The SEC vs. Eliot Spitzer: Whose Turf Is This?
from
November/December 2003
by Shelley Neumeier
There’s a face-off on Wall Street—and it’s not the investment banks that are getting antsy, it’s the keepers of law and order. Which of these cops, exactly, is in charge?
The highest-profile corporate lawman is New York State attorney general Eliot Spitzer. He has become something of a hero among investors for his aggressive pursuit of Wall Street wrongdoers—first wresting $100 million out of Merrill Lynch, then snaring a $1.4 billion global settlement with 10 major Wall Street firms.
That has left the Securities and Exchange Commission scrambling to prove that it’s no wimp. While acknowledging that the SEC needs “all the help we can get to root out the bad things that are going on,” chairman William H. Donaldson is backing a provision, introduced by Representative Richard Baker (R-Louisiana) as part of a broader securities act, that would reduce the states’ ability to supersede the SEC’s brokerage regulations with their own. The rationale: It doesn’t make sense to have 50 different sets of rules.
Spitzer says the proposed law would weaken enforcement efforts, a concern that is echoed by many in the legal community. “You want to make sure that if the SEC falls asleep at the switch, the states will still be there,” says Steve Thel, a professor at Fordham law school.
Even if the Baker provision passes, don’t expect a clear delineation of duties between state and federal securities cops. “There’s a tremendous amount of overlap,” says Benjamin N. Cardozo School of Law professor Jeanne Schroeder. Here’s how the territory is currently divided (and not):
The SEC
The governing body of the securities industry was established by the Securities Exchange Act of 1934 as part of an effort to protect the investing public from insider traders, speculators—and themselves. The SEC regulates all of Wall Street, from the brokerages to the investment banks to the companies whose shares trade on the stock exchanges. It sets the rules for how companies can go public and regulates the way they issue additional stock and bonds. It can investigate, censure, and fine those who violate its regulations.
It cannot, however, prosecute wrongdoers for criminal acts; it has only civil authority. If the SEC uncovers criminal activity, it has to hand prosecution over to a U.S. Attorney’s office. The feds can then prosecute, and if they win, it’s up to a court to send the criminal away.
But the SEC has been growing muscle. Sarbanes-Oxley makes it easier for the commission to declare a director or officer “unfit” and get that person tossed off a board. The Baker legislation would enable an SEC administrative judge to slap big fines on directors, officers, and others who break the rules or even “cause” someone else to break them. Eugene Goldman, a partner in the Washington, D.C., law firm of McDermott Will & Emery, expects to see many such penalties imposed should this legislation pass.
The Financial Accounting Standards Board
The SEC also has statutory authority to set financial reporting and accounting standards, but it has delegated that responsibility to the Financial Accounting Standards Board. This independent body establishes accounting standards for all companies—the generally accepted accounting principles, or GAAP. But the FASB does not have enforcement powers. It neither investigates nor penalizes companies that violate GAAP; that’s usually the SEC’s job.
The State Attorneys General
These folks enforce state securities laws, generally antifraud statutes known as Blue Sky laws. (The name may come from a 1911 Kansas ruling prohibiting “speculative schemes which have no more basis than so many feet of ‘blue sky.’”)
State laws ran more or less parallel with federal securities law until 1996, says Fordham professor Steve Thel. That year Congress made two exceptions, deciding that the public sale of most securities falls under federal, not state, regulation and that class-action securities suits should generally be filed in federal court, not under state Blue Sky laws.
But why is Spitzer the one going after Wall Street abuses, instead of, say, the attorney general of California, home to many publicly traded companies and investors? For one thing, Wall Street is in Spitzer’s geographic domain. Furthermore, New York’s Blue Sky laws are particularly broad. Most state laws govern the sale of securities to their residents. New York and a few others, says Cardozo professor Jeanne Schroeder, govern sales of securities by their residents as well. And New York has plenty of such residents, especially those down Wall Street way.
As far as securities go, enforcing the state’s antifraud laws is Spitzer’s main job. But, says Ted Sonde, senior counsel in the Washington, D.C., law firm of Crowell & Moring, “like any good law-enforcement official, he not only wants to enforce past violations, he wants to prevent future ones.” And that’s where Spitzer starts encroaching on regulatory turf. He imposed rules—“business conditions”—on the banks as part of the settlements, including the requirement that a company’s analysts function separately from its investment bankers.
Perhaps, say some legal experts, a compromise could be reached that would still leave the state with teeth. “I think there needs to be a mechanism that would require the state to consult with the SEC before it attempts to impose these kinds of business conditions,” says Eugene Goldman of McDermott Will & Emery. “If the SEC has no problem, fine. If it does, the state would have to defer to the SEC.”
A more deferential Spitzer? Don’t bet on it.
