Securities Enforcement: Improvements Needed in SEC Controls Over
Disgorgement Cases (Letter Report, 08/23/94, GAO/GGD-94-188).
Funds are "disgorged" when securities law violators surrender the
proceeds obtained from illicit activities. Courts may order the funds
to be distributed to investors harmed as a result of the violation, or
when SEC and the courts believe that distributing the funds is
impractical, the money is to be transferred to the U.S. Treasury. The
Securities and Exchange Commission (SEC) can improve its management
control systems for governing its disgorgement efforts. For example,
SEC does not track or maintain aggregate information on disgorgement
collected and distributed. Instead, SEC maintains information on a
case-by-case basis. Tracking this data on an aggregate basis would make
it easier for SEC to assess the overall effectiveness of its
disgorgement efforts. Further, SEC does not provide its attorneys formal
written policies and procedures to guide them in helping the courts
select receivers and in overseeing receivers' activities and
compensation. Without formalizing these policies and procedures, SEC
cannot adequately ensure that (1) any appearance of favoritism in its
receiver recommendations is precluded or (2) funds managed by receivers
are safeguarded until disbursed.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-94-188
TITLE: Securities Enforcement: Improvements Needed in SEC Controls
Over Disgorgement Cases
DATE: 08/23/94
SUBJECT: Securities
Securities regulation
Auditing procedures
Disclosure law
Funds management
Financial management
Judicial procedure
Collection procedures
Management information systems
IDENTIFIER: SEC Disgorgement Payment Tracking System
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Cover
================================================================ COVER
Report to the Chairman, Subcommittee on Oversight and Investigations
Committee on Energy and Commerce
House of Representatives
August 1994
SECURITIES ENFORCEMENT -
IMPROVEMENTS NEEDED IN SEC
CONTROLS OVER DISGORGEMENT CASES
GAO/GGD-94-188
SEC Procedures
Abbreviations
=============================================================== ABBREV
SEC - Securities and Exchange Commission
DPTS - Disgorgement Payment Tracking System
Letter
=============================================================== LETTER
B-256910
August 23, 1994
The Honorable John D. Dingell
Chairman, Subcommittee on Oversight
and Investigations
Committee on Energy and Commerce
House of Representatives
Dear Mr. Chairman:
This report responds to your request that we review the Securities
and Exchange Commission's (SEC) procedures for the handling and
disposition of disgorged funds and whether the individuals appointed
to manage the funds are benefitting from prior SEC employment. Funds
are disgorged when securities law violators surrender the proceeds
obtained from their illicit activities. Courts may order that the
funds be distributed to investors harmed as a result of the
violation, or when SEC and the courts believe that distributing the
funds is not economically practical or efficient, the funds are to be
transferred to the U.S. Treasury. When a plan for distributing
funds to investors is prepared, the court sometimes appoints a
receiver to manage the funds and carry out the terms of the
distribution plan.
Since 1990, SEC has had the authority to impose disgorgement in its
administrative proceedings. However, our report concentrates on
court-ordered disgorgement sanctions.\1 When we began our review in
March 1992, SEC had not yet ordered disgorgement in administrative
proceedings, nor had it adopted any rules governing disgorgement
sanctions imposed by its administrative law judges.\2
In this report, we address whether SEC has procedures and management
controls to (1) assess the effectiveness of its disgorgement
collection and distribution efforts, (2) preclude favoritism or
minimize any appearance of favoritism in recommending individuals as
receivers, and (3) provide adequate oversight of receivers and funds
in their possession.
Details on our objective, scope, and methodology are described in
appendix I. SEC provided written comments on a draft of this report.
These comments are presented and evaluated on pages 11 and 12 and are
reprinted in appendix III.
--------------------
\1 According to federal court and SEC officials, the federal courts
have ultimate responsibility for court-ordered disgorgement
sanctions. SEC attorneys recommend to the court how much
disgorgement to seek and how to enforce the disgorgement order. The
presiding judge must approve SEC's recommendations. (See app. II
for a description of the process for imposing and enforcing
court-ordered disgorgement.) In administrative proceedings, however,
SEC is the tribunal and is responsible for disgorgement sanctions
ordered by its administrative law judges. The commissioners must
approve recommendations made by SEC attorneys on how much
disgorgement to seek in administrative proceedings and how to enforce
disgorgement ordered in administrative proceedings.
\2 SEC first used its administrative authority to order disgorgement
in August 1992. As of April 6, 1994, SEC had ordered disgorgement in
administrative proceedings in a total of 11 cases.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
The Federal Managers' Financial Integrity Act of 1982 (Public Law
97-255), enacted to help federal agencies better manage their
financial assets and operations, requires that agencies establish
adequate management control systems, evaluate them on a continuous
basis, and report to Congress on their adequacy. SEC can improve its
management control systems for governing its disgorgement efforts.
