Last Friday, the Washington Post ran a story by Carrie Johnson outlining a new SEC settlement policy for cases involving a corporate penalty.  Under the proposed policy the Enforcement Division staff would have to obtain Commission approval before negotiating a settlement in a case involving a corporate financial penalty.  The staff will then be given a range for any penalty.  This blog noted that a key issue with financial penalties is the difficulty of determining how the SEC applies the principles outlined in its Statement of Financial Penalties issued in January 2006.  (see post 3/13/07) 

Following the Washington Post article, SEC Chairman Cox addressed the Mutual Fund Directors Forum and, in part, outlined the significant change in policy.  Traditionally, the staff negotiated a tentative settlement with defense counsel, which was then submitted to the Commission for approval.  Presumably the staff was aware of the views of the Commission on various issues, such as corporate penalties, and negotiated the tentative settlement in accord with its understanding.  The staff then submitted the settlement to the Commission with a memorandum detailing the rationale for the proposed terms.  The Commission could approve or disapprove the proposal.  

Chairman Cox said in his address that the reason for the change is because Commission review should provide for “a guarantee of fairness and of horizontal equity in a nationwide program.”  The Chairman also pointed out that it will strengthen the staff’s ability in negotiating a settlement because the staff will know precisely what the Commission will authorize.  All of this will also speed the settlement process, the Chairman said, because if the proposed settlement is within the authorized range, it will be approved seriatim – a procedure where the staff memo detailing the settlement is sent to the office of each Commissioner for approval rather than calendared for a hearing at a closed Commission Enforcement meeting.  

The new procedure should accomplish what the Chairman outlined – in some cases.  It will of course dictate to the staff precisely what the Commission wants, as opposed to the prior system where the staff relied on its experience and understanding.  But why this is necessary is unclear because there is no indication that the staff is out of sync with the Commissioners.  The new policy may in some cases strengthen the staff’s position because it can simply say “this is it.”  The reason the staff needs a stronger position, however, is far from clear.  Indeed, given the fact that most companies can ill afford to litigate with the SEC because of the significant adverse consequences increased leverage for the staff seems unnecessary.  Similarly, the reason the new policy will promote more uniformity than the old policy is far from clear.   

One benefit of the new policy might be that it may promote uniformity among the Commissioners.  Reportedly, there are disparate views among the Commissioners concerning corporate penalties.  Requiring the Commissioners to conclude whether and, if so, how much of a penalty should be sought prior to settlement negotiations will force a consensus – or at least a prevailing majority view – among the Commissioners before discussions with defense counsel.  In this sense the new policy should promote uniformity.  

The new procedure also raises a significant question however:  Will the SEC listen to defense counsel if it has already made a decision on whether to impose a penalty and the approximate amount as evidenced by a range?  Presumably the point of negotiating a settlement is for the staff and defense lawyers to discuss the case, exchange information, exchange views and come to a principled resolution of what many times is a complex case.  Under the new procedure, however, the staff will already have been told if a penalty is to be imposed and the approximate amount in a forum where defense counsel views and those of the proposed corporate defendant were not represented.  Yet presumably defense counsel and the defendant would contribute to the debate, which could impact the views of the staff and Commission.  

For example, under the SEC’s Statement on Financial Penalties key considerations in determining whether a penalty should be imposed are whether the company profited from the wrongful conduct and whether imposing a penalty would harm the shareholders.   Under the new procedure, the Commissioners will have resolved these issues prior to settlement negotiations.  If they have decided a penalty is not appropriate the issue is resolved.  If on the other hand they have concluded that a penalty should be imposed they will have also determined the approximate amount evidenced by the range.  The staff will then begin negotiations with defense counsel armed with its settlement directive from the Commission based on its unilateral determinations.  What happens, however, if defense counsel offers new arguments the Commissioners did not consider or perhaps an expert economist who demonstrates that the company did not benefit or received only a marginal benefit from the alleged fraud and that, in reality, the fired employees were the beneficiaries of the wrongful acts.  The now several things can happen: 

1) The staff does not listen because it is bound by the settlement range and the company settles because it can ill afford to litigate.  Here the company pays an inappropriate fine harming the shareholders.

2) The staff does not listen because it is bound by the settlement range and the company refuses to settle.  The case continues to litigation for the wrong reasons; again, needlessly harming the shareholders and wasting SEC resources. 

3) The staff goes back to the Commission and requests a revision of its authority.  This results in an extended delay in an already far to long settlement process; again, injuring the shareholders.

The only real “win” scenario for the SEC and the shareholders is if the unilateral decision by the SEC is correct and a quicker settlement is achieved.  

Under the new policy the SEC and the shareholders seem to have a one in four chance of benefiting.  This seems inconsistent with the SEC’s shareholder protection mission.  If the SEC is truly concerned about the imposition of penalties on corporations rather than gambling on new rules promoting Commissioner unity, it would seem far better for the agency to amplify its Statement on Financial Penalties and add some true transparency to the process.

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Over the years, the SEC has repeatedly stated that its mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”   In this context, the agency has repeatedly told Congress and the courts that private securities litigation is a necessary adjunct to its enforcement program.  The SEC recently repeated this theme in the opening paragraph of the government’s amicus brief filed in the  Tellabs, Inc. v. Makor Issues & Rights, Ltd. appeal before the U.S. Supreme Court.  In the brief, the government stated that “[m]meritorious private actions are an essential supplement to criminal prosecutions and civil enforcement actions brought, respectively, by DOJ and the SEC.”

Yet the argument in the Tellabs brief seems to move away from the SEC’s long held position.  There the government argues against a “reasonable inference of state of mind,” which is the pleading standard advanced by the Seventh Circuit Court of Appeals.  Rather, the government adopts the defendant’s position, advocating for a stricter “high likelihood” standard.  If the Supreme Court accepts the government’s argument, it would make it more difficult for plaintiffs to survive dispositive motions, such as a motion to dismiss.  It is curious that the SEC seems to be siding with defendants, not the investors it has long claimed are an “essential supplement” to its enforcement program.   

Likewise in January 2007, Conrad Hewitt, SEC Chief Accountant, advocated for limiting liability for accountants and recommended that the profession lobby Congress for such protections.   If adopted this position could limit the ability of plaintiffs to recover in private securities litigation.  Again, this seems to  undermine the SEC’s  long stated position.
Finally,  The Wall Street Journal, in an April 16, 2007 article by   Kara Scannel reported that the SEC “is exploring a new policy that could permit companies to resolve complaints by aggrieved shareholders through arbitration, limiting shareholders’ ability to sue in court.”  If adopted such a proposal could limit the ability of plaintiffs to recover in private securities litigation.  Again, this seems inconsistent with the long held views of the agency.
All of this raises fundamental questions about the views of the SEC.  No doubt the agency continues to reiterate its traditional positions about shareholders and private litigation.  At the same time, as the adage aptly notes, actions often speak louder than words.  In this context the question becomes:  Is the SEC shifting away from its strong alliance with shareholders?  If so, is this in response to the agency’s critics?  Or perhaps a response to claims that the U.S. markets are less competitive because of the threat of costly litigation.  Does this change reflect the often reported split among the Commissioners on various issues?  

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