SEC Sets Framework for Imposing Financial Penalties on Corporations

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January 30, 2006


On January 4, the U.S. Securities and Exchange Commission articulated the factors it says it considers when weighing financial penalties against corporations settling enforcement actions. The SEC issued the statement in conjunction with its announcement of two settled enforcement actions. In one, SEC v. McAfee, Inc., No. 06-009 PJH (N.D. Cal.), Lit. Rel. 19520 (Jan. 4, 2006), the defendant corporation agreed to a $50 million penalty. In the other, In the Matter of Applix, Inc., Sec. Act. Rel. No. 8651 (Jan. 4, 2006), the respondent corporation will not pay a penalty. In each case, the company stipulated to a finding that it had committed securities fraud.

The SEC included a lengthy defense of both its authority to impose financial penalties on corporations and the wisdom of doing so. This was an attempt to respond to recent criticism that significant financial penalties inappropriately punish current shareholders for violations caused by others.

The SEC’s statement described the two principal factors it weighs when determining whether to impose a financial penalty on a corporation:

  • The presence or absence of a direct and material benefit to the corporation as a result of the violation. The SEC said it is most likely to seek a penalty where the violation resulted in an improper benefit to the shareholders, and least likely where the shareholders were the victims.
  • The degree to which the penalty will recompense or further harm the injured shareholders. The SEC said that the opportunity to use the penalty to compensate injured shareholders weighs in favor of imposing a corporate penalty. The likelihood that the penalty would unfairly injure investors, the corporation, or third parties weighs against a corporate penalty.

The SEC outlined several additional factors it weighs in determining whether to impose a corporate penalty:

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  • The need to deter the particular type of offense. If the offense is unlikely to be repeated by other issuers, the SEC says it is less likely to impose a corporate penalty.
  • The extent of the injury to innocent parties. The SEC considers the harm to investors from the violation and the harm to society resulting from a violation going unpunished.
  • Whether complicity in the violation is widespread throughout the corporation. Pervasive conduct by individuals within the corporation tends to support a corporate penalty.
  • The perpetrators’ level of intent. Manifest fraudulent intent and culpability also make imposition of a corporate penalty more likely.
  • Whether the offense is difficult to detect. To heighten deterrence, the SEC says it imposes larger penalties where violations are difficult to detect.
  • Whether the corporation took remedial steps. The SEC encouraged management “to do everything within its power” to take immediate remedial steps upon learning of a violation.
  • Corporate cooperation with the SEC and other law enforcement officials. The SEC stated that cooperation, especially self-reporting, will be rewarded.

Companies negotiating settlements with the SEC will find that, while the SEC’s statement provides a framework for discussion, the factors discussed remain consistent with SEC practice in recent years and relatively subjective. It is also worth noting that the statement omits one consideration that the SEC will surely continue to weigh: the extent of a corporation’s ability to pay.


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