The SEC's new enforcement chief is leading the agency's biggest overhaul in 30 years. Will that be enough? Ben Hallman reports

The 5 November 2009 was a good day for the Securities and Exchange Commission (SEC).

At a press conference with the US attorney's office in Manhattan, new SEC enforcement director Robert Khuzami announced that his agency was bringing civil charges against 13 people associated with the Galleon Group insider trading scandal. In the post-Madoff era, it was a chance for the SEC to show that it
is back on the beat, aggressively policing the securities markets. And it was an opportunity for Khuzami (pictured), who can mix financial crime gravitas with Jon Stewart-age ironical detachment, to set a
different tone.

"There should be a moment – hopefully before you're holding a bag of cash delivered to you by somebody code-named 'the Octopussy'- that causes anyone in a position to tip or trade on inside information to think twice before taking such a misguided step," Khuzami said in his prepared remarks. "If you find yourself chewing the memory card in your cell phone to destroy any record of your misconduct, something has gone terribly wrong with your character."

Khuzami is a leader for the media age. Since taking office last March, the 53-year-old former federal prosecutor and corporate lawyer has delivered dozens of speeches, making him the most visible enforcement director in a generation. His dry sense of humour, genial demeanour, and CV – 11 years in the Southern District of New York, including a stint as head of the securities fraud unit – have helped him bring about the most sweeping changes at the 1,200-person division since the 1970s. In the past year he eliminated an entire level of management, formed national units to concentrate expertise in five major areas under the agency's purview and created a new system to handle tips and complaints. Recently he borrowed pages from the prosecutorial playbook, extending co-operating-witness immunity to informants and creating an SEC version of a deferred prosecution agreement.

These initiatives were meant to restore confidence in an agency blamed for failing to sound a warning on the risky practices that led to the biggest financial collapse since the Great Depression, and for its botched effort – detailed in a damning 477-page report by the SEC's own inspector general – to stop Bernard Madoff, arguably the greatest criminal fraudster of all time. The reforms were also meant to bring a measure of prosecutorial muscle and streamlined process to an enforcement division that has seemed defined in the past few years by its labyrinthine bureaucracy.

But as Khuzami reaches his one-year anniversary on the job, US Congress, investors and the industry his agency regulates are waiting to see whether structural changes and a beefed-up docket – enforcement actions are up under Khuzami – will lead to real change. Will there be more significant cases like the Galleon investigation, conducted in tandem with the US Department of Justice? Or will there be more embarrassments, such as the rebuke from Jed
Rakoff, the Manhattan district court judge who scuttled the agency's initial settlement with Bank of America?

Khuzami was hired to shake up the division. So far,
he has done just that. Those looking for him to remake the enforcement arm in the image of a US attorney's office, though, are likely to be disappointed. In interviews, he preaches reform, not revolution. "You can't just airlift a model from one organisation to another," he says. Will measured change be enough
to restore faith in the SEC?

On a cold day in January, Khuzami settles into a seat on the top floor of nearby restaurant America in Washington, DC's Union Station. From here he has a commanding view of the grand old railroad depot, but he chose the spot for a more pragmatic reason. In his first six months on the job, when he was working 18-hour days and commuting home to New York on weekends, Khuzami ate lunch at Union Station every day. This, still, is as far as he likes to range.

In interviews, Khuzami comes across as even-tempered and cerebral, subject to long, discursive answers to policy questions. He gamely replies to questions about his past, though he is rarely the hero in his own stories. Friends attribute this general lack of ego to a working-class background and education that was quite different from most of his white-shoe peers.

After high school, Khuzami worked for a year tending bar and painting houses, and then enrolled at the State University of New York at Geneseo. He transferred to the University of Rochester before his junior year, in part because his mother's secretarial job there provided a partial tuition waiver.To make ends meet, he worked the 10pm-6am shift three days a week unloading freight for a trucking company.

A star student at Rochester, he was accepted to Boston University School of Law, where he edited the American Journal of Law and Medicine. In 1984 he went to work at Cadwalader Wickersham & Taft. As a litigation associate, he made friends with partner Richard Walker, who was later SEC enforcement director from 1998 to 2001 and who is now global general counsel at Deutsche Bank.

Walker remembers Khuzami coming in to the office at 4pm on a Saturday after spending the day moving from one apartment to another to write a complicated Racketeer Influenced and Corrupt Organisations Act claim to help defend the target of a potential takeover. They remain close. Walker describes Khuzami as "simply unflappable" and "the world's cheapest man" (this after recounting a story about how Khuzami refused to replace an old Honda until his pregnant wife, Julie, demanded he do so). Khuzami and his wife have two young daughters.

