Expect the SEC to Soften Its 'Broken Windows' Strategy

Mary Jo White, chairman of the Securities and Exchange Commission, recently gave a speech that many believed signaled a significant change in the SEC's enforcement strategy.

White stated that her approach for the SEC in 2014 will be to take enforcement actions against "even the smallest infractions." She announced the agency would implement a version of the old "broken windows" strategy popularized by former New York City Mayor Rudolph Giuliani and Police Commissioner Bill Bratton in the 1990s. Giuliani and Bratton declared that no infraction was too small to be punished and the New York Police Department pursued infractions of law at every level – from street-corner squeegee men to graffiti artists to subway turnstile jumpers to the biggest crimes in the city.

Per the broken-windows theory, when a window is broken and someone fixes it, it is a sign that disorder will not be tolerated. But if a broken window is not fixed, it "is a signal that no one cares, and so breaking more windows costs nothing."

White said this theory can be applied to the securities markets: minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines. Accordingly, she vowed that the SEC would pursue even the smallest infractions. 

Some companies have reacted to this speech with great concern about how the SEC will act in 2014. Compliance officers, already feeling besieged by the myriad of overlapping and sometimes inconsistent regulations, are concerned that now they have to be worried even about ticky-tack infractions the SEC finds in an examination or investigation. This may cause companies to expend resources to ensure compliance with the more routine and technical regulations, rather than focusing on the big picture.

Many view White's speech as a part of the SEC's continuing effort to improve its public image in the wake of its several well-publicized failures a few years ago. This includes its failure to uncover Bernard Madoff's $50 billion Ponzi scheme and Allen Stanford's $7 billion Ponzi scheme. The SEC is always looking for opportunities to demonstrate its commitment to protecting investors and to show how aggressive it will be in terms of enforcing violations of securities laws.

Having served as inspector general of the SEC from late 2007 until early 2012, and having chronicled and investigated both the Madoff and Stanford failures, I find this new approach somewhat ironic. One area we identified as a reason for the SEC's failure to uncover the Stanford fraud was its decision to focus on smaller and easier cases rather than go after the larger fraudsters. At that time, the SEC Fort Worth enforcement program's focus was on bringing slam-dunk cases involving relatively minor violations. While this policy might make the SEC's enforcement statistics look more robust to Congress, the policy limited the SEC's ability to devote significant resources to bring actions in more complicated cases, even where these cases involved a larger number of victims. As a result of our finding, the SEC vowed to focus more on the importance of the underlying issues in the cases it reviewed rather than on the number of cases it brought.

At first blush, it may seem like the SEC is reverting to its old ways and will be looking at bringing as many cases as it can, even if they are enforcing minor infractions. However, I do not expect any real change in SEC enforcement activity.  

First, the SEC simply does not have the resources to bring enforcement cases involving major and minor violations. In fact, under Congress' 2014 spending agreement, the SEC will receive $1.35 billion, which is $324 million below President Obama's budget request.

Second, in her tenure so far, White has not exhibited an interest in focusing on stats. Instead, the SEC has recently tried to bring cases against more prominent individuals and companies. In fact, the SEC brought fewer cases than in previous years during the last fiscal year. In 2013 there were 686 cases, down from 734 in 2012, but these cases netted higher monetary penalties: $3.4 billion, up from $3.1 billion in 2012.

Finally, it is simply not productive for the SEC to pursue relatively minor infractions while leaving open the possibility that they will miss major ones. For these reasons, although 100% compliance is always the goal, compliance officers should not be overly worried about the agency's new "broken windows" strategy when establishing systems that are primarily designed to guard against significant noncompliance of securities laws.

H. David Kotz is a director at Berkeley Research Group LLC, where he focuses on internal investigations and matters relating to Foreign Corrupt Practices Act and anti-money-laundering regulations.