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In Cox Years at the SEC, Policies Undercut Action
Red Tape Halted Cases, Drove Down Penalties

By Zachary A. Goldfarb
Washington Post Staff Writer
Monday, June 1, 2009

The five enforcement officials caught a morning Acela train bound for Washington. Based at the New York office of the Securities and Exchange Commission, the team was seeking agency approval to impose tens of millions of dollars in fines on a drug company, Biovail, which had allegedly used the crash of a truck hauling depression medicine to cover up financial losses.

But when the group arrived at SEC headquarters on that winter day early last year, it was barred from the room where the commission was meeting, according to a person familiar with the case. Chairman Christopher Cox and his colleagues reviewed the case inside. When the doors opened, the enforcement officials learned the commission had knocked down the penalty to a small fraction of what they had sought.

The outcome, though discouraging to the team, was not a complete surprise, sources said. After Cox became SEC chairman in mid-2005, he adopted practices that undermined the enforcement division's efforts to investigate cases of corporate wrongdoing and punish those involved, according to interviews with 19 current and former SEC officials.

During Cox's tenure, investigators who wanted to subpoena documents or compel interviews faced an increasingly cumbersome process to win the commission's approval for each case, according to current and former agency officials.

Cox also required enforcement officials to see the commissioners before approaching a company about a civil settlement. In several high-profile cases, when SEC lawyers were ready to ask the commission to authorize lawsuits or approve settlements, Cox postponed the decisions at the last minute, leaving cases unresolved for months, the sources said. At times, as in the Biovail case, the commission eventually weakened the sanctions sought by the enforcement division.

This is the legacy Mary Schapiro inherited when she replaced Cox as chairman this year. Among her first acts, Schapiro freed enforcement officials from getting commission approval before negotiating settlements with companies and established an accelerated process for authorizing subpoenas and depositions. She speaks frequently of taking the "handcuffs" off of the enforcement division.

This effort is central to Schapiro's strategy for rebuilding the SEC and ensuring it has a dominant voice in the emerging debate on overhauling the nation's regulatory system. Since the 1930s, the agency has been the top cop on Wall Street and the primary regulator of financial markets, requiring that firms play fair and give investors honest, timely information.

But a backlog of financial crime cases continues to slow the enforcement division as Schapiro tries to turn more of the agency's attention to abuses linked to the financial crisis, SEC officials said. The agency is still working to reinvigorate its dispirited enforcement ranks.

As grounds for the policies he adopted, Cox cited efficiency and ensuring that commissioners had the chance to review cases. Cox said in a recent interview that he had taken steps that made clear that "corporate penalties are an important part of the agency's enforcement arsenal."

But former enforcement lawyers said the practices had a chilling effect. Several cases, they said, were scaled back or dropped because of anticipated resistance from the commission.

"The presentation of cases is the culmination of the investigative process. When that process is interrupted, delayed or denied, it can't help but have a negative impact on the people who conduct those investigations," said James T. Coffman, a former assistant director of the enforcement division. "Clearly some people wonder, 'If they don't want these kinds of cases, why should I bother doing them even though they're very important?' "

Most former and current SEC officials spoke on condition of anonymity because they were discussing confidential legal matters or were not authorized by the agency to comment. But in a report last month, the Government Accountability Office, after interviewing many enforcement lawyers, concluded that the SEC penalty policies in 2006 and 2007 "led to less vigorous pursuit of corporate penalties, may have made penalties less punitive in nature and could have compromised the quality of settlements."

During Cox's tenure, penalties imposed on companies fell 84 percent, from $1.59 billion in 2005 to $256 million in 2008.

Before and After Cox

Cox's predecessor as chairman, William Donaldson, had pursued hefty penalties against companies accused of wrongdoing, often despite dissent from other commissioners. But when Cox took office, there was a growing concern within government and the financial industry that the United States was losing business to less-regulated markets overseas, and Cox wanted to achieve consensus among the commissioners.

One commissioner, Paul Atkins, was particularly skeptical about corporate penalties. He argued that these ultimately were shouldered by shareholders -- the very people most frequently hurt by fraud -- and he often asked for more time to review cases.

"It's important that commissioners have a fair opportunity to fully understand the cases before they vote on them," Cox said in the interview.

