Earlier this week, the SEC announced that Altaba, a publicly-traded holding company that owns huge stakes in Chinese internet company Alibaba Group and Yahoo Japan, would pay a fine of $35 million for failing to disclose a 2014 data breach in which hackers stole information from more than 500 million Yahoo accounts.

Yahoo sold its main internet business to Verizon in 2017, renaming what remained as Altaba.  Apparently Verizon bought the assets of Yahoo but did not agree to assume all of the liabilities, including the one flowing from the SEC action.

The SEC case is a fairly straightforward disclosure fraud case but for a couple of important aspects, which undoubtedly provided some consternation for SEC Commissioners Piwowar and Peirce   Both Commissioners probably voted against the enforcement action for the following reasons:

1.  The $35 million penalty is against a corporation, which means, according to those two Commissioners, that the company’s shareholders ending up footing the bill for the fine.  Over the years, starting with SEC Chairman Christopher Cox, a parade of Republican Commissioners have advanced numerous reasons as to why corporations shouldn’t be fined for disclosure frauds.  Although not always consistent in their logic and rationales, the Republican Commissioners have been consistent in their philosophies:  no fines against corporations for disclosure frauds, with a special carve out for broker-dealer entities and if it can be shown that the company profited from the fraud, a penalty is acceptable.  Apparently Commissioner Piwowar also believes it is permissible to fine corporations for FCPA violations (a type of disclosure fraud), although the logic underpinning his rationale for this exception is not easy to follow.  I suppose also it’s possible that he voted to approve the case against Yahoo but disagreed with the fine amount, and even possible he actually voted for the fine if his views on corporate penalties evolved yet again.  I doubt, however, that Commissioner Peirce voted for any of the case — it just doesn’t seem like the sort of case that she would support given her outlook and loyalties.  Personally, while I think that corporations should be fined for securities fraud as the statutes permits, I would have liked to have more explanation concerning how the SEC came up with the $35 million penalty.  A penalty of $10 million or $20 million or $50 million would have seemed just as appropriate based on the information the SEC provided publicly.   For an agency that emphasizes transparency in others, the SEC doesn’t always do such a great job disclosing how it comes up with the penalties it accesses, but perhaps that is just too hard to do.
2. No individuals were charged even though the corporation was accused of negligence.   I’m sure this was a issue that all Commissioners discussed exhaustively and exhaustingly with Enforcement staff.  And because the proposed settlement did not include actions against individuals, the two Commissioners mentioned above would have viewed the action skeptically.  A number of Commissioners and SEC officials have long argued that you can not and should not bring a case for negligence against a corporation if you don’t have a basis for charging individuals for negligent conduct.  This is not unreasonable but it also well known that often, for a variety of reasons, an investigation will turn up evidence that a bunch of individuals at a company were involved in parts of a fraud but no particular person or persons seem to have been involved in all aspects of the fraud.  There can be risks in bringing a case against an individual that don’t exist in a case against the corporation that the individual worked for.  In this case, it’s not clear why no one was charged when the corporation was.   A Yahoo internal investigation found that Former Yahoo Chief Executive Marissa Mayer failed to “properly comprehend or investigate” the account breach.  And, Ronald Bell, Yahoo’s top lawyer, resigned shortly after the internal investigation.  Perhaps charges against individuals will follow, since, as the SEC press release and administrative order both indicate, the SEC investigation is ongoing, inferring that conduct by individuals is still under scrutiny.  That may be so, but it is also a little strange:  you would think the staff’s investigation as to the individuals would be completed before settling the case with the company.  The SEC doesn’t want to discover something new during its investigation of the individuals that implicates the company after it has already settled with the company.  My guess is that the investigation was pretty comprehensive (and there was an internal investigation to crib from, which could have been quite useful) when the case was filed.  Maybe the SEC will bring charges one day against some individuals or maybe the staff were in the process of negotiating terms with individuals (always tougher than negotiating with corporations) and those negotiations just dragged on too long, causing the staff to want to bring something sooner rather than later.  Hard to tell from the public documents but it certainly doesn’t get any easier to bring charges against individuals after the first action is filed — it’s human nature for staff investigators to want to move on to the next project or investigation and the case evidence doesn’t get fresher.  Defense counsel may now believe that the SEC doesn’t have a strong hand if it wasn’t prepared to bring the charges against the individuals when it filed its action against the entity.  Time will tell.

