Specialized Units Should Be in Place By Beginning of New Year, SEC Official Says

By Yin Wilczek  

The Securities and Exchange Commission's new national specialized units targeting complex securities law areas, recently unveiled by Enforcement Director Robert Khuzami, should be set up by the beginning of next year, a senior enforcement official said Sept. 23.

George Canellos, the new regional director for the SEC's New York Regional Office, said the positions for unit chiefs have been posted, and candidates have submitted their applications. “The positions will be filled within the next couple of months,” he said.

Canellos spoke as part of a panel organized by BNA to discuss SEC enforcement initiatives. The SEC official answered questions posed by fellow panelists Mark Schonfeld, the former head of the SEC New York Regional Office and now a partner at Gibson, Dunn & Crutcher LLP, Washington; Stephen Crimmins, a former SEC Enforcement deputy chief litigation counsel and now a partner at K&L Gates LLP, Washington; and Ira Sorkin, a partner at Dickstein Shapiro LLP, New York, and the lead defense attorney for Wall Street financier Bernard Madoff.

Division Revamp

The reorganization of the Enforcement Division announced by Khuzami in August—partly in response to the embarrassment of missing Madoff's decades-long $50 billion Ponzi scheme—represents the most significant revamp of the division in the last 30 years.

Among other changes, the division will create five specialized units focusing on asset management, market abuse, structured and new products, the Foreign Corrupt Practices Act, and municipal securities and public pensions. Khuzami also announced a host of procedural and organizational changes intended to make the division speedier and more strategic. The director further said that the division is working on four initiatives to increase the incentives for individuals to cooperate in SEC investigations.

In June, Canellos joined the SEC from Milbank, Tweed, Hadley & McCloy LLP. Before that, Canellos, like Khuzami, was a prosecutor in the U.S. Attorney's Office for the Southern District of New York.

On the issue of how cases will be assigned, Canellos noted that one important reason for the creation of specialized units is to “foster long-term strategic thinking” about issues such as risk management, and to identify issues before they develop into problems. The units, when up and running, should be initiating their own investigations and cases, he said. However, Canellos added that not every case that involves an area targeted by a specialized unit necessarily will be handled by that unit, and there could be some cases in which the investigative teams are drawn from across unit lines and general staff.

Canellos warned that the reorganization is a work in progress, and that nothing is “set in stone.” He also said that he spoke for himself and not for the commission or its staff.

Staff Increase

On the hiring of personnel with specialized experience or expertise, Canellos said the division has created seven new positions for specialized staff. If SEC Chairman Mary Schapiro's budget request for fiscal year 2011 is approved, “which is likely to happen,” there could be a significant staff increase, he said.

Schonfeld, observing that he saw phases during his time at the commission when interest in specialization waxed and waned, asked if the new specialized units can sufficiently adapt to “tomorrow's crises?” “It's all important that we develop specialization with a long-term view and with a lot of flexibility built into the infrastructure,” Canellos responded. “We don't want to create a bureaucratic silo.”

For his part, Sorkin noted that historically, the commission “has always been behind the curve” in terms of new products such as credit default swaps and collateralized debt obligations. “The SEC needs to stay ahead of the curve as to what instruments are being created and the risks they bring,” he said. “The SEC needs to understand what goes on in the street and what drives it to create new instruments.”

On the subject of formal orders of investigation, Crimmins asked whether the SEC has issued guidelines on when subpoenas may be issued. The authority to approve the orders—once the realm of the commissioners—now has been delegated to senior enforcement officers. Once the orders are entered, staff attorneys have the authority to issue subpoenas.

Canellos responded that there is no policy in place but added, “Plenty of staff attorneys deserve discretion in the handling of their investigations.” He said that he came with a federal prosecutor's bias. “The power to subpoena is the most basic investigative tool that exists, and until two months ago,” even senior SEC enforcers did not have this authority, he observed. “I think it's a long-awaited change, a great change.” Canellos said that in his opinion, the subpoena power should go further and be “self-enforcing” so that a failure to comply with the SEC's subpoena is automatically punishable by contempt without the agency having to initiate further proceedings.

Corporate Penalties

Canellos also declined to comment on what will happen to corporate penalties given Schapiro's announcement in February that the SEC will drop its “penalty pilot” experiment that required enforcement staff to seek commission approval before negotiating penalties with companies. He observed that the SEC's announcement demonstrated its intent to give staff more discretion in penalty negotiations. “Ultimately, the commissioners have the authority to accept or reject the penalties,” he said.

On the issue of cooperation, Sorkin opined that it would be impossible for the SEC to foster cooperation by individuals. Any party exposed to parallel SEC and criminal investigations would not want to cooperate with the commission given the risk of being indicted on criminal charges, he said. Sorkin also wanted to know how counsel can reassure clients that their cooperation will be recognized by the commissioners.

Canellos said that there are a number of different tools in use or being contemplated. “There likely will be a cooperation agreement that is binding on the division but not on the commission.” In some cases, there might be special agreements or deferred prosecution agreements that can be worked out with the commission. “In the end, I recognize that the authority resides with the five commissioners, and if Enforcement enters into an agreement and makes a recommendation to the commissioners not to prosecute, and that recommendation is not regularly accepted, the agreement is not worth the paper that it's printed on.” However, he argued, the commissioners appreciate that for cooperation to work, there must be appropriate deference to people in the field. “So this kind of program can work effectively,” he said.

Schonfeld suggested that one way the agency can foster and encourage cooperation is to be more transparent as to the credit parties obtained for being cooperative. Currently, unless an attorney has worked in the agency or has long-time experience defending against enforcement actions, it can be difficult to determine what benefit a cooperating party obtained from the commission's releases and orders, he said.