SEC Actions Against Bailed-Out Firms Could Weigh on U.S. Investments
Tuesday, August 4, 2009
Late last month, the Securities and Exchange Commission was poised to file suit against a subsidiary of Alabama-based Regions Financial for selling nearly $1 billion in troubled investments.
But the agency faced a new dilemma: Regions was on the list of the nation's most troubled large banks and had received $3.5 billion in taxpayer aid. SEC officials considered that filing suit to force Regions to buy back the troubled investments could hurt the bank. Should the agency act, or should it hold off to protect the government's investment?
The SEC decided to file. But the quandary shows the difficulty facing the nation's top Wall Street cop at a time when the economic crisis has left the U.S. government as the part-owner or controller of an unprecedented array of financial companies. Protecting investors on the one hand could mean harming taxpayer-owners on the other. And some troubled firms could wind up paying penalties with taxpayer money from the federal bailout.
"Normally the SEC's focus is on the protection of investors -- that is, people who are trading securities in capital markets," said James Cox, a securities law professor at Duke University. "With the government being a substantial stockholder, you could well think the SEC's consideration could extend to matters that relate to the financial success of the firm itself."
On Monday, the SEC faced another awkward question: How to pursue cases when government officials may have played a role in alleged wrongdoing? The agency charged Bank of America with violating securities laws for hiding from investors plans to pay billions of dollars in bonuses to employees of Merrill Lynch, the troubled investment bank it bought. The charges, which Bank of America settled, intensified concerns on Capitol Hill that the Treasury Department and the Federal Reserve may have been involved in efforts to avoid the disclosure of facts that could have derailed the deal.
As the SEC pursues numerous investigations into major financial firms, agency officials say they expect to wrestle with the competing demands of punishing wrongdoing and keeping financial firms healthy to support the economic recovery. In particular, they plan to take into account whether companies have received assistance from the government's signature bailout initiative, the Troubled Assets Relief Program. Officials said they are evaluating the size of fines and redress sought and the impact these could have on the financial system beyond the specific firms.
Robert Khuzami, director of the SEC's enforcement division, said in an interview that these considerations are not likely to have a major effect on the SEC's approach. "TARP status may come into play in only a few cases, but is unlikely to dictate the outcome," he said.
Khuzami said the SEC already had a policy to "consider an entity's distressed financial situation in deciding a monetary sanction." Government ownership of companies under investigation has not yet affected a case outcome, he said.
Last summer, before the government started bailing out banks, the SEC was planning massive, multibillion-dollar suits against the nation's biggest financial firms, including Merrill Lynch and Citigroup, for selling problematic bonds known as auction-rate securities.
The SEC enforcement staff pushed for the cases. But some agency officials and others at the Fed raised concerns that the suits could wound the banking sector. SEC and Fed officials discussed whether forcing banks to give billions of dollars back to investors could push several banks off the cliff, perhaps necessitating government action to save them, according to one current and one former SEC official.
In the end, after several conference calls, the officials concluded that the settlements would not cause a crisis.
But to Brian G. Cartwright, the SEC's general counsel at the time, the episode highlighted the delicate position in which the agency is increasingly finding itself.