In a speech presented to the second annual Securities Enforcement Forum on October 9, 2013, SEC Chair Mary Jo White described a broad expansion of the SEC’s enforcement program to reflect her desire “to see that the SEC’s enforcement program is—and is perceived to be—everywhere, pursuing all types of violations of our federal securities laws, big and small.” Her announced “broken windows” initiative follows other recent announced changes, including the new policy to seek admissions of wrongdoing when settling certain enforcement proceedings.
The Chair stated that no violation is too small to attract the attention of the Enforcement Division:
Investors do not want someone who ignores minor violations, and waits for the big one that brings media attention. Instead, they want someone who understands that even the smallest infractions have victims, and that the smallest infractions are very often just the first step toward bigger ones down the road.
The Chair noted that the broken windows policy was inspired by a similar strategy deployed in New York City in the 1990s under Mayor Rudolph Giuliani and Police Commissioner William Bratton. By targeting even minor infractions, law enforcement officials hoped to avoid an environment of disorder that would encourage more serious crimes to flourish.
The Commission will now take a similar approach in policing the securities markets: “minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.”
The theory sounds appealing, and by all accounts it succeeded in New York City. However, translating it to the modern-day financial regulatory scheme raises some potential issues:
While Chair White stated that “it is important to pursue even the smallest infractions,” from all indications the SEC’s enforcement staff is perennially most interested in pursuing the high-profile, high-dollar amount violations, at least in part in response to pressures from Congress, the press, and other sectors of the public to bring to justice those responsible for the financial crisis.
It has proven difficult for the SEC’s enforcement attorneys to shift gears between the high-profile cases and small matters. In addition, smaller matters are relatively inefficient to pursue, given that they still require review of documents, testimony, and significant drafting and negotiation. An increase in enforcement of minor violations without abandoning the large cases would require an increase in resources, yet one consistent theme expressed by SEC Enforcement staff at the Forum throughout the day was their lack of sufficient resources to do the job they currently have.
Chair White stated that “Retail investors, in particular, need to be protected from unscrupulous advisers and brokers, whatever their size and the size of the violation that victimizes the investor.” Yet, another regulator currently already enforces broker-dealer violations of all sizes: FINRA, which does an effective job in “backstopping” the industry to redress violations of all sizes.
Chair White’s description of actionable minor violations was a bit fuzzy. A good analogy in the securities industry to broken windows that allow crime to grow unchecked would involve inadequate supervisory procedures, weak supervision, and deficient record-keeping and reporting. It is not clear, however, that the Commission views those types of violations as minor; some cases involving systemic failures to supervise or recordkeeping have led to seven-figure fines. In other cases, the SEC will not bring a case based on deficient procedures because the federal securities laws require an underlying violation in order to name a firm for a failure to supervise; investigating the underlying violation likely would take the case out of the broken windows realm.
The direction the SEC takes in the direction of broken windows will be apparent as the enforcement staff opens and brings new cases. It is reasonable to conclude, given the Division of Enforcement’s complete restructuring in recent years, that a shift to pursue more minor cases will be more incremental than dramatic. In any event, this policy announcement is likely to increase angst of broker-dealers, investment advisers and independent directors of investment companies who already are concerned that the Commission has been turning up the heat through increasingly aggressive enforcement campaigns.