Last week was busy for SEC Enforcement Director Robert Khuzami. On Tuesday, he spoke to the AICPA, reviewing the recent achievements of the enforcement program. Wednesday he testified on Capital Hill, detailing for lawmakers positive developments about enforcement. On Friday he was back on Capital Hill defending the Commission’s settlement with Bank of America, discussed here. Little new information about the program or the Bank of America settlement emerged beyond some statistics about matters such as the number of formal orders issued discussed here.

A critical assumption to all of these proceedings is that SEC enforcement actions are firmly grounded in the merits. Commission cases are, after all, law enforcement actions designed to enforce the law. In all the discussion about the health of SEC enforcement however, this assumption is never discussed. Perhaps now it is time.

The SEC has always insisted its enforcement actions are firmly grounded in the facts, reflecting the merits. So did plaintiffs in congressional hearings about class actions. Those hearings lead to the PSLRA in 1995. Congress found the merits mattered little. Corporate defendants were paying large sums to buy peace.

In Commission enforcement actions the increasing reliance on corporate penalties in this decade challenges this assumption the assumption that the merits matter. Bank of America is a case in point. The bank has steadfastly maintained that it did nothing wrong. It paid the penalty as a business decision to avoid a confrontation with a regulator. No wiggle room in its position. No suggestion that perhaps the Commission had a point. The bank has made it clear in briefs that it gave little weight to the SEC’s previously issued Section 21(a) report which gave warning that the practice used in crafting the challenged proxies and omitting the key schedule with the bonus information was wrong. Nevertheless, the bank agreed to pay the penalty. Plain and simple, the bank paid the SEC to go away.

The Commission for its part has maintained that the shareholders were told a lie. The bank and its lawyers knew the practice it followed was improper, according to the SEC. The SEC also knew the position of the bank at the time of settlement. Yet, it tried to take the money and go away. Its rationale, according to its brief, is that the corporate penalty would inform shareholders and the marketplace about the management of the bank. Armed with that information appropriate action could be taken by shareholders in the next proxy cycle. The market place would also be cautioned not to take actions like those of the bank because of the big and costly penalty the SEC theorized.

The Commission’s rationales are dubious at best and belied by the facts. The bank made it clear the fine was paid to make the SEC go away. Stated differently, the penalty was paid to end the matter irrespective of the merits. Replay the 1995 congressional hearings. Any corporation involved in an SEC investigation, like a plaintiff facing a securities class action, confronts the potential for a costly, time-consuming and difficult process. Like the class action, the investigation can take months if not years. As in the class action, millions of pages of paper and now electronic documents may have to be produced at an enormous cost. Executives must spend time prepping for and in testimony as well as managing the inquiry. Once the matter becomes public there will be a wave of adverse publicity followed, typically by a drop in the stock price. Under these circumstances, litigating is not a real choice because it just extends a costly and difficult process. As with class actions prior to 1995, there is only one choice for most companies: try to obtain a settlement that makes business sense. Forget the merits.

Settlements structure around a standard injunction and a corporate penalty such as Bank of America make it possible and in fact facilitate a replication of the settlement model in the class actions: “buy peace.” Settlement is a business decision, not a reflection of the merits. Bank of America made this clear.

Viewed in this context, it is not difficult to understand how Wall Street’s once highly respected watch dog fell into disrepute. The heavy reliance on penalties gives corporate America the opportunity to extricate itself from any difficulty with the once feared watchdog by simply paying a fine.

To be sure scandals such as Madoff and others have contributed heavily to eroding the Commission’s reputation as an effective regulator. When however, its enforcement actions become like the nuisance suits Congress was told about in 1995, the program no doubt garners the same respect in the corporate suite as the frivolous class actions which propelled congress to pass the PSLRA.

Keying settlements to the merits in contrast rather than the payment of penalties will ground enforcement actions in the merits and help rebuild respect for the program. This means that that the SEC must return to its remedial roots, crafting settlements using its traditional remedies not just to halt a violation, but to ensure against repetition in the future. New compliance procedures, the installation of monitors and other similar remedies long effectively used by the Commission should again be employed to settle cases.

The return to using remedial procedures to resolve cases rather than fines will have a two-fold impact. First, the procedures are grounded in the conduct since they are designed to make sure that it is not repeated. Second, through these kinds of settlements, the Commission effectively stays involved with the company long after the ink on the consent decree has dried, monitoring and bringing the new ethics to the marketplace Congress intended when it wrote the securities statutes long ago. Thus, not only does the Commission not go away, but regardless of what executives claim about the situation, the company will under this kind of settlement be precluded from repeating the conduct. When the SEC crafted these kinds of settlements, the enforcement program was respected as one of the most effective in government. If the SEC is going to once again become an effective regulator and the watch dog of Wall Street, it must return to a focus on the merits.