The SEC’s Renewed Focus on Gatekeepers

In the fall of 2001, Enron Corporation collapsed amidst a scandal over its suspect corporate governance practices and accounting strategies. Arthur Andersen, the company’s primary gatekeeper, became part of the narrative over its role in the auditing of Enron and, more significantly, the charges of document destruction and obstruction of justice. Andersen was criminally prosecuted and went out of business, only to have the conviction overturned by the Supreme Court years later (see Arthur Andersen LLP v. United States, 544 U.S. 696 (2005)).

Fade in, fade out. In 2013, with financial crisis matters running their course, the Securities and Exchange Commission pivoted back to its historical mission of audit, accounting, and financial reporting issues. To advance this move, the SEC set up a task force – the Financial Reporting and Audit, or FRAud, Task Force – which now has evolved into a more permanent “Group” within the Enforcement Division. The Group is devoted to “fraud detection and increased prosecution of violations involving false or misleading financial statements and disclosures.”

A number of core principles emerged from the SEC’s enforcement program. In a widely reported speech on September 26, 2013, SEC Chair Mary Jo White articulated a “subtle shift” in pursuing “responsible individuals,” noting that the SEC wants to be sure “we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in.” Chair White remarked that this approach is “one that could bring more individuals into enforcement cases.”

In an equally important statement of policy, the SEC has renewed its focus on gatekeepers. The modern system of securities law enforcement “contemplates that much of the front-line work for prevention and discovery of financial misconduct will be done by private-sector gatekeepers.” The term gatekeeper, though commonly used, acquires a special definition in the context of financial markets regulation. One expert has described gatekeepers as “reputational intermediaries who provide verification and certification services to investors.” In 2015 congressional oversight testimony, the current director of enforcement emphasized “the importance of gatekeepers to our financial system” and identified a variety of private actors that can serve as gatekeepers, namely “attorneys, accountants, fund directors, board members, transfer agents, broker-dealers, and other industry professionals who play a critical role in the functioning of the securities industry.”

This emphasis on gatekeepers has taken on expansive attitudinal approach, marked by a proactive, prosecutorial program to ensure effective corporate governance. In a June 2014 speech at the Stanford Directors’ Conference, Chair White confirmed that this approach pointedly extends to non-management directors who are associated with an issuer and have responsibilities for overseeing financial reporting. She declared that “while there are certainly other gatekeepers who may be closer to some of the action or more familiar with the details of a transaction or a disclosure document,” “a company’s directors serve as its most important gatekeepers.” Chair White added that directors are “essential gatekeepers” and “play a critically important role in overseeing what your company is doing, and by preventing, detecting, and stopping violations of the federal securities laws at your companies, and responding to any problems that do occur.” To punctuate her remarks, Chair White advised: “As directors, you must understand your company’s business model and the associated risks, its financial condition, its industry and its competitors. You must pay attention to what senior managers are saying, but also listen for things they are not saying.”

In the linked article which appears in The Review of Securities & Commodities Regulation, New York litigation partner Todd Fishman examines this renewed emphasis and then turns to relatively recent SEC actions against directors, accountants and audit committees, and other gatekeepers. He concludes by noting that the renewed emphasis may hinder internal oversight efforts.