One of the side effects of the growing controversy over the Securities and Exchange Commission's new exemptions from Freedom of Information Act requests is that the SEC could be forced to turn over more documents about how it views its own responsibilities under FOIA. 

 

Rep. Darrell Issa, (R-Calif.), has given the SEC until Aug. 19 to turn over all communications dating back from 2005 on how it treats FOIA requests, and also asks that the agency spells out the impact of how it wants existing laws changed under the new Dodd-Frank financial reform bill.

 

The SEC has told FOX Business that the new section was needed because the Dodd-Frank bill for the first time requires the agency to examine hedge funds, private equity funds, and venture capital funds. It says those funds for years have fought SEC attempts to examine them, citing concerns the agency would disclose trade secrets and proprietary information to competitors, including customer account information, trading strategies and algorithms.

 

But a growing chorus of Congressmen and government watchdog groups have said the new section is an over reach, noting that existing FOIA laws already protected these companies, which the SEC disputes.

 

The SECrecy controversy, first brought to light by FOX Business, has drawn support from every corner of the political spectrum. In addition to conservative groups, a coalition seeking to overturn the provision now includes groups like Feminists for Free Expression and the ACLU. They join the American Library Association, the Government Accountability Project, OMB Watch, OpenTheGovernment.org and Public Citizen.

 

FOX Business was the first news organization to call attention to the new section in the Dodd-Frank bill.

 

In a July 30 letterto Rep. Barney Frank(D-Mass) and Sen. Chris Dodd(D-Conn.), SEC chairman Mary Schapirowrote that the language in the new clause is not new, noting "as far back as 2006, then SEC chairman Chris Cox sought language similar" to the new section in order to examine hedge funds and the like, and that the new section, 9291, is necessary to encourage regulated firms to comply with SEC requests for "sensitive and proprietary information."

 

The chairman wrote: "The Dodd-Frank Act mandates a number of new responsibilities for the SEC to protect investors, including new authority over hedge funds, private equity funds and venture capital funds. Fulfilling these responsibilities will require the SEC to expand and improve our examination and surveillance capabilities in order to provide the type of risk-focused regulatory oversight investors deserve."

 

Chairman Schapiro added: "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."

 

The chairman also noted in her letter that the new section addresses a "longstanding impediment" to the SEC's ability to examine companies because companies feared disclosure of sensitive and proprietary trade secrets such as "customer information, trading algorithms, internal audit reports, trading strategy information, portfolio manager trading records and exchanges' electronic trading and surveillance specifications and parameters."

 

Such information is "critical" in order for the SEC to "detect possible misconduct," Schapiro wrote, citing in particular that the agency couldn't get at personal trading records to detect insider trading, or trading algorithms needed to detected manipulations in automated high frequency and flash trading.

 

SEC subpoenas also aren't covered by FOIA, Schapiro wrote, and in some cases investment firms "whose records could be disclosed" under an SEC subpoena "have not even been parties to the proceeding," which "may cause significant harm" to the business.

 

"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," Schapiro wrote. "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)."

 

The SEC has told FBN that existing FOIA was insufficient to protect those firms from having their proprietary trade secrets disclosed by the agency because a financial institution as defined under FOIA exemption (b)(8) defines a financial institution as a bank, not a hedge fund, or private equity fund, or venture capital fund.

 

Schapiro said the new section "does not provide a ‘blanket' SEC exemption from FOIA and is not designed to protect the SEC as an agency from public oversight and accountability," noting that instead, the new section is designed to reassure financial firms and other regulated entities that they may release "highly sensitive and proprietary information" to SEC examiners without worrying that it might eventually become public.

 

Schapiro vowed in her letter that the new section will be used "only as it was intended"-to encourage regulated companies to cooperate with SEC examiners by protecting their sensitive information and for no other purpose.

 

The new section 9291 notes that such information shall be gathered "for use in" the SEC's surveillance, risk assessment and regulatory oversight. The SEC tells Fox Business the words "for use in" means only those trade secrets are protected from disclosure-the agency says it's a misread of the new law to say it means its entire regulatory oversight apparatus is exempt from FOIA.

 

Not So Fast

 

But in his August 6 letter to the SEC chairman, Rep. Issa says the chairman's "promise" to stay within the letter of the new law "is belied by your agency's first invocations of the new section," noting "the SEC's actions are louder than your words."

 

He notes that "the SEC's Office of Compliance Inspections and Examinations has already attempted in court to use the new section to avoid disclosure of much broader categories of information," including information that does not qualify as "sensitive and proprietary," noting just that happened in the SEC's case against Morgan Asset Management, parent of Morgan Keegan.

 

The SEC has alleged Morgan Keegan intentionally misled investors by not disclosing its funds were overexposed to rotten subprime securities; the agency had denied the firm's FOIA request for documents to help it in its defense, citing the new Dodd-Frank clause retroactively. A U.S. administrative judge recently ruled against the SEC, saying the agency cannot use the new clause retroactively.

