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SEC Doesn't Take Its Automatic Punishments Too Literally

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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If you violate securities laws, the Securities and Exchange Commission will (one hopes) catch you and punish you. It'll make you pay some money and promise not to do it again, and maybe hire consultants to check on you, and so forth. Those are all pretty sensible punishments for doing bad things.

But another consequence is that you might automatically be barred for five years from making use of the exemption for private placements found in Rule 506 of Regulation D.  That's the rule that lets companies do private placements of stocks or bonds to "accredited investors," meaning institutions and rich people. It's the rule that lets people invest in hedge funds and private equity funds and private companies and unregistered debt offerings, and that lets investment banks help with those private placements, which run to the hundreds of billions of dollars a year.

This is ... I don't know, maybe an appropriate punishment? Like, if you do bad private placement stuff, maybe you should be prevented from doing more private placements? A lot of securities-law badness is related to private placements. If you're going around selling stocks to rich people by lying to them, or defrauding your hedge-fund investors, and you get caught, then maybe you should get a five-year time-out from selling stocks to rich people, or having hedge-fund investors.

But sometimes it's not an appropriate punishment. Like, if some guys in the Not Private Placements Division of a big investment company engage in insider trading or fraud or whatever, then those guys should be punished. And maybe the company as a whole should be punished. It should pay a fine; maybe it should even have to shut down its Not Private Placements Division. But it's a little weird to have to shut down the innocent Private Placements Division, just because that's the division specifically called out in the rule.

The SEC knows all of this, so it frequently waives the supposedly automatic bar for big banks.  If you're an investment bank with a bunch of different businesses, and you do some bad stuff away from private placements, you're not going to be banned from doing private placements for five years.

And so when Oppenheimer & Co. got caught helping a penny-stock broker in the Bahamas evade SEC registration requirements and tax laws, it got fined a hefty $20 million and was required to hire various monitors and stuff. But because Oppenheimer's various private-placements businesses -- the Private Shares Group, for instance, or the people doing private placements and PIPEs in Equity Financing, or the ones doing private debt financing in Leveraged Finance -- didn't do anything wrong, Oppenheimer got a waiver to the automatic bar on private placements.

But while three SEC commissioners, including Chairwoman Mary Jo White, voted for the waiver, two did not. Here is the dissent, from Commissioners Luis Aguilar and Kara Stein. Aguilar and Stein want the automatic bars enforced. And they are not impressed by Oppenheimer:

The facts demonstrate that Oppenheimer has a failed compliance culture, from top to bottom. Although one can hope that the firm will turn things around, the Commission cannot be blind to the fact that prior enforcement actions have also required the firm to retain consultants and to prepare reports on its remediation efforts. The fact that these past efforts have failed to alter an entrenched culture of non-compliance makes the decision to grant a full waiver in this matter even more disconcerting.

And, look, fair enough; they write that, "Since 2005, there have been at least 30 separate regulatory actions against Oppenheimer for numerous violations of securities laws and rules," which is not a great track record.

But what is the argument for enforcing the bar here, based on this conduct? Aguilar and Stein point to the obvious core purpose of the bar, which is to protect the public from securities fraudsters: They argue that with the waiver, "a majority of the Commission is telling the public that this firm should not be labeled a 'bad actor.'" But "the public," there, means specifically "people who buy private-placement securities marketed by Oppenheimer," and helping penny-stock hucksters dodge tax and registration requirements has nothing to do with being a bad actor in private placements.  The people who helped the hucksters don't work in the private-placements business, and the people in the private-placements business did nothing wrong here. For all I know Oppenheimer is a paragon of virtue in private placements.  

The other argument is of course deterrence: The threat of an automatic bar from the private-placements business will encourage the next broker to double-check that his customers aren't running scams from the Bahamas. This is kind of a weird theory of deterrence: Why would the broker care about the possibility of a ban in an entirely unrelated area of the business? Also there is a start-up cost to that deterrence: Surely no big bank has been deterred by the automatic bars so far, because they're not really enforced. And it's a little rough to be the first big company not to get a waiver.

