Originally published in Financial Services Advisory Update, Volume 3, No. 1 February 2006
A recent change by the US Securities and Exchange Commission (SEC) is receiving praise for its thoughtful approach to imposing financial penalties upon corporations. On January 4, Chairman Christopher Cox announced that the SEC had revised the process for determining when to impose a fine on a corporation as a penalty for alleged securities violations. This announcement came on the heels of its settlements with two corporations—McAfee, Inc. and Applix, Inc. Through speeches and press statements, the SEC explained the factors that led it to impose a fine upon McAfee, but not upon Applix.
Under this new framework, the SEC will primarily consider whether the alleged violation resulted in a direct benefit to the corporation, and whether a financial penalty would recompense shareholders or result in further harm to them. Along with the two principal concerns identified, the SEC will consider seven additional points: (i) the need to deter future occurrences of the particular type of offense; (ii) the extent of injury to innocent parties; (iii) the degree of the corporation’s complicity in the wrongful conduct; (iv) the level of intent on the part of the perpetrators; (v) the degree of difficulty in detecting the particular type of offense; (vi) the presence or lack of remedial steps by the corporation; and (vii) the extent to which the corporation cooperated with the SEC or other law enforcement agencies.
Linda Thomsen, head of the SEC’s Enforcement Division, explained that McAfee benefited because the inflated stock price that resulted from the alleged violations enabled it to make acquisitions it otherwise could not afford; conversely, Applix and its shareholders did not benefit from the alleged violations at Applix. Turning to the second primary issue, Thomsen noted that McAfee was a financially sound corporation capable of paying the financial penalty without undue hardship to its shareholders, whereas a penalty upon Applix large enough to distribute to shareholders would financially cripple the corporation. Unlike financial penalties imposed by other US enforcement agencies, such as the Department of Justice, the SEC distributes money collected through fines to the shareholders harmed by the wrongful conduct. Additionally, McAfee’s alleged conduct was prolonged and pervasive throughout the corporation. Applix’s alleged violations were small in number and perpetrated by an isolated group of individuals.
Although these two settlements cannot truly predict the course of action the SEC may take against other categories of SEC-regulated entities, the settlements and the SEC’s press release indicate a significant shift in its enforcement policy. Notably, the policy was unanimous among all five Commissioners. More importantly, however, is that the SEC is now focused on punishing the individuals who perpetrated and benefited from the conduct, rather than on obtaining record-breaking settlements that ultimately harm the shareholders of the corporation. The SEC press release may be found at http://www.sec.gov/news/press/2006-4.htm.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
