Three recent settlements by the SEC raise questions concerning how fines are calculated and the standards for cooperation are applied:

First, on February 22, 2006, the SEC announced a settlement involving four KPMG auditors who worked on the Xerox engagements that were involved in the now settled SEC enforcement action. See SEC v. KPMP LLP, et al., Litigation Release No. 19573, available at Xerox had previously been accused of engaging in what the SEC called a $1.2 billion fraudulent earnings manipulation. Three KPMG partners involved in the audits during that period consented to the entry of permanent injunctions based on alleged violations of Securities Act Sections 17(a)(2) and (3) and various other provisions. One auditor agreed to a fine of $150,000, while two others agreed to fines of $100,000 each. A fourth consented to being censured pursuant to Rule 102(e). In a related news release the SEC stated that the fines were “record civil penalties . . . for auditors.” Enforcement Chief Linda Chatman Thomsen noted in the release that, “[t]his case represents the SEC’s willingness to litigate important accounting fraud allegations against major accounting firms . . . .” See Four Current or Former KPMG Partners Settle SEC Litigation Relating to XEROX Audits, available at

Second, about two weeks earlier, the SEC announced a settlement with AIG. This was part of a global settlement with various regulators in which AIG agreed to pay over $1.6 billion to resolve claims of improper accounting, bid rigging, and other improper practices. In the SEC settlement, the insurer consented to the entry of an antifraud and books and records injunction. In the consent decree, AIG also agreed to a series of undertakings including appointing a new CEO and CFO, creating a statement of “philosophy committed to achieving transparency . . . .” and establishing other compliance programs and a code of conduct. The company agreed to pay $700 million in disgorgement and a $100 million fine. In its release, the SEC commended AIG for “substantial cooperation” during the investigation following the service of initial regulatory subpoenas. See Litigation Release No. 19560, available at

Third, on February 8, 2006, the SEC announced a settlement with the former CFO of Gemstar-TV Guide International. Previously, the SEC had alleged that Gemstar overstated revenues by at least $248 million by using improper accounting practices. The complaint charged the former CFO with securities fraud, falsifying Gemstar’s books and records, aiding and abetting Gemstar’s reporting and record-keeping violations, and making false statements to auditors, in violation of Section 17(a) of the Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, 13b2-1, and 13b2-2 thereunder. In the settlement, the former CFO agreed to be enjoined from future violations of the federal securities laws, an officer director bar and to pay disgorgement of $600,000, pre-judgment interest of $14,866, and a penalty of $750,000. See Litigation Release No. 19558, available at

Clearly all of these settlements resolve significant enforcement actions. At the same time, what may be most interesting about them is what is not said. None of these settlements discuss the Commission’s prior guidance on fines or cooperation. To be sure, the guidance announced in January regarding fines only applies to issuers, not individuals. But there is no discussion in the Releases of how the fines were calculated. While the Release says three KPMG auditors paid the largest fines to date for auditors, there is no clue about the methodology for arriving at the amount for individuals the agency has long claimed are critical “gatekeepers” of financial information. Regardless of the amount, the penalties paid by the auditors pale in significance when compared to the $750,000 fine levied on the former Gemstar CFO. Again, however, there is no clue as to how the amount of the fine was calculated. Likewise, one can only speculate about the rewards for cooperation if the result of “substantial” cooperation by AIG is a fraud injunction, a $100 million fine and the imposition of extensive remedial procedures – all after the senior executives claimed to have been involved were fired. Collectively, the three settlements suggest that in the future it would be instructive for the SEC to articulate standards for levying fines on individuals and state how those and other standards are applied in arriving at a settlement as an aid to transparency.

Print Friendly, PDF & Email

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.

Print Friendly, PDF & Email