Coffee, Khuzami, Canellos and the Future of SEC Enforcement

Professor John Coffee’s recent proposal that the SEC retain outside counsel on a contingent fee basis to litigate select cases reflects a fundamental misunderstanding of Commission enforcement actions. In posts on his Columbia Law School Blog (The CLS Blue Sky Blog) dated January 2 and 16, 2013 Professor Coffee details what he believes to be a series of difficulties with the SEC enforcement program. His primary claims about the cases being brought and the recoveries obtained are well refuted in an National Law Journal article (Jan. 14, 2013) by Robert Khuzami and George Canellos, respectively the Director and Deputy Director, SEC Division of Enforcement.

Professor Coffee’s contingent fee proposal would refocus Commission enforcement actions from protecting investors to a quest for bigger dollars to fuel contingent fees, thereby distorting their purpose. First and foremost, SEC enforcement actions are about halting violations or possible violations of the federal securities laws to protect investors and the markets. Once halted the focus is on preventing a reoccurrence of the violations in the future. Stated differently, the point is to stop the wrong and make sure it does not happen again.

In view of this purpose, from the time the statutes were passed the remedy of choice for the SEC was not the money penalty but the injunction supplemented by equitable remedies. The injunction was intended to halt wrongful conduct and prohibit it in the future. Disgorgement was designed to take the profit out of wrong doing. Ancillary relief in the form of policies and procedures was focused on making sure the wrong is not repeated thereby protecting the public in the future.

The success of these remedies cannot be doubted. When the Commission’s enforcement program was considered one of the best and most efficient in government, its remedies were the injunction and ancillary relief, not money fines. In the late 1970s when the Commission implemented the Volunteer Program, for example, hundreds of companies stepped forward, admitted their complicity in what were then called “questionable payments” and faced SEC Enforcement actions. The remedies for this very successful program were not money fines but the injunction and carefully crafted procedures to prevent a reoccurrence of the wrongful conduct.

With the passage of the Remedies Act in 1990 Congress gave the SEC the authority to seek civil money penalties in appropriate cases. The grant of authority was in addition to other remedies – a supplement – not a replacement for all others. In recent years unfortunately increasing emphasis has been placed on money penalties and less on the adoption of policies and procedures. Big dollar fines make good headlines, great statistics and quick responses to Congressional inquiries.

If money penalties are used judiciously as part of an overall package of remedies they can be what Congress intended – and effect additional weapon in the SEC’s arsenal. Professor Coffee’s proposal would, however, make them the primary focus of presumably some of the Commission’s most important enforcement actions. This simply misses the mark. It would refocus enforcement actions from halting violations, preventing a reoccurrence and protecting investors and the markets to a quest for more and more dollars to fund the contingent fee. That is not what SEC enforcement is about.

The success of SEC enforcement in the future depends on the prudent use of all its weapons. The Enforcement program has undergone a dramatic transition in recent years, overcoming significant obstacles in most difficult times. If it is to continue on the path to success the focus must be on meaningful remedies to protect investors and the markets in the future, not funding contingent legal fees.