Opinion

Alison Frankel

In SEC enforcement, size matters

By Alison Frankel
September 14, 2012

For good or ill, one of my themes over the last 18 months has been frustration with the Securities and Exchange Commission’s enforcement efforts. And according to a recently published study by Berkeley Law professor Stavros Gadinis, I’m not alone. Gadinis’s paper, posted Wednesday at the Harvard Law School Forum on Corporate Governance, said that it’s been three decades since any academic analysis of SEC enforcement actions against broker-dealers. In that time, Gadinis wrote, the information vacuum has been filled with complaints about the commission’s perceived foot-dragging and questions about the so-called revolving door between the SEC and private law firms. To add some substance to the discussion, Gadinis undertook what he said was the first systematic examination of SEC enforcement actions against broker-dealers — a category that includes major financial institutions — in 30 years, analyzing more than 400 cases finalized in 1998 and 2005-2007. (Gadinis added 1998 to the study so it would include cases brought in a Democratic administration.) His overall conclusion: Size matters, at least when you’re a broker-dealer facing off against the SEC. According to the prof’s data, firms with more than 1,000 employees fared much better than their smaller counterparts in terms of whether cases are brought against individual defendants; whether the SEC brought cases as administrative proceedings; and what kind of sanctions the SEC extracted.

“Big firms get different treatment,” Gadinis said in a phone interview Thursday. “That could be for many reasons (but) it’s not a nice result for the SEC, which is supposed to be a unbiased regulator of markets. Whatever the motivation, the results are not good.”

Gadinis said it’s too soon to opine on the SEC’s actions since the first four months of 2007, which is when his study ended. He also said that ideally, his data would have included SEC investigations that did not result in enforcement actions, but, as I’ve noted, those aren’t captured in publicly available materials. But with those caveats, Gadinis said his study indicates that, historically, the SEC “is reluctant to bring cases against individuals connected with big firms.”

Let’s look at the numbers. Of the cases Gadinis analyzed, 103 involved broker-dealers with more than 1,000 employees. In 40 percent of those cases, only the corporation was charged. (In another 20 percent, both the corporations and individuals were targeted; the remaining 40 percent involved only allegations against individuals.) By contrast, of the 345 cases against smaller broker-dealers, just 10 percent involved actions only against the corporation. Sixty-four percent of the cases were brought only against individuals.

Gadinis checked to see whether the gap is explained by the kind of claims the SEC asserted against large and small broker-dealers and found that it isn’t. He also concluded that the driver behind SEC decisions not to sue big-firm employees isn’t the difficulty in collecting evidence or attributing wrongdoing. Inde e d, Gadinis told me, “In those cases they do bring against individuals,” he told me, “the decision to charge or not is not obvious.”

That’s particularly worrisome for small firms because their employees face significantly more severe penalties than big-firm employees who are sued by the SEC. According to the study, “for the same violation and comparable levels of harm to investors, big firms and their employees were less likely to receive a ban from the securities industry, compared to small firms and their employees.” And in cases in which the SEC obtained bans against individual defendants, those against small-firm employees averaged 22 months longer than those against their big-firm counterparts charged with the same violation.

Big firms and their employees were also likelier to face administrative proceedings — and not federal-court litigation — than their small-firm counterparts, according to the study. (Seventy-one percent of big-firm cases, compared to 41 percent of small-firm suits, were handled administratively.) There has been academic speculation that the SEC has been filing tougher cases as administrative proceedings, which are perceived to favor the commission, but Gadinis’s study discounted that theory. Instead, he considered it a benefit to defendants to resolve their cases in administrative proceedings, which generally involve less negative publicity.

All of these factors led Gadinis to conclude that as of the first four months of 2007, it was better to be a big broker-dealer than a small one before the SEC. That’s a finding with significant public policy implications.

In fairness — and as Gadinis notes in his study — the SEC redesigned its enforcement model when SEC Chairman Mary Schapiro took office in 2009, so it could be that the enforcement gap Gadinis uncovered has narrowed since the new model was completed in 2010. I sent the study to SEC spokesman John Nester for comment but didn’t hear back.

For more of my posts, please go to Thomson Reuters News & Insight

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