Why Did SEC Acting Chair Take an Ax to Enforcement Unit’s Subpoena Power?

By James A. Kidney: February 20, 2017

The Trump administration assault on investor protections put in place following the 2007-08 financial crisis continues apace.  The war on investors takes place in arenas both large and small.

The large issues get the attention, of course.  These include repeal of much of the Dodd-Frank law and regulations of the biggest Wall Street banks, limiting or eliminating the Consumer Financial Protection Bureau, which actually helps individual customers abused by giant financial institutions, and preventing adoption of fiduciary standards for financial professionals recommending securities that line their pockets but are risky to customers.

But Washington is not merely a swamp of self-interest with large, highly visible alligators munching on small fish to satisfy their insatiable greed.  Another apt metaphor is a field of giant weeds — weeds of rules, processes and procedures that can be manipulated for the interests of the Fat Cats.

These weeds are everywhere in Washington. Whether your particular self-interest lies in financial dealings regulated by the Federal Reserve and the Securities and Exchange Commission, looser regulations at the Environmental Protection Agency, exercising greater control of your employees by removing Labor Department regulations, or a host of other rules, processes and procedures, powerful interests with highly paid lawyers can push back easily against the much-maligned bureaucracy every day.

This is especially the case when there is one-party government and the president appoints those at the center of the oligarchy to head government agencies, as is true today.

What goes on hidden by these weeds is not usually paid attention to by either the press or the public.

Case in point:  Although the SEC currently has three vacancies on its five-person commission, the designated temporary chairman, Republican Michael S. Piwowar, has quietly restricted the authority of the SEC’s civil servants in the Enforcement Division to issue subpoenas for witnesses and documents when investigating whether securities laws have been violated.  A small number of news articles suggest this unwarranted reversal of an eight-year-old policy delegating authority to the supervisors in the Enforcement Division may remove Division discretion in its use of civil investigative powers completely.

There is zero evidence that this power has been abused.  Rather, reinstating a requirement that all investigations be approved in advance by the commissioners before a subpoena can be issued is simply an opportunity to allow the Wall Street lawyers (some of whom generally end up as chairman of the SEC and head of the Division of Enforcement, then return to the fold) to intervene to slow or kill an investigation deemed worthy by those who actually conduct the investigations and have long experience at the SEC.

A little background is in order.

Until 2009, SEC rules required that the Commissioners themselves vote to approve issuance of a “Formal Order.” Approval permitted the Commission staff to employ the power of a subpoena to obtain witness testimony and documents.  Absent a formal order, the Division of Enforcement staff only could open an “informal investigation” to seek voluntary compliance with requests for witnesses to appear and documents to be produced.  Obtaining a formal order to issue subpoenas required circulating a memo to all commissioners, meeting with some or all of them, and, sometimes, appearing in a closed commission meeting to defend the request.  Doing so was time consuming and clearly an opportunity for lobbying by the investigation target.

As in any bureaucracy with built-in routines, many formal orders were obtained without controversy and in relatively short order.  For that very reason, authority was finally delegated.

Voluntary production was usually not a problem when the SEC went after minor league fraudsters.  They are often scared to death of the cost of hiring a lawyer to run interference for them in a run-of-the-mill case of insider trading.  The cost of defending an investigation for the average guy or gal can quickly exceed the likely penalty imposed if insider trading profits were small.  (As an aside, the Division of Enforcement spends a lot of time on such small stuff.) In my experience, many small insider traders came clean without a formal order or subpoena because they wanted to put the personal disruption behind them quickly.

But the bigger cases, especially those involving a large institution such as a broker-dealer firm or a public company, could be delayed for months by “voluntary production.”  Pricey lawyers can stretch out matters without actually telling the SEC staff that no material documents or witnesses will be forthcoming.   Lawyers know how to “voluntarily” bury the staff in irrelevant documents and produce witnesses low on the totem pole who can honestly testify they know nothing about improprieties arranged by those higher up in the organization.

The power of a subpoena, enforceable by going to court and publicly exposing that an investigation is in process, is a substantial lever for the Division of Enforcement.  Subpoenas enable investigators to more quickly get to the heart of a matter and assess whether a rule or law has been violated.  That is why, beginning in 2009, the SEC delegated authority to issue investigative subpoenas to supervisory staff in the Enforcement Division.

In announcing a new SEC rule delegating subpoena power to the Division of Enforcement, then Division Director Robert Khuzami said, “This means that if defense counsel resist the voluntary production of documents or witnesses, or fail to be complete and timely in responses or engage in dilatory tactics, there will very likely be a subpoena on your desk the next morning.”

The SEC release announcing the change of rules (originally for one year, but later made permanent) stated that “this delegation will expedite the investigative process by reducing the time and paperwork previously associated with obtaining Commission authorization prior to issuing subpoenas.”

At least two sources (here and here) report that Piwowar, who is an economist, not a lawyer, and worked for very conservative Republicans on the Senate Banking Committee before arriving at the Commission, reportedly already has restricted authority to issue a subpoena to the Division director alone and is considering eliminating the authority altogether.

The question, which Piwowar and the SEC have thus far declined to answer, is why retract the delegation?

There is no evidence that the Division of Enforcement has gone mad with its authority.  In fact, the Division of Enforcement under Khuzami is mostly known for having applied its investigative powers very sparingly to the big Wall Street banks, as evidenced by the few cases brought, low sums in settlements relative to much larger settlements by the Department of Justice, and the near total absence of individuals named in civil SEC complaints arising from the financial collapse.

Nor did the Commission under Chairman Mary Jo White and Khuzami’s successor, Andrew Ceresney, run amuck with investigations.  To the contrary, White preached the notion of “broken windows” during her run.  She claimed that if the SEC went after small violators, the big financial institutions would be fearful of the “cop on the street.”  There is no evidence that Fat Cats looking on the Street from the 60th floor were especially concerned about those souls on the sidewalk grabbing the attention and resources of their regulator.

If there is evidence of large, unwarranted investigations in which the Division of Enforcement has used its delegated powers irresponsibly, Piwowar and the SEC should let the public know about them if they want to change the rules.

If there is no such evidence, the only reason for reversing the rule is the old one:  Let’s give the lawyers for the biggest potential defendants a way to continue exhausting Commission time and effort on meaningless “voluntary” production of evidence.  If, despite the delays, an exhausted staff pushes for Commission approval to use tougher enforcement tools, the lawyers and their clients can get an audience with the commissioners themselves to push their defense. The commissioners might then tell the SEC staff to back off or to restrict their investigation.

This would allow unscrupulous financiers to pursue their real work — fleecing the public.

The weeds are tall in Washington. Just know that the harmful insects are alive and working hard.


James A. Kidney, Former SEC Trial AttorneyJames Kidney retired as trial counsel in the Division of Enforcement of the Securities and Exchange Commission in 2014 after a 25 year career.  You can read more of his work at watchthecircus.com.

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