Cox defended his enforcement credentials and pointed to the agency's aggressive pursuit last year of financial firms that misled investors into buying the exotic bonds called auction rate securities. Billions of dollars were returned to investors.

Cox also said he took an important step to modernize the enforcement division and speed cases by introducing a new case-management system. He said staff turnover during his tenure decreased, and he noted that the number of cases brought by the commission has stayed level.

But within months of Cox's appointment, tensions surfaced between the chairman and the enforcement division. Lawyers said in interviews they sometimes waited weeks to appear before the commission to request "formal orders," which enabled them to subpoena documents and conduct depositions. During Cox's tenure, the annual number of these orders fell 14 percent.

"Some investigative attorneys came to see the commission as less of an ally in bringing enforcement actions and more of a barrier," the GAO reported.

But enforcement lawyers faced even greater frustrations once investigations were finished and cases were finalized. In early 2006, Cox outlined nine conditions for investigators to consider when proposing penalties.

On many occasions, former enforcement lawyers said, Cox removed cases from the agenda because of Atkins's concerns. Often, the enforcement team had already reached a settlement with a company. The practice made it more difficult for enforcement lawyers to negotiate credibly, the attorneys said.

"Cases would sit and linger for months while you waited to get a response. . . . There was often a question as to what authority the staff had," said Thomas O. Gorman, a defense lawyer at Porter Wright Morris & Arthur in Washington who specializes in SEC cases.

Cases began disappearing from the agenda shortly after Cox became chairman. Two similar cases against financial firms -- MBIA and RenaissanceRe Holdings -- were plucked from the calendar after the companies agreed to pay penalties. The commission removed the items because of its concerns about the size of the proposed penalties, $50 million for MBIA and $15 million for RenaissanceRe, according to sources familiar with the cases. It took more than a year to close the cases, with penalties the parties had agreed to earlier.

In 2007, the SEC prepared to charge Ingram Micro, a California technology company accused of abetting a "massive financial fraud" in exchange for business at the software company McAfee from 1998 to 2000. But the case was repeatedly pulled from the commission's agenda. In mid-May, the SEC approved the settlement. Ingram, which agreed to pay $15 million, did not admit or deny wrongdoing.

Smaller Settlements

In 2006, an SEC enforcement team forged an agreement with Brocade Communications Systems for the company to pay $7 million to settle allegations it illegally backdated hundreds of millions of dollars worth of stock options. Afterward, Brocade wrote the commission directly, saying the penalty was unreasonable because the company had cooperated with the investigation.

The SEC enforcement team flew to Washington from California to present its case against the company and its executives. On the eve of the meeting, while the lawyers were at dinner, a message from the chairman's office appeared on their BlackBerrys: The commission would hear the case against the executives but postpone the one against the company, a source said.

Ten months later, to the surprise of the enforcement team, the commission met in executive session and approved a penalty against Brocade. The company did not admit or deny wrongdoing.

When subsequent cases were brought against firms for alleged backdating of stock options, penalties often were not sought, several former and current agency officials said. "People openly discussed that if you wanted to get your case done quickly, you didn't put in a civil penalty," a former enforcement lawyer said.

In two cases involving large banks, the commission eased the penalties sought by the staff. Last year, the commission slashed the penalty proposed in a case against J.P. Morgan Chase. The bank was accused of ignoring improper transactions at one of its clients that had cost investors $2.6 billion. J.P. Morgan agreed to pay a $2 million penalty to settle the case.

In late 2006, the SEC enforcement staff sought a penalty of $122 million against Deutsche Bank, which was charged with granting a hedge fund exclusive information about trading by mutual funds in exchange for business. The commission proposed reducing the fine to $17 million.

In paying penalties, neither company admitted or denied wrongdoing.

In the Biovail case, the company had projected earnings that proved too rosy. The company blamed its poor performance on the crash of a truck in Illinois carrying depression medication. But SEC investigators determined the accident "had no impact on Biovail's financial results." Rather, the SEC said Biovail was engaged in a broader effort to defraud investors. The enforcement team sought penalties in the tens of millions of dollars, a source said.

Instead, the commission set a range of $2 million to $10 million. Biovail settled for $10 million, without admitting or denying guilt.

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