In the FCPA’s modern era of enforcement, the bulk of SEC settlement amounts consist of disgorgement and prejudgment interest (See here). Stated differently (and although there have been a few notable exceptions), civil penalties are not a major feature of most corporate SEC Foreign Corrupt Practices Act enforcement actions.
Even so, SEC civil penalties can be FCPA relevant and it is thus interesting to note that SEC Commissioner Caroline Crenshaw (appointed by President Trump and sworn into office in August 2020) recently stated that the SEC’s historical practice of placing emphasis on factors beyond the actual misconduct when imposing corporate penalties is “fundamentally flawed.”
In this recent speech before the Council of Institutional Investors , Crenshaw began by stating how an SEC decision made 15 years (see here) “has taken us off course.”
In pertinent part, Crenshaw stated:
“Over the years, Commissioners on both sides of the political aisle have agreed that a strong enforcement program incentivizes compliance with the securities laws, and that enforcement helps to promote a market that inspires investor confidence, creating a level playing field for market participants. But Commissioners have had different views about when corporate penalties further those goals. It is clear to me that the Commission has historically placed too much emphasis on factors beyond the actual misconduct when imposing corporate penalties – including whether the corporation’s shareholders benefited from the misconduct, or whether they will be harmed by the assessment of a penalty. This approach is fundamentally flawed. This approach, more concerningly, could allow companies to profit from fraud as it unnecessarily limits the Commission’s ability to craft appropriately tailored penalties that more effectively deter misconduct. If we are going to confront the novel issues today’s markets present and deter ever more complicated and hard to detect frauds, we must revisit our approach.
This is a subject that I imagine matters to you as investors and market participants, because, unless there is a financial incentive to follow the rules, we know there is a temptation to break them. We know there is a temptation to spend money on operations at the expense of investing in compliance. To help deal with those misaligned incentives, the Commission was given civil penalty authority, allowing it to tailor remedies to misconduct and effectively deter malfeasance to promote a fair market. Fairness yields better results for everyone.
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I have been, and will continue to be, focused on vigorous enforcement of our existing laws and regulations. As I’ll explain further, enforcement best advances our agency’s goals when it concentrates the costs of harm with the person or entity who committed the violation. For these reasons, ensuring that the violator pays the price is key to a successful enforcement regime and to promoting fair and efficient markets more broadly.
This “price” that I mention—the amount corporations have to pay when they violate the securities laws, has been a topic that the Commission and many commissioners have addressed over the years. In 2006, a unanimous, five-member Commission issued a statement discussing a multitude of factors that the Commission will consider when deciding whether to assess a penalty against a corporation. In addition to stating that “corporate penalties are an essential part of an aggressive and comprehensive” enforcement program and contribute to the Commission’s ability to deter misconduct, the 2006 statement suggested that the Commission should be careful not to impose penalties that unduly burden shareholders. Since then, when assessing penalties, the Commission has looked at whether a corporation’s shareholders benefited from misconduct, or whether they will be harmed by the assessment of a penalty because the costs may be passed on to shareholders. This myopic approach is flawed and the reason why we need to make a change.
First, corporate penalties should be tied to the egregiousness of the actual misconduct – not just the benefit or impact on the shareholders. It is common sense and bedrock to our law enforcement regime that worse conduct comes with stiffer penalties. I agree with former Commissioner Luis Aguilar’s observation that focusing on how and whether the penalty will impact the wrongdoer and its shareholders takes the focus off the actual misconduct at issue. Even the unanimous 2006 statement acknowledged that corporate penalties must be tailored to the violation.
Second, the Commission should not treat the presence or absence of a shareholder or corporate benefit as a threshold issue to imposing a penalty. Let me explain. The rationale behind looking to whether a violation conferred an improper benefit on shareholders stems from the view that it is unfair to impose a penalty if shareholders will be harmed by that penalty, unless the shareholders also benefited from the violation. While this rationale was the subject of many speeches following the release of the 2006 statement, time has revealed its limitations. Corporate benefit calculations are quite simply incomplete. This is because the shareholder benefit stemming from a violation is not limited to the assets the company acquired as a result of its violation, nor is it just the inflated stock price shareholders enjoyed. Corporate benefits include economic and intangible benefits that the company obtained when the market was in the dark about the full extent of the violation. How do we identify and measure the benefits conferred by a good reputation, or determine the impact of dripping bad information out through multiple disclosures over time? How do we adequately measure the impact fraud has on the market? Does undisclosed fraud effectively reduce a company’s capital costs? And what if there is a stock buyback during the period the share price is inflated? Does that harm shareholders because the company is spending money to repurchase its stock, or does it actually further benefit them by potentially raising earnings per share (EPS)? And one significant benefit we seem to have overlooked is the benefit all investors receive by encouraging companies to obey the law or face penalties. If we are going to consider the benefit to shareholders, we need to consider all of the benefits. I disagree with the notion that a corporation should pay any less of a penalty simply because the total benefit it received from its misconduct is difficult to quantify with exact precision. If that were the case, corporations might actually profit from their fraud. That is a bad outcome and not what the securities laws were intended to achieve.
