Category: Articles & Publications

LAW 360: Current SEC Shutdown May Set New Record

By Jody Godoy
Published by Law360 (January 3, 2019, 10:15 PM EST)

From halted compliance examinations to frozen cases and delayed stock offerings, experts expressed concern Thursday about the effect of what could be the U.S. Securities and Exchange Commission‘s longest shutdown.

At almost two weeks, President Donald Trump’s partial government shutdown over his demand for a wall on the U.S.-Mexico border is only the fourth-longest in U.S. history. But attorneys who have worked at the SEC over the years say they can’t remember a shutdown affecting the agency this long.

Larry E. Bergmann, an attorney at Murphy & McGonigle who worked at the SEC for 30 years starting in 1975, says the longest closure he can recall lasted a week or less.

“It’s demoralizing to not be able to go to work. You want to do your job,” Bergmann said. “There are people on the outside who are looking for guidance on specific issues and you are not there to help them.”

The agency has been able to weather some past shutdowns by drawing on funds carried over from the previous year. David Lynn of Morrison & Foerster LLP worked at the SEC during the longest-ever government shutdown during the Clinton administration, which lasted 21 days. He remembers the agency staying open.

“I remember going to lots of meetings where they talked about it, but it just didn’t happen,” Lynn said.

This time around, the agency was down to minimal staff levels on Dec. 27, five days after the shutdown began on Dec. 22. The SEC’s shutdown plan prioritizes stopping imminent investor loss but puts most investigations and other work on hold.

Andrew Calamari, a former director of the SEC’s regional office in New York who now practices at Finn Dixon & Herling LLP, said that running the securities regulator on a skeleton crew inevitably creates a risk that issues will go unchecked.

Criminal fraud cases handled by the U.S. Department of Justice are largely exempt from the shutdown. But the SEC’s civil investigations play an important role too, even where the threat of loss isn’t imminent, Calamari said.

“That is what the SEC is there to do. To the extent they are not actively investigating matters they have already determined should be investigated, there is harm in that,” he said.

The work that has stopped also includes routine inquiries carried out by the Office of Compliance Inspections and Examinations.

According to a recent report, the office referred 160 matters for enforcement in 2018. Two days before the shutdown, OCIE had announced that its top priority for 2019 would be to look at financial services marketed to retail investors.

“Right now, you have no exams going on. That process quite often uproots various problems,” Calamari said.

At the same time, businesses lined up for examinations have no choice but to wait. Guy Talarico, CEO of Alaric Compliance Services in New York, received word from the SEC this week that an exam his firm is handling was paused because of the shutdown.

“We basically got an email saying, ‘We’re not here and we’re not even reviewing emails, so speak to you later,'” Talarico said.

The news was double-edged: Talarico said there was a moment of relief but that his client wants to get the examination over with.

“What can we say other than we all have to be patient as we sort through the impact of this?” Talarico said.

Defense and investigations attorneys are also seeing a regulator-shaped hole in matters involving the SEC and the U.S. Commodity Futures Trading Commission.

One SEC attorney found himself telling a judge Wednesday that an insider trading case from 2013, which is now in Vermont, needs to go on ice. Defense attorneys had floated the idea of carrying on during the shutdown.

Gregory Kasper, a former BigLaw attorney in New York who serves as the SEC’s regional trial counsel in Denver, the office handling the case, replied that if it goes forward, he would do his best and “hope” that the SEC would send co-counsel back to his side.

“Undersigned counsel, who would ordinarily be devoting virtually all available time to this matter, has been addressing administrative issues and seeking continuances and monitoring a docket of approximately two dozen cases assigned to trial attorneys that are furloughed,” Kasper wrote.

U.S. District Judge Christina Reiss decided to split the difference. If the shutdown is still in effect as of noon the day before the Jan. 8 hearing, she’ll grant a continuance, according to her order.

For defense attorneys with less clarity about who’s on first, one option is to call the relevant SEC staffer and listen for an “out-for-the-shutdown” voicemail. When it comes to ongoing investigations, attorneys are finding that depositions and conference calls have been canceled.

For the SEC’s sister agency, the CFTC, the quagmire emerged after the agency announced it had been on an enforcement kick last year. Already a small agency, the regulator is now down to 61 staffers from 673.

Elizabeth Lan Davis of Murphy & McGonigle, a former CFTC enforcement attorney who went through a previous shutdown, said this one likely would mean most cases go into a “holding pattern.”

Investigators faced with deadlines to bring civil charges likely sought to pause the statute of limitations during the shutdown, Davis said.

“I would imagine a defense counsel who did not agree to a tolling agreement during a shutdown would not be looked kindly upon in terms of cooperation credit,” she said.

The impact the shutdown could have in the long term is anybody’s guess. It comes not only amid a volatile time in the securities markets, but ahead of a number of anticipated initial public offerings including Silicon Valley rideshare juggernauts Lyft Inc. and Uber Technologies Inc.

Columbia Law School professor John Coffee Jr. said the impact on planned IPOs could be one of the most significant effects of the SEC going dark.

The process of vetting the IPO filings could take a month. With the SEC’s staff horsepower cut, it will take longer to get those offerings out, Coffee said. The offerings were rumored to be valued in the billions of dollars, but there’s no telling what market conditions will look like when the SEC reopens and clears its backlog.

“All of that could change if the market has a different perspective. And the possibility that the economy was going to stimulated by exciting IPOs is going to be substantially delayed,” Coffee said.

Smaller companies seeking to raise capital may be affected too, said MoFo’s Lynn. There’s a potential option to register a security and allow the registration to automatically become effective after 20 days without SEC intervention. But because that involves risking investors finding fault with the offering later, Lynn said it’s something of a “nuclear option.”

However, desperate times may call for desperate measures.

“We are almost getting to the point where we might start seeing people doing that,” Lynn said.

— Additional reporting by Alison Noon. Editing by Jill Coffey and Philip Shea.

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