One unintended consequence of the rich salaries at the SEC is that many extremely qualified staff attorneys have limited chances to advance in the Enforcement Division.  Years ago, when I started work as a staff attorney, there were regular opportunities for advancement.  An Enforcement staff attorney who worked hard and was effective had a reasonable chance of getting promoted to supervisor after working three to five years in the Division.  Today, it is drastically different:  a number of highly capable Enforcement staff attorneys are stuck doing the same basic work regardless of the their skill sets and capabilities. Some have toiled for many years in the same roles, yet still have little chance of being promoted any time soon.  Supervisory vacancies are extremely rare because many first line supervisors — handcuffed by the high pay and good benefits — have no plans to retire or leave the agency.

Adding to that problem, too many assistant directors are mediocre at best.  Having grown complacent, a number of assistant directors work just forty hours a week without much diligence or energy, adding little of value to their subordinates’ work.  Some assistant directors are simply not competent.

Don’t get me wrong, some excellent assistant directors work in the Enforcement Division.  I know because I worked for a few truly amazing ones. These individuals should be given life tenure.  There are also assistant directors who are very good managers — conscientious, thoughtful, and well-regarded.  

Senior management should do something to address the obvious lack of promotion opportunities and work to improve the caliber of its assistant directors.  If they don’t, some of the best and brightest attorneys will find work elsewhere and the Division (and the Commission and the investing public) will be worse off because of it.  With the position of assistant director so critically important to the success of the Enforcement Division, senior management should do what it can to ensure that its assistant directors are of the highest caliber.  Ones that are not should be reassigned to less important positions to make room for those that are.

Anyone paying attention can’t help but notice that the SEC’s Enforcement Division is not producing nearly as many enforcement actions as it had in the recent past.  Penalties collected against securities law violators are way down as well.  The facts are not altogether unsurprising in a pro business administration—enforcement actions, particularly those against business entities, just aren’t going to be as common.  But the degree of the decline is much greater than most expected.  Because the number of Enforcement staff has remained somewhat constant and the productivity of the staffers probably hasn’t changed much, an interesting question is what has caused the dramatic decline in the number of enforcement actions?

I think there are multiple culprits. Without a doubt, the Commission is ultimately responsible for the drop off in cases. After all, the Enforcement Division reports to the Commission. The Commission (primarily through the Chairman) sets enforcement priorities and allocates resources as it sees fit.  This Commission signaled that it planned to be kinder and gentler than its predecessors when it came to enforcement of the securities laws.  This naturally has resulted in fewer enforcement matters brought. Moreover, presumably because there is now a full compliment of Commissioners, it has become even more challenging to get actions successfully completed.  A full set of Commissioners means more meetings, followed by more briefings, followed by still more meetings and briefings and then follow up meetings and briefings.  Following these briefings, Commissioners often seem to want to know what other Commissioners are asking about and this can result in still more meetings and follow up meetings.  As a staff person, this absurd and exhausting process often seems like it will never end.

The Enforcement Division co-directors also share some of the blame for the dramatic fall of enforcement actions.  I don’t know exactly what the co-directors are doing, but perhaps the low output is occurring because the directors are still getting use to their new roles or are more cautious than they really ought to be.  The issue is probably not one of diligence or competence.  For some Enforcement executives, it takes considerable time before they are fully comfortable making non-controversial decisions without soliciting views from defense counsel, subject matter experts (other SEC divisions), trial unit personnel, colleagues, and economists. It’s hard to tell what’s going on from the outside looking in, but the co-directors bear significant responsibility for the Enforcement Division’s tangible productivity (or lack thereof).

I also know that the trial unit is continuing to gum up the works. As I have advocated before, the Home Office Trial unit model should be disbanded. Trial unit personnel spend way too much time conjuring up litigation risks and too little time actually litigating cases.  Perhaps they should spend some of their time finding holes in the putative defendants’ cases.  Putting forth an opinion that a judge won’t like a particular case or that a particular defendant would present well before a jury is not really a particularly enlightening observation, particularly from someone who has little experience actually trying cases and little insight into the personalities of the relevant judges.  The current trial unit set up is not a good use of spare resources and not good for the enforcement program (to the extent that the goal is actually to bring cases in a timely manner).

