Witnesses Criticize SEC "Regulation by Enforcement"

Witnesses before the House Financial Services Subcommittee on Capital Markets criticized the current SEC approach to enforcement, suggesting it fails to strike the right balance between deterring and punishing securities fraud and preserving due process rights.

In her remarks at the hearing, Chair Ann Wagner (MO-02) articulated concerns about "regulation by enforcement," which compromises "due process [and] public trust." Chair Wagner emphasized that the SEC's current approach "harms market participants by implementing policy changes that are not subject to the Administrative Procedure Act’s notice and comment requirements." She asserted the need for a balance that respects both the legal rights of market participants and the SEC’s mission to protect investors. She argued that public trust in the SEC declines when (i) "its employees are sanctioned and forced to resign for their 'gross abuse of power'" (referring to a recent case against the crypto platform known as DEBT Box; see related coverage); (ii) "its staff pursue 'shadow trading' enforcement actions or engage in off-channel communications sweeps that consider each of a company’s unarchived WhatsApp messages a separate violation of the securities laws"; and (iii) "market participants cannot share truthful information related to their settlements, or when SEC staff act as both the prosecutor and judge in cases seeking millions of dollars in penalties."

The following witnesses testified:

• Mercatus Center Senior Affiliated Scholar and former SEC Deputy General Counsel, Andrew Vollmer highlighted: (i) the SEC’s unguided discretion to impose extremely high civil penalty amounts and (ii) the need to clarify the 2021 disgorgement statute, which is already the subject of differing views by federal appellate courts.
• Investor Choice Advocates Network ("ICAN") President and Founder, Nick Morgan argued that "regulation by enforcement" is a form of "shadow rulemaking." He said that this practice lacks transparency and does not incorporate public input, leading to hardships for individuals who are not accused of fraud. He cited the experiences of two of ICAN's clients, who faced aggressive SEC enforcement despite no allegations of harming investors.
• College of William & Mary Law School Professor, Paul Eckert asserted that the SEC's enforcement processes suffer from significant inefficiencies which negatively impact public companies and regulated entities. He highlighted the burdensome nature of prolonged SEC investigations which impose high costs and disrupt business operations, potentially damaging reputations and delaying business initiatives. Professor Eckert proposed reforms including: (i) "refining investigative practices to be... more targeted," (ii) ensuring faster responses to investigative requests and (iii) reevaluating the use of certain compliance measures like deficiency letters and interpretive guidance.
• Consulting President and former Chief of the SEC Office of Internet Enforcement, John Reed Stark defended the SEC’s enforcement efforts in the digital asset space arguing that "crypto promoters ... [are engaging in a] well-funded, coordinated, and unfounded assault on the SEC and its mission." He argued that "the SEC is just enforcing the law. Period. You may not like the outcome, but that doesn’t amount to an absence of Due Process and Fair Notice or somehow translate into rogue SEC Regulation by Enforcement."