Last month, a group of former Securities and Exchange Commission (SEC) attorneys sent a letter to the Commission expressing concern about reports that the SEC has changed the process to initiate a formal investigation.
The attorneys, who now represent whistleblowers in private practice, sent the letter in response to media reports that the Division of Enforcement would require Commission approval before initiating formal investigations.
After the Bernie Madoff scandal and the subprime meltdown of 2008 and 2009, the SEC delegated authority to issue orders of investigation to the Division of Enforcement.
The former SEC attorneys said that the change to requiring full Commission approval will create potentially significant bureaucratic obstacles for the staff, leading to delays and potentially discouraging the staff from pursuing certain meritorious investigations.
“In the long-term, this policy threatens to make the whistleblower program less effective and less capable of fulfilling the Commission’s investor-protection mandate,” the attorneys wrote.
One of the signers of the letter is Andrew Feller of Kohn Kohn & Colapinto. Feller currently represents whistleblowers before the SEC and other agencies.
Prior to joining the firm, he worked for fifteen years at the SEC investigating and litigating securities fraud matters.
What’s the process the SEC uses now to open an investigation?
“The way it works now is that when something comes in, whether from a whistleblower tip or something the staff learned about either from the news or in the course of another investigation or from a referral – any way that a case comes in – the staff can open a matter under investigation – or what we refer to as a MUI,” Feller told Corporate Crime Reporter in an interview last week.
“A MUI can be something as simple as someone at the SEC staking a claim to a particular matter and saying – I’m just going to kick the tires on this, look at the publicly available information, look at the information available in house, possibly call someone up and ask some questions.”
“Then, at a certain point, if the staff wants to issue subpoenas, or take sworn testimony, they need what is called a formal order of investigation. The formal order is essentially a delegation by the Commission of its statutory investigative power to certain named staffers.”
“The 1934 Act says that the Commission can issue subpoenas or take sworn testimony. So they issue a formal order which designates a staffer as an officer of the Commission for purposes of this investigation and they can use the Commission’s authority to issue subpoenas and take sworn testimony.”
“Over the past fifteen years, there has been a little bit of back and forth. After the financial crisis and the Madoff scandal, when Mary Shapiro was the Chair and Rob Khuzami was the director of enforcement, they undertook some reorganization of the Division of Enforcement. Among the actions they took was to delegate to the Director of the Division of Enforcement the ability to issue a formal order. That cut out the process of writing a memo and going to the Commission for a Commission vote on a formal order.”
“When I started in 2007, you had to go to the Commission and get them to vote on a formal order of investigation. That involves writing a memo, possibly going to a meeting where you answer questions from the Commissioners.”
“Then it was delegated to the director and the director had the ability to sub-delegate to some of the senior officers within the division. As I recall, it was sub-delegated until Jay Clayton came in. And then after that they undid the sub-delegation. It was still delegated to the director. You did not have to go to the Commission to get approval of a formal order of investigation.”
If the Director of Enforcement issued an order of enforcement, they could start issuing subpoenas without going up to the Commission?
“Yes. And to be clear, there was still a process in place that involved writing up your justification as to why a formal order was merited. But it was somewhat more streamlined than the process of going up to the Commission to get a vote on an investigation.”
If the Division of Enforcement issued an order of investigation, would the Commission know about it?
“The Commission would receive a periodic report that listed the formal orders that had been issued. Over time, that report became more detailed. For any exercise of delegated authority, any time that delegated authority is exercised, a single Commissioner could say – I want to bring that back to the Commission and have us discuss and vote on it rather than allow it to be done through the delegated authority.”
How often did that happen with formal orders of investigation?
“During the three years I was working for Commissioner Lee it was intermittent – not with great frequency.”
That was the practice up until when?
“They got rid of the sub-delegations during the first Trump administration. And then when Commissioner Lee became the acting chair in January 2021, she and the then acting Director of the Division of Enforcement, Melissa Hodgman, brought back the sub-delegation to senior officers – the top level supervisors.”
“One thing that I didn’t mention was that the delegation to the Director of Enforcement was done pursuant to a rule issued by the Commission. That’s a regulation that had been adopted.”
“Then there were reports recently that the delegation has been in some fashion done away with and that formal orders were required to be brought to the Commission. They haven’t said anything publicly about what’s happening there. The rule would presumably have to be reversed by the Commission in a public vote.”
