Securities Enforcement Cracks Down in Post-Madoff World
Ponzi scheme actions an indication of increased SEC activity
April 27, 2009
In the annals of Ponzi schemes, Shawn Merriman is small potatoes. But when the Securities and Exchange Commission announced April 8 that it had charged Merriman of Aurora, Colo. with fraudulently obtaining $17 million to $20 million, the agency's new director of enforcement, Robert Khuzami, seized on the news. "We pursue Ponzi schemes with a great sense of urgency," he said, "and bring cases swiftly and successfully to protect investors."
During the first three months of 2009, the SEC has brought over two-dozen emergency enforcement actions to "halt an ongoing fraud," added Khuzami. Nine of the cases announced by the agency this year were related to Ponzi schemes; over the same period in 2008, there were none. Observers haven't had to look far for the reason for the sudden interest.
Khuzami's predecessor, Linda Thomsen, announced her resignation in February, shortly after a scathing Congressional hearing in which lawmakers railed against the agency for its failure to detect Bernard Madoff's $65 billion fraud.
Thomson had held the position since 2005 and worked for the agency since 1995. Khuzami was previously general counsel for the Americas at Deutsche Bank and logged 11 years as a federal prosecutor with the United States Attorney's Office for the Southern District of New York.
At recent hearings, witnesses have repeatedly discussed weaknesses in the SEC's division of enforcement, which accounts for more than 60 percent of the agency's annual resources, according to its yearly report.
Former SEC chairman Arthur Levitt on March 26 told the Senate Banking Committee that "enforcement staff dropped 11 percent from 2005 to 2008. We have seen regulators are often overmatched, both in staffing and in their capacity to use and deploy technology, and they can't meet even a modest calendar of regular inspections of securities firms."
At the same hearing, Fred Joseph, president of the North American Securities Administrators Association, noted that enforcement "has received far less support than it deserves. We should toughen punishments for those who violate the law and increase enforcement budgets for state and federal regulators, including the SEC."
Stagnant Budget
From 2004 through 2008, the enforcement division's annual budget stayed flat or declined and staffing levels were essentially stagnant, according to the SEC. Yet that period saw explosive growth in the financial services industry. For example, the number of investment advisers registered with the SEC rose 33 percent--from 8,302 to 11,030--says the Investment Adviser Association.
Even as the number of advisers was growing, the SEC was conducting fewer inspections. The commission in 2004 examined 1,543 registered investment advisers; last year, that fell to 1,300. Meanwhile, the number of investment companies examined dropped from 783 to 250. Since exams are a precursor to investigations and prosecutions, they are a leading indicator of enforcement activity.
"The SEC doesn't investigate IAs on a regular basis, and that is not the way it is supposed to work," said Jeffrey Plotkin, partner in New York law firm Day Pitney and former assistant administrator of the SEC's New York regional office.
But the Madoff scandal, with its devastating implications for the SEC's ability to detect fraud, has spurred a new mindset at the regulator that some experts say is already producing signs of a turnaround in the enforcement division.
Tougher Stance
"I think that overall, the SEC will take a much tougher stance on cases," said Plotkin. "There is going to be an uptick in all enforcement activity. We are in this post-Madoff world. The SEC has egg on its face and going forward in an enforcement context it does not want to be second-guessed."
