Broken Windows Policy – The Underlying Rationale
The term “broken windows” comes from an eponymous 1982 article in The Atlantic, which asserted that unaddressed disorder encourages more disorder, followed by more serious crimes.[1] SEC Chairwoman Mary Jo White, who witnessed the transformation of New York City during the period of broken windows policing, took the lesson to heart. On October 9, 2013, at the Securities Enforcement Forum, Ms. White said the same theory could be applied to the securities markets—minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.[2] Thus, Ms. White emphasized that it is important to pursue even the smallest infractions, whatever the size of the violation that victimizes the investor, and that the SEC should be the agency that covers the entire neighborhood and pursues every level of violation, making you feel like it is everywhere.[3]
The broken windows enforcement policy as outlined by Ms. White has several components:
- Expanding the agency’s reach by collaborating with other regulatory authorities (e.g., Department of Justice, FINRA, and state securities regulators) and registered entities (e.g., broker-dealers, investment advisers, and exchanges), incentivizing whistleblowers, and strengthening technological capabilities;
- Pursuing deficient gatekeepers (e.g., investment company boards, auditors, etc.);
- Not overlooking the small violations; and
- Prioritizing the bigger cases and sending a message of deterrence.[4]
The agency’s broken windows approach is not without critics. SEC Commissioner Michael S. Piwowar, for example, argued that “[i]f every rule is a priority, then no rule is a priority. If you create an environment in which regulatory compliance is the most important objective for market participants, then we will have lost sight of the underlying purpose for having regulation in the first place.”[5] The practical reality is that the SEC cannot be everywhere at once, simply because the agency’s resources, to Ms. White’s own admission, aren’t “nearly sufficient to the enormity and scope of the responsibility we have.”[6] Ms. White emphasized, however, that “[a]ll of this talk about being everywhere should not be taken to suggest that the SEC’s investigative flashlight will shine only or mostly into the dark corners and hidden nooks of the financial system; quite the opposite. It is critical that [the SEC] continue to focus on the larger, tougher, and more complicated cases.”[7]
At any rate, the SEC seems determined to pursue broken windows. In November 2014, for instance, the SEC announced that it had sanctioned ten companies (generally, smaller reporting companies) for failing to make required Form 8-K disclosures (a routine disclosure made by reporting entities for material events) for financings and unregistered stock sales, with penalties ranging from $25,000 to $50,000.[8] And in March 2015, the SEC charged eight officers, directors, and major shareholders for failing to update their Schedule 13D stock ownership reports to reflect material changes in connection with several “going private” transactions, with penalties ranging from $150,000 to $75,000.[9] In this new enforcement environment, smaller companies may not hope to escape liability just by being small; internal controls and compliance will matter more than ever.
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This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
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About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] Id.
[2] Mary Jo White, Remarks at the Securities Enforcement Forum (Oct. 9, 2013), http://www.sec.gov/News/Speech/Detail/Speech/1370539872100.
[3] Id.
[4] Id.
[5] Michael S. Piwowar, Remarks to the Securities Enforcement Forum 2014 (Oct. 14, 2014), http://www.sec.gov/News/Speech/Detail/Speech/1370543156675.
[6] Jaclyn Jaeger, Behind the SEC’s New ‘Broken Windows’ Enforcement, Compliance Week (Nov. 2013), http://www.strozfriedberg.com/wp-content/uploads/2013/11/BehindtheSECsNewBrokenWindows_CW_Stark.pdf.
[7] White, supra n.3.
[8] SEC, SEC Sanctions 10 Companies for Disclosure Failures Surrounding Financing Deals and Stock Dilution (2014-248), http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543368026.
[9] SEC, Corporate Insiders Charged for Failing To Update Disclosures Involving “Going Private” Transactions (2015-47), http://www.sec.gov/news/pressrelease/2015-47.html.
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