By Anne Sherry, J.D.
SEC Commissioner Caroline Crenshaw offered her thoughts on enforcement in an address to the Council of Institutional Investors. Crenshaw focused specifically on corporate penalties, taking issue with the current approach that examines whether shareholders that did not benefit from the misconduct would be harmed by a penalty. Linking penalties instead to the egregiousness of the misconduct will protect law-abiding companies and create the right incentives, the commissioner said.
Crenshaw observed that a 2006 statement from the Commission suggested the SEC should be careful not to impose penalties that unduly burden shareholders. The agency now assesses whether shareholders benefited from the misconduct or would be harmed by a corporate penalty. Calling this a "myopic approach," Crenshaw said that the penalty should be tied to the egregiousness of the misconduct rather than the benefit or impact on shareholders. "It is common sense and bedrock to our law enforcement regime that worse conduct comes with stiffer penalties," she said, adding that even the 2006 statement says that penalties must be tailored to the violation.
The official also said that whether the shareholder or corporation benefits should not be a threshold issue in imposing a penalty. It is difficult to determine precisely how shareholders benefited because the corporate benefit includes not just the assets the company acquired as a result of its wrongdoing or the inflated stock price, but also the reputational benefits and harms incurred while the market was in the dark. As just one example, Crenshaw pondered whether stock buybacks during the artificially inflated pricing harm shareholders because the company pays more to repurchase its stock, or benefit them by raising earnings per share. She also said that there is a significant benefit to investors of encouraging companies to obey the law. If companies pay less of a penalty because the total benefit is hard to quantify, they may end up profiting from their fraud.
Also, Crenshaw said, it is unclear that SEC penalties ultimately harm investors. If the penalties motivate the company to strengthen internal controls and otherwise strengthen their governance and accountability, this will lead to higher profits for shareholders. Investors rarely realize harms or gains by a single day’s events if they hold the shares for a longer period. Finally, penalizing companies only when shareholders benefitted from the violation essentially amounts to disgorging the proceeds of wrongdoing. In contrast, higher penalties can deter violations that are hard to detect and motivate shareholders to invest in companies that follow the law.
Crenshaw encourages the collection of any and all data or studies on the impact of SEC penalties on investors. The Commission should also consider the other factors identified in the 2006 statement, including the degree to which the corporation self-reported, cooperated, and remediated its violations. The SEC takes cooperation seriously, although Crenshaw cautioned that cooperation credit is not available for merely responding to staff requests or conducting an investigation led by corporate counsel. Meaningful cooperation means proactively identifying and remediating wrongdoing and holding responsible individuals accountable.
In addition to basing penalties in part on cooperation, the SEC should base penalties on the actual misconduct, the extent of the harm to victims, and the number of harmed investors, if that information is available. Penalties should also be higher for violations that are harder to detect and for wrongdoing that stems from a culture of complicity within the organization. Giving equal or greater weight to the other factors in the 2006 statement will deter misconduct, and "deterrence was a primary reason the Commission was given penalty authority in the first place," Crenshaw concluded.