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Does FinReg Contain Anti-Transparency Measures?

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I’ve been reading about a brewing controversy over whether language in the new Financial Regulations Act -- officially the Dodd-Frank Wall Street Reform and Consumer Protection Act, aka HR 4173 -- weakens public oversight over banks and investment companies. The alarm was publicly raised by Fox Business News last week  over section 929I of the legislation.

Fox's complaint: SEC is guarding the henhouse

Fox is suing the SEC for information “related to the agency’s response to complaints, tips and inquiries” stemming from the Bernie Madoff scandal. The SEC denied the FOIA request, citing the new provision.

To explain why this is important, Fox Business’s Dunstan Prial quotes SEC “whistleblower” and former SEC attorney Gary Aguirre as saying the law “permits the SEC to promulgate its own rules and regulations regarding the disclosure of records without getting the approval of the Office of Management and Budget, which typically applies to all federal agencies.”

The Washington Post’s Zach Goldfarb noted on July 28th that the SEC complies with “substantially fewer” FOIA requests than other agencies. Fox’s lawyer said the law’s purpose was to “keep the SEC’s failures secret.” The media giant's concern, no pun intended, is that the fox is guarding the henhouse. Equally plausible is the argument that the agency has been "captured" by those it regulates -- or that it's doing the will of Congress.

It seems to me that there are two anti-transparency concerns: why were the new FOIA exemptions created?, and why should the SEC be able to shrug off court subpoenas for information stemming from private lawsuits?

Goldfarb provides additional context and a caveat:

While, as Fox notes, the law exempts the SEC from disclosing records derived from ‘surveillance, risk assessments, or other regulatory and oversight activities’ this only concerns documents obtained through examinations of broker-dealers and investment advisers -- periodic or targeted reviews of financial firms.

People and organizations can still use FOIA to obtain a range of SEC information, such as inspector general reports; communications with Congress and the business community; and officials' calendar, salary and conflict-of-interest information.

SEC: These rules will improve enforcement

SEC Chairman Mary Schipiro reportedly responded to Fox’s allegations via letters to Senator Dodd and Representative Franks (which is not available on the SEC’s website, but is available from news outlets like the Washington Post.) She calls “false” the assertion that the legislation “'exempts’ the SEC from the Freedom of Information Act (FOIA).”

Out of fairness to Fox, the Chairman's characterization of its position is off base: the news conglomerate asserts that the SEC can set its own rules regarding how to comply with FOIA -- which means in practice that the SEC will only comply with FOIA requests to the extent it wants to -- but Fox does not claim the agency is exempted from FOIA entirely. Her characterization of Fox’s assertion seems to be a strawman.

The nub of Chairman Schapiro’s argument is that “[i]n order for our efforts [to protect investors, including those in hedge funds, private equity funds, and venture capital funds] to be successful, it is important that registered entities be able to provide us with access to confidential information without concern that the information will later be made public.”

She adds:

Prior to the Dodd-Frank Act, regulated entities not infrequently refused to provide Commission examiners with sensitive information due to their fears that it ultimately would be disclosed publicly. Existing FOIA exemptions were insufficient to allay concerns due in part to limitations in FOIA (including that certain existing exemptions may not apply to all registrants) (FN 1) and the fact that FOIA exemptions are not applicable when the SEC must respond to a subpoena (as either a party or non-party) (FN 2). The Commission's resulting inability to obtain this information hindered our capacity to enforce the securities laws and protect investors.
The first argument about “allaying concerns” is interesting because of the lack of a subject in the sentence. Whose concerns were not being allayed? Apparently the financial institutions the SEC oversees. Based upon the Commissioner’s letter, perhaps the problem from a regulatory point of view is that the SEC is relying (and perhaps must rely) on voluntary compliance from financial institutions for it to engage in regulatory oversight; FOIA (and public disclosure in general) is a side issue as to whether the SEC is empowered to do its job, and a fig leaf for financial institutions who do not wish to comply with a voluntary regulatory regime.

The second argument concerning subpoenas is not a FOIA argument, but one rather of regulated institution’s concerns that courts would be able to use information gathered by the SEC to help resolve litigation, potentially against a company’s interests. (Who knows -- they may be disclosing one set of books in court and another to the SEC.)

