Dodd-Frank Broadens SEC powers

On July 21, 2010, President Obama signed the landmark Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Senate Banking Committee’s summary of the more than 2,300 page legislation declared:

“Years without accountability for Wall Street and big banks brought us the worst financial crisis since the Great Depression, the loss of 8 million jobs, failed businesses, a drop in housing prices, and wiped out personal savings.

“The failures that led to the crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs.”

Much public debate about Dodd-Frank and subsequent media coverage have focused on its broad policy and structural implications for banks, including, for example, stricter capital and leverage requirements and limitations on proprietary trading, and on its consumer protection provisions. However, the act also has significant implications for firms and individual participants in the investment business.

Although the president said in his signing statement, “unless your business model depends on cutting corners or bilking your customers, you’ve got nothing to fear from reform,” the Securities and Exchange Commission (SEC) and other regulators have been charged with substantial study and rulemaking tasks to bring clarity to what this reform will mean. And a number of features of the act that have received little attention directly affect the securities industry by way of enhancing the SEC’s investigative and enforcement powers.

Fiduciary standard for broker-dealers

Broker-dealers historically have not been considered fiduciaries and have been held to a standard of “suitability” in recommending investments to retail customers. In contract, investment advisers have been held to a “fiduciary” standard, meaning they are required to act in the best interests of their customers, without regard to the adviser’s interest and disclosing potential conflicts of interest.

The Dodd-Frank Act requires the SEC to conduct a study (and to issue a report to Congress within six months) to determine whether a broker-dealer should be held to the same fiduciary standard now applicable to investment advisers in providing personalized investment advice to retail customers. Although Dodd-Frank does not change this standard of care, implications are that an enhanced standard will be applied to broker-dealers following the SEC’s work. SEC Chair Mary Schapiro stated in a speech on July 9, 2010, “I have long advocated such a uniform fiduciary standard and I am pleased the legislation would provide us with the rulemaking authority necessary to implement it.”

And the ramifications for broker-dealers may well be significant. For example, will a new fiduciary standard require retail customers to provide written consent before a broker-dealer may trade on a principal basis (as is currently the case with investment advisers)? Will broker-dealers offering proprietary products of the firm or its affiliates be required to provide advance notice to and receive the consent of the customer? And, if a broker-dealer makes an attractive investment opportunity available to certain customers but not others, would the broker violate a duty to the latter? Much remains to be resolved.

Whistleblower compensation and protections

Dodd-Frank provides significant incentive for financial industry whistleblowers to assist the SEC in identifying fraudulent practices and unlawful conduct. The available financial reward—or “bounty”—available to whistleblowers in publicly traded companies ranges from 10 percent to 30 percent of financial recovery in excess of $1 million that the SEC obtains from targeted companies.

The act also protects the whistleblower from being retaliated against by his or her employer. Remedies for the successful whistleblower include reinstatement, double back pay and attorneys’ fees. Early indications are that these expanded whistleblower incentives and protections have created a heavy volume of calls to whistleblower hotlines, the SEC and plaintiffs’ lawyers.

Expansion of aiding and abetting liability

The SEC previously could only charge aiding and abetting violations under the Securities Exchange Act and the Investment Advisers Act. Dodd-Frank authorizes the SEC to charge aiding and abetting violations under the Securities Act and the Investment Company Act as well. The act also alters the state of mind requirement for aiding and abetting violations of the securities laws. The prior standard required that an aider or abettor “knowingly” provide substantial assistance to another person’s violations. Dodd-Frank provides for liability for those who aid and abet violations knowingly or recklessly. Negligent aiding and abetting claims now appear to be precluded, but the act’s changes are likely to increase the level of SEC aiding and abetting charges.

Further enhancements of SEC tools

Responding to increasing criticism the SEC has faced from investors and the press since the beginning of the ongoing financial crisis, Dodd-Frank contains a number of additional provisions that will enhance the SEC’s ability to bring enforcement actions:

Nationwide service of subpoenas: A subpoena issued to compel attendance of a witness at trial may now be served by the SEC anyplace within the United States. Previously, the applicable federal rule placed a 100-mile limit on the distance a witness had to travel, frequently requiring the SEC to use a videotaped deposition at trial. Now the SEC can require a witness who resides in the United States to appear at trial, no matter the distance traveled. This change will afford the SEC greater freedom to select the jurisdiction in which to file actions, with the potential for the SEC to select the jurisdiction with the most favorable law.

Collateral bars: The SEC is now authorized by Dodd-Frank to suspend or bar a regulated person who violates securities laws in one area of the financial services industry from associating with a regulated entity in another part of the industry. For example, if an individual associated with a broker-dealer is the subject of an enforcement action, the SEC may now suspend or bar that person not only from associating with any broker-dealer, but also from associating with an investment adviser or investment company (mutual fund).

Civil penalties in administrative proceedings: Prior to Dodd-Frank, the SEC could only impose a civil penalty in an administrative proceeding against an individual associated with a regulated entity, such as a broker-dealer or investment adviser. This required the SEC to file an action in federal district court to seek a civil penalty against a person not associated with a regulated entity, such as officers or employees of public companies or accountants. Dodd-Frank authorizes the SEC to seek a civil penalty against any person in an administrative proceeding. It also increases the penalty amounts the SEC can seek. These features likely will increase the volume of administrative proceedings, where the SEC enjoys considerable tactical advantages, including the absence of juries and less strict application of the rules of evidence.

Extraterritorial jurisdiction: An increasing number of SEC investigations have involved conduct and participants outside of the United States, posing potential jurisdictional challenges to SEC enforcement actions, particularly in light of a U.S. Supreme Court ruling earlier this year. Dodd-Frank makes it easier for the SEC to overcome these jurisdictional issues by giving federal district courts jurisdiction over SEC actions charging violations of the federal anti-fraud provisions where (1) conduct within the United States constitutes a significant step in furtherance of a violation even if the securities transaction occurs outside the United States and involves only foreign investors, or (2) conduct occurring outside the United States has a foreseeable substantial effect within the United States. This jurisdiction provision will enhance the government’s ability to bring anti-fraud actions addressing transactions and conduct wherever they occur in financial markets that have become truly global.

SEC resources: Although the SEC did not obtain sought “self-funding” (from its registration and transaction fees), Dodd-Frank authorizes appropriations that will substantially increase its budget, virtually doubling its resources from $1.3 billion in fiscal 2011 to $2.25 billion in 2015. In addition, the SEC has been given discretion to access a new $100 million reserve fund for necessary expenses to supplement its budget. These increases will enable the SEC to increase substantially its inspection and examination and enforcement programs.


While most attention—with justification—has focused on Dodd-Frank’s application to financial institution oversight and consumer protection, the act has significant ramifications for the financial services industry that have received less publicity. In his remarks at the signing of Dodd-Frank, President Obama said:

“In the end, our financial system only works—our market is only free—when there are clear rules and basic safeguards that prevent abuse, that check excess, that ensure that it is more profitable to play by the rules than to game the system. And that’s what these reforms are designed to achieve—no more, no less.”

It remains to be seen how effective Dodd-Frank’s attempted reforms will prove to be, but in any event it is highly likely that the level of SEC enforcement activity as well as private litigation addressing alleged wrongs in securities activities will rise markedly.

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