SEC Clarifies Philosophy on Penalties
Thursday, January 5, 2006
Securities and Exchange Commission officials made public yesterday a new approach to penalizing companies that engage in accounting fraud, helping to clarify an issue that had vexed corporate executives and sharply divided the agency's five members.
The strategy, which proposes greater penalties for companies that benefit directly from widespread fraud, was presented by SEC Chairman Christopher Cox and enforcement chief Linda Chatman Thomsen at a news conference in Washington.
The SEC used two cases to illustrate its approach -- one resulting in a $50 million penalty and the other requiring the company only to hire an independent consultant to review the company's financial accounting policy.
The SEC slapped California software maker McAfee Inc. with a $50 million penalty for a nearly two-year fraud that pumped up revenue by $622 million.
At the same time, regulators said, they would not lodge financial penalties against Applix Inc., a Massachusetts software maker, because its conduct was confined to two discrete transactions that under-reported losses in 2001. The SEC moved against individual executives at both companies.
Agency officials said the guidance would help companies and their lawyers better understand how to stay within the bounds of the law -- and, likewise, deter executives from breaking the rules. More than three-quarters of enforcement cases end in settlement, which makes it difficult for outsiders to assess how the SEC determines sanctions.
"It ought not to be a matter of what the judge had for breakfast as to whether the penalty is higher or lower," Cox said. "There needs to be horizontal equity from case to case."
Financial penalties imposed by the SEC had reached historic levels, topped by a $750 million settlement with WorldCom Inc. and a $715 million deal with Adelphia Communications Corp. in April 2005. Before 2002, only three penalties of more than $50 million had been imposed, compared with numerous such fines in the three years since, in what Cox called "a sea change" from earlier agency practice.
Among the factors regulators will consider in imposing financial penalties: whether the company's fraud led to some benefit for shareholders, the deterrent effect, the presence of intentional fraud and the level of cooperation the company gives authorities.
Securities experts praised the move for giving companies more clarity and transparency about regulators' point of view. "It's a terrific thing that they are thinking in policy terms and coming up with a policy they can apply to all cases," said David M. Becker, a former SEC official who now works at Cleary Gottlieb Steen & Hamilton LLP in the District.
The policy statement, unanimously approved by all five commissioners, also signaled that Cox has begun to build consensus at an agency that has been rife with bickering. The panel spent more than 40 hours behind closed doors ironing out differences and developing the guidelines since Cox took over in August.
Of all the issues that had divided the commission, corporate penalties had proved among the most contentious.
Republican commissioners Paul S. Atkins and Cynthia A. Glassman have argued that levying penalties against companies sometimes had negative consequences for investors, forcing businesses to pay fines that could have been used to hire more workers or develop new products, among other things.
They opposed penalties against several companies, including Time Warner Inc. and HealthSouth Corp. But then-SEC Chairman William H. Donaldson cast his deciding vote alongside the panel's two Democrats in those cases.
Gary P. Naftalis, a New York securities lawyer, yesterday said that the agency had properly recognized that penalties are not always appropriate. "There are times when imposing a penalty is counterproductive because they hurt the very investors they are supposed to protect," said Naftalis, a former prosecutor who now works at the law firm Kramer Levin Naftalis & Frankel LLP.
Thomsen, the enforcement director, said it was impossible to evaluate whether the agency would lodge fewer or smaller fines. There will, she said, still be complex negotiations with companies and their lawyers.
"I am not sure difficult work will be made easy," she said. "I'm confident it will be better at the end of the day."