The good stuff is in the footnotes to her letter, which are not shown in the Washington Post’s reprint of the letter, but are available in the PDF the Post links to.

Footnote 1 explains that the FOIA exemptions do not apply to all registrants.

1 For example, FOIA exemption (b)(8) protects matters that are "contained in or related to examination, operating or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions (emphasis added).
Footnote 2 discusses the SEC’s response to subpoenas, which is unrelated to FOIA but does concern a person’s ability to have his or her day in court.
2 With respect to subpoenas, the staff is forced to contest them on grounds such as relevance and common law privileges. Depending on how a judge resolves the issues, the SEC may be ordered to produce sensitive records received from a registered entity to the firm's competitors. In some cases, the firms whose records could be disclosed have not even been parties to the proceeding in which the subpoena had been issued. Such disclosures obviously may cause significant harm to the businesses whose records and information are disclosed, and to the integrity of our examination program.
As a gesture towards the public, the Commissioner says that she is “asking the Commission to issue and publish on our website guidance to our staff that ensures the provision is used only as it was intended.” Congress didn't provide much guidance to aid the SEC, as the committee report that accompanied the legislation (House Report 111-517) does not provide any context as to legislative intent or explanation for this change in these provisions.

FOIA law prior to passage of the financial regulation bills (5 USC 552) seems to address the SEC’s concerns. FOIA exemption 4 excludes from disclosure “a trade secret or privileged or confidential commercial or financial information obtained from a person.” FOIA exemption 8 excludes information “contained in or related to examination, operating, or condition reports about financial institutions that the SEC regulates or supervises.”

Three Exemptions to FOIA and Court Subpoenas

Looking at the legislation itself, it appears that three exemptions have been inserted, all of which exempt the SEC from certain FOIA requests and court subpoenas arising from civil matters.

Exemption #1

First, a new provision was added to the rules regarding “public availability of information” for security exchanges, 15 USC 78x. Note that the SEC no longer needs to comply with court subpoenas or FOIA requests. Here's the language (with emphasis added in bold, and notes in square brackets):

‘‘(e) RECORDS OBTAINED FROM REGISTERED PERSONS.—

‘‘(1) IN GENERAL.—Except as provided in subsection (f), the Commission shall not be compelled to disclose records or information obtained pursuant to section 17(b), or records or information based upon or derived from such records or information, if such records or information have been obtained by the Commission for use in furtherance of the purposes of this title, including surveillance, risk assessments, or other regulatory and oversight activities.

‘‘(2) TREATMENT OF INFORMATION.—For purposes of section 552 of title 5 [FOIA laws, in other words], United States Code, this subsection shall be considered a statute described in subsection (b)(3)(B) of such section 552 [and thus be exempt from FOIA]. Collection of information pursuant to section 17 shall be an administrative action involving an agency against specific individuals or agencies pursuant to section 3518(c)(1) of title 44, United States Code [the section that establishes Office of Information and Regulatory Affairs within the Office of Management and Budget].’’.

I am not clear what provision 17(b) refers to, although I would guess that it is section 17(b) of the Securities and Exchange Commission Act of 1934 concerning “automated quotation systems for penny stocks,” codified at 15 USC 78-q2. If I'm right, this provision concerns the making publicly available of information regarding trading activity. (Note that subsection (f), not reproduced here, contains examples of when the agency must respond to subpoenas, e.g., in lawsuits brought by the government.)

Exemption #2

Second, a provision was modified that requires investment companies to maintain records, (15 U.S.C. 80a-30), which now allows the SEC to shrug off court subpoenas demanding information for the resolution of civil suits, as well as ignore FOIA requests. Inserted text is in caps; deleted text is struck through and in brackets; text I am emphasizing is in bold.

