Federal Agencies: Securities and Exchange Commission

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The U. S. Securities and Exchange Commission (SEC) is the federal agency responsible for ensuring that federal securities laws are enforced; developing the regulatory scheme for trading stocks, bonds and debentures; monitoring the securities industry; overseeing the stock market and options exchanges; and other related securities undertakings (“What We Do”). The commission was created by the Securities Exchange Act of 1934, extensive legislation which regulates U. S. financial markets and those participating within them. Sometimes there is confusion between the Securities Exchange Act of 1934, and the Securities Act of 1933, which is distinctive. The Securities Act of 1933 regulates the primary market, while the Securities Exchange Act of 1934, regulates the secondary market (“What We Do”). The primary market arises when a company, such as Apple or Facebook has their IPO, or initial public offering. The IPO consists of new stocks or bonds issued by the company for the first time. Typically, a company wants to raise capital to grow and develop their business, so they issue new securities. The company is, in effect saying, in exchange for the one share of ownership that I am giving you, you are giving me $100. The issuing of new stock generally occurs through the hands of an investment bank, or can occur through a syndicate of multiple securities dealers (Koba). In the case of the secondary market, otherwise known as the aftermarket, stock, bonds, options, and futures, which were initially issued through the primary market, are bought and sold. For example, if Mary bought securities from StartupCompany.com, during their initial public offering in the primary market, she could then decide that she no longer wants to keep her shares. She will then sell her shares in the secondary market, through her broker, to John, who has been keeping an eye on StartupCompany.com, and did not have the funds to buy into the company at the time of the company’s IPO. But unfortunately, Johns fortunes have changed, so he has to now sell his shares in StartupCompany.com, which will be purchased by Willard, in the secondary market, through his broker.

The SEC is in charge of enforcing the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Sarbanes–Oxley Act of 2002, Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the Jumpstart Our Business Startups (JOBS) Act ("What We Do"). The goal of the SEC is to protect investors and make sure that the financial markets are operated in a fair, organized and healthy way ("Division of Enforcement"). In addition, the SEC’s goal is to advance the formation of capital to ensure and enhance economic growth ("What We Do"). One of the primary objectives of the SEC is to ensure that as long as an investor, big or individual, holds a security, they have the fundamental right to be provided information about the investment, both prior to buying it and while holding it. Public companies must disclose information that is relevant to providing a full appreciation of their securities. This allows investors to make informed decisions about their actions, with respect to buying, selling or holding the security. Sound investment decisions are made when information flows freely and is available for public consumption. Thus, the SEC monitors the essential participants, like the security exchanges, mutual funds, securities brokers, securities dealers and investment advisors ("What We Do").

There are five Commissioners appointed to positions within the SEC (“Current SEC Commissioners”). The Commissioners are appointed by the President of the United States and confirmed by the Senate. There can only be three Commissioners from the same party at any one time, and their terms are staggered. There are five main divisions within the SEC, including Enforcement, Investment Management, Corporation Finance, Trading and Markets, and Economic and Risk Analysis. Within the divisions, there are eleven regional offices spread across the U. S. (“SEC Regional Offices”). For example, the New York Regional Office is in charge of New York and New Jersey.

The enforcement arm is probably the most well known component of the SEC. The SEC’s Enforcement Division is responsible for initiating civil enforcement actions against both companies and individuals when they violate securities laws ("Division of Enforcement"). An action might be for insider trading, fraud, or provision of misleading or totally inaccurate information about a company’s securities and the company itself. The SEC relies heavily on information provided by the actual investors to bring the civil enforcement actions, in addition to watching certain actions taken by principals and others who are selling their shares. 

Major SEC Enforcement Actions

Insider Trading

Insider trading is a form of illegal securities trading involving stock and/ or other securities types, by people who have information that is not yet public (“Insider Trading”). These individuals might know that a certain required license has been denied by an agency, or some other material requirement that the company needs to prosper, and that person now wants to dump their stock, while the price of the stock is still high. Once the insider information that they have becomes public, the price of the stock will go down immediately, thus devaluing their holdings. The securities laws in the United States are designed to allow everyone to trade securities on the same level playing field, thus dumping the stock prior to an event, based on that exclusive information is illegal (“Insider Trading”).

