Risk & Compliance

SEC Clarifies Policy on Fines

The commission also announced settlements with two companies, McAfee and Applix, only one of which will pay a monetary penalty.
Stephen TaubJanuary 5, 2006

The Securities and Exchange Commission has clarified what many critics have said is a capricious and controversial policy for fining companies as part of a disciplinary action or settlement. The commission also announced settlements with two companies, McAfee Inc. and Applix Inc., only one of which will pay a monetary penalty.

Previously, the issue had proved very divisive at the SEC. During the tenure of former chairman William Donaldson, Republican commissioners
Cynthia Glassman and Paul Atkins generally opposed settlements that included fines, arguing that they hurt shareholders. Not infrequently, Donaldson (also a Republican) side with the two Democratic commissioners, Roel Campos and Harvey Goldschmid. (Goldschmid’s position has since been filled by Annette Nazareth; Donaldson was succeeded by Christopher Cox.)

In general, the commission wrote in a statement, penalties should be assessed when a securities law violation improperly benefits shareholders. The SEC cautioned, however, that when “shareholders are the principal victims of the violations,” the commission “will seek penalties from the individual offenders” acting on behalf of the company.

The SEC also said it will weigh other critical factors, such as:

• The need to deter the particular type of offense.

• The extent of the injury to innocent parties.

• Whether complicity in the violation is widespread throughout the corporation.

• The level of intent on the part of the perpetrators.

• The degree of difficulty in detecting the particular type of offense.

• Presence or lack of remedial steps by the corporation.

• Extent of cooperation with the commission and other law enforcement.

In the case against McAfee Inc. (formerly known as Network Associates Inc.), the developer of computer security and antivirus tools agreed to pay a $50 million fine stemming from charges it engaged in a fraudulent scheme to overstate its revenue and earnings by hundreds of millions of dollars. McAfee also agreed to appoint an independent consultant to recommend improvements to the company’s internal accounting controls as well as its revenue recognition and reserves practices.

“This settlement takes into account both the underlying misconduct and the resulting investor harm, as well as the significant benefit that accrued to McAfee from having artificially inflated the price of its stock and using it to acquire other companies, capitalizing on the artificial value McAfee had created through its fraud,” said Linda Chatman Thomsen, director of the SEC’s Division of Enforcement, in a statement. “The company’s channel-stuffing and use of manipulative accounting artifices warrants a severe civil sanction that will act as a deterrent for other public companies and provide a source of funds that can be distributed to injured McAfee investors.”

The SEC did not fine Internet software supplier Applix, which was accused of improperly recognizing revenue and understating losses in two separate transactions. Under its settlement, the company consented to a cease-and-desist order requiring future compliance with federal securities laws and regulations, and it will retain a consultant to help review its compliance procedures.

According to The Wall Street Journal, Thomsen said Applix and its shareholders did not appear to benefit from the fraud, and that given that Applix is a smaller company than McAfee, a fine could have a disproportionate effect on shareholders.

The SEC did, however, file civil fraud charges against former Applix chief executive officer Alan C. Goldsworthy, former chief financial officer Walter T. Hilger, and current director of worldwide operations Mark E. Sullivan.

The commission, which alleged that the individuals participated in the fraudulent revenue recognition transactions, is requesting that Goldsworthy and Hilger disgorge the bonuses they consequently received. The SEC also asked the court to impose civil monetary penalties and permanently bar the individuals from acting as officers or directors of a public company.

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