Speech by SEC Commissioner:
Remarks before the ALI-ABA Broker-Dealer Regulation Conference
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
January 12, 2006
Good afternoon. Thank you for this opportunity to speak to you today. In preparing for my remarks, I reflected on my first time at an ALI-ABA Broker-Dealer Regulation Conference. I believe it was in about 1987, and I came at the invitation of Tom Russo, who no doubt thought that I needed to enhance my understanding of this important area of securities law. I am not sure what the lesson of this anecdote is for you-whether you should have the right to ask for a refund given the choice of luncheon speaker-or whether this is a terrific way to educate yourself about broker-dealer regulatory issues. Whatever is the case, for many years since that time, I have been focused on broker-dealer and market regulation issues. Since becoming a Commissioner in August, I also have had the opportunity to immerse myself in a number of other areas that are central to the SEC's mission of investor protection. One of those areas is the enforcement of our federal securities laws. Before I begin, however, I must remind you that my remarks represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or the staff.1
In recent years, we have seen an increasing number of complex financial fraud cases. Settlements with the SEC in some of these cases have involved large monetary penalties, both against individuals and against corporations. Penalties against public corporations in particular resulted in certain Commission votes in which the Commissioners were split about whether to seek a monetary penalty. Mindful of this history, and desirous of adding clarity, consistency, and predictability to the process, the new Commission, led by Chairman Christopher Cox, has been working diligently to arrive at a set of principles to govern the imposition of monetary penalties against corporate issuers.
On January 4, 2006, Chairman Cox announced a unanimous Commission statement about financial penalties against corporations.2 This statement of principles was the product of over 40 hours of meetings among the Commissioners as well as the SEC's General Counsel and the Director of the Division of Enforcement. In the course of these meetings, the Commission arrived at a series of factors that will guide our future decisions about the appropriateness of a monetary penalty against a corporate wrongdoer. We hope that these factors will assist the public and issuers who may be subject to these penalties. I would like to spend some time today discussing the history of our statutory authority for monetary penalties, which was crucial in my mind in crafting our statement. I will also discuss the factors themselves.
Although much attention has been paid to the cases in which Commissioners disagreed on penalties, in fact, in the vast majority of enforcement cases that we consider, the Commissioners unanimously agree on the course of action to take and the penalties to impose. The Commissioners have traditionally all agreed that monetary penalties are appropriate against the responsible individuals. The recent dissents have arisen primarily in a particular type of case-a financial fraud case in which the shareholders are the victims of the fraud. In such instances, differences arose as to whether a monetary penalty against the corporation was appropriate.
This fall, Chairman Cox initiated a series of discussions among the Commissioners to build a consensus about the circumstances under which seeking monetary penalties against corporate issuers may be appropriate. Let me emphasize that, from the outset, we were united in our desire to protect investors and our belief that civil monetary penalties are an important tool for deterrence of wrongdoing. We started our discussions by identifying the principles on which we agreed. To do this, we closely examined the source of our authority to impose monetary penalties-particularly, the law and its legislative history.
Monetary penalties are a relatively new tool in the SEC's enforcement arsenal. In 1990, Congress passed the Remedies Act.3 This law for the first time allowed the SEC to seek civil monetary penalties against both individuals and entities for a wide range of federal securities law violations. Prior to the Remedies Act, the SEC could obtain civil monetary penalties only in limited instances such as insider trading cases and certain Foreign Corrupt Practices Act cases. The Remedies Act also added or strengthened other enforcement remedies, including cease-and-desist orders and officer and director bars. The law's purpose was to provide the SEC with stronger and more varied tools to protect investors and maintain the integrity of the securities markets.
The SEC had urged the adoption of the Remedies Act. Former Chairman David Ruder submitted a legislative proposal for the Remedies Act to Congress in January 1989. Chairman Ruder noted that the additional sanctioning authority proposed would "enhance the Commission's enforcement capabilities and enable it to tailor enforcement remedies more precisely to particular facts."4
Chairman Ruder also submitted a memorandum from the SEC in support of the proposed legislation.5 The SEC's memorandum specifically proposed civil penalty provisions that would permit, but not mandate, penalties against issuers. Accordingly, the Commission would have the flexibility and discretion to seek or not seek penalties from an issuer, depending on the facts of the case. The Commission noted that in deciding whether to assess penalties, it could "properly take into account its concern that civil penalties assessed against corporate issuers will ultimately be paid by shareholders who were themselves victimized by the violations."6 The Commission specifically noted that penalties against issuers "should be imposed or sought only where the violation resulted in an improper benefit to shareholders," and it noted that it "would consider this factor and also the extent to which the passage of time has resulted in shareholder turnover."7 Thus, examining the contemporaneous documents demonstrated to us that even in 1989 when it proposed broad monetary penalty authority, the Commission was concerned that in exercising that authority it not penalize the victims of a fraud.