For example, SEC does not track or maintain on an aggregate basis
information on disgorgement collected and distributed. Instead,
SEC's information is maintained on a case-by-case basis. Tracking
this data also on an aggregate basis would make it easier for SEC to
assess the overall effectiveness of its disgorgement efforts.
Further, SEC does not provide its attorneys formal written policies
or procedures to guide them in assisting the federal courts to select
individuals as receivers and ensure adequate oversight of receivers'
activities and requests for compensation. Without formalizing these
policies and procedures SEC cannot adequately ensure that (1) any
appearance of favoritism in its receiver recommendations is precluded
or (2) funds managed by receivers are safeguarded until disbursed.
BACKGROUND
------------------------------------------------------------ Letter :2
The use of the disgorgement sanction in securities law violation
cases is a relatively recent phenomenon. Disgorgement was first
ordered in a securities law violation case in 1970.\3 In this case,
the court ordered the defendants, who profited from inside
information, to disgorge their profits for possible distribution to
those who suffered losses as a result of the defendants' actions. A
widely publicized case of court-ordered disgorgement was the $400
million disgorgement order in November 1990 against Michael Milken
for, among other things, insider trading, stock manipulation, and
failure to make required disclosures of beneficial ownership of
securities. Another case resulted in the imposition of a $52 million
disgorgement sanction against "Crazy Eddie" Antar in June 1990 for
insider trading. Disgorgement sanctions have been imposed against
violators involved in insider trading, investment adviser fraud,
market manipulation, and fraudulent financial reporting.
The primary purpose of disgorgement is to ensure that securities law
violators do not profit from their illicit activities. A secondary
objective of disgorgement is to compensate investors harmed as a
result of the violation. When SEC and the courts believe it is not
economically practical or efficient to locate and notify potential
investor claimants, disgorged funds are paid to the U.S. Treasury.
While disgorgement is principally a deterrent against securities law
violations, SEC and the federal courts view the disgorgement sanction
as not only a deterrent but also as a means of compensating
investors. A description of the process for imposing and enforcing
court-ordered disgorgement is contained in appendix II.
Until 1990, SEC could obtain a disgorgement sanction only by
obtaining a court order from a civil suit filed in federal district
court. However, in 1990, Congress, through the Securities
Enforcement Remedies and Penny Stock Reform Act (Remedies Act), gave
SEC the authority to impose disgorgement sanctions in its
administrative proceedings. SEC's Task Force on Administrative
Proceedings was created in July 1990 by the former Chairman of SEC to
review the rules and procedures relating to SEC's administrative
proceedings. After Congress passed the Remedies Act, the task force
expanded its agenda to develop recommendations to implement SEC's new
powers under the act. One of the new powers is the authority to
order disgorgement in administrative proceedings. The task force
issued its report in February 1993, which included proposed rules
for, among other things, disgorgement imposed by SEC administrative
law judges. As of April 1994, the task force was reviewing comments
it had received on the proposed rules before finalizing them for the
Commission's approval.
--------------------
\3 SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77 (SDNY 1970),
aff'd on this point, 446 F.2d 1301 (2d Cir.), Cert. denied, 404 U.S.
1005 (1971).
SEC DOES NOT MAINTAIN AGGREGATE
INFORMATION THAT COULD HELP IT
BETTER ASSESS THE EFFECTIVENESS
OF ITS DISGORGEMENT EFFORTS
------------------------------------------------------------ Letter :3
According to SEC data, federal district courts imposed an estimated
$2 billion in disgorgement sanctions in about 600 cases from 1987
through April 1994. Although SEC collects data on the imposition of
disgorgement sanctions, it does not maintain aggregate information on
the amount of disgorgement collected from defendants and distributed
to investors or to the U.S. Treasury. Aggregate information could
help SEC better assess the effectiveness of its disgorgement efforts
and could point out areas where more attention is needed. For
example, the aggregate amount of disgorgement collected and the
proportion of that amount that was (1) distributed to investors, (2)
sent to the Treasury, and (3) paid to receivers could help SEC
improve the efficiency of its disgorgement efforts, better monitor
the effectiveness of its collection efforts, and monitor trends in
receiver costs.
Information on the distribution of funds is now available only on a
case-by-case basis from the attorneys working on the cases and their
files. SEC does maintain information on the amount of disgorgement
collected on each case in the Office of the Secretary's Disgorgement
Payment Tracking System (DPTS). DPTS tracks disgorgement ordered and
collected from defendants for individual cases but does not provide
aggregate information.
We obtained a printout of the individual case data from DPTS for the
period from 1987 to April 1994. These data showed that about 50
percent of the $2 billion in disgorgement imposed by the courts
during this period was actually collected. According to SEC
enforcement attorneys, the uncollected amounts do not indicate poor
collection efforts. Instead, they said the unpaid amounts usually
reflect default and other judgments against defendants that, despite
collection efforts, remain unpaid because defendants have either no
assets or insufficient assets to satisfy the judgment.
