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SEC Publishes Guidelines For Companies On Fines

By Melissa Klein Aguilar - January 10, 2006

The Securities and Exchange Commission kicked off 2006 with a public declaration of its standards for levying fines on public companies that violate securities laws. But while the SEC said the move aims to set out objective standards that it will use in levying penalties, some experts say the guidelines may not actually offer companies much help in that regard

"The SEC release doesn't provide the kind of bright-line rules that would give companies and practitioners comfort in predicting whether penalties are likely in any given situation," says P. Blake Allen, a partner at Duane Morris. "The release doesn't really tell companies or corporate lawyers much that we didn't know before"

Spencer Barasch, a partner at Andrews Kurth and a former SEC enforcement division staffer, agrees. "I still expect there to be a good deal of inequity going forward because the factors and considerations articulated by the Commission leave individual commissioners, and the staff, a large amount of discretion in how to interpret and apply the factors in each individual case," Barasch tells Compliance Week.

The guidelines, agreed upon unanimously by its five commissioners, were issued Jan. 4, 2006, concurrent with the filing of two settled cases intended to illustrate how the SEC will apply them. "Recent cases have not produced a clear public view of when and how the Commission will use corporate penalties, and within the Commission itself a variety of views have heretofore been expressed, but not reconciled," the SEC statement notes.

Besides describing the process for determining the appropriateness of fines, the move appears to be an effort to convey a united front among the commissioners on an issue that was said to be a source of some contention during former chairman William Donaldson's tenure, which was marked by sky-high penalties against several companies, including WorldCom and Time Warner. Donaldson, a Republican, sometimes sided with former Democratic commissioners Roel Campos and Harvey Goldschmid in favoring fines, while Republican commissioners Cynthia Glassman and Paul Atkins generally opposed massive fines, arguing that they hurt shareholders.

"Our intention is that these principles will establish objective standards that will provide the maximum degree of investor protection," SEC chairman Christopher Cox said in announcing the guidelines. During a press conference, Cox noted that, "It ought not to be a matter of what the judge had for breakfast that the penalty in a case is higher or lower. There needs to be horizontal equity from case to case."

Illusory And Unworkable Test

However, Derek Meisner, a former branch chief in the SEC's enforcement division, now of counsel at Kirkpatrick & Lockhart Nicholson Graham, says, "The guidelines, although helpful in understanding the deliberative process that the SEC staff employs, may be of limited use to the defense bar because they are inherently subjective. Assessments of the levels of deterrence, cooperation and harm to shareholders are subjective decisions that will still be subject to different, but reasonable interpretations by the SEC staff and defense bar."

While some of the standards the SEC says it will apply-which experts say are essentially those articulated in the so-called Seaboard report (see box at right)-are objectively measurable, those factors "come into play at the front end, when the SEC is determining whether to bring an enforcement action," says Kramer. "If a company is already subject to an enforcement action, the SEC has already looked at those and the company has already lost on those factors."

According to Kramer, the factors that companies are left with when arguing against a penalty-did the company's shareholders improperly benefit from the purported fraud and will the shareholders be harmed by a penalty-are "in the eye of the beholder, and that's an illusory and unworkable test."

Stiff corporate penalties are a fairly recent trend at the SEC, thanks in part to Sarbanes-Oxley. While fines collected from companies previously went into the Treasury's coffers, SOX changed the rules to allow the SEC use the penalties to repay injured shareholders. Since then, the fines on companies have skyrocketed. Indeed, Cox noted that all but three of the penalties of $50 million or more obtained in Commission settlements since 1986 were obtained in the last three years.

Back To First Principals

According to the standards, the two principal considerations the SEC will take into account are the presence or absence of a direct benefit to the corporation as a result of the violation, and the degree to which the penalty will recompense or further harm the injured shareholders. The SEC will also consider several additional factors in determining whether to impose a penalty on the corporation:

• The need to deter the particular type of offense;
• The extent of the injury to innocent parties;
• Whether complicity in the violation is widespread throughout the corporation;
• The level of intent on the part of the perpetrators;
• The degree of difficulty in detecting the particular type of offense;
• The presence or lack of remedial steps by the corporation; and
• The extent of cooperation with the Commission and other law enforcement

"In practice, I don't see any shift in the size or number of penalties that the SEC will levy," says Meisner at Kirkpatrick & Lockhart Nicholson Graham. "I do see defense attorneys, perhaps in Wells submissions or settlement discussions, using the criteria to measure their client's conduct against."

Cox noted the Commissioners "haven't manufactured anything new. Instead what we did is go back to first principals."

A More Circumspect Approach

But what experts say is new is the public recognition by the SEC that in some cases, penalties against companies may harm shareholders.
"The new emphasis is to acknowledge that in cases in which the conduct has provided no benefit to the corporation and where a penalty will cause harm to innocent shareholders, the SEC is less likely to impose a penalty," says David Ruder, former SEC chairman and law professor emeritus at Northwestern University.
"The notion that the SEC will differentiate between an officer and a corporation, on the one hand, and the recognition of the impact on shareholders, on the other, is significant. The defense bar has been arguing and pushing that proposition for the last several years," says Thomas Sjoblom, chair of the Securities Litigation Group and Regulatory Enforcement Group at Chadbourne & Parke.

"I think we may see a more circumspect approach to penalizing companies," says Sjoblom. "I suspect that if violations are egregious, we might see penalties of the same dollar size. That is part of the Commission's law enforcement obligation. However, with this pronouncement, I also hope we're going to see far fewer penalties and smaller ones."
Experts say the standards serve as a reminder to companies that compliance is still paramount.

"What's woven in here is compliance," says Sjoblom. "This all goes back to the SEC's Seaboard release and the Thomson memo (see box above, right). Companies need to have a custom-fitted, fine-tuned compliance program in place."

"The message for companies is that the SEC will continue to enforce the law," says Robert Benowitz, a partner at Rick Steiner Fell & Benowitz, formerly an attorney at the SEC. " There's also a strong message to boards that audit committees have to be more proactive in the area of revenue recognition, and this is especially the case for technology-oriented companies."

"The release reiterates that post-violation remediation efforts and cooperation with the SEC will continue to be high on the SEC's list of factors weighing for or against penalties," says Duane Morris' Allen. He adds that it also indicates that "certain current best practices, such as having a compliance program, will continue to be significant to the SEC in the future when it is considering assessment of penalties."

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