Khuzami joined the Southern District's office in 1991. He quickly impressed Andrew McCarthy, a more experienced prosecutor, who second-chaired one of Khuzami's first trials. "I was a potted plant," McCarthy recalls. "I didn't have to do anything. He was already a very polished litigator."

Mary Jo White met Khuzami on her second day on the job as the new Manhattan US attorney. "I was taken with his sense of humour and maturity," she recalls. "He had a fine reputation as one of the smartest people in the office." In 1993 she assigned him to a career-changing case, the prosecution of Sheikh Omar Abdel Rahman – the Blind Sheikh – and his associates, who had plotted to blow up New York landmarks, bridges and tunnels.

As head of the securities and commodities fraud task force from 1999 to 2002, Khuzami brought a case involving a mob union pension fraud and Ponzi scheme that led to 121 arrests in one day. Andy Applebaum, who ran the general crimes unit at the same time and shared an office with Khuzami early in their careers at the US attorney's office, credits his former colleague with being able to manage up and down. "Mary Jo White is a tough person, and very demanding of her unit chiefs," Applebaum says. "He handled that well. He made her look good. He shaped the next generation of white-collar prosecutors in that office."

In 2001 Khuzami was awarded the Henry Stimson medal, named for the former Manhattan US attorney who served as secretary of war for two presidents and who oversaw the Manhattan Project to build the first atomic bomb.

Three years later, Richard Walker (pictured) hired him to head regulations and investigations at Deutsche Bank. When Timothy Mayopoulos, then the general counsel, left for Bank of America in 2004, Khuzami was named his successor. "It was a big step up for him," Walker says. "Before that, he was in his comfort zone." Walker later recommended Khuzami to SEC chairman Mary Schapiro for the enforcement job.

Khuzami joined the agency at what was, arguably, its lowest point. A month before he arrived last spring, in a moment that is enshrined on YouTube, representative Gary Ackerman, a Democrat from New York, told Khuzami's predecessor Linda Thomsen and other SEC officials testifying before his committee that they were "inept," that their value to the American people was "useless," and – the kicker – "We thought the enemy was Mr Madoff. I think the enemy is you."

Given this reality, Khuzami might have the toughest mandate of any enforcement director in agency history. He must reform the division to the satisfaction of the US Congress and investors, while also boosting morale. And he must win cases, lots of them, a point he acknowledged on his first day when he gave a speech laying out the division's priorities.

What constitutes a win, though, in the SEC lexicon, is a moving target. In the 70s and 80s the division had few tools to pursue wrongdoers, save the threat of injunction – judicial orders to stop future violations – and, when appropriate, restitution. Yet under legendary enforcement director Stanley Sporkin, enforcement officials used injunctions to force major governance changes at companies accused of violating securities laws. Publicly-traded companies took notice and voluntarily instituted some reforms that were being foisted on their competitors. It is standard practice now, for example, that audit committees be composed of independent board members.

In 1990 Congress passed a law that added considerable muscle to the division, most notably the power to ask courts to impose civil monetary penalties on violators. In the post-Enron era especially, the agency has relied on big penalties and fines as its chief means of deterrence. In the 2009 fiscal year, violators paid $345m (£230m) in penalties, a 35% increase over 2008. Almost all of this money came into the agency through settlement agreements.

Given that financial penalties are the agency's biggest cudgel, many of Khuzami's reforms are intended to make the process that leads to a settlement agreement more efficient. At the front end, Khuzami has created the Office of Market Intelligence in an attempt to better analyse and sort the hundreds of thousands of tips, complaints and referrals that the agency gets each year.

At the investigative stage, he revived an old idea to make enforcement generalists into subject-area experts, creating national units in asset management, market abuses, structured and new products, the Foreign Corrupt Practices Act and municipal securities and public pensions. He has hired several Wall Street veterans, who understand how the markets are supposed to function, to advise the lawyers in the more specialised units.

Khuzami also convinced the commission to decentralise authority so that formal orders of investigation, with their accompanying subpoena power, can be issued by senior enforcement division officers. (Previously, investigators often waited half a year or longer for approval, which had to come from the five SEC commissioners.) "You lose part of the message and you lose part of the deterrent effect if there is a long gap between conduct and accountability," Khuzami says.

Starting an investigation is easier; bringing formal charges still requires clearing several internal hurdles, much to the frustration of the enforcers. Commissioners must approve every charging decision and all elements of settlements. "What that means is that you need an enormous infrastructure to vet information and create memos so that every decision can be made by five people," says one division lawyer.

