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SEC’s “Gatekeeper” Enforcement Initiative Impacts Directors

Senior SEC officials have become increasingly vocal in recent months about the roles and responsibilities of corporate “gatekeepers” and the need to impose stronger penalties on those who fail to satisfy their professional obligations.  One notable example came from SEC Commissioner Luis A. Aguilar, who issued a rare dissenting opinion in In the Matter of Lynn R. Blodgett and Kevin R. Kyser, CPA, File No. 3-16045 (Aug. 28, 2014).  Blodgett involved a former chief financial officer charged in a public company’s failure to comply with its financial reporting, record-keeping, and internal control obligations.  Commissioner Aguilar took particular exception to the SEC’s willingness to resolve what he termed to be “egregious conduct” by the CFO without the institution of fraud charges.  He also characterized the more than $200,000 in penalties and disgorgement levied upon the CFO to be “a wrist slap at best.”  As Commissioner Aguilar commented in his dissent:

Accountants – especially CPAs – serve as gatekeepers in our securities markets.  They play an important role in maintaining investor confidence and fostering fair and efficient markets.  When they serve as officers of public companies, they take on an even greater responsibility by virtue of holding a position of public trust.  To this end, when these accountants engage in fraudulent misconduct, the Commission must be willing to charge fraud and must not hesitate to suspend the accountant from appearing or practicing before the Commission.

While Commissioner Aguilar’s remarks in Blodgett concentrated on accountants, his general reference to corporate gatekeepers was especially noteworthy, since it dovetailed neatly with the SEC’s latest enforcement priorities.  Last year, the SEC’s Enforcement Division instituted what it internally labeled “Operation Broken Gate.”   This enforcement initiative targets corporate gatekeepers who fail to comply with their professional responsibilities and place investors at risk of undetected fraud or material misstatements in financial statements and corporate disclosures.

“Operation Broken Gate” roughly coincided with the arrival of SEC Chair Mary Jo White, whose brief tenure has featured a notable increase in sanctions imposed against both companies and individuals.  During a speech at Stanford University in June, Chairwoman White discussed the importance that the SEC places on “gatekeepers” in a presentation titled “A Few Things Directors Should Know about the SEC.”   She advised that while “the term ‘gatekeeper’ [refers] to auditors, lawyers and others who have professional obligations to spot and prevent potential misconduct,” corporate directors are “the essential gatekeepers upon whom [the] investors and, frankly, the SEC rely.”  Chairwoman White proceeded to spotlight two enforcement proceedings this year – SEC v. AgFeed Industries, Inc. and In the Matter of L&L Energy, Inc. – in which the SEC brought charges against directors (and, in particular, audit committee chairpersons) for their “disturbing” failure to prevent corporate fraud and the issuance of false public filings at their respective companies.

Chairwoman White’s presentation served as far more than just a series of cautionary tales from the regulatory frontlines.  Far more significantly, it also provided a pragmatic blueprint for “conscientious, diligent director[s]” to avoid the prospect of personal liability through the adoption of essential corporate governance measures designed to detect and prevent potential violations. These measures collectively provide an invaluable perspective on the SEC’s likely approach when assessing director performance in connection with future charging enforcement decisions. They included:

  • Setting a proper “tone at the top”: Directors need to establish expectations for senior management and their companies, and exercise appropriate oversight to ensure that those expectations are being satisfied.  Selecting CEOs who understand and embrace corporate governance should be one of their highest priorities.

  • Understanding the company’s business: Directors should be asking senior management the hard questions and listening to what is being said – and not said.  Gaining an astute appreciation for their company’s business model and the associated risks allows directors to identify and promptly address potential “red flags.”

  • Instituting strong compliance programs: Directors should ensure that ethics and honesty are viewed as fundamental corporate values through the adoption of robust corporate compliance programs, which include regular employee training and accessible codes of conduct that place no employees “above the law.”

  • Implementing a responsive internal whistleblower program: Directors need to foster a corporate culture that encourages, empowers and potentially rewards employees who report instances of possible wrongdoing – and support an environment in which whistleblower complaints are taken seriously and addressed appropriately.  

  • Evaluating the need to self-report potential violations: When wrongdoing has been uncovered, directors need to reach an informed decision whether a violation warrants disclosure to the company’s regulators, mindful that self-reporting, cooperation and remediation may lessen the scope of investigations and the severity of sanctions.

Many of these measures that Chairwoman White identified may seem familiar to those who have grappled with Sarbanes-Oxley compliance in the past.  Nevertheless, there is every reason to believe that they will take on added significance in the SEC’s evolving enforcement landscape.  SEC Director of Enforcement Andrew Ceresney announced recently that “financial reporting cases for 2014 so far have surpassed last year’s total number of cases by 21 percent,” which reverses a substantial downward trend in such enforcement proceedings that originated during the early stages of the economic crisis.  With the economy now slowly improving and financial reporting cases poised to regain their regulatory prominence, it is prudent for directors to revisit and, if necessary, begin the process of strengthening the oversight measures at their public companies.

©2019 Drinker Biddle & Reath LLP. All Rights Reserved


About this Author

Stephen Stroup, Securities Attorney, Drinker Biddle

Stephen G. Stroup has substantial experience in securities and corporate governance litigation, white collar criminal defense and corporate investigations, and complex business disputes, with a particular emphasis on Securities and Exchange Commission (SEC) enforcement proceedings and private actions involving accounting and financial issues. Steve is counsel in the firm’s Litigation Practice Group.

He has a proven track record of obtaining optimal results for his clients, both at trial and during the pre-trial and investigatory stages. In...