Chairman Cox’s New Corporate Penalty Procedures: More Transparency or More Process?

The SEC is about to shift the way it assesses corporate penalties according to a story in the Washington Post today. Under a new formula crafted by SEC Chairman Cox, enforcement staff will have to obtain authority from SEC Commissioners prior to beginning negotiations with defense counsel on corporate penalties. Under the new methodology, the staff reportedly will be given specific authority on a case by case basis for negotiating corporate penalties. That authority may include a specific range for the penalty.

The new Chairman Cox system contrasts sharply with the traditional approach. Until now the enforcement staff typically negotiated with defense counsel over whether a penalty should be imposed and, if so its amount. Once an agreement was reached it was submitted along with the balance of the proposed settlement terms to the Commissioners for approval. According to an SEC spokesman, who apparently is the source for the Washington Post article, the new process is designed to speed a resolution of these matters and add to investor protection.

The SEC has been criticized for what some have called the increasingly harsh tone of its enforcement program. Some news reports have suggested that the five Commissioners are divided over the imposition of corporate penalties, with some arguing that the imposition of fines on companies only further harms the shareholders. These criticisms lead to the issuance by the SEC of its Statement on Financial Penalties on January 4, 2006. According to this statement the SEC considers a number of factors in determining whether to impose a penalty on an organization and if so the amount. The two key factors are suppose to be the presence or absence of a benefit to the corporation and the degree to which it will recompense/harm shareholders. This statement is the first of its kind by the SEC.While the SEC’s Statement on Penalties was a welcome first step, in reality it has done little to illuminate the process by which the agency determines whether to impose a penalty or how it decides on the amount. A review of recent settlements with issuers suggests only once constant — the SEC seems to be demanding a penalty almost as a matter of course. In what is perhaps the ultimate irony the SEC, which is suppose to be a disclosure agency fostering corporate transparency, discloses virtually nothing about how it determine corporate penalties. The SEC’s releases discussing settlement typically do not discuss how any of the factors in its Statement on Financial Penalties were applied in the case. Indeed, perusing through SEC corporate consent decrees suggests that the amount of the penalty has little to do with the underlying conduct. Rather, the amounts appear to be almost random.

The new policy being instituted by SEC Chairman Cox does not appear to address the transparency issue. Likewise, it is hard to see how it will speed the process or add to investor protection. What it will do for sure is give the Commissioners more direct impute into the settlement negotiations, although the Commissions already have all the impute they want if they chose to exercise their authority since everyone knows that a settlement negotiated with the staff is not final until approved by the Commissioners. The new Chairman Cox procedure will however add another layer of red tape to an agency which is already far to slow.

What the SEC really needs to do is disclose how it applies the factors in its Statement on Financial Penalties in particular cases. If this is going to part of the new initiative by Chairman Cox, then the extra layer of red tape may be worth while. If not, then it will just be more process which will slow an already far to slow process.