January 5, 2006
SEC Announces Principles for Imposing Penalties on Companies
SEC Chairman Christopher Cox has cobbled together a set of principles (here) regarding when the Commission will impose civil penalties on companies ("issuers") who run afoul of the federal securities laws. Like any pronouncement of guidelines that will apply in a wide variety of cases, they are vague to the point of providing little more than a direction to "do no harm" or "don't do anything stupid." That said, the Commission outlined two general considerations in deciding whether to seek a fine:
The presence or absence of a direct benefit to the corporation as a result of the violation. The fact that a corporation itself has received a direct and material benefit from the offense, for example through reduced expenses or increased revenues, weighs in support of the imposition of a corporate penalty. If the corporation is in any other way unjustly enriched, this similarly weighs in support of the imposition of a corporate penalty. Within this parameter, the strongest case for the imposition of a corporate penalty is one in which the shareholders of the corporation have received an improper benefit as a result of the violation; the weakest case is one in which the current shareholders of the corporation are the principal victims of the securities law violation.
The degree to which the penalty will recompense or further harm the injured shareholders. Because the protection of innocent investors is a principal objective of the securities laws, the imposition of a penalty on the corporation itself carries with it the risk that shareholders who are innocent of the violation will nonetheless bear the burden of the penalty. In some cases, however, the penalty itself may be used as a source of funds to recompense the injury suffered by victims of the securities law violations. The presence of an opportunity to use the penalty as a meaningful source of compensation to injured shareholders is a factor in support of its imposition. The likelihood a corporate penalty will unfairly injure investors, the corporation, or third parties weighs against its use as a sanction.
The key question for corporate lawyers is the role cooperation will play in the decision whether to impose a fine, and how much cooperation is necessary to avoid or at least limit any monetary payment. After outlining its two primary considerations, the release discusses a number of other points, such as intent and pervasiveness of the violations, until finally it reaches the concluding factor:
Extent of cooperation with Commission and other law enforcement. Effective compliance with the securities laws depends upon vigilant supervision, monitoring, and reporting of violations. When securities law violations are discovered, it is incumbent upon management to report them to the Commission and to other appropriate law enforcement authorities. The degree to which a corporation has self reported an offense, or otherwise cooperated with the investigation and remediation of the offense, is a factor that the Commission will consider in determining the propriety of a corporate penalty.
Does last mean least? Don't be misled by the order of these considerations because cooperation will be the first thing that comes to mind in the Division of Enforcement when it makes it negotiates with counsel over a settlement or makes a recommendation to the Commission. How much cooperation is enough? Remember, this is the agency that resisted defining insider trading for years, and even now its definitions in Rule 10b-5-1 and 10b-5-2 are so broad as to encompass almost any type of trading while in possession of material nonpublic information. So don't look for much more than a general description of the benefits cooperation could bring ("life is a fountain"), and decisions in particular cases will have to provide the general parameters of what is sufficient cooperation. (ph)
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