Why did the SEC remove the enforcement director’s authority to issue formal investigations? Sources have different ideas.

The SEC’s recent move to eliminate the enforcement director’s authority to issue formal investigations is sure to reduce the number of probes, sources said.

But the motivation behind it is up for interpretation.

Some believe the SEC made the change in an effort to refocus an overly eager enforcement division, while others say the move aimed to gut staff's power at an agency tasked with protecting investors in the securities markets.

The commission’s enforcement director has had the authority to issue formal investigations since 2009, but in a rule amendment issued March 10, the SEC removed that authority, placing it in the hands of the agency's politically appointed commissioners. The amendment cites the commission’s “experience with its nonpublic investigations” as a rationale.

“The amendment is intended to increase effectiveness by more closely aligning the Commission’s use of its investigative resources with Commission priorities,” according to the rule amendment.

“I think that it signals a shift toward a more deliberate and strategic enforcement process that’s designed to help ensure that investigations, moving forward, align with the SEC’s broader regulatory agenda,” according to David G. Adams, a partner at Mintz.

However, “based on what we’ve seen from this administration,” Urska Velikonja, a law professor at Georgetown University Law Center, speculated that a significant motivation behind the change was to “disempower staff.”

Velikonja contended that “it's much easier for the commission, who do not directly work with (enforcement) staff” to deny a request for a formal investigation by citing a lack of evidence.

The SEC said the move is a return to how things were, as “the Division of Enforcement operated for 40 years without delegated authority." an agency spokesperson said in an emailed statement on March 10.

"We are returning to how the Division operated for most of its existence, ensuring the Commission has the utmost insight into the cases we bring throughout the process," the statement continued.

In general, sources agreed that requiring the commission’s approval to launch a formal investigation will lead to fewer of those investigations.

A formal investigation, as opposed to an informal investigation, authorizes staff “to subpoena documents and to compel witnesses to appear before the commission,” according to Velikonja.

“The follow-on effect of this is … we’re probably just going to see fewer cases that are being brought,” Velikonja added.

Adams said the same, given that formal investigations are now “going to take more time to get them approved, and it’s going to require approval of multiple people, as opposed to one.”

The move is likely to “reduce the number of investigations” and “also reduce the number of complicated investigations," because it will require enforcement staff to explain that complexity to the commission, contended Igor Rozenblit, founder and managing partner at Iron Road Partners, a regulatory and compliance consulting firm, and former SEC staffer from 2010 to 2021.

That “could create some potential risk,” because oftentimes when investigations start, there’s not enough information available, Rozenblit added.

“It’s going to be a balancing act, because the fewer cases you have, the more potential there is for something to slip through the cracks,” according to Adams. “But, on the other hand, you also have fewer cases against individuals or people out in the market who, in my view, were trying to do the right thing, but maybe got crossed up on a particular issue.”

Opinions differ on what motivated the SEC to remove the enforcement director’s formal investigation powers, reversing course on a practice that’s been in place since 2009.

The change likely took place “because the current commission wants to reduce the number of active enforcement investigations … and commence investigations only on certain matters,” Rozenblit said.

Noting the commission granted such authority after the Bernie Madoff scandal, “post-Madoff, the commission wanted to remove barriers and frictions to starting enforcement investigations. And this commission actually wants to increase those frictions,” Rozenblit contended.

Removing the enforcement director's investigations authority indicates that new SEC leadership "doesn't necessarily trust the staff to be opening investigations to the same extent that prior SEC leadership has trusted the staff to do so," according to Benjamin Schiffrin, director of securities policy at Better Markets, an investor watchdog group.

"You can imagine investors suffering the consequences if, as a result of the delay, the SEC doesn't act as quickly as it might otherwise have been able to," Schiffrin added.

Adams suggested the move is “signaling that (the SEC) wants to focus its enforcement efforts on high impact cases, rather than pursuing a really large volume of investigations of varying significance.”

And “there must be at least some relation” between the change and the overwhelming criticism of the SEC’s enforcement actions against the cryptocurrency industry, Adams said.

Under former Chair Gary Gensler, Republicans in Congress and industry stakeholders often denounced the commission for what they deemed a “regulation by enforcement” approach to crypto, given the agency’s enforcement actions against major crypto firms and exchanges.

Since President Donald Trump appointed Mark Uyeda as acting chair, the SEC has seen a series of industry-friendly changes to its crypto approach, including the launch of a new crypto task force and the dismissal of the commission’s lawsuit against crypto firm Coinbase.

Republican Commissioner Hester Peirce, who leads the new task force, said March 5 that the agency is “trying to move away from a regulation by enforcement approach and really bring policymaking back.”

“When you add all of that together, and the sequencing of this announcement, I do think that the decision can be seen as, in part, a response to the mounting pressure that the SEC was receiving” on crypto, Adams added.

However, Georgetown’s Velikonja thinks the change was not “driven primarily” by crypto, but rather focused on the “bread and butter cases that the SEC regularly brings” against investment advisers, investment funds and public companies.

“They’ve already announced they’re not going to go after (crypto),” Velikonja added.

Adams said he thinks the move “will help to focus some of the investigative and enforcement activity in a way that maybe wasn’t true over the course of the last few years.”

He noted that in his practice, representing clients in investigations, there were “certain situations where you kind of scratched your head” at why the SEC advanced a case to a formal investigation.

However, Velikonja said she “would like to see a better explanation for why (the change) is necessary.”

Given that the enforcement director has had formal investigations authority since 2009, “I haven't heard a case for what's wrong ... such that an abrupt change is necessary at this time."