Behind the SEC’s enforcement statistics: Does the U.S. securities regulator misreport its own performance?

Most countries require all companies incorporated in the jurisdiction to prepare an annual report and share it with their shareholders and usually one or more regulators. Listed companies are subject to even more frequent and demanding reporting obligations. Corporate disclosures are very valuable: they are used by investors to buy and sell securities; by companies to make investments or acquisition decisions; by corporate boards to select, evaluate, and reward managers; and by regulators charged with regulating businesses. But they also have a significant downside: some worry that quarterly reporting forces listed companies to focus on the short term, to chase earnings targets, instead of pursuing longer-term goals that may not show results in the next reporting cycle. And sometimes, short-term performance targets lead to financial manipulation and even outright accounting fraud. These concerns about the consequences of reporting are known.

It is less well known that the U.S. federal agencies face similar reporting requirements as companies. And like companies’ reports, reporting requirements have upsides and downsides. Not all agencies’ reports are read very closely, but some face considerable scrutiny, including the ones prepared by the U.S. Securities and Exchange Commission. The SEC releases its annual enforcement report every October, after the end of the SEC’s fiscal year. The report details the agency’s activity for the year, including its enforcement of securities laws. It often boasts of record activity, sometimes showing significant increases over the prior fiscal year in the number of enforcement actions brought and monetary penalties ordered. The numbers suggest that the SEC is ever tougher on securities violators.

The SEC includes these statistics in its budget requests; the figures are repeated in congressional testimony, policy and regulatory proposals, and the business press.
Performance reporting and annual reviews create incentives for the SEC to report improvement. And like with companies, the SEC’s reports can mislead and distort the agency’s enforcement policy.

Required to report

The SEC, like other federal agencies, is required to report its financial and non-financial performance under several federal statutes and rules, most notably the federal Government Performance and Results Act of 1993. Enacted during the Clinton administration, the Act was one in a series of statutes designed to “re-invent government”; to improve government performance by reducing “waste and inefficiency” and by “holding Federal agencies accountable for achieving program results.”

Influenced by private-sector management practices, federal agencies are required to set performance goals, measure their performance, and to report the results annually to the president and Congress. The goals are to be expressed in “objective, quantifiable, and measurable form,” and agencies are instructed to develop performance indicators that are to be used in measuring and assessing agency output and the outcomes of their activities.
There are significant consequences for federal agencies that miss performance targets.

Agencies must report their shortfalls to the Office of Management and Budget and submit an improvement plan, including proposing statutory changes or requesting additional funding. In the era of post-financial crisis austerity, congressional appropriations committees have been loath to increase agency budgets, so most agencies muddle through as best as they can. But if an agency misses a performance target three years in a row, the Office of Management and Budget may propose to Congress to terminate the program or reduce its budget.

Measuring the performance of government agencies

Agency goals are both more difficult to express in easy-to-track figures and more often in conflict than performance targets for companies. A mature listed company can measure its performance by reporting its earnings, EBITDA, and the stock price. A tech start-up might use the number of new users as a key performance indicator.

By contrast, agencies pursue goals such as safety, public health, election integrity, or in the case of the SEC, investor protection and capital market efficiency. These are difficult to express in numbers. On top of that, external changes in the economy confound measuring the impact of one agency’s varied activities. For example, when the SEC files more enforcement actions for securities violations, the increase might reflect that the SEC is protecting investors better and preventing more fraud, or that more fraud is happening.
Unlike companies that usually can focus on the bottom line, government agencies are required to pursue multiple, conflicting goals. For example, reducing securities fraud to zero would protect investors maximally, but may not be efficient. The oversight and enforcement cost of eliminating all Ponzi schemes, for example, would almost certainly exceed the benefit.

Despite the issues with performance reporting, lawmakers routinely use it to reward and punish agencies. And like companies, agencies respond by massaging the numbers and or changing activities in such a way to generate results that can be measured, regardless of whether they further their goals.

