Commentary: Dodd-Frank Arms the SEC
Traders Magazine Online News, August 17, 2010
Prior to 1934, FBI agents were not permitted to carry firearms. This changed when "Pretty Boy" Floyd, his sidekick Adam Richetti, and hit man Verne Miller tried to free their friend and fellow bank robber Frank "Jelly" Nash, who was being transported back to Leavenworth by two federal agents and three local policemen. On June 17, 1933, in downtown Kansas City in broad daylight, Floyd's gang attacked with submachine guns, killing four officers--including one federal agent--as well as Nash, and then escaped. The "Kansas City Massacre," as it became known, shocked the voting public, leading Congress to arm the FBI the following year.
Stephen J. Nelson
Congress has reacted to the Panic of 2008 in much the same way. There might not be much evidence so far that unlawful activity caused the Panic. Nonetheless, the Dodd-Frank Wall Street Reform and Consumer Protection Act grants the Securities and Exchange Commission an entire assortment of new enforcement firearms.
For some time now, the SEC has had the authority under the Securities Exchange Act of 1934 to prosecute persons who, while not actually committing securities fraud themselves, provide "substantial assistance" to fraudsters. However, this authority was limited to violations of the Exchange Act, which, as a practical matter, generally meant violations of Rule 10b-5's prohibitions against fraudulent and deceptive practices.
Dodd-Frank extends the SEC's authority by empowering it to prosecute aiding and abetting violations of the Securities Act of 1933, the Investment Advisers Act of 1940 and the Investment Company Act of 1940. This is a major expansion of the SEC's enforcement powers. In the past, the SEC has brought numerous actions against hedge fund managers under the Investment Advisers Act; under Dodd-Frank, the SEC also will be able to prosecute prime brokers, accountants and lawyers for providing "substantial assistance" to the manager.
Dodd-Frank lowers the standard of proof in such aiding and abetting prosecutions, making it much easier for the SEC to obtain judgments. Dodd-Frank also states that a person who provides substantial assistance to the fraudster "shall be deemed to be in violation ... to the same extent as the person to whom such assistance is provided." This makes clear that the liability for aiding and abetting will be the same as that of the person who actually committed the fraud. The liability may consist of civil fines and penalties assessed by the SEC in administrative proceedings or damages ordered by a federal court to compensate the victims of fraud.
It is often difficult to obtain compensation for all of the persons who were victims of securities fraud. The persons committing the fraud often end up in bankruptcy or prison and therefore are unable to compensate for all of the harm they have done. So, the private plaintiff's bar has for many years sought the right to obtain compensation from brokerage firms, accountants and lawyers who, while not actually committing the fraud, may have provided assistance without which the fraud would never have taken place. For example, the SEC has long argued that without the substantial assistance of brokerage firms, "pump and dump" schemes and other frauds in micro-cap securities traded in the OTC equity markets would be impossible to accomplish.
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