Getting an enforcement case to the finish line is, as one attorney colorfully noted, a lot like “pushing a pig through a python.” It seems as if the python has grown much longer under the current Commission. My guess, though, is that in the not too distant future the trend will start to reverse, as those in charge begin to realize the political hazard of fewer enforcement cases.  I believe that some time soon, enforcement staff will be told that more cases need to be brought to beef up enforcement statistics, even though the staff hasn’t actually been causing the holdup.  Expect to see a significant uptick in the number of cases brought in the coming months—before the end of the fiscal year. Inevitably, in the rush to generate enforcement cases and favorable statistics, some of the actions brought (so-called stat generators) will be properly seen as a dubious use of the resources of the federal government.

My last post briefly addressed the miniscule number of trials the SEC has conducted in the past few years.  In this post, I will discuss whether the SEC Home Office should continue to separate its trial attorneys from its investigative attorneys.  As discussed below, I believe that the obvious answer is no.

By way of background, for some time the SEC Enforcement Division in the National Office (the Home Office) has had two separate groups of attorneys.  The primary responsibility of the first attorney group (the investigative unit) is to conduct investigations, while the second group (the trial unit)  is responsible for reviewing (sometime preparing) litigation papers and then litigating if a case goes to trial.  Attorneys from the investigative group almost always draft the initial litigation papers and are frequently involved in the trial work.

Based on their defined roles, trial attorneys in the Home Office usually get their first look at a case only when it seems the matter will litigate, often some time after investigative steps have been completed.  Because of this, attorneys from the trial unit generally do not take witness testimony; they learn about a case solely by reading staff memos, defense submissions, and testimony transcripts.  In a complex matter, this tedious effort may take months of concerted effort to get up to speed (some trial attorneys try to be more efficient by initially reading just the defense submissions).  In many situations, the sheer volume of investigative material to digest makes it difficult for a trial attorney to be well-steeped in the facts uncovered in the investigation.

Perhaps, as a result of this dynamic, a number of trial attorneys have a propensity to exaggerate the litigation risks associated with a particular case.  Moreover, because trials require enormous time and energy, a trial unit attorney not involved in an investigation from the start or not intimately familiar with its details is more likely to think he has discovered flaws with a case and be less interested in taking a case to trial, not having a vested interest in the outcome.  This is not ideal.  I can tell you from first-hand experience that nothing is more maddening than working long and hard on an investigation and then having a trial unit attorney muck up the case by conjuring up cockamamie farfetched litigation risks or misstating the evidence in meetings with outside counsel or senior officers of the Commission.

Similarly, the separation of investigative and litigation functions likely causes investigative attorneys to inadequately consider the litigation risks associated with a proposed Enforcement action.  While conducting an investigation, an attorney may not be naturally attuned to the litigation issues, since an investigative attorney’s primary role is trying to figure out the facts, not how to present the facts in a courtroom.  Moreover, an investigative attorney is not likely to objectively confront the litigation risks of a case, thinking he will not have to play a significant role in litigating the matter.  Having put forth an extensive investigative effort and uncovered bad behavior, the staff attorney’s goal is to try to figure out how to bring the most meaningful charges possible rather than to close the case without action or take a settlement that seems insufficient.

Of course, a natural byproduct of all this is a fair amount of friction between the two groups of attorneys.  While historically there were always disagreements between the two groups of attorneys, the attitudes and personalities of the recent trial chiefs exacerbated the mistrust and disrespect between the two groups.  Some embarrassing trial losses further frayed relations.  As a result, Home Office trial unit attorneys now are instinctively skeptical toward any case assigned to them before even looking at the evidence, and investigative attorneys often believe most Home Office trial attorneys to be risk averse and ineffective.  It doesn’t help that the two groups have different supervisory chains.

While the current Home Office setup for enforcement attorneys may suffice for a simple insider trading case, it is widely understood that it does not work well for a case of any complexity (which now comprise a large number of enforcement actions).  So, the current Enforcement Directors have a choice. They can take the easy way and simply maintain the status quo, or they can modify the existing setup and have both sets of attorneys subject to the control and direction of the same supervisors.  Restructuring the Home Office Enforcement groups that way could result in more trials and would likely meet resistance by attorneys in both groups (and defense counsel, who rightly believe they can work the existing system to their advantage).  It would require fortitude and commitment but would be well worth the effort, almost certainly leading to a more productive and efficient enforcement program.  The change would not be a total cure but it would be a significant improvement.

