In early January, the Securities and Exchange Commission's (SEC) new chairman, Christopher Cox, announced guidelines for penalizing companies that engage in accounting fraud--an issue that has angered corporate executives and divided the SEC's five commissioners over the past few years.
In his first major policy decision as chairman, Cox said the commission would impose monetary fines in cases where companies profit from a violation and punishment is necessary to deter violations by other companies. In addition, the more a company benefits from accounting fraud, the stiffer the penalties will be. But Cox said the SEC also would consider "the degree to which the penalty will recompense or further harm the injured shareholders." The SEC also said it would consider how widespread complicity in the fraud was within the company.
"The imposition of a corporate penalty is most appropriate in egregious circumstances, where the culpability and fraudulent intent of the perpetrators are manifest," the SEC stated.
Finally, it said that companies that aid the commission in its investigation and quickly take remedial steps would be more likely to avoid financial penalties.
According to agency officials, the guidance will help companies and their lawyers better understand how to stay within the bounds of the law and deter executives from breaking the rules. More than three-quarters of enforcement cases end in settlement, which has made 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." Securities experts praised the move for giving companies more clarity and transparency about regulators' point of view.
A Commission United
The guidelines, which continue the stiff regulation and tough enforcement legacy of Cox's predecessor, William H. Donaldson, were approved unanimously by the SEC's five commissioners. According to The New York Times, the unanimous agreement came after 40 hours of meetings, during which the commissioners and two staff members reviewed the legislative history of the laws that gave the SEC the right to impose financial penalties on companies.
To issue the new standards, media reports said Cox had to win over the two Republican commissioners, Paul Atkins and Cynthia Glassman. The two have argued that levying penalties against companies sometimes has negative consequences for investors, forcing businesses to pay fines that could have been used to hire more staff or develop new products. For years, the SEC largely accepted the argument that a company's shareholders were the biggest victims in financial fraud and that levying a fine in an SEC civil case would only punish stockholders. Before 2003, the SEC assessed only three penalties topping $50 million, all against securities firms.
However, Enron and WorldCom changed that viewpoint, and the Sarbanes-Oxley Act of 2002 paved the way for large penalties--such as the $750 million fine levied against WorldCom--as a deterrent to corporate crime. Instead of collecting fines in the federal Treasury, the SEC now stores them in "Fair Funds" to pay injured shareholders.
The SEC's new guidelines support penalties. The SEC says it will strike a balance between current shareholders, who will bear the brunt of any penalty, and past shareholders, whose losses will be eased by Fair Funds. "We have to ask, 'If I take money from this entity, who am I hurting?'" said a senior SEC staffer. "But we also have to ask, 'Who will we help?'"
Among the factors regulators will consider in imposing financial penalties: whether the company's fraud led to some benefit for shareholders, the deterrent effect, whether the fraud was intentional, whether the fraud involved many top managers, whether the violation harmed innocent investors, and the level of cooperation the company gives authorities. …