SEC officials told us the Enforcement Division is working on an
improved case tracking system so that the attorneys can easily
determine the status of their cases, including the status of the
disgorgement. As an interim substitute for this system, the Office
of the Secretary is currently trying to obtain an off-the-shelf debt
collection software system to track unpaid disgorgement. We
encourage SEC's efforts to develop and obtain systems to track the
status of disgorgement cases. Including aggregate information on
amounts collected and distributed in the tracking system that the
Enforcement Division ultimately develops would help SEC to assess the
Enforcement Division's efforts more effectively.
SEC LACKS FORMAL QUALIFICATION
STANDARDS FOR RECEIVER
SELECTION PROCESS
------------------------------------------------------------ Letter :4
Qualification standards and guidelines for selecting individuals to
recommend as receivers are necessary to promote public confidence
that the selection was made on an impartial basis. Without such
standards, the selections by federal courts and SEC can convey the
appearance of favoritism. However, SEC has no formal policies or
qualifying standards to ensure that the receivers it recommends to
the courts are selected on an impartial basis.
According to SEC attorneys, if the court wants SEC's help in
selecting a receiver, SEC attorneys will contact at least three
individuals and obtain proposals from them. SEC attorneys said they
choose individuals to contact on the basis of their judgment and
personal knowledge of the individuals. The proposals from potential
receivers are to include the individuals' credentials and the hourly
rates that they will charge for their services as receivers.
According to SEC attorneys, receivers often give a discount from
their normal hourly rates because they consider this work a public
service. SEC attorneys said they evaluate the credentials and
expected charges to make a final determination on the individual to
recommend for the court's consideration. The attorneys do not have
formal criteria to use in their evaluation of the proposals. They
said factors they look for in determining whom to recommend for
receiver appointment are a good reputation, credibility, and
experience in securities law or a specialized area germane to the
case. Some attorneys told us that they prefer to recommend former
SEC attorneys because of their relevant experience. However, the
subjective judgment involved in this process and the fact that former
SEC attorneys are sometimes recommended for receiver appointments in
SEC disgorgement cases could give the appearance of favoritism.
Qualification standards and guidelines that must be met by any
potential receiver could help minimize the appearance of favoritism.
For several reasons, we could not determine exactly how many former
SEC employees had been appointed as receivers or whether former SEC
employees were favored in the receiver selection process. First, SEC
did not have summary information on the backgrounds of receivers for
all of its cases, so information on the total number of receivers who
were former SEC employees was not available. Second, determining
whether favoritism occurred requires detailed knowledge of the intent
of the individual making the recommendation, and we found no
documentation of this intent. Third, even when reviewing individual
case files we could not determine whether the judges just accepted
the SEC recommendations or made their own determinations as to the
relative strengths of the SEC recommendations compared to other
possible receiver candidates. Finally, the selection of a former SEC
employee, although perhaps giving the appearance of favoritism, does
not imply that the person was not the most qualified of those
considered. We judgmentally selected and reviewed nine cases in
which receivers were appointed. One of the receivers was appointed
in two different cases, resulting in eight different individual
selections. We determined that three of the eight were former SEC
employees.
SEC's Task Force on Administrative Proceedings supported the need for
qualification standards and guidelines for selecting receivers in
administratively-imposed disgorgement cases. The Task Force report
stated that the method used to select an administrator--the person
responsible for administering the distribution plan--should comply
with any applicable federal law and promote public confidence that
the selection was made on an impartial basis. The report proposed
several alternatives, including issuing criteria required of an
administrator and allowing interested parties who meet these criteria
to place their names on a roster from which administrators in a
particular case could be chosen. These guidelines have not been, but
could be, used by SEC to recommend a receiver in court-ordered
disgorgement cases because the objectives are the same regardless of
whether disgorgement is ordered by a judge in federal court or by SEC
in administrative proceedings.
SEC HAS WEAK CONTROLS OVER
RECEIVERS AND THE FUNDS IN
THEIR POSSESSION
------------------------------------------------------------ Letter :5
Monitoring receivers and the funds they hold is an important
management control for ensuring that receivers adhere to their
responsibility as court-appointed fiduciaries to protect the funds
with which they are entrusted and to ensure they comply with court
orders. SEC does not provide its attorneys with guidelines or
procedures on how to monitor receivers. One way SEC attorneys can
monitor receivers is by reviewing receiver fee applications.
However, no requirements are placed on receivers concerning the
format or contents of fee applications. Also, neither the courts nor
SEC uniformly require receivers to periodically report on the status
of the disgorged funds in the receivers' possession. The lack of
reporting requirements, for both fee applications and accounting of
funds, could result in the courts and SEC attorneys not having
adequate information to monitor receivers to ensure their fees are
not excessive and could provide the opportunity for fraud, waste, and
abuse. Although our review was not designed to detect fraud, we
found no evidence of fraud or mismanagement in the cases we reviewed.