So, there you have it.  What are the chances of this sensible and useful idea being implemented?  Virtually zero.

Long ago, while working for the SEC, I lead an investigation into the conduct of a research analyst named Paul Johnson.  Johnson refused to settle with the SEC and went to trial, where he was found liable for fraud.  At the time of Johnson’s trial, I was under the impression that SEC trials in federal court were fairly common.  To my amazement, I was completely wrong in that belief.  There were very few trials then and there are even fewer today.  The reality is that the likelihood of any SEC case of significance ever making it to trial is pretty close to zero.  In fiscal year 2016, the SEC had just six trials, which matched the number it had in fiscal year 2015.  When you consider that the SEC Division of Enforcement has 150 or so trial unit attorneys, the number of cases that the Division takes to trial each year seems ridiculously small.  So the obvious question is:  How can the SEC expect to attract talented trial attorneys when there are so few cases to try?

 

Working in the SEC Enforcement Division as a staff investigator was by far the best job I ever had.  The work was exciting, fun, and full of surprises and challenges.  I enjoyed the public service aspect of the job immensely.  Although the position is not suited for everyone, for the lucky few it can be the job of a lifetime.  Here are some of the reasons why:

1) The work you do is critically important.  The primary mission of the SEC is to protect investors, and the Enforcement Division plays an essential role in that mission.  The investigations conducted by Enforcement staff help ensure that the U.S. securities markets are fair and honest.  And, as an investigative staffer in the Enforcement Division, you are quickly given significant responsibility to investigate major frauds and a wide variety of shady financial practices.

2) You are a public servant.  Staff investigators get to make decisions with the public interest in mind.  To me, furthering the public good was much more gratifying than representing a large bank or a millionaire caught trying to profit at the expense of others.

3) The work is fun.  The investigations are almost always interesting and the characters involved are quite often colorful.  Plus, almost every investigation has some challenge associated with it.  Sometimes the challenge is determining motive or deciding on the appropriate legal theory, other times it might convincing others (or yourself) that the case is worth pursuing or finding enough evidence to make a compelling case.  If you like solving puzzles, dealing with knotty issues, and cornering sophisticated con men, the job is terrific.

4) Some investigations have the potential to be highly consequential. Certain cases involve enormous sums of money or serious sanctions, some even result in jail time for the offenders.  Other cases aim at changing fraudulent industry conduct that has gone undetected for many years.  Still others uncover cutting-edge frauds or crimes. These features of the work make the work exciting.

5) The vast majority of the people in the Division are enjoyable to work with.  Although weasels and snakes sometimes slip past the hiring committee firewall, these destructive personalities can almost always be spotted and avoided, and thankfully most leave after a short time (usually after being marginalized).  Nearly all of the people in the Division are kind and decent, and, with some luck, you may even end up with a few friends that you can keep long after you leave the agency.

6) You get to work with some truly exceptional professionals.  I had the very good fortune to work with several individuals who fit this description:  all had terrific judgment and were persuasive and decisive, always willing to share their time and insights.  The best said what everyone knew to be true but were afraid to say and stood up for what was right even when it is not in their self-interest to do so.  They were quick to take responsibility for the mistakes of others and thrived in pressure cooker situations.  Such leaders existed while I worked at the SEC and can still be found there today.  These individuals can made work seem more like play and inspire in ways that that one will remember long after leaving government service.

7) The defense bar is pretty good too.  Though I often wondered how certain attorneys managed to end up representing some fairly significant clients when I wouldn’t have hired them to represent me in a minor lawsuit, I found other defense counsel to be extremely talented.  You can learn a tremendous amount dealing with the talented defense attorneys.  At the same time, the worst defense attorneys will provide you with lots of entertainment and endless examples of how not to behave.

8) You can really enhance your skills as an attorney.  While I worked as a staff investigator, I probably took the testimony of twenty or more individuals each year, and interviewed or participated in proffer sessions of many more.  I also wrote or edited dozens of memos every year.  When I started in the Division, I had almost no experience taking testimony and my writing needed some serious work, but after much practice I got significantly better at these important legal skills.