I want to say one additional thing about the shareholder harm concern. It is not clear to me that SEC penalties actually harm investors. I am interested in seeing any and all data or studies on this point. If the penalties are sufficiently high to motivate the company to remediate problems, strengthen internal controls, clarify lines of responsibility, and prioritize individual accountability, those are all changes that likely lead to better future outcomes, and higher profits for shareholders. Moreover, rarely do investors realize harms or gains by things that happen on a particular day, especially if they hold the shares for a period that exceeds the duration of the event’s impact. Finally, if we limit penalties to instances where shareholders benefited from the violation, then we’re doing no more than disgorging the proceeds of corporate wrongdoing. Penalties are intended to incentivize compliance, and higher penalties can be effective in deterring violations that are particularly hard to detect. There becomes less of an incentive for shareholders to invest in companies that choose to follow the law if there are no repercussions for investing in those that do not. And for policy reasons, I think such an approach is likely to jeopardize the integrity of our capital markets in the long-term. Simply put, a single-minded focus on having companies pay a calculated corporate benefit will not appropriately deter fraud or ensure fair and efficient markets. If our penalties were limited in such a way, the price of getting caught might not be high enough to deter misconduct.
So what should we do? In addition to gathering additional data that can better inform how we assess corporate penalties, we need to consider the impact of the other factors identified in the 2006 statement on penalties. This, includes the degree to which a corporation self-reported its conduct, cooperated with law enforcement investigations, and then self-remediated violations. Cooperation provides companies with a potential path toward reducing or, perhaps, entirely avoiding penalties because it promotes and protects investors’ long-term interests. Issuers should take note that the Commission takes cooperation and self-reporting seriously.
I want to make clear, however, that cooperation credit is not afforded to companies that merely respond to Enforcement Division requests, or to those that offer to conduct a not-so-independent investigation led by corporate counsel. Meaningful cooperation requires a commitment to proactively identifying and remediating wrongdoing, as well as holding accountable those individuals responsible for misconduct. It’s about substantially shortening the staff’s investigation and working with the staff toward an efficient resolution.
Additionally, because corporate benefits and shareholder harm are rather amorphous concepts, moving forward the Commission should focus on setting penalties that are based on the actual misconduct and reflect the extent of cooperation with the Division of Enforcement staff. We should consider the extent of harm to victims and, if we know it, the number of harmed investors. Penalties should be higher for violations that cause more harm, either on their own or in the aggregate when considering their frequency. Similarly, we should also impose higher penalties on violations that are more difficult for us to detect. There is a greater need to deter conduct that requires more Commission resources to uncover, investigate and address. The pervasiveness or complicity within the organization is another relevant consideration. Corporate culture comes from the top, and there is a strong need to incentivize companies to foster a culture of compliance – not misconduct. If companies believe they can profit from violations and are unlikely to be caught, they are more likely to break the rules. We can help solve this by giving at least equal, if not even greater weight to the other factors mentioned in the 2006 statement. That is how we will be most effective in deterring harmful misconduct – and we should remember that deterrence was a primary reason the Commission was given penalty authority in the first place.”
Crenshaw ended her speech by stating:
“The SEC has a three part mission, and protecting a company’s shareholders is part of that, but not at the expense of the larger market, particularly when there are other companies – and shareholders – who have committed to and invested in compliance. So in setting penalties, we can’t look only at the impact the penalty will have on a particular group of investors who own shares in the specific violating entity. As the Commission noted 15 years ago, we must examine the impact more broadly. We must think about the impact on all investors, and that will help ensure fair and efficient markets. Every enforcement decision we make effects multiple constituencies in myriad ways. Therefore, we must consider those impacts and seek the right balance. We must correct this course.”