However, improved monitoring procedures could minimize the chance of
fraud or mismanagement occurring in the future.
SEC ATTORNEYS ARE NOT
PROVIDED FORMAL GUIDELINES
FOR REVIEWING FEE
APPLICATIONS
---------------------------------------------------------- Letter :5.1
Returning disgorged funds to investors is a secondary objective of
disgorgement but one of obvious importance to the harmed investors.
A review of receiver fee applications is important for meeting this
secondary objective because receivers' fees and expenses are paid
from the disgorgement fund, decreasing the amount available for
distribution to investors. The court must approve receivers' fee
applications before the receivers can be compensated. SEC attorneys
assist the courts by reviewing the fee applications and advising the
courts of the results of their review. However, instead of formal
guidelines, SEC attorneys use their own judgment to determine the
reasonableness of work claimed by receivers and their charges for
that work as described in the fee applications. SEC attorneys said
they generally look at (1) the hourly rate to determine if it is in
compliance with the court order; (2) the amount of time spent
performing services to determine whether it appears that the
resulting fees are too high; and (3) expenses like postage, delivery,
and travel. While these steps appear reasonable, they are not
written or required of the attorneys and might not be applied
consistently in all cases. For example, the courts do not always
indicate a maximum hourly rate for receivers. A maximum hourly rate
was contained in a court order in only five of the nine cases we
reviewed. In addition, no criteria or guidance exist on what fees or
expenses may be too high or questionable.
Although SEC attorneys described the factors they look at when they
review receiver fee applications, we found little documented evidence
that the attorneys reviewed fee applications in the nine cases we
reviewed. In three cases, the files indicated that fee applications
had been submitted to and approved by SEC. We found no documentation
of what type of review SEC did in these three cases. In one of these
three cases, the court-ordered maximum fee for the receiver was $195
per hour. The fee applications we obtained and reviewed for this
case included, in addition to 188 hours of work done by the receiver,
over 105 hours of work done by four other individuals of the
receiver's law firm that was charged at rates varying from $360 per
hour to $420 per hour. (The fee applications did not describe the
work done by each individual, as discussed in the section on fee
application requirements.) We could not determine from the files
whether these fees were questioned before an SEC official approved
the fee applications. The SEC approving official in this case told
us that he discussed these fees with the receiver and was satisfied
that the fees were not out of line because at least one of the
individuals, a partner in the firm, is a tax expert who was consulted
on tax matters that a nontax attorney would be ill-equipped to
answer.
In one case, the receiver said SEC reviewed his fee application and
told the court it had no objections. However, we found no
documentation of this review in SEC or court files. In three other
cases, we determined that applications had been submitted, but we
found no evidence in the files that SEC reviewed or approved these
fee applications. In the two remaining cases, the receivers said
they had not yet submitted any fee applications. SEC attorneys told
us it is not standard practice for litigation attorneys to document
reviews of court papers or oral requests for information.
NO PARTICULAR FORMAT OR
CONTENTS ARE REQUIRED FOR
FEE APPLICATIONS
---------------------------------------------------------- Letter :5.2
For SEC attorneys to have adequate information to review fee
applications, receivers would need to provide a certain amount of
detail about the individuals assisting them and the services they
perform. However, for the cases we reviewed, no requirements were
placed on receivers concerning what information should be included in
their fee applications.
The court orders appointing receivers that we reviewed were prepared
by SEC attorneys and approved by the courts. None contained
requirements for the contents or format for receiver fee
applications. We determined that receivers had submitted fee
applications in seven of the nine cases we reviewed. These fee
applications usually included (1) a description of the services
provided by the receiver and any assistants, such as counsel,
paralegal, or accountant; (2) the number of hours spent performing
these services and the charges per hour and in total; and (3)
reimbursable expenses paid by the receiver's firm, such as
photocopying, messenger service, and telephone.
The amount of detail in the fee applications we reviewed varied. For
example, a fee application submitted by the receiver in one case
included a summary listing the names and positions of people
performing the services, hourly rates, number of hours, and total
fees requested for the period. This summary was followed by a
detailed statement itemizing the services performed by each
individual, their hourly rates, and the number of hours they spent on
those tasks.
In contrast, the fee applications in a case involving high attorney
fees (see p. 7) included only an overall description of services
provided by all staff, followed by a list of the individuals, the
number of hours billed per individual, the hourly rate, and total
billed per person. This case differed from the first in that the fee
application did not connect particular services with the individual
performing the service. Also, the persons' positions were not
identified. Therefore, the attorney reviewing this fee application
might not have been able to determine whether particular tasks were
needed or performed by the lowest cost individual, such as a
paralegal, capable of performing the tasks. As discussed in the
previous section, the approving official said he satisfied himself as
to the reasonableness of these fees through discussions with the
receiver.
