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U.S. Securities and Exchange Commission

Statement of the Securities and Exchange Commission Concerning Financial Penalties


Washington, D.C., Jan. 4, 2006 – The U.S. Securities and Exchange Commission today issued the following statement concerning financial penalties:

Today the Commission announced the filing of two settled actions against corporate issuers, SEC v. McAfee, Inc. and In the Matter of Applix, Inc. In one, the company will pay a civil money penalty; in the other, a penalty is not part of the settlement.

The question of whether, and if so to what extent, to impose civil penalties against a corporation raises significant questions for our mission of investor protection. The authority to impose such penalties is relatively recent in the Commission’s history, and the use of very large corporate penalties is more recent still. Recent cases have not produced a clear public view of when and how the Commission will use corporate penalties, and within the Commission itself a variety of views have heretofore been expressed, but not reconciled.

The Commission believes it important to provide the maximum possible degree of clarity, consistency, and predictability in explaining the way that its corporate penalty authority will be exercised. To this end, we are issuing this statement describing with particularity the framework for our penalty determinations in these two cases. We have issued these decisions, and this statement of principles, unanimously.

In determining whether or not to impose penalties against the corporations in these cases, we carefully considered our statutory authority, and the legislative history surrounding that statutory authority.

In 1990, Congress passed the Securities Enforcement Remedies and Penny Stock Reform Act (the “Remedies Act”), which gave the Commission authority generally to seek civil money penalties in enforcement cases.1 The penalty provisions added by the Remedies Act expressly authorize the Commission to obtain money penalties from entities, including corporate issuers. These provisions also enhanced the Commission’s authority to fine individuals. Today, we limit our discussion to penalties against corporations, although we view penalties against individual offenders as a critical component in punishing and deterring violative conduct.

The Remedies Act legislative history contains express references to penalty assessments against corporate issuers of securities. In its Report on the legislation, the Senate Committee on Banking, Housing, and Urban Affairs expressly noted both that the civil money penalty provisions would be applicable to corporate issuers, and that shareholders ultimately may bear the cost of penalties imposed on corporate issuers. According to the Report, such penalties should be assessed when the securities law violation that is the basis of the penalty has resulted in an improper benefit to the shareholders. It also cautioned that the Commission and courts should, in considering corporate issuer penalties, take into account whether the penalty would be paid by shareholders who had been the principal victims of the violation:

"The Committee believes that the civil money penalty provisions should be applicable to corporate issuers, and the legislation permits penalties against issuers. However, because the costs of such penalties may be passed on to shareholders, the Committee intends that a penalty be sought when the violation results in an improper benefit to shareholders. In cases in which shareholders are the principal victims of the violations, the Committee expects that the SEC, when appropriate, will seek penalties from the individual offenders acting for a corporate issuer. Moreover, in deciding whether and to what extent to assess a penalty against the issuer, the court may properly take into account whether civil penalties assessed against corporate issuers will ultimately be paid by shareholders who were themselves victimized by the violations. The court also may consider the extent to which the passage of time has resulted in shareholder turnover."2

As this discussion indicates, a key question for the Commission is whether the issuer’s violation has provided an improper benefit to the shareholders, or conversely whether the violation has resulted in harm to the shareholders. Where shareholders have been victimized by the violative conduct, or by the resulting negative effect on the entity following its discovery, the Commission is expected to seek penalties from culpable individual offenders acting for a corporation. This same point was made in the SEC’s memorandum in support of the Remedies Act, which the then Chairman of the SEC, David Ruder, transmitted to the Senate in a January 18, 1989 letter.3

In addition to the benefit or harm to shareholders, the statute and its legislative history suggest several other factors that may be pertinent to the analysis of corporate issuer penalties. For example, the need for effective deterrence is discussed throughout the legislative history of the Remedies Act.4 The Senate Report also notes the importance of good compliance programs and observes that the availability of penalties may encourage development of such programs.5 The Senate Report also observes that penalties may serve to decrease the temptation to violate the law in areas where the perceived risk of detection of wrongdoing is small.6 Other factors discussed in the legislative history include whether there was fraudulent intent, harm to innocent third parties, and the possibility of unjust enrichment to the wrongdoer.7

The Sarbanes-Oxley Act of 2002 changed the ultimate disposition of penalties. Section 308 of Sarbanes-Oxley (the Fair Funds provision) allows the Commission to take penalties paid by individuals and entities in enforcement actions and add them to disgorgement funds for the benefit of victims. Penalty moneys no longer always go to the Treasury. Under Fair Funds, penalty moneys instead can be used to compensate the victims for the losses they experienced from the wrongdoing. If the victims are shareholders of the corporation being penalized, they will still bear the cost of issuer penalty payments (which is the case with any penalty against a corporate entity). When penalty moneys are ultimately returned to all or some of the investors who were victims of the violation, the amounts returned are less the administrative costs of the distribution. While the legislative history of the Fair Funds provision is scant, there are two general points that can be discerned. First, the purpose of the provision is to provide an additional source of compensation to victims of securities law violations. Second, the provision applies to all penalties and makes no distinction between penalties against individuals or entities.8

We have considered the legislative histories of both the Remedies Act and the Fair Funds provisions of the Sarbanes-Oxley Act in reaching the decisions we announce today.

