SEC's Enforcement Capabilities and Ancillary Relief Mechanisms, Lecture notes of Remedies

Download SEC's Enforcement Capabilities and Ancillary Relief Mechanisms and more Lecture notes Remedies in PDF only on Docsity! ..... i SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 (202) 272-2650 Address to The Washington State Bar Association Northwest Securities Institute Seattle, Washington February 23, 1985 Ancillary Relief and Reffledies: Exotic, Extraordinary or Just Plain Effective? Aulana L. Peters Commissioner The views expressed herein are those of Commissioner Peters and do not necessarily represent those of the Commission, other Commissioners, or the staff. ANCILLARY RELIEF AND REMEDIES: EXOTIC, EXTRAORDINARY OF JUST PLAIN EFFECTIVE? I thank Jack Bookey and Steven Graham very much for inviting me to speak to this distinguished group today. I am pleased that there is such diverse representation here, because it is only through the cooperation, at all levels, state and federal, public and private, of various groups and professions that we are able to maintain such high standards in our securities markets. You may be aware that recently I cautioned various segments of the securities industry to be alert for increased sales practice abuses which could develop as a by-product of the decrease in profits after the boom periods of yesteryear. I want to emphasize that my concerns are not limited to broker-dealers pressuring their account executives to produce more while iqnorinq their obliqation to supervise these people carefully and closely. My warnings should also be heeded by reporting companies that are caught in the financial wringer that demands ever improving balance sheets and who are, thus, tempted to "cook their books". That is to say, they manipulate the numbers in their financial statements so that the bottom line appears rosier than it is. Likewise, my admonitions should be ringing in the ears of each and every accountant out there practicing before the Commission who may be contemplating engaging in what some of my colleagues have dubbed "cute accounting". Am I beginning to sound like the "Enforcer"? - 4 - Commission and the proposed defendants. (While settlements are an efficient use of resources, I believe that they are not always the best solution under all circumstances. The Commission is, and must be, willing to litigate any and all cases it pursues. But that is a topic for another day.) Back to where I was before I digressed -- though not judicially sanctioned, much of the ancillary relief remains unchallenged in court, enabling the Commission and its staff to continue to weave meaningful relief from the thin cloth of the federal statutes. I applaud the innovative approach to remedies and sanctions that the staff of the SEC has taken, and I encourage them to continue down that road. Generally, the ancillary relief meted out by my colleagues in Washington, both past and present, falls roughly into three broad categories. First, and perhaps the oldest type of equitable relief imposed in the context of the securities ~aws, is the appointment of a third party, either a receiver, or special counselor other expert to manage and/or monitor the affairs of a regulated entity. Second, the imposition of monetary relief, most frequently in the form of disgorgement of profits gained from one's illegal activity. Finally, many cases have rectified past financial statement inaccuracies and violative practices through the adoption of procedural undertakings and/or public disclosure of past transgressions (e.g. restatement of financials). Before delving into some of the newer and, perhaps, more innovative approaches, let me just take the next few minutes to discuss a few situations in which the remedies I have mentioned have been applied. - 5 - Third Party Watchdoqs: In a variety of situations, the Commission has effectively remedied various types of unlawful conduct by using variations on this theme. Receivers have been appointed when there was a fear that corporate assets may be wasted or when it appears that the positions of corporate share- holders are in jeopardy due to mismanagement or fraud. Similarly, the Commission has stepped into the world of corporate manaqement, and, in egregious cases, replaced elected management with impartial third parties. It has required the appointment of independent directors to a company's board. The individuals are usually subject to prior court and Commission approval. Let me give you an example -- the often-cited MatteI case. Independent directors were brought into the toy company's management structure to oversee accounting procedures and the preparation of financial statements. This imaginative approach allowed MatteI to continue its operations, but assured the SEC that MatteI would not continue to inflate its profits and make fraudulent disclosures. A similar consent decree was entered into in connection with the settlement last year of the u.s. Surgical matter. Surgical was required to appoint two non-affiliated directors to its Board. The two were to serve on the audit committee that was charged with reviewing the company's SEC filings and financial statements. Also of interest -- Surgical was required to secure the services of an independent accounting firm to report directly to the audit committee with respect to all of the company's accounting practices and procedures. - 6 - Another ancillary remedy that has been successfully used in the past is the appointment of a special counsel to review and investigate corporate procedures and then report the findings to the court. They also have been used to ensure specific compli- ance with undertakings assumed in connection with settlement of a case. You are probably aware of the Commission's much publicized recent settlement with First Jersey Securities, Inc. and its president, Robert Brennan. First Jersey and Mr. Brennan consented to the entry of