SEC Enforcement Division Gets New Powers Under the Dodd-Frank Act

The Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R.4173) gives significant power to the SEC Division of Enforcement. Buried deep in the 2,323 page bill is a little noticed provision extending the power of the SEC to impose penalties in administrative law proceedings, rather than the more cumbersome federal court system. This gives greater clout to investigators, because defendants no longer have the issuer-friendly federal court system to oppose the SEC, and will likely settle claims to get on with business. In short, look for faster resolution of investigations, swifter imposition of penalties, and much more discretion (i.e. power) by the reviewer in establishing penalties.

Under the new regime, the SEC has the authority to go to administrative-law judges to seek financial penalties from anyone whose activities in any way involve securities — from hedge-fund magnates, to bank CFOs, to day-trading retirees. For registrants and auditors of commercial companies, this new power could have far reaching accounting and financial reporting impact including liability accruals, considerably expanded qualitative disclosures of contingencies and potential impact on the going concern analysis.

Prior to Dodd-Frank, the SEC could impose penalties in an “administrative proceeding” before its own administrative law judges, only against those it directly regulated, such as broker-dealers and investment advisors, and against all others was limited to prohibiting future violations and requiring the return of illegal profits. Only the federal court could in the past award additional amounts as a “penalty” to deter future misconduct.

Now, Section 929Pa permits the imposition by the SEC of civil monetary penalties in addition to cease and desist orders. These administrative proceedings provide considerable tactical advantages to the SEC including the absence of juries in administrative proceedings, the generally more supportive attitude of administrative law judges, the absence of meaningful pre-trial discovery and motion practice in administrative proceedings, the short deadlines imposed on the completion of the administrative trial, less strict application of the rules of evidence during administrative trials, and appeal from a decision of an administrative law judge to the SEC Commissioners rather than to a Court of Appeals. Additionally, for cease and desist proceedings instituted under the Securities Act, the Dodd-Frank Act adopts the three-tiered penalty grid already contained in the Securities Exchange Act, but raises the penalty amounts by fifty percent. It remains to be seen whether the SEC will respond to this change in the law by increasing the number of cases it brings as administrative proceedings.

In general, the SEC would prefer to litigate cases in administrative proceedings, but has in the past been constrained by its inability to obtain certain remedies such as fines against persons who were not associated with regulated entities, from hedge-fund magnates, to bank CFOs, to day-trading retirees. Dodd-Frank expands the SEC’s powers in administrative proceedings, enabling them to obtain fines against registrants and, those not associated with regulated businesses. These administrative actions can be disadvantageous to defendants in that (1) they go to hearing on an accelerated schedule which must be completed and an initial decision rendered by an administrative law judge within 300 days of the filing of the Commission’s complaint; (2) there is no discovery, including no depositions and limited subpoena rights, in administrative proceedings; (3) there is no right of trial by jury; and (4) factual findings by the SEC in an administrative proceeding can only be reversed on appeal if the defendant shows that the findings failed to meet the “substantial evidence” test. In other words more power by the SEC. And just because the SEC has new power doesn’t mean it has to use it. But merely possessing the option, for the first time, to sue a hedge-fund manager or derivatives trader in an administrative- law court and seek a big fine gives the agency additional leverage. For example, the agency could push for a quick settlement by offering a respondent the option of cutting a deal in a lower-profile administrative setting rather than federal court. Defense lawyers may rest a decision on whether to fight charges or not based on the mere possibility of such a maneuver.”

How will all of this additional enforcement be paid for? Dodd-Frank increases the SEC budget from a record $1.3 billion in 2011 to an eye-popping $2.25 billion in 2015.

There are several other significant enforcement-related provisions in Dodd-Frank. Section 929U, for instance, imposes a firm deadline of 180 days after a Wells Notice has been issued for the SEC staff to file a case. Section 922 states that a whistleblower who voluntarily provides information to the SEC that leads to a successful enforcement action that results in monetary sanctions, may be awarded by the SEC. The Act states that determination of the amount of the award shall be in the discretion of the SEC, taking into consideration the significance of the information provided and the degree of assistance provided. The Dodd-Frank Act gives the SEC the authority to bar a person found to have violated one of the securities acts from associating with a range of SEC-regulated entities, and not just entities regulated by the specific title that was violated. Specifically, Sections 15(b)(6)(A), 15B(c)(4), and 17A(c)(4)(C) of the Securities Exchange Act and Section 203(f) of the Investment Advisers Act are amended to permit the SEC to bar a violator from association with a “broker, dealer, investment adviser, municipal securities dealer, transfer agent, municipal adviser, or nationally recognized statistical rating organization” in each case. Still, certain enforcement remedies may only be imposed by a federal judge. These include, for example, an order issued pursuant to Section 21(d)(2) of the Securities Exchange Act prohibiting a person from serving as an officer or director of a public company, and an order requiring forfeiture of incentive based or equity based compensation following a restatement of financial statements under Section 304 of Sarbanes-Oxley.

Public companies, broker-dealers, and other regulated entities should be aware that Dodd-Frank has changed the regulatory landscape dramatically.

Samir Bijlanicontributed to this article.