Standards for contents and format of fee applications would
facilitate SEC's review of receiver fee applications. An SEC senior
attorney agreed that a standardized structure with appropriate detail
would be useful.
RECEIVERS NOT ROUTINELY
REQUIRED TO REPORT ON FUNDS
STATUS
---------------------------------------------------------- Letter :5.3
Information on the amount of funds in receivers' possession,
including earnings on such funds, where the funds were invested, fees
paid to receivers, and other disbursements made from disgorged funds
was also not available in every case we reviewed. This information
would allow the courts and SEC attorneys to better monitor the
disgorged funds held by receivers to ensure the funds are protected
against fraud, waste, and abuse. Receivers in cases we reviewed were
generally not required by the courts to file periodic reports with
SEC or the courts accounting for disgorged funds in the receivers'
possession. Rather, this type of accounting was usually required of
the receivers in their final reports to the courts. Also, SEC did
not recommend and the courts did not require that the disgorgement
funds held by receivers be audited. Therefore, no one independent of
the receivers had the information needed to monitor the funds.
Receivers in eight of the nine cases we reviewed had control of the
disgorged funds. In the ninth case, the court maintained the
disgorged funds in the court registry account. Court orders in six
of these eight cases directed the defendants to pay the disgorgement
directly to the receiver. In the other two cases, the courts ordered
the defendants to pay the disgorgement to a court registry account.
The courts then ordered the funds in these two cases to be
transferred from the court registry accounts to the receivers when
they were appointed.
Court orders appointing the receiver in three of the eight cases we
reviewed in which receivers had control of the funds required the
receivers to prepare and maintain complete, accurate, and legible
records indicating the date, amount, and description of each asset
received, each transaction, and the recipient of each disbursement
made by the receiver. However, these court orders did not (1)
require that receivers report such information to SEC or to the court
or (2) state that the funds could be subject to audit. Court orders
in the other five cases were silent regarding recordkeeping
requirements.
SEC's Task Force on Administrative Proceedings reported that in
administrative proceedings SEC has a responsibility to ensure that
disgorged funds are safeguarded until they are distributed. This is
similar to the responsibility that the courts have in court
proceedings. The task force recommended that the administrators of
SEC-ordered disgorgements be required to file quarterly reports
accounting for money earned, received, and spent. The report stated
that "Requiring periodic, public accounting is a basic safeguard for
assuring that disgorged funds are husbanded to the greatest extent
possible until distributions are authorized." The task force's
findings and proposed rules pertain only to disgorgement ordered in
administrative proceedings. However, because SEC also assists the
courts in their monitoring of court-appointed receivers, the controls
the task force recommended would also be appropriate for
court-ordered disgorgements. SEC would need to recommend to the
courts that these controls be adopted.
CONCLUSIONS
------------------------------------------------------------ Letter :6
Determining the overall effectiveness of disgorgement collection and
distribution efforts is difficult for SEC managers because SEC does
not track the aggregate amount of funds collected from violators and
disbursed to investors, to Treasury, and to receivers for their
compensation. Further, while we found no evidence of conflict of
interest in the receiver selection process, the process itself is not
open and public. When a former SEC employee is appointed as
receiver, this could appear to be a conflict of interest.
SEC does not provide its enforcement attorneys and their supervisors
written guidance for monitoring receivers' activities and requests
for compensation. We recognize that flexibility is needed in
monitoring receivers because SEC enforcement cases can be very
different in content and are handled by different courts, judges, and
SEC attorneys around the country. However, certain basic principles,
such as comparing the receiver's court-ordered hourly rate to that
claimed by the receiver may be applicable to many, if not all, of
SEC's court cases involving receivers. Written guidance could help
SEC ensure that receivers are monitored consistently, regardless of
the type of case, location, or attorney involved. Such guidance
could also include a standardized format for fee applications and
could require receivers to report on the funds they hold. This
information could help SEC determine whether requests for
compensation should be questioned or whether the fund in a particular
case should be audited.
The recommendations of SEC's Task Force on Administrative Proceedings
covered, among other things, both appointing a fund administrator and
accounting for funds earned, received, and spent by the administrator
of SEC-administered disgorgement cases. These recommendations also
address the weaknesses we found in SEC's management of court-ordered
disgorgement cases. The recommendations could therefore also apply
to these cases.
RECOMMENDATIONS
------------------------------------------------------------ Letter :7
To help SEC better assess the effectiveness of disgorgement
collection and distribution efforts, we recommend that the Chairman
of SEC ensure that systems used to manage disgorgement cases include
aggregate and individual case information on disgorgement ordered,
disgorgement collected, amount and recipients of disgorgement
distributed, and information about receivers and funds in their
possession.
To help SEC preclude favoritism or minimize any appearance of
favoritism in selecting individuals to recommend as receivers, we
recommend that the Chairman of SEC establish formal guidelines for
SEC attorneys to use for recommending individuals as receivers. In
establishing such guidelines, SEC should consider issuing criteria
that receivers must meet and allowing interested parties whom SEC
determines meet these criteria to place their names on a roster from
which a receiver could be chosen for a particular case.