The Bank of America bonus deal seemed to fit well into Khuzami's vision for a streamlined, faster enforcement division. In late 2008, investigators started looking into allegations that Bank of America failed to notify shareholders about $5.8bn (£3.8bn) in bonuses for Merrill Lynch bankers in a proxy disclosure. Less than a year later, in August 2009, the SEC asked Judge Rakoff to approve a $33m (£22m) settlement.

Then the wheels fell off. Rakoff, perhaps empowered by outrage over the financial crisis, refused to approve it. (The settlement "does not comport with the most elementary notions of justice and morality," Rakoff said.) He wanted to know why, if the bank relied on advice from outside counsel, no individuals were charged.

On 4 February the parties offered up a new $150m (£100m) settlement for Rakoff's approval. Under this deal the bank agreed to a series of new oversight provisions, including hiring an independent auditor and outside counsel to monitor financial statements and disclosure, and a requirement that only independent directors serve on its compensation committee. (Still, the deal didn't include any enforcement actions against Bank of America executives or advisers.)

As of press time, Rakoff had yet to confirm whether he would approve the new settlement.

The settlement-as-primary-remedy model, though, does not sit well with everyone. Brian Cartwright, a former SEC general counsel now at Latham & Watkins, says that when the division is confident it is on solid legal ground, it needs to go after individuals. "The division has to be prepared to litigate more often and be tested in court, and not be afraid to lose on occasion," he says.

Khuzami says his division is taking a more proactive stance to litigation. Last summer the SEC charged Angelo Mozilo, the former head of Countrywide Financial, with securities fraud and insider trading. Earlier this year the agency charged three former top officers of New Century Financial with securities fraud for misleading investors as the company's subprime mortgage business was collapsing in 2006. In early February the agency announced a $313m (£208m) settlement with money manager State Street Bank and Trust Company, which was accused of misleading investors about their exposure to subprime mortgages.

In the course of reporting this story, The American Lawyer interviewed more than two dozen current and former SEC officials. If there is a shared conventional wisdom, it is that the enforcement division needed an outsider to shake up some of its traditions and correct bad habits, and that Khuzami has done just that. SEC veterans interviewed for this story were also generally inclined to give Khuzami more time to make his mark.

How effective are the SEC's people? That, too, is subject to debate and, as the Madoff case showed, could ultimately pose the biggest challenge to reform. At the top, New York regional director George Canellos, who joined from Milbank Tweed Hadley & McCloy, and division of enforcement deputy director Lorin Reisner, who joined from Debevoise & Plimpton, are well-credentialed lawyers with corporate securities litigation experience. Both men are also veterans of the Manhattan prosecutor's office.

Many current and former SEC lawyers interviewed for this story describe the talent level elsewhere in the division, however, as uneven. A common complaint is that agency lawyers, as compared to those who tend to work as assistant US attorneys in 'glamour' offices such as the Southern District, aren't as driven to succeed. "Lawyers at the SEC have the best-paying job in Government. Many of them want to make a career there, working 9:30am-5pm, and taking every other Friday off. They lose their edge," says one former SEC lawyer.

Enforcement lawyers acknowledge that not everyone at the agency pulls his or her weight, but attribute most of the blame to poor leadership and congressional negligence. (Congress froze the SEC's budget from 2005 through 2007 and approved only a small increase in 2008 and 2009. For 2010 the SEC got a 16% boost in funding, to $1.13bn (£706m), and President Barack Obama has proposed an 11% increase, to $1.23bn (£768m), in 2011, which would include $419m (£262m) for more than 100 new enforcement staffers.)

If Khuzami follows the lead of most of his predecessors, he will serve for four years or so and then return to private practice. In the final analysis of his tenure, few outside of Washington, DC and Wall Street will care much about how the enforcement division is organised, or how much money it won in disgorgements. The investing public, and even Congress most of the time, only pay real attention to the SEC's enforcement arm when it screws up. And if that happens, to some degree, it may be beyond Khuzami's control.

William McLucas, a partner at Wilmer Cutler Pickering Hale and Dorr, served as enforcement head for eight years, longer than anyone in its history. He, more than anyone, knows that Khuzami's success or failure isn't entirely in his own hands. McLucas says that when he was director, he drove home every evening preoccupied by one single fear. "God," he thought, "I hope someone working on one of the 2,000 cases isn't doing something incredibly stupid or missing something incredibly important today."

A version of this article first appeared in The American Lawyer, Legal Week's US sister title.