What happened to the kinder, gentler Securities and Exchange Commission? Less than four years ago, then-chairman Harvey Pitt wanted an agency that favored cooperation over confrontation. The SEC seemed headed in a business-friendlier direction, and critics feared that the agency would grow softer on financial fraud. In particular, they pointed to the precedent-setting case of Seaboard Corp., whose self-reporting of an accounting fraud enabled it to avoid charges and fines in October 2001—just days after the SEC opened its investigation of Enron.
As it turned out, the critics needn't have worried. In the SEC's next high-profile case after Seaboard, in April 2002, the agency slammed Xerox for financial fraud with a then-unheard-of $10 million fine, citing the company for its lack of cooperation. Since then, the SEC has come down increasingly hard on companies it deems uncooperative, specifically citing uncooperative behavior as a determining factor in huge fines for Qwest, Dynegy, Computer Associates (CA), and others (see "Who Played Ball?").
Today, few would call the SEC soft. Under Pitt's successor, William Donaldson, total fines levied by the agency have soared—from $44 million in 2001 to more than $1 billion in each of the past two years. Over the same period, the number of financial-fraud actions filed has increased 70 percent.
But the SEC's tougher stance has its critics, too. Some are troubled by the rapid escalation of fines, which the agency says is deliberate. "We have intentionally tried to make sanctions more meaningful [so] that their deterrent effect is increased," says SEC deputy director of enforcement Linda Chatman Thomsen. "It is important that the penalty portion have some sting."
Moreover, defense lawyers are concerned about what they see as a rationale for the large penalties: failure to cooperate with the SEC. "To exact a penalty for lack of cooperation by a public company is completely without statutory basis," complains Greg Bruch, a former SEC assistant director of enforcement, now with Foley & Lardner LLP in Washington, D.C.
Indeed, several of the defense lawyers interviewed by CFO—all former SEC enforcement division attorneys—charge that companies that don't follow the recommendations in the SEC's Seaboard report are automatically considered uncooperative by SEC staff. "The Seaboard factors, originally held out as a carrot, are now used more often against companies as a stick," claims attorney Russell G. Ryan, a former assistant director of enforcement at the SEC, now a partner in the Washington, D.C., office of Atlanta-based King & Spaulding LLP.
Whether Seaboard is a carrot or a stick, of course, depends largely on perspective. What is clear is that the tougher enforcement environment has made Seaboard more costly as well. While following its recommendations to the letter offers no guarantee of leniency, doing so is likely to increase a company's exposure to shareholder suits. And in an era of heightened personal liability, Seaboard can pit executives and the company against each other from the moment the first call from the SEC comes in.
Extraordinary Cases
The Seaboard recommendations include 13 factors that may earn companies credit for good behavior—and three often-overlooked caveats that note the SEC retains broad discretion, particularly in cases where great harm has been done. Seaboard was never meant to be a get-out-of-jail-free card, says Thomsen. And while the SEC's press releases clearly connect fines with uncooperative behavior, Thomsen insists the fines are prescribed by the securities laws the companies violate. Meanwhile, she says, Seaboard "absolutely" remains SEC policy. "We intend to, and do, reward extraordinary cooperation."
But extraordinary means just that. Since Seaboard, only two public companies—Homestore Inc. and Electro Scientific Industries Inc. (ESI)—have entirely avoided both penalties and charges. The SEC's explanation in both cases was nearly identical, covering the essential provisions of Seaboard cooperation. In the case of Homestore, that meant "reporting its discovery of possible misconduct to the Commission immediately upon the audit committee's learning of it, conducting a thorough and independent internal investigation, sharing the results of that investigation with the government (including not asserting any applicable privileges and protections with respect to written materials furnished to the Commission staff), terminating responsible wrongdoers, and implementing remedial actions designed to prevent the recurrence of fraudulent conduct."
Last year, a third company, Royal Ahold, avoided an SEC fine (but settled civil charges) by fully cooperating with the agency's investigation into accounting fraud at the grocery-chain giant. "We all felt good and gained confidence at the outcome of the SEC decision," says Royal Ahold CFO Hannu Ryöppönen. Thomsen insists there are many more instances of companies receiving consideration for cooperation. The Seaboard report, she notes, actually lays out a range of reduced penalties and sanctions; the "extraordinary step of taking no enforcement action," as the SEC describes it, is clearly intended to be rare.
Reader Comments» Post a comment