And finally, to help ensure adequate oversight of receivers and the
funds in their possession, we recommend that the Chairman of SEC
establish a standard format for fee applications submitted by
receivers. The Chairman should also establish formal written
guidelines for SEC attorneys to use for monitoring receivers'
activities and the funds they handle. In establishing such
procedures, SEC should recommend, where appropriate, that the court
orders include requirements that (1) receivers file periodic reports
with SEC on the funds they hold and (2) the funds may be subject to
an audit if SEC believes it necessary after reviewing the periodic
reports.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :8
We provided a draft of this report to SEC for review and comment.
SEC agreed with our recommendations to (1) ensure that systems used
to manage disgorgement cases include aggregate and individual
information, (2) establish a standard format for receivers' fee
applications, and (3) require receivers who hold funds to file
periodic reports on those funds.
SEC did not agree with our recommendation to establish formal
guidelines for SEC attorneys to use for recommending individuals as
receivers. We recommended that in establishing these guidelines, SEC
consider issuing qualification criteria required of receivers and
allowing interested parties to put their names on a roster. SEC said
the variety of situations in which a receiver may be needed makes it
difficult to generalize regarding receiver qualifications. For
example, a case involving hundreds of millions of dollars and complex
legal issues may require a receiver with sophisticated knowledge of
securities laws and the resources of a large law firm at his or her
disposal. Another example SEC gave is that a case involving the
fraudulent sale of securities in a new technology telecommunications
company might require someone with an appropriate technical
background.
The intent of our recommendation is to ensure that the nomination
process is open to any qualified candidate and not just people known
to SEC. In this regard, SEC could publicize the fact that it is
establishing a receiver roster and that it is seeking candidates of
various experiences and resources. The roster would indicate any
special skills, knowledge, or access to resources an individual might
have. It would provide SEC with a larger pool of candidates to meet
any special needs and also provide the flexibility SEC needs.
SEC also commented that the court, not SEC, has control over receiver
selection. We realize that in some cases a judge will select a
receiver without SEC input or will not select SEC's specific
recommendation. However, in other cases the judge will seek SEC's
input and even ask for specific recommendations. By following our
recommendation for these cases, SEC could preclude or minimize any
appearance of favoritism in recommending receivers to the court.
SEC also did not agree with our recommendation to establish formal
written guidelines for SEC attorneys to use for monitoring receivers.
SEC said it would be impractical to prepare guidelines for its
attorneys to use when reviewing receiver fee applications because of
the wide variety of cases, tasks, and billing rates and practices
that might be encountered. SEC said it prefers to adhere to a more
flexible approach and that such guidelines would do no more than tell
the attorneys to use common sense. We agree that flexibility is
needed. Our intent is not to establish specific guidelines to cover
every possible situation that might arise. Rather, our intent is to
establish basic principles for monitoring receivers. For example,
some attorneys told us they look for certain things, such as making
sure the hourly rate is the rate authorized by the court, making sure
the amount of time spent looks reasonable, and making sure other
expenses, like postage, are not too high. These are principles that
apply to most SEC court cases involving receivers. Formalizing these
principles could help ensure that every attorney knows and follows
them and that receivers are consistently monitored. We have expanded
the conclusions section of the report to clarify our rationale for
recommending that guidelines be established.
SEC's letter and our additional comments are contained in appendix
III.
---------------------------------------------------------- Letter :8.1
We are sending copies of this report to SEC and other interested
parties upon request. This report was prepared under the direction
of Michael A. Burnett, Assistant Director, Financial Institutions
and Markets Issues. Other major contributors to this report are
listed in appendix IV. Please contact either Mr. Burnett or me on
(202) 512-8678 if you have any questions concerning this report.
Sincerely yours,
Helen H. Hsing
Associate Director, Financial
Institutions and Markets Issues
OBJECTIVE, SCOPE, AND METHODOLOGY
=========================================================== Appendix I
Our objective was to determine whether SEC had procedures and
management controls to (1) provide adequate information to assess the
effectiveness of disgorgement collection and distribution efforts,
(2) preclude favoritism or minimize any appearance of favoritism in
selecting individuals to recommend as receivers, and (3) provide
adequate oversight of receivers and the funds in their possession.
To learn about the objectives of disgorgement, we studied the
legislative history and applicable case law and interviewed
Securities and Exchange Commission (SEC) officials and federal
district court judges. To gain a better understanding of how the
process works and to determine the roles and responsibilities of all
parties involved, we interviewed SEC officials and case attorneys,
federal court judges and clerks, receivers, and staff of the
Administrative Office of the U.S. Courts.
