The SEC Critiques Itself – Could Changes to SEC Enforcement Investigations Be On The Way?

Last week, the SEC’s Office of Inspector General (“OIG”) released its semiannual report to Congress, which details the OIG’s independent and objective audits, evaluations, investigations and other reviews of the SEC’s programs and operations in order to prevent and detect fraud, waste and abuse in SEC programs and operations, and other vulnerabilities the SEC faces.  In the most recent report, the OIG was critical of various programs, but most notably: (1) recommended a new framework to increase the Office of Compliance Inspections and Examinations coverage of registered investment advisors, and (2) informed Congress it was conducting a further evaluation on the SEC’s enforcement investigations to ensure that investigations are coordinated internally and across SEC divisions and offices.

The latter critique was a direct response to a federal court order that discussed the lack of coordination of cases with overlapping factual circumstances.  Although the OIG semiannual report did not acknowledge the case or court, it appears that the investigation stems from Judge William H. Pauley III’s November 2015 order in SEC v. Caledonian Bank Ltd.  The SEC (through its Washington, D.C. regional office) brought that case and froze the assets of the defendant bank as part of a “pump and dump” penny stock scheme.  The SEC (through its New York regional office) subsequently filed four other cases split between different district courts that involved different defendants, but with overlapping factual circumstances to the penny stock scheme.  In each of the subsequent filings, the SEC failed to relate the cases or notify Judge Pauley of the similar factual circumstances.  Therefore, to Judge Pauley it was apparent that the New York and Washington, D.C. offices were unaware of the key documents received by each office and unaware of the allegations made by the other office in enforcement actions.  In his order, he further chastised the SEC for failing to rummage through its own files for answers, for deploying sixteen attorneys to litigate cases involving overlapping factual circumstances, and for failing to coordinate the five cases.  Judge Pauley also suggested that the SEC needs to examine itself to review its internal procedures.  The OIG took heed, and now expects to complete its evaluation during its next reporting period, which ends September 30, 2016.

What will the OIG’s evaluation reveal?  It is certainly too early to tell, but any further critique of the SEC’s investigation practices by district court judges could lead to even more SEC cases being brought as administrative actions.  As it stands, recent studies have shown that nearly 90% of all SEC actions in fiscal year 2016 against public companies and related subsidiary defendants have been brought as administrative proceedings.  Because administrative proceedings are brought before judges in SEC in-house courts (a hotly debated topic), there has historically been less public and openly vocal critique of the process, although that is certainly no longer the case.