Opinion

Alison Frankel

Wachtell says commissioner is muddling SEC’s mission

By Alison Frankel
October 23, 2012

Disgruntled investors, Commissioner Luis Aguilar of the Securities and Exchange Commission feels your pain. In a speech last week at the Securities Enforcement Forum, he acknowledged that he hears a lot of investors asking “why more individuals and entities have not been held accountable” in the five years since the financial crisis. To restore faith in the markets, the commissioner said, the SEC needs to show that it’s on the side of the investing public — and that means doing more “to prove that robust enforcement is the norm and investors and fraudsters should take notice.”

Specifically, Aguilar said that individuals need to answer for corporate wrongdoing. “The fact remains that corporations and other business are led by men and women who are ultimately responsible for their actions,” he said. “The investing public has a right to expect that government regulators will continue to hold accountable those individuals responsible for misconduct — and that includes those culpable at the top, not just the flunkies below.”

The commissioner also called for beefed-up sanctions: barring individual wrongdoers from serving as directors and officers of public companies and boosting the monetary penalties available to the SEC. Aguilar explained that the statutory limits on what the SEC can recover don’t always permit penalties that reflect the harm to investors. He pointed by way of example to the SEC’s case against Citigroup, which involved a collateralized debt obligation deal in which investors lost almost $700 million. The maximum sanction available to the SEC, Aguilar said, was $160 million, and the SEC ended up agreeing to a $95 million penalty as part of a $285 million settlement. (That settlement was rejected by U.S. Senior District Judge Jed Rakoff of Manhattan and is now on appeal to the 2nd Circuit Court of Appeals.) Aguilar called for Congress to pass legislation that would permit the agency to seek higher penalties that would “compensate investors for actual harm suffered, match the penalty amount to the severity of the alleged violation and enhance (the SEC’s) bargaining power in settlement negotiations.”

Aguilar’s speech should have been red meat to SEC critics — here, after all, was a commissioner essentially conceding that the agency hasn’t restored investors’ faith in the integrity of the markets — but the most notable public reaction instead came Monday from Wachtell, Lipton, Rosen & Katz, which put out a client alertarguing that Aguilar’s suggestions would muddle the SEC’s regulatory mission. “We certainly understand the desire to rethink the SEC’s enforcement priorities, particularly in light of recent criticism of the agency,” the alert said. “But we are concerned that this speech reflects an unwarranted blurring of the line that should separate the role of criminal prosecutors from that of the SEC.”

Aguilar’s emphasis on holding wrongdoers accountable through bars on individuals and enhanced penalties against corporations is misplaced, according to Wachtell. Barring people who have committed securities violations from serving as directors or officers is not supposed to be a sanction, the firm said, but a rarely used remedial measure when someone can’t be trusted not to repeat misconduct. And it’s not the SEC’s job, the memo said, to recover investor losses. That’s what class action settlements and criminal restitution are for. Empowering the SEC to peg penalties to investor losses, Wachtell argued, would be a mistake. “Redefining the SEC’s mission in that way would distort the enforcement function, and would make it challenging for (the SEC’s Enforcement Division) to adhere to the standard that for decades it generally lived up to extremely well — being ‘tough but fair.’”

Besides, the memo concluded, the SEC has been doing a good job of enforcement, despite critics’ complaints. “Critics undervalue the deterrent effect created simply when the SEC brings a case,” Wachtell said. “Indeed, magnifying the SEC’s ability to ‘punish’ may not ultimately serve the SEC’s goals. Seeking to impose harsher penalties inevitably results in more cases proceeding to trial, causing the SEC to expend additional resources and confront sometimes significant litigation risk on matters that could otherwise have been favorably resolved. The SEC needs to have the wisdom and courage to stand by its regulatory mission.”

It’s no surprise that a defense firm like Wachtell would take issue with Aguilar’s call for tougher enforcement and harsher penalties. I was surprised, however, that the firm was so public about it. On Tuesday, I spoke with the two lead signers of the memo, Wachtell partners John Savarese and David Katz. Both said their intention was not to criticize the commissioner but, in Savarese’s words, “to contribute to the discussion.”

“We’re not trying to be controversial here, we’re just trying to point people to what we think is the right path,” said Katz, who said some of Aguilar’s suggestions left Wachtell concerned “that the SEC’s mission could be compromised.”

“We totally understand the criticism of the agency and we think it’s appropriate for a commissioner like Luis Aguilar to think outside the box,” said Savarese. But “we wanted to remind people that the SEC is not a prosecutor. It’s a regulator.” As an example of how the SEC could use its regulatory power, Savarese mentioned a long-ago project in which the Enforcement Division asked banks and broker-dealers to file reports on how they dealt with conflicts.

“It didn’t involve subpoenas or penalties, but it was a force for good,” he said. “It shows there are other ways the agency, using its regulatory voice, can encourage what everyone wants, which is for banks to be compliant.”

Aguilar’s office declined to comment on the Wachtell memo. An SEC spokesman said the agency does not comment on statements of individual commissioners.

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