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Opinion: Regulatory Overreach –The SEC Racket

By: Publius

By: Publius

Editor’s note: The author of the following guest article is a chief executive officer in the financial services industry, who, for fairly obvious reasons, elects to share his thoughts on this subject anonymously. The DI Wire does not normally publish articles that do not disclose the author. In this instance, however, we have allowed it given the nature of the piece, the importance of open discussion and varying viewpoints, and the fact that we have personally confirmed Publius’ identity.

Last month, we took a closer look at the SEC’s whistleblower program and how it incentivizes individuals to come forward with nearly any claim against their employer through the use of kickbacks. This month, as we continue our analysis of the entity’s overreach, we will examine the SEC itself and how its operations may be more akin to other questionable entities.

Approximately 60 percent of SEC enforcement actions are resolved before litigation. Of the remaining cases, 90 percent of those are resolved after litigation is filed, during the discovery phase. In total, this means that 96 percent of all SEC cases settle without going to trial.

Additionally, when it goes to trial, the SEC sends more of its cases to its in-house judges, where it wins more than 90 percent of the time. All of this creates a situation in which the SEC’s burden of proof is very low. Thus, it simply needs to make the threat of going to trial, and the vast majority of individuals and corporations do what they can to resolve the issue.

As things currently stand, settling can make sense for the individuals or businesses being threatened by the SEC. As we’ve previously discussed, for large corporations, the market can react very adversely once one receives the SEC’s “scarlet letter” and, for individuals or smaller companies, potential clients may be turned off after doing a simple Google search and reading that the company once faced incriminating charges from the SEC, regardless of the outcome.

Often, these groups are not allowed to defend themselves publicly, as they must sign documents that limit discussion of the case. In addition, these documents include language stating the agreement is made “without coercion,” but, if not signed, the SEC will pursue charges. Furthermore, the cost of fighting against an entity like the SEC, which has nearly unlimited resources, can be prohibitive for even large organizations. Thus, for many, settling may be the lesser evil.

So, unless companies or individuals pay the fine dictated by the SEC, they face potential serious harm in the form of an even larger penalty or significant damage to their reputation. Both of which can lead to a loss of their business and livelihood. Is there another name for this type of organization? Yes. It’s called a protection racket.

A protection racket is defined as an entity that “threatens to cause harm to a business or individual unless they are paid a protective fee.” Is this not, in essence, what the SEC does? It uses fear-based tactics to encourage the accused to pay fines, and, for the SEC, this racket is working beautifully. The SEC strongarms the accused until nearly everyone accepts some damage to avoid much more significant consequences.

Again, as stated in the previous article, SEC investigations are civil cases where the burden of proof is low. The SEC must only show that it is more likely than not that an infraction occurred. This highly incentivizes SEC litigators to find any infraction once they start the process. The combination of incentivization with today’s complex system of rules and regulations makes it extremely likely that SEC investigators will find something with which to threaten an individual or company.

This is not just borderline criminal. This is un-American. One of the fundamental tenets of our American society is “innocent until proven guilty,” yet this appears to be reversed in the eyes of the SEC. Just the mere threat of action seems to imply guilt in the eyes of the SEC and the court of public opinion. Even the name – the SEC Division of Enforcement – indicates a bias toward prosecution instead of an effort to legitimately discover the truth of the matter.

As stated on the SEC’s website, “the mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public’s trust.” This is an important mission that seems to be hijacked by the perverse incentivization of revenue seeking through fines or a laissez faire attitude about who gets caught in their enforcement net. I wholeheartedly agree that truly bad actors need to be removed from the arena, but there must be a way to achieve this with less collateral damage to innocent parties.

The SEC is a flawed institution, but my goal is not just to bring these flaws to the forefront but also to provide a platform for possible solutions, and I have received many ideas from readers who have emailed me at Publius.Connect@gmail.com. One suggestion that I received was that of an impartial review by a third-party panel before any allegations or complaints be included in disclosures. As has been previously mentioned, it is challenging to clear one’s name should it be discovered later that the claims were without merit.

Another proposition was to implement a mechanism for government restitution. Currently, there is no downside to the SEC bringing a case to court without merit, but what if it had to pay all court costs and the costs of defendants who won their cases? Again, this seems like a fair proposal that could refine the focus of the SEC to the pursuit of the more severe cases that result in public harm.

Finally, another reader presented the idea that the SEC should also have to publicly declare whenever they are wrong, much as we in the financial industry must do. This, again, may lead to greater care from the SEC when presenting charges.

What has been your experience with the SEC and its litigation process? What other solutions might you suggest? Please email me at Publius.Connect@gmail.com and let me know. I appreciate every email and the dialogue that we have started. I also love our country and the opportunities it provides for all of us to lead prosperous lives. As leaders in our businesses and communities, we must continue to refine our industry to ensure that it continues to provide these opportunities in the best and most fair manner possible.

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The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.

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