From the April 2017 issue of Investment Advisor • Subscribe!

Ex-Enforcement Chief Suggests Priorities of a Jay Clayton SEC

Robert Khuzami predicts less emphasis on record-setting penalties and first-ever cases, along with closer scrutiny of anti-corruption cases

SEC chair nominee Clayton has said the Dodd-Frank Act 'should be looked at.' SEC chair nominee Clayton has said the Dodd-Frank Act 'should be looked at.'

A telling statistic about the Trump administration was delivered by Sen. Dean Heller, R-Nev., at the recent Hispanic Chamber of Commerce's Legislative Summit in Washington: 1,200 nominees must be confirmed for each new administration, of which 25 have been confirmed so far.

For the investment advisory industry, it goes without saying that two appointees — a new Securities and Exchange Commission chair as well as a new Labor secretary — will be central to dictating the policies they’ll be dealing with under President Donald Trump.

The former head of the SEC's enforcement division, Robert Khuzami, said on an early March call with reporters that Sullivan & Cromwell partner Jay Clayton will likely be confirmed as chair of the SEC; Clayton's nomination hearing was scheduled to take place on March 23.

(Related: Dodd-Frank ‘Should Be Looked at,’ SEC Nominee Clayton Says)

Discussing the priorities of a Clayton-led commission, Khuzami, now a partner in Kirkland's Government & Internal Investigations Practice Group, warned that “one scandal or high-profile matter” could derail such an agenda.

Khuzami, who was SEC enforcement chief in the wake of the financial crisis (from 2009-2013), worries about the administration's announced federal agency hiring freeze, which would have “a real impact” on agencies like the SEC.

The problem is that positions that open up as officials rotate out of government won't be filled, which will “slow down the work of these agencies.”

Since the administration has signaled its intent to cut back on the number of federal workers, Khuzami added that “there have been some suggestions that freezes might not be sufficient but actual cuts may occur.”

Moreover, streamlining and even potential consolidation of agencies may also come into play, as Trump issued an executive order in mid-March to reorganize the executive branch of government, which includes such federal agencies as the SEC and the Cabinet — including the departments of Labor and Justice — as well as the Social Security Administration.

Trump's “Comprehensive Plan for Reorganizing the Executive Branch” directs the Office of Management and Budget director to propose a plan to “reorganize governmental functions and eliminate unnecessary agencies.”

The plan requires that heads of federal agencies must submit, within 180 days of the order, to OMB a proposed plan to “reorganize the agency, if appropriate, in order to improve the efficiency, effectiveness and accountability of that agency.”

A Changed Focus at SEC

One thing is certain, said Khuzami: With a new administration comes “different priorities.”

With the backlog of financial-crisis-related cases largely “cleared up,” he continued, “it's a safe bet that there's going to be less of a priority on record-setting penalties and maybe less of an emphasis on first-ever cases,” which was a central focus of former SEC Chairwoman Mary Jo White.

Much of the focus over the past four years under White was “new cases in new areas that hadn't been brought before,” Khuzami said. “I think that's an approach that might get closer scrutiny.”

Objections to what's been seen over the past few years as “too much regulation by enforcement” — the idea that members of public companies or regulated entities only discover that certain types of conduct could be subject to an enforcement action as they’re being examined — will also likely be reined in, Khuzami suggested, via agency guidance detailing “where the lines are between proper and improper conduct.”

SEC Acting Chairman Michael Piwowar announced recently that the “delegated authority” granted to senior officials at the agency to open formal investigations and issue subpoenas has been pulled back and now resides in the hands of the enforcement director only.

“This means it will take more time to open cases and more questions being asked,” Khuzami said. “I think there are legitimate questions about whether or not that serves a proper purpose. Certainly the commission has the right to understand what cases are opened, but I think there's a significant view out there that there are ways to do that without slowing down the process of how these formal orders are issued. Certainly, [the rollback] could be viewed as demoralizing to the staff who want to move pretty quickly on some of these cases.”

The Financial Choice Act

House Financial Services Committee Chairman Rep. Jeb Hensarling's Financial Choice Act, which he said in mid-March would be reintroduced in a matter of weeks, would affect another signature achievement of White's SEC: its whistleblower rules.

The goal of Hensarling's legislation? As he proudly told members of the Hispanic Chamber during remarks in mid-March, it is to throw the Dodd-Frank Act onto “the ash heap of history.”

As Khuzami points out, the Choice Act — as detailed in a Feb. 6 memo about the act's new mandates — calls for whistleblowers “to report in-house first before going to the SEC, in order to give companies the opportunity to investigate the matter and take corrective action.”

The Choice Act memo also floats the idea of prohibiting co-conspirators from getting a whistleblower award. Khuzami said that this “could be significant because obviously it's often individuals who are involved in the wrongdoing who know most about it and make the best whistleblowers, despite their own involvement.” Should those individuals become ineligible for an award, “that could have an impact on the number of people who choose to blow the whistle.”

Hensarling's Choice Act also seeks to crack down on “stacking of penalties,” where multiple regulators bring actions against the same institutions for the same conduct. The Act would require federal regulators “to take into account penalties imposed by others in deciding what's appropriate in their particular cases,” Khuzami said.

Piwowar and others have also discussed giving corporate penalties a “closer look,” Khuzami continued, regarding “objections raised to corporate penalties in some circumstances where shareholders [didn't benefit] from the misconduct, in the sense that the company they owned shares in may have purchased an asset, for instance, whose stock's value was inflated due to misconduct that hadn't yet been revealed.”

There's also the issue of “whether or not shareholders would be penalized if a penalty were imposed. So there's a view that you shouldn't impose a corporate penalty if shareholders didn't get a benefit and would suffer as a result of the penalty.”

Still others opine, Khuzami continued, that penalizing companies in general “may not serve much of a purpose because of the view that shareholders will, as a result, call for changes in controls, or changes in senior management” where penalties haven't been backed by “empirical data. So ... you could see a rollback of such penalties.”

--- Read Reintroduction of Financial Choice Act Coming in ‘Weeks’: Hensarling on ThinkAdvisor. 

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