April 14, 2013

With the recent confirmation of Mary Jo White as the new Chair of the Securities and Exchange Commission (the "SEC"), much has been made of her considerable credentials as a former prosecutor and veteran litigator - Wall Street purportedly has a new pit bull on the beat, but how much of that feistiness is bark and how much is bite? We may soon find out. See, "Securities And Exchange Commission Revolving Door Spins For Mary Jo White" (, January 22, 2013).

In a recent BrokeAndBroker column, "Second Circuit Pounds Last Nail Into Madoff Plaintiffs' Coffin" (April 10, 2013), I reported that:

In Molchatsky, et al. v. United States (2nd Circuit, 11-2510 April 10, 2013), Plaintiffs were investors victimized by Bernard Madoff and Bernard L. Madoff Investment Securities LLC. Plaintiffs sought to hold the United States liable for the United States Securities and Exchange Commission (the "SEC"). employees' failure to detect Bernard Madoff's Ponzi scheme over a 16-year period and for the financial losses sustained.

Pointedly, Plaintiffs asserted that the SEC had missed many opportunities to timely uncover the Madoff Ponzi fraud because of the SEC's:

  • repeated failure to alert other branch offices of ongoing investigations,
  • properly review complaints and staff subsequent inquiries, and
  • follow up on disputed facts elicited in interviews.

On April 10, 2013, the United States Court of Appeals for the Second Circuit ("2nd Circuit") concluded that Plaintiffs' harm ultimately stemmed from the SEC's failure to investigate Madoff and uncover his Ponzi scheme, which was deemed as conduct "too intertwined with purely discretionary decisions" made by SEC personnel. The 2nd Circuit found that the United States was effectively shielded from this lawsuit because the SEC retained complete discretion over when, whether and to what extent to investigate and bring an action against an individual or entity. Morever, the cited misconduct was similarly immunized from civil suit because the SEC was engaged in the allocation of time and resources based upon somewhat appropriate economic, social and policy considerations.

Notwithstanding the 2nd Circuit's affirmation of the dismissal by the District Court for the Southern District of New York, the higher court expressed its compassion for plaintiffs and its anger with the SEC's desultory conduct, as evidenced by this comment:

Despite our sympathy for Plaintiffs' predicament (and our antipathy for the SEC's conduct), Congress's intent to shield regulatory agencies' discretionary use of specific investigative powers via the DFE is fatal to Plaintiffs' claims.

New York Times reporter Gretchen Morgenson just turned up the heat on new SEC Chair White in "Note to New S.E.C. Chief: The Clock Is Ticking" (New York Times, "Fair Game," April 13, 2013). Pointedly, Morgenson raised a very timely concern about a number of matters on the SEC's plate that are nearing the expiration of their five-year statute of limitations - particularly involving cases arising from the mortgage bust of 2008.

As I noted in "Supreme Court Reverses SEC v. Gabelli On Discovery Rule Grounds" (, February 27, 2013) those statute of limitations concerns have recently become all the more pressing given the United States Supreme Court's ruling SEC v. Gabelli (2nd Circuit, 653 F. 3d 49, August 1, 2011), in which the Court reversed and remanded to the 2nd Circuit. In setting forth its rationale, the Court noted, in part:

There are good reasons why the fraud discovery rule has not been extended to Government enforcement actions for civil penalties. The discovery rule exists in part to preserve the claims of victims who do not know they are injured and who reasonably do not inquire as to any injury. Usually when a private party is injured, he is immediately aware of that injury and put on notice that his time to sue is running. But when the injury is self-concealing, private parties may be unaware that they have been harmed. Most of us do not live in a state of constant investigation; absent any reason to think we have been injured, we do not typically spend our days looking for evidence that we were lied to or defrauded. And the law does not require that we do so. Instead, courts have developed the discovery rule, providing that the statute of limitations in fraud cases should typically begin to run only when the injury is or reasonably could have been discovered.

The same conclusion does not follow for the Government in the context of enforcement actions for civil penalties. The SEC, for example, is not like an individual victim who relies on apparent injury to learn of a wrong. Rather, a central "mission" of the Commission is to "investigat[e] potential violations of the federal securities laws." SEC, Enforcement Manual 1 (2012). Unlike the private party who has no reason to suspect fraud, the SEC's very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit. It can demand that securities brokers and dealers submit detailed trading information. Id., at 44. It can require investment advisers to turn over their comprehensive books and records at any time. 15 U. S. C. §80b-4 (2006 ed. and Supp. V). And even without filing suit, it can subpoena any documents and witnesses it deems relevant or material to an investigation. See §§77s(c), 78u(b), 80a-41(b), 80b-9(b) (2006 ed.).

The SEC is also authorized to pay monetary awards to whistleblowers, who provide information relating to violations of the securities laws. §78u-6 (2006 ed., Supp. V). In addition, the SEC may offer "cooperation agreements" to violators to procure information about others in exchange for more lenient treatment. See Enforcement Manual, at 119-137. Charged with this mission and armed with these weapons, the SEC as enforcer is a far cry from the defrauded victim the discovery rule evolved to protect. . .

Page 7 - 8 of the Opinion.

Morgenson's April 13th column warns about a pending SEC whistleblower complaint involving tens of billions of dollars in transactions that may have been furthered by potentially misleading disclosures by SunTrust Banks, a regional bank holding company in Atlanta. Pointedly she asserts that the matter was

[F]iled with the S.E.C. more than a year ago by a former SunTrust employee, it appears to be languishing even though time's a-wasting.

The SunTrust whistle-blower complaint, which I reviewed, contends that company financial filings of recent years misrepresented the bank's exposure to risky no-documentation mortgages that it underwrote from 2006 to 2008. Many were sold to Fannie Mae and Freddie Mac, the taxpayer-backed mortgage finance giants.

Shareholders have not been aware, the complaint says, that many mortgages SunTrust was selling to Fannie and Freddie in this period were so-called liar loans, with little to no documentation of borrowers' income or assets. The bank maintained that it had little exposure to low-documentation loans, the complaint says.

As with many whistle-blower complaints, the person filing this matter asked not to be identified. Aegis J. Frumento, a lawyer at Stern Tannenbaum & Bell who represents the whistle-blower, said the plaintiff is an experienced mortgage underwriter at SunTrust who was disturbed by dubious practices at the bank. . .

Clearly, there will be no honeymoon for SEC Chair White and, frankly, that's far too quaint a notion or expectation in these days of economic crisis and tepid recovery. Much has been made about the need to reform Wall Street. Beyond bluster and hyperbole, the test of that resolve is manifested in action - and such action must be timely and meaningful. There were lessons for the SEC to learn from its disgraceful handling of tips about Madoff and from the organization's plodding response. SunTrust may or may not be guilty of whatever allegations have been presented by whistleblowers and possibly uncovered by the SEC's staff - as such, the bank is entitled to the presumption of innocence. On the other hand, the SEC is not entitled to dawdle until such time as the statutes of limitation have expired and the lights are turned out on any justified prosecution. One Harry Markopolous was more than enough for this generation.

Also see, WHISTLEBLOWING: The Bounty Hunter Comes To Wall Street (, February 6, 2013).  In August 2012, the SEC made its first whistleblower bounty payment and individuals are lining up with their tips, hoping for a pay day. How does this modern day bounty hunting on Wall Street work? Veteran Wall Street lawyers Bill Singer and Aegis J. Frumento discuss this new regulatory initiative. Watch the video.