SEC "monetary penalties speak very loudly," but what do they say? A critical analysis of the SEC's new enforcement approach.

• Author: Steinway, Sonia A.

The U.S. Securities and Exchange Commission (SEC) has not been shy about promoting its use of monetary punishments under new Chair Mary Jo White. (1) In September 2013, White asserted that "we must make aggressive use of our existing penalty authority, recognizing that meaningful monetary penalties--whether against companies or individuals--play a very important role in a strong enforcement program." (2) Co-Director of Enforcement Andrew Ceresney was even more blunt in an address several days later: "Monetary penalties speak very loudly and in a language any potential defendant understands.... Enforcement needs to be aggressive in our use of penalties." (3)

Although the rhetoric is new, the SEC's growing reliance on monetary penalties preceded White's appointment. (4) The amount of penalties that the SEC has assessed against securities law violators in judicial and administrative proceedings since 1990 has increased at a calculated annual growth rate of 22%, compared to only a 4% increase in total cases filed annually. (5) Since 2000, the growth has been even more striking: penalties have grown 30% year-over-year, compared to 3% growth in cases filed. The maximum fee assessed has also skyrocketed: Xerox's 2002 $10 million civil penalty was then "the largest ever levied in a Commission action against a public company for financial fraud." (6) By 2006, one commentator noted that "[t]oday, a $10 million SEC penalty would probably be considered a 'victory' for most entities settling SEC fraud charges." (7) From 2000-2013, the mean payment by corporate defendants in SEC issuer reporting and disclosure cases was $57.9 million. (8) Although that figure includes several outliers, the median payment was still $9 million. (9)

Despite the increase in the sums assessed, most of the money collected goes where it always has: to the U.S. Treasury General Fund. Compensating harmed investors was not historically an agency priority, (10) but the Sarbanes-Oxley Act of 2002 (SOX) fundamentally shifted the SEC's approach to distributing funds collected--at least nominally. Section 308 authorized the SEC to use penalty funds, in addition to disgorgements, to compensate harmed investors via Federal Account for Investor Restitution (Fair) Funds. The agency's response has been seemingly enthusiastic, with multiple proclamations about its efforts on behalf of shareholders." However, based on

an analysis of SEC data, this enthusiastic rhetoric does not reflect reality. Efforts to distribute funds to harmed investors have tapered off over time, such that the vast majority of sums collected are still deposited in Treasury's General Fund. This ensures that the SEC contributes more revenue to the government than any other independent agency. (12)

The dramatic increase in monetary sanctions with minimal changes in the location to which the money goes raises certain questions: Does the new strategy improve the SEC's efforts to police the securities markets and protect investors? What are the strategy's larger implications for corporations and their shareholders? I address these issues and argue that the net consequence of the SEC's new approach is negative. My focus is on corporate violators, both because they have incurred the steepest fines and because they implicate the unique concerns that arise when third parties (that is, shareholders) foot the bill. This Comment is organized as follows: Part I explains where the sums that the SEC collects go. Part II examines the effectiveness of fines on corporations and the implications for deterrence when shareholders pay for management misdeeds. Part III highlights additional concerns stemming from the SEC's self-interest in setting its enforcement agenda, while Part IV argues that this dynamic is particularly troubling in light of the SEC's near-total discretion, absent effective judicial scrutiny. Part V concludes.

1. WHERE DOES THE MONEY CO?

   The SEC has loudly championed its ability to collect billions of dollars from securities law violators every year, but it has not been as clear in identifying where all of this money goes. The answer to that question, which I addressed by sifting through SEC Annual Reports and the Office of Inspector General (OIG) Semi-Annual Reports, is threefold: (1) Fair Funds; (2) the new Investor Protection Fund; and (3) the Treasury General Fund. But how much is distributed to each, and who decides, are more complicated questions.

