Risk & Compliance

Fine Time at the SEC

Looking for the logic behind penalties imposed by the Securities and Exchange Commission.
Tim ReasonDecember 1, 2005

Records were made to be broken. But when the Securities and Exchange Commission levied an unheard-of $10 million fine against Xerox in April 2002, few could have imagined the amounts that other companies would soon be shelling out. Less than four years later, the record fine — now held by WorldCom — stands at $750 million. At least half a dozen other companies, including Royal Dutch/Shell Group, Qwest Communications International, AOL-Time Warner, and Computer Associates International, are also members of the $100 million–plus club.

SEC chairman Christopher Cox, who owes his position in part to the backlash against such fines, told The Wall Street Journal in September that he hopes the SEC can adopt a “framework” that will make penalties more predictable. But is the issue predictability, or size

Last May, the Government Accountability Office found that the SEC “followed a consistent process” when setting penalties for mutual-fund trading abuses, even though the penalties ranged from $2 million to $140 million. “I don’t think there is any unfairness in the commission’s processes,” says former SEC chairman Harvey Pitt, noting that many factors affect penalties. During his tenure, he explains, Xerox’s record fine was levied because “we felt Xerox had been uncooperative.” Still, he says, Cox should address any perception that “sanctions are somehow whimsical.”

SEC enforcement director Linda Chatman Thomsen says penalties are defined by securities law, based on the number of violations and loss or gain to investors. Critics counter that most penalties are exacted by settlements, and don’t conform to the maximums prescribed in the Securities Enforcement Remedies Act of 1990 and other laws. “Many times, the penalties imposed by the SEC are simply a byproduct of negotiation,” says ex-SEC enforcement attorney Derek M. Meisner, now with the Boston office of Kirkpatrick & Lockhart Nicholson Graham LLP. The Sarbanes-Oxley Act, which directs penalty proceeds to investors rather than to the U.S. Treasury, may also increase the SEC’s inclination to seek large fines, he says.

Developing penalty guidelines beyond those already in place for SEC staff would be difficult, admits Meisner. But Pitt notes that it is the five commissioners who “set the ultimate guidelines for prosecutorial discretion.” Commissioners have often split recently over large fines, with the two Republican commissioners worrying that they penalize shareholders already harmed by fraud. Framework or not, Cox is now the tie-breaking vote in those debates.