(b) Investment Company Act of 1940.—Section 31 of the Investment Company Act of 1940 (15 U.S.C. 80a-30) is amended—

(1) by striking subsection (c) and inserting the following:

‘‘(c) Limitations on Disclosure by the Commission.—Notwithstanding any other provision of law, the Commission shall not be compelled to disclose ANY RECORDS OR INFORMATION [internal compliance or audit records], or information contained therein provided to the Commission under this section, OR RECORDS OR INFORMATION BASED UPON OR DERIVED FROM SUCH RECORDS OR INFORMATION, IF SUCH RECORDS OR INFORMATION HAVE BEEN OBTAINED BY THE COMMISSION FOR USE IN FURTHERANCE OF THE PURPOSES OF THIS TITLE, INCLUDING SURVEILLANCE, RISK ASSESSMENTS, OR OTHER REGULATORY AND OVERSIGHT ACTIVITIES. Nothing in this subsection authorizes the Commission to withhold information from the Congress or prevent the Commission from complying with a request for information from any other Federal department or agency requesting the information for purposes within the scope of jurisdiction of that department or agency, or complying with an order of a court of the United States in an action brought by the United States or the Commission. For purposes of section 552 of title 5, United States Code, this section shall be considered a statute described in subsection (b)(3)(B) of such section 552. COLLECTION OF INFORMATION PURSUANT TO SECTION 31 SHALL BE AN ADMINISTRATIVE ACTION INVOLVING AN AGENCY AGAINST SPECIFIC INDIVIDUALS OR AGENCIES PURSUANT TO SECTION 3518(C)(1) OF TITLE 44, UNITED STATES CODE.’’;

(2) by striking subsection (d); and

(3) by redesignating subsections (e) and (f) as subsections(d) and (e), respectively.

As you can see, the pendulum has swung away from broader disclosure. Instead of excluding “internal compliance or audit records,” now no entity can compel the SEC to disclose any records or information, or anything derived from them, except for the reasons identified above. Again, this isn’t just a FOIA exemption, but also allows the SEC to decline to provide materials subpoenaed by a court by a lawsuit brought by anyone except the federal government.

I do not know what it meant here by an “administrative action.”

Exemption #3

A third provision was added, which provides FOIA and subpoena exemptions regarding disclosure of information by investment advisers (15 USC 80b-10). Here's the text, with my emphasis in bold.

c) INVESTMENT ADVISERS ACT OF 1940.—Section 210 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-10) is amended by adding at the end the following:

‘‘(d) LIMITATIONS ON DISCLOSURE BY THE COMMISSION.—Notwithstanding any other provision of law, the Commission shall not be compelled to disclose any records or information provided to the Commission under section 204, or records or information based upon or derived from such records or information, if such records or information have been obtained by the Commission for use in furtherance of the purposes of this title, including surveillance, risk assessments, or other regulatory and oversight activities. Nothing in this subsection authorizes the Commission to withhold information from the Congress or prevent the Commission from complying with a request for information from any other Federal department or agency requesting the information for purposes within the scope of jurisdiction of that department or agency, or complying with an order of a court of the United States in an action brought by the United States or the Commission. For purposes of section 552 of title 5, United States Code, this subsection shall be considered a statute described in subsection (b)(3)(B) of such section 552. Collection of information pursuant to section 204 shall be an administrative action involving an agency against specific individuals or agencies pursuant to section 3518(c)(1) of title 44, United States Code.’’.

I am conjecturing that section 204 is codified at 15 USC 80b-4, which requires investment advisers to keep records and make reports to the SEC. In addition to creating an exemption from FOIA, this is another get-out-of-court-free provision, where courts are prohibited from compelling the SEC from provide records from investment advisers. In other words, it’s again up to the SEC’s sole discretion.

What does this say about transparency?

What does this all mean? I don’t really know. It appears that less information will be available to the public or to resolve lawsuits. The SEC is granted a freer hand to help shield corporate information from public view, and apparently the agency is unafraid to wield that power. Based on the Commissioner’s letter, these provisions have shown up in legislation before -- thus demonstrating how omnibus legislation allows a pre-existing laundry list to be enacted into law.

This also shows how difficult it can be to figure out what’s going on. With the move into the regulatory implementation phrase -- and a request for public comments on the implementation of these regulations already issued by the SEC -- it is likely that those who are in the know will work very hard to keep the rest of us from figuring out what’s going  on ... until it’s too late.

  • Disclosure: I was a law clerk for Fox Television Stations Incorporated and had no dealings with Fox News.