“There are a number of ways they could get around that. A particular Commissioner could say – I’m making a blanket statement that I want to pull all formal orders for a Commission vote. And then it stops being an exception and starts being the rule.”
Let’s back up. You represent whistleblowers. A whistleblower comes to you with an SEC whistleblower case. What’s the process?
“We write something up that explains the significance of the information, why it’s a violation of the rules and any important context. And then there is a online portal called the TCR system – tips, complaints and referrals. You submit the information through the TCR portal. It’s required that any submission go through that TCR portal. And it must be submitted on Form TCR.”
“There is a group within enforcement that last I checked was called the Office of Market Intelligence. They do what is called triaging the tips that comes through. They look at them and see if they appear to state a securities law case on their face. They see if the conduct is related to an open matter. And then they will often distribute those cases based on subject matter or jurisdictional nexus for a regional office, or potentially to somebody who has worked on a case against a particular company and may have some familiarity with that company.”
“Of course, a large number of tips have nothing to do with the securities law – they don’t state a securities law case on their face. There are a lot of people who put in tips pro se. There are unfortunately people who abuse the system. Some of this triaging is just separating out what appear to be real tips from some of the noise that comes into the system.”
“They will distribute the tips to the staff. And someone on the staff will determine whether it’s a matter that they want to investigate, taking into consideration Commission and Division priorities, resource constraints, whether there is another agency already looking at it – all the factors that are looked at in determining whether the staff is going to pursue an investigation.”
“They may or may not tell the whistleblower and whistleblower counsel that they are pursuing a case. They do not always communicate that to a whistleblower.”
If you file a tip and the Division issues an order of investigation, you may not know it?
“Correct. A formal order of investigation is not public. They do have to show it to anybody they intend to subpoena or take testimony from. And the whistleblower would not necessarily know.”
“On the other hand, there are many cases where the staff of the SEC works with the whistleblower, because the whistleblower can be helpful to the staff in pursuing its investigation. So you may know when an investigation has become formal because you may hear back from the staff.”
There are many within the Trump administration who are ideologically aligned with movements to shut down government enforcement agencies. They appear to be doing this with the Consumer Financial Protection Bureau (CFPB). This is the so-called chainsaw approach.
But it looks like with the SEC they will just slow walk it. And people say Paul Atkins would be ideal for the slow walk.
“My concern is the impact of some of the changes we are hearing about on staff morale. Moving formal order authority back to the Commission is one. Now we are hearing they are getting rid of the regional director structure. There is the entire about face on crypto enforcement. There is a lot going on right now that might make the staff feel undermined, unsupported or potentially exposed. And that can impact effectiveness.”
“If you think about Bernie Madoff, he was a well known and well respected figure in finance for a long time. To investigate him required on the part of the SEC staff both a knowledge of the industry and courage. They needed courage and skill to investigate him. And right now, lawyers are flooding out of the SEC. Those that remain are not necessarily feeling supported. You are losing both the skill and the courage.”
Are they leaving voluntarily or being fired?
“As with many other government agencies, many are leaving voluntarily. But the incentives for SEC lawyers are higher because there is a lot of money defense law firms will pay for that kind of talent.”
“But people are also anticipating layoffs. Everybody is on edge.”
Traditionally when there is a change of administration, you see government lawyers go over to work for corporate law firms. How is it different this time?
“This time it’s from the top to the bottom. Traditionally, you would see the most senior policy people leave. Today, it’s up and down. It’s line attorneys leaving as well as division heads.”
The SEC has a strong alumni bar. Have they kicked into gear to defend the agency?
“There are many ad hoc efforts. I, along with four other SEC alumni who now represent whistleblowers, wrote a letter to the Commission asking for transparency on the change of the formal order process because in part a loss of investigative efficiency could impact whistleblowers, among other things.”
“There is a lot of activity on social media with SEC alums speaking out and writing about the potential damage that could come from undermining the staff.”
“It’s been mostly ad hoc. People are responding to reporting and rumors at this point.”
But it’s not like the CFPB where it looks like they are trying to shut it down. How do you explain the difference?
“There is a longer history with the SEC, with bipartisan support. There is also probably a perception that a competent SEC is necessary for market stability. I’m not sure you have the same direct tie to the stability of an industry with the CFPB.”
[For the complete q/a format Interview with Andrew Feller, see 39 Corporate Crime Reporter 10(13), March 10, 2024, print edition only.]