9) The pay and benefits are excellent.  Many enforcement employees make more than $200,000 per year and staff are often permitted to work remotely from home one or more days a week.  Moreover, most supervisors are flexible about how you accomplish your assignments if you are getting your work done.  Not bad for government work.

Recently I read the Securities and Exchange Commission’s complaint against Rio Tinto and the company’s former CEO and CFO, accusing the defendants of serious securities fraud. The case is quite intriguing, but it is puzzling why the SEC complaint is so poorly written. I wanted to highlight the substandard writing, put forth some possible reasons as to why it ended up the way it did, and suggest a simple way for the SEC to avoid such outcomes in the future.

By way of background, on October 17th of this year, the SEC filed a civil fraud lawsuit in Manhattan against Rio Tinto and the former officers. The company, founded in 1873, is one of the world’s largest mining corporations, with operations in six continents. Rio Tinto’s stock trades on the London and Australian stock exchanges and its ADRs trade in the United States.

The SEC complaint is crudely written and makes it seem that some of the serious fraud allegations will probably be difficult to prove. It has a number of confusing passages and a lot of superfluous information. Moreover, there are some glaring errors in the SEC public documents. The SEC press release says that the fraud was discovered in January 2013, but the complaint says it was actually December 2012. Likewise, in a crucial section of the complaint, the SEC says that if Rio Tinto had “properly” valued its coal properties in mid-2012, it would have reduced Rio Tinto’s reported earnings by more than fifty percent. I’d like to see the SEC staff’s math on that suspect contention—it can’t possibly be correct.

So, the obvious question is why the complaint in this high profile matter isn’t first rate? The first possibility is that the complaint reads the way it does because the SEC is being overly aggressive with its charges and the complaint reflects the shortcomings in the underlying case. I can’t imagine that is the situation here. Cases like Rio Tinto are thoroughly vetted within the SEC, especially these days, given the agency’s string of high-profile trial losses. Moreover, the SEC trial lawyers, who are notoriously risk averse, will often argue strenuously against proceeding at all unless they believe that they can prove the case beyond nearly all doubt (even though in an SEC fraud case the standard of proof is only a preponderance of the evidence). I expect that everyone up and down the chain of command went over all of the evidence in this case with a fine-tooth comb before deciding to go forward.

A second possibility is suggested in the complaint itself: the statute of limitation on the defendants’ conduct was set to expire on October 18, 2017, just one day after the SEC filed the complaint. Perhaps the SEC staff assumed the defendants would agree to extend the statute of limitations period and when they refused, the complaint had to be hastily written. I doubt that is likely either, because a case like this one would have taken months to get through the review process at the SEC, leaving plenty of time for the complaint to be written and re-written several times.

A third possibility is that those assigned to write the complaint just weren’t up to the task. An SEC investigative attorney signed the Rio Tinto complaint but attorneys in the SEC trial unit were almost certainly involved the drafting process. For reasons that are understood by few, the D.C. office of the SEC (commonly called the Home Office) has two separate groups of enforcement attorneys. The primary role of the investigative unit is to conduct investigations while the primary role of the trial unit is to draft the complaint and related documents that will be filed in court and then litigate if the case goes to trial. Because the Home Office handled this case, attorneys from the trial unit likely became involved in the case only toward the end of the investigation, after it seemed likely that the defendants would not settle. Part of the role of the trial attorneys was to write or oversee the writing of the complaint.

I guess it is still unclear why—in a high profile matter, which was carefully vetted—the SEC complaint wasn’t as well written as it deserved to be. I don’t know the answer, but I do know that the complaint makes the case seem much more complicated than it probably is and the complaint’s poor quality could be interpreted by the defense as a signal that the SEC is not yet ready to litigate.

The complaint is not an example of the SEC’s best work. I hope that in similar cases in the future, the SEC assigns a skilled editor to polish and revise the charging document, which is often the only substantive document available to the public. Many such attorneys exist at the SEC and the benefit to the SEC enforcement program would significantly exceed the effort required.

I look forward to following the case as it moves forward. We shall see if the SEC can develop the facts in the complaint and how the defendants challenge the allegations.