A key goal of Dodd-Frank is to increase transparency.
The market crisis centered, in part, on trading in derivative markets with
little regulation and virtually no transparency. For this reason, a key focus
of the legislation is transparency. This emphasis is so strong that Congress is
now considering the repeal of Section 9291 of the Act. That section was
intended to give the SEC a limited exemption under the Freedom of Information
Act. Since many view it as a mechanism to withhold broad categories of
information as discussed
here it may be repealed.
As the SEC continues retooling its enforcement program,
it would do well to consider adding transparency to the process. This would be
consistent with the overall goals of the statutes as well as Dodd-Frank. It
would also facilitate the goals of the program and the new cooperation measures
of the Division.
A good illustration of the need for additional
transparency is the case of Kevin Schott, former CFO of Zoltek Corporation. SEC
v. Schott, Case No. 4:10-cv-01500 (E.D. Mo. Filed Aug. 13, 2010). The
complaint alleges what appears to be a straight forward financial fraud. Mr.
Schott, the SEC says, circumvented the internal controls of the company and
ignored the explicit directions of Zoltek's CEO in making two payments of
$250,000 to an outside financing consultant. According to the Commission, Mr.
Schott lied to the controller of a foreign subsidiary to make the payments,
created false documents including entries in the books and records and made
false and misleading certifications to the auditors and the public. The case
was resolved with Mr. Schott's consent to the entry of a permanent injunction
prohibiting future violations of Exchange Act Section 132(b)(5) and the related
rules and an agreement to pay a $25,000 penalty. End of case.
A closer look at the complaint, however, raises other
questions. The payments trace to a September 2005 deal Mr. Schott arranged for
the company with a financial consultant to raise funds from Zoltek's hedge fund
clients. Under the agreement, the company would pay the consultant $250,000 if
it received any additional funds from the consultant's clients in the following
three years. It did. Two years later Zoltek entered into a separate funding
agreement with one of the consultant's hedge fund clients. The consultant
learned about the agreement, demanded payment and threatened to sue. Mr. Schott
told the CEO the company should pay the fee. The CEO refused. Mr. Schott then
arranged for payment through a foreign subsidiary, averting the threatened
On this record, Mr. Schott clearly acted contrary to the
instructions of the CEO, but arguably for the benefit of the company by
avoiding litigation. Falsifying the books and records of the company might have
resulted in a fraud charge. It did not. Falsifying filings might have resulted
in a fraud charge. It did not. Falsifying CFO certifications might have
resulted in a fraud charge. It did not.
It may be that Mr. Schott was not charged with fraud
because he cooperated with the Commission. The papers, however, give no
indication of cooperation. There may have been other circumstances which
warranted not brining fraud charges. Again there is no indication in the papers
to this effect.
The company has not been charged. There is no indication
that the investigation is continuing or that any future action is contemplated.
Likewise, there is no indication that the company cooperated. To the contrary,
since the Commission frequently identifies situations where the investigation
is continuing or cooperation credit has been given, the inference from the
record is that the investigation is over and that the company did not
cooperate. If the defendant and the company did not cooperate, there is little
on the record to explain the manner in which the Commission exercised its
discretion in resolving the underlying investigation.
In an era of increased transparency, and particularly in
view of its recent efforts to encourage cooperation, it would behoove the
Commission to disclose more about the predicate for its enforcement actions.
Disclosing cooperation efforts determined to merit credit in the charging
process for example, can aid individuals and companies faced with the question
of whether to cooperate with the Commission and if so how to proceed. It also
strengthens the Commission's efforts to encourage self-reporting and
cooperation which are critical to the overall success of the enforcement
program. This is particularly true in view of recent academic papers which
raise significant questions about the value of cooperation (here).
If the Commission and enforcement officials are reluctant
to discuss specific situations, there are other avenues such as releases and
speeches. The bottom line, however, is that both the Commission and the public
would benefit by bringing a new transparency to the enforcement charging process.
If the Commission is really serious about retooling enforcement, more
transparency is essential.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.