It would probably be better just to get rid of the automatic bars, no? They're not really serving a deterrent function. And if the SEC thinks that the consequences to a specific firm for specific misconduct should be a disqualification from doing private placements, then it can make that a specific part of its punishment. But if it doesn't think that, it really shouldn't go through the rigmarole of making the disqualification automatic and then semi-automatically waiving it.

Financial regulatory enforcement is full of symbolic fights like this. Every time a firm settles a case, we are treated to earnest discussions of whether it can "neither admit nor deny" guilt, though it normally admits to the factual predicates of guilt. ("I said these things, and they were not true, and I knew it," but not "I lied.") The neither-admit-nor-deny stuff might have practical implications for the bank, but it's purely symbolic for the SEC and prosecutors. Demanding an admission is simply a badge of toughness, and regulators are supposed to collect badges of toughness. Similarly here, the waiver issue "creates a conundrum for Ms. White, the deciding vote, whose reputation as a tough-on-crime former federal prosecutor helped her sail through Senate confirmation." Wouldn't want to sully that reputation by not fighting over everything!

It just seems like there is an economy of attention with these things. SEC enforcement is not free. Focusing on one thing makes it harder to focus on other things. Attention to symbolism distracts from effectiveness. An automatic punishment is a convenient time-saver if you usually think the punishment is appropriate, but a wasteful distraction if you often don't.

If the SEC were sitting around spitballing appropriate ways to punish Oppenheimer for lax anti-money-laundering controls, "shut down its private placements business" probably wouldn't be in the top 50 ideas for how to do it. But now two SEC commissioners have gone and produced a strained argument for doing just that, just because it's in the rules. And there's a whole backstory on how the SEC staff and the majority of the commission came to the opposite conclusion after much debate. It might be better if the SEC had more time and power to craft and fight for appropriate penalties, and spent less time debating whether to waive inappropriate ones.

  1. The automatic five-year bar is in Rule 506(d)(1)(v).

  2. But here is DealBook:

    Two people who spoke on the condition of anonymity said that under Ms. White, the commission rejects most requests for waivers. The S.E.C., however, does not record such data because many companies convey requests in an informal manner. The people spoke on condition of anonymity because they were not authorized to discuss the matter.

    Obviously, if a private-placement huckster asks for a waiver, he'll get shot down, but a large U.S. bank is different. The closest I've seen the SEC come to enforcing it for a big bank is yelling a lot at Bank of America while granting the waiver. Here is a list of Rule 506(d) waivers since the rule was enacted in 2013; it's a pretty comprehensive list.

  3. They sound sort of linked, and Aguilar and Stein suggest that they are, but they're not. Oppenheimer's most recent misdeeds involved allowing offshore penny-stock brokers to trade penny stocks without checking into whether they were subject to registration requirements (or money-laundering reporting requirements). So it did some sales of stocks that perhaps should have been done under Rule 506, but weren't. They weren't done by its private placements group, or by investment banking at all. They were done by its regular equity brokerage group, just like if you had 100 shares of IBM that you wanted to sell through an Oppenheimer account. The problem was not recognizing that these were unregistered sales and sending them to the appropriate group; there's no claim that Oppenheimer did anything wrong in its actual unregistered-sales group.

  4. Ha, no, it's totally not -- it defrauded some investors in its own private equity fund -- but that has nothing to do with this case. That was almost two years ago! That fraud predated the Rule 506 automatic bar (and the specific provisions that it violated don't seem to be on the Rule 506(d)(1)(v) list anyway), though it did trigger a Rule 405 bar. Which the SEC waived.

    Also here is a blog that tracks Oppenheimer's misdeeds; my favorite headline is "Oppenheimer Fined $1 Million for Abuse of Widow -- Later Told She 'Only Had Herself to Blame'."

  5. Sadly, they're new since Dodd-Frank, so I assume the constituency to get rid of them isn't really there.

  6. Or take Antonio Weiss. Maybe there's an argument that his confirmation fight was over qualifications, but to me it seems pretty clear that it was about Signalling Toughness On Banks.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at

To contact the editor on this story:
Zara Kessler at