   Fair Funds are relatively new; [section] 308 of SOX (14) granted the agency authority to compensate harmed investors with Fair Funds composed of both penalty funds and disgorgements. Before 2002, the vast majority of funds collected by the SEC were directed to the General Fund. (15) Although disgorgements were available to compensate harmed investors, the SEC made limited use of the remedy. Only after SOX was passed did investor compensation become an explicit goal of the agency. (16) SOX gave the SEC total discretion to direct that funds be distributed to harmed investors; neither corporations nor their shareholders can object to the creation of such a fund. (17) Although the text of [section] 308 does not explicitly encourage the SEC to elevate investor compensation as an agency priority, and the available legislative history focuses on the use of disgorgements as a tool to penalize wrongdoers rather than to benefit their victims, the SEC nonetheless interpreted the provision as requiring a shift in agency policy. In its 2003 Annual Report, the agency listed "[w]herever practical, continue to seek to return recovered funds to defrauded investors" as one of its "main objectives" going into 2004. (18) Moreover, the agency's 2006 Statement Concerning Financial Penalties--intended to clarify the SEC's decision-making process in seeking monetary penalties--explicitly included "[t]he degree to which the penalty will recompense or further harm the injured shareholders" as one of its two principal considerations in assessing a financial penalty against a corporation. (19) Deterring future misconduct, historically the SEC's foremost priority, was demoted to an "additional" concern.

   Despite the SEC's vocal support, the creation of new Fair Funds has dropped dramatically over time. In 2004, more than twenty funds were created from corporate violators; only one such fund was created in 2010. (20) The total amount in such funds has also decreased: the average fund created in 2005- 2006 contained more than $90 million at inception, versus $24 million for funds created between 2007 and 2013. (21) Distribution takes a long time: 67 of the 93 funds created from corporate violators since 2003 are still extant. (22) Each step of the fund distribution process takes time; for example, the average delay between the initial order creating the fund and the proposed distribution plan is over two years (816 days). For those funds that have terminated, the average time between initial order and termination was over five years. (23)

   One potential reason for the SEC's disinclination to create new funds is the administrative burden of distribution. Because the SEC historically has focused on enforcement, fund distribution is not a core competency. (24) As a result, the publicity surrounding Fair Funds has often been less than positive. Critics have focused on the SEC's lack of coherence in its distribution policy, beyond "reacting to pressure to negotiate large funds." (25) The agency has also struggled in its efforts to actually distribute collected funds. Two cases in particular highlight the agency's disorganization. In one, an enforcement against seven specialists, an approximately $250 million fund was created for investor compensation. Although seven years passed between the initial order creating the fund (March 30, 2004) and the date of termination (May 26, 2011), the administrator "encountered a number of obstacles in its efforts to identify injured investors," such that $160 million remained at the end. (26) There was vigorous opposition on the part of one Commissioner, who argued in dissent that closing the fund with so much money remaining was premature. (27) Similarly, a 2003 case against ten investment banks and two individual analysts resulted in a $1.4 billion "Global Research Analyst Settlement," (28) which went from "much-heralded" to "embarrassing," in the words of Judge Pauley

   who presided over the case. (32) Most damningly, Judge Pauley noted:

   Of course, the April 2003 headlines regarding the "Global Research Analyst Settlement" had faded by September, and the SEC as well as these Defendants were indifferent to the mechanics of restitution.... In the final analysis, this Court does not question the SEC's interest in bringing to an end improper conduct. Nor does it question the SEC's interest in recompensing investor victims and deterring future violations. However, whether the SEC has the institutional resolve and commits adequate resources to reach these goals is an open question. (33) By the time that fund was closed in 2009, almost $80 million of the originally earmarked $432.5 million was remitted to the U.S. Treasury rather than to the investors for whom it was intended. (34) These administrative hassles, compounded by the resulting bad publicity, may have dampened the agency's enthusiasm for creating new funds.

   The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) also created a new destination for collections: the Investor Protection Fund. (35) Under Dodd-Frank, monetary sanctions not otherwise earmarked to disgorgements or Fair Funds (or remaining in Fair Funds upon termination) can be used for two purposes: to pay whistleblower awards (36) or to fund the SEC Office of the Inspector General's Employee Suggestion Program. (37)

   The whistleblower program is designed to incentivize individuals with "specific, credible, and timely information" to proactively contact the SEC. (38) Would-be informers have...