurs, we continue to look closely at the gatekeepers — that is, the lawyers inside and outside the company, the auditors, and the directors.
We’ve also continued to aggressively pursue insider trading cases. That includes a number of enforcement actions growing out of a case originally focused on suspicious overseas trading in Reebok. These cases are worthy of their very own colorful chapter in the history of the Enforcement Division (and they could easily provide the basis for a sequel to Steven Spielberg’s Catch Me If You Can).
In one of the schemes, traders persuaded an analyst at Merrill Lynch to provide inside information on upcoming mergers and acquisitions; in another, traders illegally obtained advance copies of Business Week’s “Heard on the Street” column; and in a third, traders managed to steal and illegally trade on information leaked from a secret grand jury convened in a high profile accounting fraud investigation. We charged that, all told, the defendants illegally traded in, or tipped others about, no less than 27 stocks.
In 2006, we continued to order record monies to be returned to harmed investors. These so-called Fair Funds included $50 million in McAfee; $50 million in Tyco; $55 million in Hartford; $153 million in Security Brokerage; $250 million in Bear Stearns; $270 million in Prudential; $350 million in Fannie Mae; and $800 million in AIG.
In all, during my 80-week tenure with the Commission, we have distributed over a billion dollars to injured investors — including significant distributions from enforcement actions in cases involving WorldCom, Global Analysts Research, NYSE Specialists, Hartford, and Bristol-Myers Squibb. In the process, we have learned a great deal that will help us accelerate the Fair Funds distribution process and return moneys to injured investors with a minimum of delay.
We can all take comfort in knowing that every time the Commission succeeds in getting money back to injured investors, there’s a little more justice, and a little more fairness, in the world. But for those of you who are quants, and not poets, let me reel off some numbers:
In the last year, the Enforcement Division filed 37 emergency actions to halt ongoing fraudulent conduct, sought 46 emergency asset freezes and 97 officer and director bars, and halted trading in the securities of 71 issuers about which there was inadequate public disclosure.
And in all of that, we maintained a near-perfect litigation record last year. How do we follow that for 2007? Well, we’re going to pretty much follow the philosophy of the former New Orleans Saints running back, George Rogers. When he was an active player, he was asked about his goals for the upcoming season. And he said, “I want to rush for 1,000 or 1,500 yards, whichever comes first.”
The SEC wants to shut down 1,000 or 1,500 bad guys, whichever comes first.
In fact, all of you know that the enforcement actions we take are important not so much for their numbers, but for the results they achieve. They send the would-be swindlers a powerful message: if you prey upon America’s investors, you’ll face stiff penalties. They’re important because they let millions of America’s investors, young and old, have confidence that the cop is on the beat. And they’re important because, in the sphere of civil society so central to our opportunities to work and save and provide for our families, they are our foremost bulwark of the rule of law.
None of the positive results that flow from our enforcement program would ever be possible without exceptional people committed to justice and truth and fairness. That describes, to a “T,” the professionals of the SEC. America can be very proud of them. I know I am.
There are over 200 million adults in America, and more than 4.5 billion adults around the world, who participate in the global economy each day. It is a daunting challenge for a relatively tiny band of law enforcement officials at the SEC to police our sprawling capital markets and keep them free and fair. And as America’s markets are increasingly interconnected with securities markets around the globe, the difficulty of that task is increasing exponentially.
And yet there can be no more important function of government than protecting the savings and investment that undergird the economic prosperity of the United States. And so we require of this special group of otherwise ordinary people that they be possessed of extraordinary talent and exceptional dedication.
In other words: Save the Cheerleader — Save the World.
[Laughter] I’m glad that some of you get the allusion. For those of you who’re wondering what I’m talking about, it’s the NBC-TV show Heroes, in which a handful of seemingly average men and women discover that they possess secret super powers.
In that superhero drama, a nurse can fly, an artist can paint the future, and a high-school cheerleader is totally indestructible. Without question, the appeal of this series lies in its use of characters from everyday life who meet the challenge of saving the world using powers they didn’t even know they had.
Of course none of the men and women in the Division of Enforcement, or in our Office of Compliance, Inspections, and Examinations, can fly or hear people’s thoughts or stop time. But by sheer willpower and hard work, they routinely accomplish great deeds. And to the many Americans who depend on them — like the men and women of our military whose life savings they protected through an enforcement settlement; or the victims of the WorldCom fraud who are now getting some of their money back through a Fair Funds distribution — they are very real heroes, in every sense.
In ways vastly more important than the fantasies of television, they really are saving the world.
So thank you, all of you who are here from the Commission staff today, for all that you do; thank you to all of our alums who are here as well, for upholding our country’s high ethical standards in the private sector; and thank you to all of the practitioners, accountants, lawyers, economists, brokers, bankers, and financial services experts in this audience who work with us each day, for all that you do to protect the integrity of our markets and to encourage capital formation and economic growth. That is our mission at the SEC as well, and we’re proud to be your partners.