TheCorporateCounsel.net

Yesterday, in remarks at Practicing Law Institute’s 58th Annual Institute on Securities Regulation, Commissioner Uyeda shared his views on the SEC’s Corporate Penalty Statement, which provides a framework for evaluating whether to impose corporate civil penalties in connection with enforcement actions, and looked back at how the statement has fared in the 20 years since it was issued. Commissioner Uyeda supports the principles behind the statement, which he says still point in the right direction (particularly that the Commission should consider the degree to which any penalty would compensate or further harm injured shareholders). But he identifies ways in which the world today differs from the world in which the statement was written, and how applying the statement may not always further the Commission’s goals or the principles for which it stood. For example:

[T]he broader use of dual-class stock corporate structures, where a founder or controlling shareholder may direct the company with a majority of the votes while owning a smaller fraction of the equity.  When such a company pays a civil penalty, the cost tends to be borne by economic ownership, not by voting power.  The public shareholders who had little or no influence on how the company was run may end up shouldering most of the civil penalties, while the controlling shareholder, who might arguably be closer to the misconduct at issue, may be impacted significantly less.  Whatever one thinks of dual-class structures, that is a reason to look first to the individuals responsible for the violations.  As corporate structures evolve, Commission staff should be thinking about which shareholders will be impacted the most by a civil penalty. Are there ways of using Fair Fund authority to recompense non-controlling shareholders in such situations?

[T]he interaction of the civil penalty with the SEC’s whistleblower program.  The whistleblower program, created in 2010, pays awards of 10 to 30 percent of monetary sanctions collected in actions over $1 million, so the issuance of a penalty and its size now have consequences beyond deterrence. While the potential for a whistleblower award does not and should not factor into whether a corporate penalty is imposed, a greater focus on individual wrongdoers, who may lack the resources to pay, could result in smaller awards, or even possibly no award if the amount falls below the $1 million threshold, for the whistleblowers who made those cases possible.  Given the public interest in encouraging reports of wrongdoing and malfeasance, are there other ways to ensure whistleblowers are meaningfully rewarded that do not depend on imposing large civil penalties borne by victimized shareholders?

He pointed to these developments to suggest that the statement should be revisited to address situations that were not originally contemplated. He also stressed the importance of holding the individuals responsible for the noncompliance personally accountable using the tools the Commission has for this purpose – including D&O bars, suspensions and clawbacks – even though pursuing individuals can be a harder path for Commission Staff.

The Commission should not be reluctant to pursue individuals and use these tools where warranted.  Individual remedies can be harder to obtain.  They take longer to investigate, they are litigated more often, and individuals with their livelihood at stake fight harder than corporations deciding whether to settle.  Individuals are also often covered by insurance, indemnification, and expense advance provisions to fund their defense.  Those are reasons to staff and support individual cases properly, not reasons to accept a corporate settlement in their place.  When the choice is between a large corporate penalty and holding the responsible officers and employees accountable, the 2006 framework and common sense point in the same direction [. . .]

A civil penalty paid out of the corporate treasury is too often borne by shareholders and rarely is it felt by the executives and other company insiders who caused it.  Personal consequences are different.  An officer who knows that misconduct could end a career in public company leadership weighs a decision differently from one who expects the company—and by extension the shareholders—to write a check to cover their misdeeds.

– Meredith Ervine