Martha Stewart is one of the most well known insider traders ("SEC Charges Martha Stewart”). Her investment behavior was particularly egregious because Stewart always projects an image of doing the right thing. On June 4, 2003, the Securities and Exchange Commission, issued a press release that it had filed charges against Stewart and former stockbroker, Peter Bacanovic. The SEC alleged that Stewart engaged in illegal insider trading when Bacanovic, a former Merrill Lynch broker, gave her a tip about ImClone Systems, a biopharmaceutical company. Bacanovic advised Stewart, who held 4,000 shares in the company, that Erbitux, did not receive the expected approval by the Food and Drug Administration (FDA). Further, the SEC stated that Stewart and Bacanovic established an alibi to explain Stewart’s sale of the stock, and that the pair withheld information during the subsequent criminal investigations ("SEC Charges Martha Stewart”). Also, the United States Attorney for the New York district criminally indicted Stewart and Bacanovic for fraudulent statements made about their trades. Stewart was ultimately sentenced to a prison term of five months, five additional months on home confinement, and was required to pay a fine of $30,000, as a result of misleading investigators about the sale.

Accounting Fraud

Jeffrey Skilling, former CEO and President of Enron Corporation, an energy trading company transformed from a pipeline company, was indicted on 35 counts of fraud and insider trading (“Jeffrey Skilling”). The SEC initiated its investigation in October 2001, though critics say that the Commission should have looked into the company long before (McManus). Skilling made use of accounting loopholes, limited entities reserved for a special purpose, and sketchy account reporting, where billions were hidden when deals failed (“Jeffrey Skilling”). The company’s board of directors was not told about the questionable accounting practices used by the executives that carried out Skilling’s biddings, while at the same time, putting pressure on Arthur Andersen not to address the apparent irregularities. He was even arrogant when fund managers questioned him about aspects they wondered about. Sherron Watkins, Vice President of Corporate Development, identified numerous accounting inconsistencies at the company and is applauded by many as a whistleblower (“Female Whistleblowers”). Yet her critics say that she voiced her concerns to Enron Chairman Kenneth Lay, which to many was tantamount to reporting the theft to the criminal (Ackman). Some feel that she should have reported her concerns to a newspaper, or the SEC. Skilling abruptly left the company in August 2001, once he realized the company was on the verge of bankruptcy (“Jeffrey Skilling”). He sold close to $60 million in shares of the company, trying to unload the shares before they were totally diluted. Enron declared bankruptcy on December 2, 2001, and was the largest bankruptcy in U. S. history. Caught in the cross-hairs was Arthur Anderson, one of the Big 5 accounting firms at the time (Brown and Dugan). The company was found guilty of criminal charges lodged against it, for its participation in auditing, or failing to properly audit Enron’s accounting fraud. It was also found guilty of obstruction of justice for shredding audit documents. The Big 5 accounting firm, with offices worldwide, was never able to recover from the scandal.  

Ponzi Schemes – Bernard Madoff

Bernard “Bernie” Madoff was convicted of running the biggest fraudulent Ponzi scheme in the history of the United States (“Bernard Madoff”). He was sentenced to 150 years in prison, and will only leave the prison in a casket. He was sent to the Butner Federal Correctional Institution, in North Carolina. Madoff encouraged investors with his prior stellar reputation, his secretive methodologies, and the powerful positions of the other investors who were primarily institutional investors. The scheme worked for these investor particularly, because of the 5% payout rule, which was a federal law that required 5% of the funds of private foundations to be paid out every year. With this requirement, many of the institutional investors needed a safe place to keep their funds, and unfortunately for them, they felt that Madoff was that safe place. Madoff had a second legitimate component to his securities company, the trading arm, run by his sons, that was not affiliated with the Ponzi scheme. So many were blindsided by Madoff’s actions that several committed suicide, including his son Mark Madoff (“Bernard Madoff”); René-Thierry Magon de la Villehuchet, founder of Access International Advisors LLC (Berenson and Saltmarsh); and British soldier William Foxton (Adams), who lost his family’s entire savings. 

Recent SEC Enforcement Actions

In a recent Securities and Exchange Commission enforcement action, Health Net, Inc., a California health insurance company, will pay $340,000 for use of severance agreements that forced departing employees to waive the ability to receive financial awards from the SEC’s whistleblower program in order to receive severance payments and other potential benefits due post employment ("Company Punished for Severance”). The company violated federal securities laws for years, when they subjected parting employees to such an agreement (Petersen). Health Net modified its severance agreements, when the Dodd–Frank Wall Street Reform and Consumer Protection Act financial reform legislation, was signed by President Obama, on July 21, 2010. SEC rules prohibit any company actions that thwart communications about potential securities law violations. It is, of course, the SEC’s objective to promote whistleblowing, for it is often the best mechanism for disclosing securities violations. Health Net’s actions were in direct contravention to the Commission’s whistleblower program ("Company Punished for Severance”). The company agreed to the SEC’s order requiring them to cease-and-desist, without admission or denial of guilt. Further, Health Net must inform former employees that the prohibition, as signed, was invalid, and that they were, in fact, able to seek an award if there was a disclosure issue, without losing their severance package. Finally, the company must certify that all requirements have been complied with.

Works Cited

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