New SEC Guidelines on Financial Penalties

The SEC should be commended for its Release (No. 2006-4) (Release: (Chatman Thomsen Speech: ) on January 4, 2006 giving guidance on the imposition of financial penalties on corporations. This marks the first time the agency has given guidance in this area beyond its prior statements on cooperation.

While the statement represents a good beginning, it is just that – a beginning. The guideposts articulated by the SEC are intended to be “objective.” Perhaps, but they are also vague.

In the release, the SEC states two principal considerations and lists a number of other factors that may be used in evaluating the propriety and presumably amount of a fine. First is the presence or absence of a direct benefit to the corporation. Second is the degree “to which the penalty will recompense or further harm the injured shareholders.” While these two principles may be consistent with the legislative history of the 1990 Remedies Act and the SOX Fair Funds Provision as the Release argues, they do little to give guidance. For example, in many financial fraud cases it can be argued that the company received some benefit by perhaps meeting street expectations or in some other manner. At the same time ,one can frequently argue that imposing a fine will harm current shareholders because it takes away cash regardless of the amount without giving the company any benefit. It can also be argued (using the SEC’s Fair Funds argument) that any shareholder loss from the fine is minimized by paying the money to shareholders through SOX.

The other “considerations” listed in the Release are equally general. These include: the need for deterrence which presumably is always present, otherwise there would not have been a violation to start with: the extent of injury to innocent parties which again is present in many cases since, for example, buyers and sellers of the issuer’s stock are presumably injured by a financial fraud; whether the violation is pervasive at the company, which may happen in some cases but not others; the level of intent of the perpetrators which also may vary with the case; and the difficulty of detection which presumably the perpetrators thought was high or it would have made little sense to have engaged in the illegal conduct.

The two case examples cited by the SEC, its Chairman, and the current enforcement chief add some measure of guidance. McAfee, Inc. ( is a pervasive, large scale financial fraud while the other, Applix,( – found under First Quarter, # 338651) is, by comparison, a modest financial fraud case involving few executives. Citation to these cases suggests they may mark the outer parameters of the policy since McAfee was fined $50 million while no fine was imposed on Applix. Analysis of the two cases does refine the factors from the Release. For example, while it could be argued that both companies obtained some benefit from the financial fraud, the SEC says that McAfee benefited by using its inflated stock for acquisitions while Applix did not benefit, presumably because it did not engage in similar conduct. If the meaning of “benefit” to the company is a McAfee type benefit, the Release and related comments start to give definition to the standards. Similarly, the fact that Applix is not fined because imposing a meaningful fine would cause financial hardship to the company while McAfee can pay the large penalty suggests that the size (if any) and amount of the fine is in part a function of the impact the sanction might have on the operations of the company. If this is the intended message, then again the Release goes farther than would first appear in giving guidance and helps the SEC achieve its stated goal of transparency as to the imposition of a penalty. Future cases hopefully will be consistent and serve to illuminate further the general principles in the Release. At present, however, there is no doubt that the Release is a good beginning, but is only that.

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