In addition to submitting its memorandum in support of the legislation, the SEC provided testimony before Congress on this bill. Then Chairman Richard Breeden testified before the Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs on February 1, 1990. His prepared statement included a nine-page discussion of the need for civil monetary penalties.8 In that statement, he noted that virtually all other federal regulatory authorities have the statutory authority to seek or impose civil monetary penalties. He observed that the Commission's experience with civil monetary penalties in the insider trading area had been positive. He cited two primary reasons to authorize civil monetary penalty authority: increased deterrence and increased flexibility to tailor a remedy to the violation.
In his oral testimony, Chairman Breeden was asked under what circumstances it was appropriate to fine a company as opposed to the individuals. He responded that traditionally the Commission proceeds against both the company and the individual. Specifically, he observed that "where an entire organization has engaged in a pattern of conduct that must have required the participation of a large number of individuals," it is not always practical to proceed against every individual.9
The Senate committee report on the Remedies Act noted that civil monetary penalties will "enhance the remedial nature of the SEC's enforcement program" and "will serve to increase deterrence and help maintain public confidence in the integrity of the markets."10 In particular, the committee report commented that monetary penalties are "necessary for the deterrence of securities law violations that otherwise would provide great financial returns to the violator."11
Following the Remedies Act, the Commission has used monetary penalties as one of its tools to deter future violations and help maintain investor confidence. Large civil monetary penalties against corporations were used only rarely throughout the 1990s. However, the financial scandals of recent years have resulted in a fundamental shift in the types and magnitudes of frauds that have been uncovered. Individuals and companies became household names, not for their business success, but for the massive schemes that they perpetrated or losses that they caused. During this time period, there has been a corresponding increase in the number of cases in which the SEC has sought large financial penalties against corporations for their wrongdoing. In 2002, the Commission obtained a $10 million civil penalty against Xerox Corporation, which at the time was the largest penalty we had ever imposed against an issuer in a financial fraud case. More recent penalties have included $150 million against Bristol-Myers in a fraudulent earnings management scheme and $120 million against Royal Dutch Shell in connection with its misstatements of oil reserves, not to mention the $750 million penalty against WorldCom. These penalties reflected a rash of large-scale corporate wrongdoing that received nationwide focus and contributed to the passage of the Sarbanes-Oxley Act in 2002.
For purposes of the Commission's recent discussions on penalties, the Remedies Act continues to provide the appropriate framework and tools with which to address these frauds. However, Section 308 of the Sarbanes-Oxley Act, the "Fair Funds" provision, has given the SEC an important additional tool with which to tailor our remedies in fraud cases. Prior to Fair Funds, any penalty money that the SEC collected went to the U.S. Treasury. Fair Funds allows the SEC for the first time to add monetary penalty amounts to any disgorgement that will be distributed to harmed investors. The availability of a Fair Fund distribution was a critical consideration in our recent discussions about the appropriateness of monetary penalties against corporations. In my view, the Fair Funds provision has the potential to substantially mitigate the concerns raised in the legislative history of the Remedies Act, and shared to this day by the Commissioners, about avoiding duplicative harm to victims of fraud. We now have the means to return monies to investors in corporate fraud cases.
All of this legislative history provided an important platform for the Commissioners to focus on the areas on which we could agree. Not surprisingly, we all agree that monetary penalties serve an important deterrence function and that they allow us to tailor a remedy more closely to the facts of each case. Thus, you will note that we made a strong statement that penalties are an essential part of an aggressive and comprehensive enforcement program. Our challenge was to provide added guidance and transparency about the factors that we consider in determining whether it is appropriate to impose a monetary penalty on a corporation and the size of any such penalty. After extensive discussions, we arrived at two principal considerations and seven additional considerations.
One principal factor is the presence or absence of a direct benefit to the corporation. The fact that a corporation itself has received a direct or material benefit from its wrongdoing weighs in support of the imposition of a penalty. A benefit can come in a variety of forms, including increased revenues or reduced expenses. The benefit need not be solely monetary or be capable of precise measurement. This factor reflects the notion that a wrongdoer should not be enriched by his wrongdoing, and in that way it is similar to the rationale for disgorgement in many of our cases. Thus, cases in which a corporation unjustly has benefited provide the greatest opportunity, and the greatest need, for deterrence. Conversely, the fact that the current shareholders are the principal victims of the wrongdoing weighs against imposing a penalty. Once again you can see that the Commission shared the concerns reflected in the legislative history. We remain mindful of the additional harm that penalties may impose on shareholder victims.
