by T. GormanPosted on Posted in SECActions

The Government Accountability Office (GAO) will issue a report today critical of the SEC. The report focuses on the relationship SEC and Self Regulatory Organizations (SROs) which police the markets and frequently conduct the initial portion of inquiries insider trading cases. Specifically, the GAO report notes that the SEC fails to review SRO internal audit reports and that the agency lacks the computer capability to efficiently analyze data provided by the SROs from their insider trading and other inquiries, according to an article in the New York Times by Gretchen Morgenson. “Quick, Call Tech Support for the SEC,” New York Times, December 16, 2007, Sunday Business at 1. The GAO report, entitled “Opportunities Exist to Improve Oversight of Self-Regulatory Organizations,” was prepared at the request of Senator Charles E. Grassley following Pequot Capital Management debacle and hearings discussed here. While the report raises questions about efficiency, Ms. Morgenson’s article ends by noting that if the inefficiencies are not remedied it is “one more data point for those who increasingly wonder whose side the SEC is on.”

It is not surprising that a GAO study (or any study) would find that the SEC is inefficient. That does not mean, however, that the agency is not doing a good job which is the usual implication of such a finding. Likewise, that finding says nothing about “whose side” the agency is on, as suggested by the Times article.

The SEC is a relatively small regulatory agency. Nevertheless, it has long enjoyed a reputation for excellence and efficiency. This well-deserved reputation does not come from superior systems, model internal procedures or other similar advantages that many Wall Street players may enjoy. Nor does it come from having armies of highly paid lawyers, paralegals and expert consultants like most of the law firms which defend the investigations and enforcement actions brought by the SEC and conducted by its enforcement division.

As Ms. Morgenson acknowledges at the beginning of her article, the SEC has long been overwhelmed by the number of professionals and the amount of talent and money those which it regulates, investigates and litigates against can throw at any matter. That fact has been true since the days of its first Chairman, Joseph Kennedy, and will continue to be true long after Chairman Cox is a distant memory.

The SEC’s well-deserved reputation for excellence and efficiency has come from the dedication of its people. The small band of dedicated professionals who work at the agency are charged with overcoming the well-known inefficiency of its internal procedures, outdated computer systems and lack of resources. And they do. Time after time the Commissioners and staff rise above these limitations and produce excellent results. This is a reason the U.S. capital markets are the envy of the world.

This is not to say that the agency does not make mistakes, have its short coming, or need improvement. It does. Posts in this blog have repeatedly pointed out shortcoming of the SEC and its enforcement program. There is no doubt the SEC needs better equipment, more staff, and that it needs to be more efficient, bringing cases which are based on solid evidence more quickly.

The GAO report is thus clearly correct in suggesting that computer and other systems at the SEC need improvement. That might start by returning to the agency a fraction of the huge fees it pays to the pays to the U.S. Treasury each year. A return of even part of those fees can enable the SEC to upgrade its systems and make them more efficient.

At the same time, any suggestion that system inadequacy or the lack of a quick fix of its inefficiencies reflects a lack of dedication to investor protection is simply wrong. Over the past year there has been endless speculation over whether the agency is properly protecting investors stemming from the botched Pequot Capital investigation to its positions in Tellabs and Stoneridge. The botched Pequot inquiry is not only hard to understand, but inexcusable. The flurry of discussion about the two Supreme Court cases is keyed to the debate about the propriety and usefulness of private securities class actions and their contribution to policing the markets, not the efforts of the SEC.

The focus of the GAO report is SEC efficiency in policing the markets. While the SEC may be inefficient and lack resources, there should be little doubt that it is aggressively policing the markets. This past year, as has repeatedly been discussed here, the SEC has been very aggressive in bringing insider trading cases. There is every indication that the agency intends to continue its aggressive war on insider trading. Giving the SEC more money and more resources can only help it win that fight.

by T. GormanPosted on Posted in SECActions

Last week, securities enforcement by the SEC and DOJ struck familiar themes – insider trading and option backdating. The impact of last week may, however, have significant, lasting implications.