 

And Rep. Issa notes the SEC cited the new section to "discourage" Fox Business's "future [emphasis Issa's] FOIA requests for information related to the SEC's failure to stop alleged Ponzi schemers Bernard Madoffand R. Allen Stanford."

 

He adds that "of course there is no way to evaluate the content of a FOIA request that has not yet been made, but the agency has already decided that the ‘intended' purpose of section 9291 will apply to these future requests."

 

Rep. Issa adds: "Congress and the American people are justifiably suspicious that the SEC intends to use section 9291 to avoid accountability and transparency by keeping broad categories of information secret."

 

Rep. Issa also says that the SEC chairman does "not fully explain how FOIA's existing exemptions" are ‘insufficient' to allay the fears of hedge funds, private equity funds, and venture capital funds that their trade secrets would become public after an SEC examination.

 

He writes: "As you should know, FOIA already exempts from mandatory disclosure trade secrets and confidential commercial or financial information, and information covered in financial regulators' examinations."

 

Rep. Issa adds: "I do not believe that your letter has made a compelling case that section 9291 should be retained."

 

With that, Rep. Issa is asking for the following records from the SEC:

 

• All communications referring or relating to internal policies or guidance, effective between Jan. 1, 2005, and the present, governing the SEC's treatment of FOIA requests;

 

• All records and communications referring or relating to Section 929I and every similar legislative proposal referred to in the SEC's July 30 letter;

 

• State the basis for the suggestion that FOIA's examination exemption might cover some entities that the SEC regulates, but not others;

 

• Describe every action taken by the SEC in response to a Sept. 25, 2009, Inspector General report;

 

• Describe any information that was actually withheld from an SEC examiner under the circumstances described in the July 30 letter and was not covered by any FOIA exemption;

 

• If it is your position that "customer information, trading algorithms, internal audit reports, trading strategy information, portfolio manager trading records and exchanges' electronic trading and surveillance specifications and parameters" are not covered by any FOIA exemption, state the basis for your position.

Government Watchdog Group Questions SEC's Position

 

In an Aug. 3 letter to Congressmen Dodd and Frank, The Project on Government Oversight says "the SEC has a troubling history of being overly aggressive in withholding records from the public."

 

And it notes in its letter to Congressmen Dodd and Frank that the SEC already has ample authority under existing law to protect proprietary information.

 

For example, the Project notes that existing exemption 8 in existing FOIA law "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.'"

 

The Project adds that "Chairman Schapiro argues that this exemption may not apply to all registrants, but it's worth noting that the courts have broadly construed the term 'financial institutions,' holding that it is not limited to depository institutions and can also include investment advisers."

 

The Project also adds that existing FOIA exemption 4 protects "trade secrets and commercial or financial information obtained from a person [that is] privileged or confidential."

 

It says "the Department of Justice's (DOJ) FOIA guide states that this exemption 'encourages submitters to voluntarily furnish useful commercial or financial information to the government and it correspondingly provides the government with an assurance that such information will be reliable." That calls "into question chairman Schapiro's claim that additional exemptions are needed in order for the SEC to collect information from its registered entities," the Project notes.

 

And it says "the SEC's track record with FOIA raises additional concerns about giving the agency even more authority to withhold information from the public."

 

Last year, an audit conducted by the SEC Office of Inspector General "uncovered a wide range of problems related to the SEC's FOIA operations," the Project says. "We were particularly troubled by the OIG's finding that the SEC Chief FOIA Officer was not operating in compliance with Executive Order 13392 or the OPEN Government Act; that few FOIA liaisons have written policies and procedures for processing FOIA requests, increasing the risk that the agency is unnecessarily withholding information from the public; and that there is an insufficient separation between the initial FOIA determination and the appeal process. The OIG concluded that the SEC's FOIA release rate was "significantly lower when compared to all other federal agencies."

 

The Project also questions chairman Schapiro request that the agency will "issue and publish on our website guidance to our staff that ensures [Section 929I] is used only as it was intended."

 

It says: "The solution for addressing the uncertainty surrounding this provision is not additional guidance. The solution is clarification in the law that public access is vital to accountability and that the existing FOIA exemptions can adequately protect confidential business information provided by regulated entities."

 

"Chairman Schapiro neglected to mention that the SEC already has the authority to compel registered entities to provide information and records. Under the Securities Exchange Act of 1934, the SEC has the authority to subpoena witnesses and require the production of any records from its registered entities. If these entities fail to comply, the SEC has the authority to suspend these entities, impose significant monetary penalties, and refer cases to DOJ for possible criminal proceedings."

 

"But instead of using these existing authorities, Chairman Schapiro seems to think that Congress needs to provide blanket FOIA exemptions in order to convince the SEC's registered entities to cooperate. We think such a blanket exemption fosters an environment that defers to the entities it regulates and is unadvisable."