The second, and equally important, principal factor, is the degree to which the penalty will recompense or further harm the injured shareholders. Part of the SEC's mission is to protect investors as well as to avoid harming innocent parties. Imposition of penalties on a corporation may impose additional harm on shareholders. That having been said, in some cases, the penalty may be used to recompense shareholders. This ability to recover monies for injured shareholders weighs in favor of a penalty. Indeed, there is evidence that Congress was mindful of this in adopting the Fair Funds provision of the Sarbanes-Oxley Act. Representative Richard Baker stated that under this proposal, "every penny in every example of corporate thievery recovered under this new provision would go into a special fund for investors."12 Representative Michael Oxley similarly noted that the money recovered should be returned to the investors rather than to plaintiffs' counsel.13 The comments of Representatives Baker and Oxley made clear that the Fair Funds provision could be used to recompense injured parties in a way that avoided the attorneys' costs involved in private litigation. Fair Funds distribution does have associated administrative costs, however, so even with a Fair Fund, not every dollar of recovery benefits investors. As we gain more experience with the Fair Funds distribution process, I am hopeful that we will be able to more quickly identify the injured parties and provide distributions to them in a more expeditious and cost-effective manner.
In addition to these two primary considerations, we have set forth seven additional factors that will guide our decisions about whether to seek a monetary penalty from a corporate issuer. They are: the need to deter a 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; the presence or absence of remedial steps by the corporation; and the extent of cooperation by the corporation with the Commission and other law enforcement bodies. Many of these additional factors are aspects of the increased deterrence and increased flexibility that were among the reasons Congress gave for enacting the Remedies Act. Doubtless, many issuers and their attorneys will focus on cooperation and remediation by the corporation, but it is important to emphasize the obvious: that our primary goal is for corporations to avoid the wrongdoing in the first place.
In crafting the statement of principles, I was mindful of the overall regulatory climate in which we operate. Since 2000, there have been an increasing number of fraud cases brought both criminally and civilly by other enforcement entities, including the U.S. Department of Justice and state attorneys general. Our counterparts on the criminal side, particularly the Department of Justice's Corporate Fraud Task Force, have faced some of the same challenges in determining when they should prosecute a corporation that we face in determining whether to seek civil monetary penalties. In January 2003, then Deputy Attorney General Larry Thompson wrote a memo concerning the principles of federal prosecution of business organizations.14 His memo sets forth the factors that the Department of Justice will consider when determining whether to bring criminal charges against a corporation. One factor is the adequacy of other remedies including civil or regulatory enforcement actions. The Thompson memo guides prosecutors to consider, among other things, the likelihood that an effective sanction would be imposed through a civil or regulatory process. As the Thompson memo demonstrates, the SEC's actions do not occur in a vacuum but often are one piece of a larger set of government efforts to address wrongdoing. If we do not thoughtfully address these penalty issues, others may fill the void. Thus, in our penalty discussions, I was aware of and considered the reality that our actions may impact whether other authorities decide to take independent action. Our mandates, and our standards of proof, may be different from those of other authorities, but we have common deterrence goals. In fact, many of the principles that we reached in our unanimous statement overlap with the factors that guide federal prosecutors in deciding whether to charge a corporation criminally.
With all of the attention that has been paid to corporate penalties, it is important to remember that the SEC remains vigorous in its determination to use its enforcement remedies against individuals as well. Corporate penalties are not a substitute for enforcement actions against responsible individuals. Similarly, an action against responsible individuals is neither a prerequisite nor a substitute for penalizing a corporation. There may be situations in which it is not possible to identify or to prove a case against specific individuals who are responsible for the violation, even when it is very clear that there was wrongdoing by the company that benefited the company. All of our decisions about bringing enforcement proceedings and the remedies we will seek are made based on the facts and circumstances of the individual case and the individual party. Whether one individual is charged does not determine whether another individual also will be charged. Whether an individual is charged does not determine whether a corporation also will be charged. Each decision is made based on the facts appropriate to that party, independent of the facts appropriate to any other party. As in the past, going forward I expect there will be cases in which we seek monetary penalties from individuals alone, from the corporation alone, and also from both individuals and the corporation.
Our hope in setting forth these principles is that they will provide added transparency as to what we, the Commission, consider when we evaluate whether to seek monetary penalties against a public corporation. The Commissioners unanimously agree on these principles, but of course each case will be considered based on its own facts. Ultimately, each Commissioner must make an admittedly subjective determination about how these factors apply to the facts of a specific case. Reasonable people can disagree about this application, even when they agree on the framework. Different individuals may attribute different weights to each factor, depending on the facts of a particular case. The two cases that we announced in conjunction with our statement of principles on penalties represent relatively clear examples of the principles we set forth.15 I expect that we will continue to have vigorous discussions about cases, particularly those in which the factors are less clear. What is important is that we now have a common framework within which to consider and discuss the cases. I expect that our dialogue will be productive and much more focused, and we will be able to better understand our differences and potentially reach mutually agreeable solutions.
In conclusion, I hope that the Commission's statement will help reaffirm that monetary penalties against issuers remain an important remedy that we will continue to use and on which the Commissioners can agree. Investors should know that the SEC continues to protect their interests as we pursue wrongdoing. Having this clear statement will provide added transparency as well as guidance to the public and to the Commissioners ourselves as to how we will proceed in this aspect of our enforcement mandate.