Misleading SEC reporting

A study of the last 15 years of the SEC’s enforcement reporting supports the conclusions above. The SEC has used performance indicators opportunistically to suggest that it enforcement program is targeting ever more violators and securing ever larger fines.

The most widely-used performance indicators that the SEC uses are the number of enforcement actions filed and the amount of monetary penalties imposed. Neither measures what it is supposed to measure – the increase in investor protection and/or capital market efficiency – and both are unreliable: they are used inconsistently from year to year and can be manipulated.

For example, the SEC regularly highlights the number of enforcement actions it files. In the fiscal year 2016, the SEC filed 868 enforcement actions, a 7.5 percent increase from 807 filed in 2015, and a 28 percent increase from 676 actions filed in 2013, when then-Chair Mary Jo White was appointed to the Commission. If true, that is a massive increase in output.

But counting enforcement actions is not only a poor proxy for measuring enforcement output or the likelihood that any violator will face enforcement, it can also be manipulated quite easily. An enforcement action is effectively a lawsuit that the SEC files against a defendant at the end of an investigation. In it, the SEC seeks to establish that the defendant broke the law and to impose sanctions. Sometimes, the SEC joins several defendants in a single enforcement action and at other times it sues them individually in multiple actions. The SEC’s practices of filing separate or consolidated actions are not consistent over time and even between regional offices. As a result, the number of enforcement actions will vary from year to year for reasons unrelated to underlying misconduct or the intensity of enforcement.

More significantly, the SEC double and triple counts many of the enforcement actions it brings. Most of the SEC’s enforcement actions seek to establish liability and to impose sanctions. But the SEC also files many so-called follow-on enforcement actions seeking to bar the offender from working in the securities industry, to suspend or revoke registration of a broker-dealer or investment adviser, or to suspend the right of an auditor or attorney to practice before the Commission. All follow-on actions are derivative: these actions are ordinarily based on an injunction that the SEC secured in an earlier primary enforcement action against the same offender for the same violation. In all follow-on cases, either the defendant already settled with the SEC (or lost in litigation), was convicted, or was sanctioned by another federal agency or state securities regulator. None of the follow-on actions are new enforcement actions and all have already been counted at least once in the SEC’s enforcement tally, or that of another agency. Some have been counted three or more times.

In addition, the overall number and the relative share of follow-on cases has increased over the last few years. Once these measures are adjusted, they reveal that SEC enforcement remained steady between 2002 and 2014, but shifted towards easier-to-prosecute strict-liability violations. That, standing alone, would not be an issue of any significance if the SEC did not advertise misleading figures that suggest real increases in enforcement.

A problem?

The SEC is not alone in using statistics that have a propensity to mislead to report its output. The Federal Trade Commission uses suspect metrics, as have other agencies. Unlike companies that mislead investors to divert resources to themselves, agencies report flawed statistics to protect their ability to continue enforcing the law. If an agency were to report declining or stagnant enforcement, its budget might be reduced.

But insistence on performance metrics does have real-world consequences. When regulators face rigid performance targets designed to make them run more like a business, regulators are likely to respond much in the same way businesses do. When regulators cannot increase their budget but are expected to deliver anyway, they might fudge. Nothing that the SEC has done amounts to outright manipulation, but the agency’s leadership certainly put a misleading spin on its enforcement statistics.

That, standing alone, would earn little more than a shoulder shrug if the decision-makers at the SEC and in Congress all knew that the numbers were bogus, as they likely do. It rises to the level of a real problem when the pressure to report good numbers leads the agency to change how to enforce the law, what market players to target and for what types of violations. The SEC has shifted away from prosecuting more serious fraud claims and filed more negligence-based or strict liability claims in recent years.

Rather than try to improve reporting, the SEC’s use of its enforcement statistics suggests that simplistic performance targets are not useful. They produce distortions similar to those in the private sectors with consequences that are greater because agencies have a monopoly over enforcement. Government agencies are different from businesses, and transplants from business practices may do more harm than good.

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Urska Velikonja
Professor of Law, Georgetown University Law Center

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