To identify SEC's procedures and management controls, we requested
all written procedures and controls and reports containing
information on disgorgement ordered, collected, and distributed;
reviewed disgorgement case files; and interviewed SEC officials and
case attorneys in Washington, D.C., and New York. Because SEC had no
written procedures or guidelines for its attorneys or receivers
covering court-ordered disgorgement, our discussion of roles and
responsibilities is based primarily on interviews with SEC officials
and attorneys, federal judges and other court personnel, and
receivers appointed in SEC disgorgement cases.
For the case file reviews, we judgmentally selected 15 of the 374
cases listed in the Disgorgement Payment Tracking System printout as
of March 1992. Because of limited travel resources we selected cases
from the home office in Washington, D.C., and the New York Regional
Office. The 15 cases included 10 in which the disgorgement was paid
and 5 in which the disgorgement was not fully paid. We anticipated
that by selecting these cases, we would cover collections (because 5
cases still had disgorgement owed) and distributions, including any
involvement of receivers and SEC oversight of the receivers (because
10 cases had disgorged funds available for distribution). SEC
attorneys familiar with disgorgement cases told us that each case had
unique factors, but the cases we selected would give us a general and
overall view of how the process works.
Our reviews of the 15 cases initially included reviewing SEC and
federal court records on these cases and interviewing SEC attorneys
involved in the cases. We determined from our initial file reviews
and discussions with SEC attorneys that 9 of the 15 cases involved
receivers. One of the receivers was appointed in two different
cases, and two cases were heard by the same judge, resulting in eight
different receivers and eight different judges. To determine (1) how
the receivers were selected, (2) what their roles and
responsibilities were, and (3) their involvement with and oversight
by SEC, we interviewed, on the basis of their availability, six of
the eight receivers and four of the eight judges involved in these
nine cases. We also obtained written answers to our questions from
another receiver whom we did not interview face-to-face. The results
of our case reviews are not necessarily representative of all SEC
disgorgement cases.
We also reviewed the report of SEC's Task Force on Administrative
Proceedings to determine whether the proposed rules for handling
disgorgements ordered in administrative proceedings could be
applicable to court-ordered disgorgements.
We did our work between March 1992 and April 1994 at SEC in
Washington, D.C., and New York and at federal district courts in New
York (Southern District), New Jersey, and Washington, D.C. We met
with receivers whose offices are located in Washington, D.C., New
York, and New Jersey. We did our work in accordance with generally
accepted government auditing standards.
SEC'S PROCEDURES FOR COURT-ORDERED
DISGORGEMENT CASES
========================================================== Appendix II
SEC's Enforcement Division attorneys investigate alleged violations
of securities laws. If the attorneys believe a violation has
occurred, SEC can seek sanctions against the violator through civil
litigation or administrative action; or SEC can reach a settlement
with the violator. A settlement results in a judicially enforceable
agreement in which the violator accepts the penalty or sanction
without admitting or denying guilt. When SEC seeks a civil remedy
and the violator has not agreed to a settlement, SEC attorneys can
file a civil suit in federal district court against the violator. If
the court agrees with SEC, it will render a judgment and can order
the violator to, among other things, disgorge illegal profits.
Like all other remedies, SEC must authorize the attorneys' request
for the remedy of disgorgement. SEC attorneys said they determine
the amount of illegal profits they seek to be disgorged on the basis
of the facts of the particular case and existing case law. SEC
attorneys include this determination in a proposed court order they
draft for the court's review and approval. These court orders
drafted by SEC attorneys can direct that disgorgement be paid to
either (1) a court registry account until the funds are disbursed;
(2) SEC for transmittal to the Treasury; or (3) a court-appointed
receiver, who is to invest and manage the funds until they are
distributed to harmed investors. All or part of the disgorgement
amount might be waived when defendants can prove that they are not
able to pay. In remarks before a business law conference, an SEC
Commissioner said that inability to pay can be a legitimate reason
for waiving payment of disgorgement. The Commissioner said the staff
has been instructed to thoroughly investigate claims of inability to
pay and that defendants should provide sworn financial statements and
tax returns. SEC also requires the defendants to complete a
standardized statement of financial condition. The Commissioner also
said that all settlements that excuse payment of disgorgement based
on inability to pay will be voidable if the defendants have
misrepresented their financial condition.
Once a court order for disgorgement has been issued, SEC attorneys
are to pursue collection of the disgorgement amount owed from
violators. Collection actions staff attorneys wish to take are to be
approved by their supervisors, i.e., branch chief, assistant
director, or deputy chief litigation counsel. If SEC determines that
the violator is able to pay but is not making payments, it can take
additional enforcement action, such as freezing the violator's
assets, filing liens against or seizing the violator's property, and
obtaining civil contempt judgments. SEC attorneys can also pursue
disgorgement claims against defendants in U.S. bankruptcy courts.
SEC has recently hired an individual with special knowledge of
bankruptcy laws to serve as the Enforcement Division's bankruptcy
counsel.