One key issue from last week is the question of cooperation standards, a key question raised by the insider trading case of Hans Wagner, a former director of msystems, Ltd. Much has been written about cooperation under the SEC’s Seaboard Release and DOJ’s Thompson and McNulty memos. Usually, the question is whether government prosecutors and lawyers should ask for privilege waivers from corporations seeking to minimize their potential liability. This question is highlighted by the proposed legislation which recently passed the House of Representatives and was sent to the Senate for consideration – The Attorney Client Protection Act of 2007, which is discussed here.

The case of Mr. Wagner is different, however. In his capacity as a director of msystems, Mr. Wagner learned of a proposed offer to buy his company. Before his company announced the merger, Mr. Wagner bought 200,000 shares at $27.77 per share. After the announcement, the value of the shares increased by 13.2%. Nothing unusual here – a routine insider trading case.

What happened next is not routine, however. Mr. Wagner, according to the SEC’s release, reported himself to the staff and offered to disgorge his trading profits. Mr. Wagner took this action in recognition of his ethical obligations as a board member.

The SEC and Mr. Wagner settled the matter. An insider trading case alleging violations of antifraud Section 10(b) was filed, and Mr. Wagner consented to the entry of a statutory injunction. Mr. Wagner also consented to the entry of an order requiring that he disgorge $566,756 in trading profits and prejudgment interest of $11,335. No penalty was assessed. SEC v. Wagner, Civil Action No. 07-2213 (D.D.C. Filed December 7, 2007).

This is not the standard SEC settlement. Typically, a penalty is assessed which equals at least the amount of the disgorgement if not more. While the SEC’s release does not mention cooperation, it seems clear that the settlement reflects Mr. Wagner’s cooperation. In this regard, the SEC and the staff should be commended. Cooperation standards should be about more than the issue of waiving the attorney client privilege. Cooperation standards should be about what their title says: Cooperation. Those standards should encourage everyone to aid legitimate law enforcement efforts and help foster a climate of lawful and ethical conduct. This is the ultimate “tone at the top” issue – the government not just enforcing the law but helping create a climate that encourages everyone to do this.

In this context I offer a thought for consideration. Actions such as those taken by Mr. Wagner in self reporting are rare. Clearly he made a huge mistake by trading. Self-reporting does not take that away. At the same time, Mr. Wagner’s conduct in self-reporting is precisely what the SEC wants and should expect. In the future, rather than requiring the person who takes such actions to consent to an injunction, an alternative resolution should be considered: a Section 21(a) report of investigation, along with the payment of disgorgement and whatever other restitution might be necessary should be considered. The report and lack of sanction would serve to encourage others who make mistakes to self report and correct them. Encouraging cooperation, self reporting and an atmosphere of compliance is clearly preferable to having a court enter a standard injunction which is not needed.

Another significant insider trading case was also in court this week. The trial of U.S. v. Naseem started and ended – at least for now. As discussed earlier, Mr. Naseem is the former Credit Suisse investment banker alleged to have been involved in the TXU deal as discussed here. This is the first of the major insider trading cases brought this year to go to trial and may have given some indication of where other similar cases might go. Earlier this week, the case ended when District Judge Richard Berman in Manhattan declared a mistrial when two jurors failed to follow instructions.

Finally, as discussed earlier here, former UnitedHealth Group CEO William W. McGuire settled his option backdating case with the payment of a record sum. While the roughly $800 million total payment number drew a lot of ink, it clearly did not end the matter. Dr. McGuire still faces an on-going criminal probe.

Another little noticed ramification of Dr. McGuire’s case may be its impact on derivative suits. Typically, derivative suits settle for revised corporate government procedures and the payment of attorney fees to the attorneys who brought the case on behalf of the corporation. The case involving Dr. McGuire and UnitedHealth, however, settled for more that $400 million – about half of the reported approximately $800 million paid in settlement went to resolve the derivative suit. Such a huge payment is this case may well impact settlements in other derivative suits based on option backdating. Ultimately, this settlement, and perhaps others which follow, may alter the course of future derivative suit settlements.

Overall, the past week may change the course of securities suits. Mr. Wagner’s case could alter cooperation standards in the future. Dr. McGuire’s settlement may alter future derivative suit settlements.