We proceed from the fundamental principle that corporate penalties are an essential part of an aggressive and comprehensive program to enforce the federal securities laws, and that the availability of a corporate penalty, as one of a range of remedies, contributes to the Commission’s ability to achieve an appropriate level of deterrence through its decision in a particular case.

With this principle in mind, our view of the appropriateness of a penalty on the corporation in a particular case, as distinct from the individuals who commit a securities law violation, turns principally on two considerations:

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.

In addition to these two principal considerations, there are several additional factors that are properly considered in determining whether to impose a penalty on the corporation. These are:

The need to deter the particular type of offense. The likelihood that a corporate penalty will serve as a strong deterrent to others similarly situated weighs in favor of the imposition of a corporate penalty. Conversely, the prevalence of unique circumstances that render the particular offense unlikely to be repeated in other contexts is a factor weighing against the need for a penalty on the corporation rather than on the responsible individuals.

The extent of the injury to innocent parties. The egregiousness of the harm done, the number of investors injured, and the extent of societal harm if the corporation’s infliction of such injury on innocent parties goes unpunished, are significant determinants of the propriety of a corporate penalty.

Whether complicity in the violation is widespread throughout the corporation. The more pervasive the participation in the offense by responsible persons within the corporation, the more appropriate is the use of a corporate penalty. Conversely, within this parameter, isolated conduct by only a few individuals would tend not to support the imposition of a corporate penalty. Whether the corporation has replaced those persons responsible for the violation will also be considered in weighing this factor.

The level of intent on the part of the perpetrators. Within this parameter, the imposition of a corporate penalty is most appropriate in egregious circumstances, where the culpability and fraudulent intent of the perpetrators are manifest. A corporate penalty is less likely to be imposed if the violation is not the result of deliberate, intentionally fraudulent conduct.

The degree of difficulty in detecting the particular type of offense. Because offenses that are particularly difficult to detect call for an especially high level of deterrence, this factor weighs in support of the imposition of a corporate penalty.

Presence or lack of remedial steps by the corporation. Because the aim of the securities laws is to protect investors, the prevention of future harm, as well as the punishment of past offenses, is a high priority. The Commission’s decisions in particular cases are intended to encourage the management of corporations accused of securities law violations to do everything within their power to take remedial steps, from the first moment that the violation is brought to their attention. Exemplary conduct by management in this respect weighs against the use of a corporate penalty; failure of management to take remedial steps is a factor supporting the imposition of a corporate penalty.

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.

This framework for the consideration of the propriety of corporate penalties is grounded in the Commission’s statutory authority and supported by the legislative history underlying that authority. It is the Commission’s intent that the elucidation of these principles will provide a high degree of transparency to our decisions in these and future cases, and will be of assistance to the Commission’s professional staff, to corporate issuers and their counsel, and to the public.

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1 Before the enactment of the Remedies Act, the Commission’s penalty authority was essentially limited to the ability to seek penalties in district court for insider trading violations.

2 S. Rep. No. 337, 101st Cong., 2d Sess. at 17 (1990) (“1990 Senate Report”).

3 Securities Law Enforcement: Hearings on H.R. 975 Before the Subcomm. on Telecommunications and Finance of the House Comm. on Energy and Commerce, 101st Cong., 1st Sess. 47-48 (1989) (statement of David S. Ruder, Chairman, SEC, attaching Memorandum of the SEC in Support of the Securities Law Enforcement Remedies Act of 1989).

4 See, e.g., 1990 Senate Report at 6-11; see also Section 21B(c)(5) of the Exchange Act.

5 1990 Senate Report at 10-11.

6 1990 Senate Report at 15.

7 1990 Senate Report at 14. See, e.g., Section 21B(c)(1)-(3) of the Exchange Act.

8 See House Committee on Financial Services Release, “Baker Proposes FAIR Account to Return Funds to Defrauded Investors” (July 17, 2002)(including statements of Chairman Oxley and Chairman Baker), available at http://financialservices.house.gov/news.asp.

Additional materials:
  Litigation Release 19520
  Administrative Proceeding Release No. 33-8651



Modified: 01/04/2006