No Slack at Cox's SEC

By Mike McNamee
BusinessWeek
January 5, 2006

Christopher Cox's Securities & Exchange Commission isn't turning out to be the corporate-friendly place that many in the boardroom set were hoping for -- or expecting. In the SEC chairman's first major policy move, as outlined by BusinessWeek Online in late November, the commission issued standards on Jan. 4 for fining companies that commit financial fraud (see "Corporate Fines: The SEC's Search for Rules"). With that action, Cox locked in a key legacy of his predecessor -- William H. Donaldson, who angered much of Corporate America with his stiff regulation and tough enforcement -- and rejected the conservative line that corporate penalties do more harm than good.

To issue the new standards, Cox had to win over his two felllow Republicans, Commissioners Paul Atkins and Cynthia Glassman. The GOP duo often took exactly that conservative line in dissenting from civil fines imposed by Donaldson's SEC. "There was significant sentiment to go toward Atkins and Glassman," says a top former SEC staffer.

ENRON EFFECT.

That would have meant barring corporate penalties in cases where the fraud hurt only the company's own shareholders. "Instead, they stuck with the standards that we used for the last three to five years," the ex-staffer says. "That's going to disappoint some people."

Corporate penalties have long been a contentious issue within the SEC and on K Street. For years, the SEC largely accepted the argument that a company's shareholders were the biggest victims in financial fraud and that levying a fine in an SEC civil case would merely compound stockholders' pain. Before 2003, the SEC assessed only three penalties topping $50 million, all against securities firms.

That sentiment began to shift in the wake of Enron and WorldCom. The Sarbanes-Oxley corporate reform act of 2002 bolstered the case for penalties: Instead of collecting fines in the federal Treasury, the SEC now stashes them in "Fair Funds" to pay injured shareholders. That let the SEC impose mega-penalties -- topped by $750 million levied against WorldCom -- as it struggled to clean up the corporate crime wave.

"MASTERFUL JOB."

The SEC's new guidelines come out solidly behind penalties. "The chairman did a masterful job in bringing the commission to a unified position loudly and expressly" in favor of fines, says Stephen Cutler, who directed the SEC Enforcement Div. under Donaldson and is now a partner at the law firm WilmerHale.

The SEC says it will strike a balance between current shareholders, who'll bear the brunt of any penalty, and past shareholders, whose losses will be eased by Fair Funds. "We have to ask, 'If I take money from this entity, who am I hurting?'" says a senior SEC staffer. "But we also have to ask, 'Who will we help?'"

The SEC will also look at whether a company benefited directly from its fraud. In a settlement announced alongside the new standards, the agency charged that software maker McAfee (MFE ) overstated its net revenues by $622 million from 1998 to 2000, creating an inflated stock price that fueled acquisitions and other benefits for the company. McAfee, without admitting or denying the charges, agreed to pay a $50 million penalty into the Fair Funds.

ALL ABOUT CLARITY.

Companies can reduce their chances of a fine by cooperating with investigators and by cleaning house -- including firing former management. Their chances of a penalty rise if the fraud was deliberate, involved many top managers, and was harmful to innocent investors.

Cox insists that he couldn't predict how the standards will change a corporate defendants' odds of paying a fine (see BW Online, 12/1/05, "Chris Cox's Standards for Corporate Fines"). Their key value is predictability: "A penalty ought not be a matter of what the judge had for breakfast," the SEC chief told a news conference. As SEC Enforcement Director Linda Chatman Thomsen added: "Now, when we sit down with defendants, everyone will know what the standards are."

In the end, those standards aren't likely to be tougher than the unwritten rules Donaldson's SEC followed. But investors can take some comfort in the fact that they're not significantly lighter, either.

Labels: Enron