an in;unction against future violations of the law. However, the consent further provided for a court-appointed independent consultant, with complete access to First Jersey's books and records, whose task is to review First Jersey's proce- dures and policies to insure its compliance with the appropriate statutory and self-regulatory guidelines. Upon completing his examination, the consultant will make recommendations for improving procedures, etc. to First Jersey's Board of Directors in the form of a report, a copy of which will he filed with both the SEC and the court. Monetary relief. Justification of the imposition of monetary relief by the SEC can be made on the theory that vio- lators of the law should not benefit by their illegal activity. Today, it is fairly well settled that a court of equity, at the request of the Commission, can order disgorgement, or order rescission and restitution. Therefore, disgorgement is now a regular weapon in the enforcement arsenal and it is used, since the landmark decision in Texas Gulf Sulphur, to deprive those who illegally trade while in possession of inside information of their - 9 - question has been raised as to whether the SEC should be given express authority to impose various forms of monetary relief -- an idea worthy of serious consideration. In addition, I believe that there is one sometimes overlooked avenue which we could pursue. That is, to work within the statutory framework we now have to the fullest extent, and to be inventive. We should not ianore pr shy away from any of the tools Congress has laid at our doorstep. Let me give you some examples of what I mean. The first is not a remedy, but it's certainly a way to get there. I would urge increased use of Section 20(a) of the 1934 Act to impose direct liability on individuals responsible for violations of the securities laws. Section 20 provides that "every person ••• who directly or indirectly, controls any person liable ••• shall also be liable ••• " In my view, this section clearly grants authority to the Commission to bring an action against individuals who are control persons of entities which report to the SEC. It is interesting that the Insider Trading Sanctions Act also a~ends Section 15(c)(4) to permit the Commission to name individuals, other than securities professionals, as defendants in administrative proceedings. Another tool infrequently used is that providen in Section 12(j) authorizing an anministrative proceeding to revoke the registration of a security. This can be an effective remedy against the pro~oters of thinly traded shell corporations who use the badqe of reqistration to palm worthless stock off onto the public. - 10 - Lately, an idea for ancillary relief has surfaced at the Commission that allows the Commission greater flexibility in administering the federal securities laws -- that idea is to remedy egregious violations of the law, particularly by repeat offenders, by a bar of certain violators from actinq as corporate officers or directors. I have no doubt that a court, in the exercise of its equitable powers, could order such a remedy. Dan Goelzer sugqests corporate bars, as well as other innovative remedies, are now also possible in an administrative context as a result of amendments to Section l5(c)(4), which were adopted by Congress last year as part of the Insider Tradinq Sanctions Act ("ITSA") package. In its present formulation, Section 15(c)(4) enables the SEC to institute public administrative proceedings against any person for violations of Sections 12, 13, 14 and 15(d). Clearly, individuals who cause a violation of those sections are within the purview of the section. The section expressly states that the Commission may order "any person who was a cause of fa] failure to comply due to an act or omission the person knew, or should have known, would contribute to the failure" ••• to comply with the Act. Even more important than who falls within Section 15(c)(4)'s scope, is the flexibility that Section 15(c)(4) now qives the SEC in meting out meaningful sanctions. The Commission is empowered, pursuant to the section, to order violators to comply "upon such terms ann conditions that the Commission may specify." This language should provide consi- derable latitude in fashioning relief. - 11 - I like Mr. Goelzer's rationale and agree with his conclusions. I applaud the insight Congress had when it granted us the much needy flexibility to promote compliance with the laws we ~dminister. Let's hope that this is just the beginning of a trend. There are many instances where it would be appropriate to forbid a violator from acting in a specified capacity for a limi- ted but defined period of time. Or, perhaps, to curtail the acti- vities of the individual within a specified realm. While this type of remedy has not been used with any great degreee of frequency so far, it is certainly not without precedent. The Commission has express statutory authority to censure, suspend or bar securities professionals such as regis- tered representatives and investment advisers. Significantly, the Commission has successfully extended this authority to barring accountants and attorneys who practice before the Com~ission from that practice. Recently, the Commission has used the bar device in a couple of consent decree situations, one of which involved a settlement with Florafax International, a nationwide floral delivery firm. A Commission investigation revealed that Florafax had employed improper accounting practices which resulted in the material overstatment of financial statements. In addition, it was discovered that Florafax's Chief Executive Officer and Chairman knowingly engaged in the improper accounting practices and actively concealed the fraud from Florafax's independent auditors. Rather than litigating the case, the defendants offered to settle for an injunction against future violations and for a restatement of the