VideoBy SEC standards, it was an odd sort of press release.
On January 4, the Securities and Exchange Commission issued a statement regarding actions against McAfee Inc. and Applix Inc. The commission reported that the suits had been settled, and that in McAfee's case, the company would pay a civil fine of $50 million, while Applix would pay nothing.
The discussion of the settling of the two actions took exactly two sentences. The SEC devoted another 2,000 words to describing how it determined the civil fines in the two cases. "We are issuing this statement describing with particularity the framework for our penalty determinations in these two cases," the commission noted.
Actually, the statement had precious little to do with the two cases. Instead, it was the SEC's roundabout way of addressing recent concerns about the size — and calculation — of settlement fines. The penalties have certainly gotten bigger. Four years ago, the $10 million penalty assessed against Xerox was a record. These days, $10 million barely qualifies as a slap on the wrist. WorldCom now holds the dubious distinction of receiving the largest-ever SEC fine ($750 million), with Adelphia a close second at $715 million. Bank of America was fined $10 million simply for dragging its heels in supplying documents to the SEC. All told, the SEC fined companies a combined $3.1 billion in its fiscal 2005, up from $313 million in 2003, the first year it started tracking such numbers.
That 10-fold increase begs the question of exactly what the SEC is trying to accomplish by imposing hefty fines on corporate entities that do not think, operate, or commit crimes by themselves. While the fines have always been intended to scare companies (and their executives) straight, a good deal of the increase is driven by the SEC's new power to return fines to investors, thanks to the Fair Fund provision of the Sarbanes-Oxley Act. Says Lynn Turner, former SEC chief accountant and managing director of research for Glass, Lewis, & Co., a shareholder research firm: "When you see the magnitude of the fines in the WorldCom case, there's no question they're being driven in part by a desire for restitution."
Fining a corporation to help compensate shareholders is fraught with difficulties, however. Figuring out what constitutes an appropriate fine has become a confused affair, both for the fined and — apparently — for those doing the fining. In its January 4 statement, the SEC acknowledged that recent cases have not produced a clear public view of when and how the commission levies penalties. The release also noted that "within the Commission itself a variety of views have heretofore been expressed, but not reconciled."
What's more, investors are hardly leaping at the money, with only about half claiming what was due to them in the first major settlement. That, combined with the administrative and ethical hassles associated with cutting checks to past investors, meant that only $302 million of the $1.6 billion in fines that the SEC collected last year went to investors.
Cash Back
To its credit, the SEC has done an admirable job of improving its record on collecting fines. Between 1995 and 2001, it collected only 14 percent of the $3 billion in fines levied during those six years, according to a 2002 Government Accountability Office report. After hiring some 20 full- and part-time staff and implementing a new software system, however, the agency was able to recover more than 70 percent in 2004 and 2005.
But getting that money back to investors is an inherently Byzantine process. The SEC must appoint a distribution agent, subject to court approval, whose first task is to come up with a fair plan for divvying up the fine among injured investors. That plan has to be published in major newspapers so that shareholders can dispute it, if they desire, and then be approved by a judge. Next, investors that held the shares during the time of the crime have to be identified, contacted, and given a deadline for submitting their claims. Once all the claims are in, the judge must make final approvals before checks can be cut — if any money is left over.
Given all the procedural elements, most of the money that has been collected in fines over the years — $1.9 billion — is still sitting at the U.S. Treasury Department, held in various government securities. Even one of the faster cases — the global research analysts' settlement with 12 investment banks — took about 27 months from the final settlement date in October 2003 to the day the checks were sent out last month. And while the government may be able to expedite matters to some degree, the $433 million fund earmarked for investors in that case is a perfect example of how necessarily painstaking the distribution process is.
In trying to compensate shareholders of such companies as Adelphia and Inktomi, who might have been swayed by phony research reports, there was no easy formula. Distribution agent Francis McGovern, a professor at Duke University Law School, says his first challenge was deciding which losses would be eligible for the money, since not all could be attributed to faulty research. "There were analyst reports that affected people's decisions about buying those stocks, but the importance of those reports dissipates over time," says McGovern.
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