SEC attorneys are to recommend to the court whether the disgorged
funds, when available, should go to harmed investors or to the
Treasury. According to some attorneys, the factors they might
consider in making this determination include the amount disgorged,
number and types of securities involved, where the securities were
traded, size of each security's national daily trading volume on the
days the defendants traded, and the estimated cost of administering
the distribution plan. Some attorneys told us that they will decide
to send the funds to the Treasury when returning disgorged funds to
investors harmed as a result of the violations is not economically
feasible. The attorneys said that the size of the disgorgement may
be small compared with the number of harmed investors, which may be
large and difficult to identify. The attorneys also may look at how
previous cases were handled to help them make their decisions.
When the court agrees with SEC's determination that the funds should
be disbursed to investors, SEC attorneys are to draft a distribution
plan, which specifies how and to whom the disgorged funds are to be
disbursed. When preparing these distribution plans, the attorneys
can access the division's computerized Formfile, which contains
sample distribution plans for different situations. For example,
there are sample plans for (1) an insider trading case in which only
one stock was traded and the district court clerk's office
distributes the funds, (2) an insider trading case in which only one
stock was traded and a receiver is appointed, and (3) an insider
trading case in which multiple stocks were traded and a receiver is
appointed. Supervisors are to review and approve distribution plans
drafted by staff attorneys. SEC files distribution plans with the
court for approval, and the parties involved are allowed to comment
on the proposed plans.
When disgorged funds are to be distributed to investors, the court
sometimes appoints a receiver to manage the funds and administer the
distribution plan. Receivers are appointed to take charge of
disgorged property and administer it for the benefit of harmed
investors or the U.S. Treasury. In this capacity, receivers are
considered court-appointed fiduciaries and are subject to the same
standards of trust and confidence as other fiduciaries.
SEC has developed a procedure to solicit proposals from at least
three individuals. The attorneys evaluate the proposals, which
contain the individuals' credentials and expected charges for their
services. Receivers generally discount their normal rates for work
performed on these cases. The attorneys select one of the
individuals to recommend to the court for consideration to appoint as
receiver. The judge makes the final determination and has complete
discretion about whether to accept SEC's recommendation or choose
someone else.
The court order appointing the receiver is generally drafted by SEC
attorneys and usually describes the receiver's duties and
responsibilities in general terms. Depending on the case, these
duties can include locating assets, investing the disgorged funds,
reviewing and determining eligibility of investor claims, and
distributing the funds. The court usually specifies the receiver's
investment options, such as only purchasing obligations backed by the
U.S. Government. The receiver is to distribute the funds pursuant
to the distribution plan prepared by SEC attorneys and approved by
the court. Compensation for receivers' services is paid from the
disgorged funds after the court approves the receivers' fee
applications. The court order appointing the receiver generally
requires SEC to review the receiver's fee applications and recommend
to the court whether or not to approve the fee applications.
Finally, SEC attorneys close their cases when (1) disgorged funds
have been distributed, (2) disgorgement has been waived, or (3) they
determine disgorgement is uncollectible. A February 1993 memorandum
from the Director of the Enforcement Division to division staff
instructs them to maintain information on cases in which disgorgement
has been waived in the event they uncover information in the future
that would invalidate the terms of the waiver. If the attorneys
determine disgorgement is uncollectible, the memorandum instructs
them to notify SEC that further collection efforts would be futile
and give the reasons for no longer pursuing the funds. As in waived
cases, if information is obtained that the defendant may be able to
satisfy the disgorgement judgment, the case can be reopened for
appropriate action. SEC must approve the closing of cases in which
disgorgement is still outstanding.
(See figure in printed edition.)Appendix III
COMMENTS FROM THE SECURITIES AND
EXCHANGE COMMISSION
========================================================== Appendix II
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
The following are GAO's comments on the Securities and Exchange
Commission's letter dated June 16, 1994.
1. The internal review that SEC makes of receiver recommendations
made by its attorneys may help ensure that conflict of interest does
not occur, but it does not remove the appearance of conflict of
interest.
2. The recommendation states that receivers should "where
appropriate, ... file with SEC periodic reports on the funds they
hold."
3. We agree that if a receiver does not have possession of or
control over funds, then the recommended requirements would not be
applicable. However, sometimes the funds are in the receiver's
possession rather than in a court registry account. We added a
paragraph to the report saying that of the nine cases with receivers
we reviewed, receivers in eight of the cases were holding the
disgorged funds at the time of our review.
4. As we pointed out on page 6, whether disgorgement is ordered by
SEC in administrative proceedings or by a court, the objectives are
the same. If SEC implements a roster system for cases decided in
administrative proceedings, we see no reason why the roster could not
also be used for court cases when a judge asks SEC for a
recommendation.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
Richard L. Wilson, Assignment Manager
Diane N. Morris, Evaluator-in-Charge
Gloria Cano, Evaluator