Legislation introduced in the U.S. Senate on July 23, 2012, by Senators Jack Reed (D-Rhode Island) and Charles Grassley (R-Iowa) would substantially increase the statutory limits on civil money penalties available to the U.S. Securities and Exchange Commission (SEC) for violations of the federal securities laws. The “Stronger Enforcement of Civil Penalties Act of 2012” (S.3416) (the SEC Penalties Act) would not only increase the maximum financial penalties for securities laws violations in both civil and administrative actions brought by the SEC, but also multiply available money penalties for repeat offenders. New limits established by the legislation would, for example, result in money penalties for individuals of up to the greater of $1 million or three times the gross pecuniary gain obtained, and would add the alternative penalty amount calculation based directly on the amount of victim losses where the most serious offenses are involved. Companies would face as much as $10 million or three times the gain, or a penalty based on the amount of victim loss. For recidivists, these numbers would treble. New authority also would be created for the imposition of money penalties for violations of previous SEC injunctions or bar orders.
The SEC Penalties Act comes in response to a call by SEC Chairman Mary Shapiro for changes to the penalty provisions of the federal securities laws to enhance the effectiveness of the SEC enforcement program, which she believes is hampered by existing statutory limits. It is also seen as means to address criticism regarding the adequacy of the SEC’s actions against securities law violators in recent years. Under the Act, for the first time a money penalty based directly on investor losses will be permitted for the highest tier offenses. Recidivist penalties added to all penalty provisions of the federal securities laws are likewise entirely new.
SEC authority to obtain or impose civil money penalties
Enforcement provisions of the federal securities laws permit the SEC to seek court orders imposing civil money penalties against persons who have violated the federal securities laws, and also for the SEC itself to impose money penalties in its own administrative proceedings against regulated persons and entities and in obtaining cease-and-desist orders against persons or entities generally. The authority to seek or impose civil money penalties was added to the federal securities laws to broaden the range of remedies available to the SEC in addition to injunctions and other equitable relief. The civil penalty authority was structured so as to provide the SEC with a means to tailor enforcement remedies to the seriousness of a particular violation. Civil penalties are thus currently based on a three-tiered structure that focuses on the severity of a violation and, to a limited extent, its consequences.
Currently, in an enforcement action brought by the SEC in court, at the First Tier the amount of a penalty is determined in light of the facts or circumstances, and may not exceed the greater of: (a) $5,000 for a natural person, or $50,000 for an entity; or (2) the gross amount of pecuniary gain to the violator as a result of the violations. The Second Tier substantially increases the maximum amounts when the violation involves fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement to the greater of $50,000 for individuals and $250,000 for entities, or the amount of gross pecuniary gain. The most serious violations are subject to Third Tier maximum amounts, which currently are the greater of $100,000 for individuals or $500,000 for entities, or the gross amount of pecuniary gain. 1 At this level, the extent of victim losses, although a consideration, is not directly part of the penalty calculus.
There is presently a disparity between civil penalties available to the SEC from a court and the penalties it may impose in its own administrative proceedings. The “gross pecuniary gain” method of determining the maximum penalty is not available in administrative proceedings. And neither situation provides for calculation of the maximum money penalty based upon the extent of victim losses. Also, the current three-tiered structure for money penalties makes no provision for recidivists -- those persons who previously committed the act or omission, were previously convicted of securities fraud or were the subject of a judgment or order in any prior SEC action. As discussed below, the SEC Penalties Act specifically addresses the repeat offender issue with a new Fourth Tier penalty level, and likewise grants new authority to impose money penalties for violation of an SEC injunction or other order.
Raising the stakes
Presenting the SEC Penalties Act as part of “forceful oversight of Wall Street,” Senator Reed observed:
If they [violators] look at the bottom line and see they can break the law, get caught, pay a nominal fine, and still profit, the cycle of misconduct will continue. The law needs to change to ensure the punishment fits the crime. This bill gives the SEC more tools to demand meaningful accountability from Wall Street.
Responding to the call for more significant penalties, and for authority specifically to deal more effectively with recidivists, the SEC Penalties Act alters the existing tiered structure by boosting the current penalty levels for the First through Third Tiers across the board, and adds the element of victim loss as an available basis for calculating maximum penalty amounts for the most serious offenses. And, with an entirely new Fourth Tier penalty level, the Act would dramatically raise the stakes for repeat offenders.
For all of the money penalty provisions in the federal securities laws, the maximum amount under the SEC Penalties Act will be: (a) $10,000 for individuals and $100,000 for entities at the First Tier level; (b) $75,000 for individuals and $500,000 for entities at the Second Tier level; and (c) $1 million for individuals and $10 million for entities at the Third Tier level. As is currently the case, the Second and Third Tier levels address violations involving fraud, manipulation, or deliberate or reckless disregard of a regulatory requirement. Also as currently provided, at the Third Tier level the maximum amount will be the greater of these numbers or three times the gross amount of a violator’s pecuniary gain. However, the SEC Penalties Act adds to the mix an alternative maximum Third Tier Penalty consisting of the amount of losses incurred by victims which directly or indirectly resulted from the violation.
To deal with recidivists, the Act adds a new Fourth Tier penalty level applicable to all SEC enforcement cases or proceedings, providing across the board that the maximum amount of penalty for each violation will be three times the otherwise applicable penalty:
[i]f, within the 5-year period preceding such violation, the defendant was criminally convicted for securities fraud or became subject to a judgment or order imposing monetary, equitable, or administrative relief in any Commission action alleging fraud by that person.
The Act also includes new authority for the SEC to obtain money penalties for violations of injunctions and cease-and-desist orders obtained by the Commission, or any order that bars, suspends or places limitations on the activities or functions of a person, as, for example, officer and director bars. Under the Act, each violation of an injunction or order is deemed to be a separate offense, and in the event of a continuing failure to comply, each day of non-compliance will be a separate offense. This particular provision was urged by SEC Chairman Shapiro as a more efficient, effective and flexible remedy than the limited and cumbersome contempt remedy that is the Commission’s only recourse.
With bipartisan support and the appeal to the “forceful oversight of Wall Street” as it has been characterized by Senator Reed, the SEC Penalties Act is likely to be enacted into law with little, if any, opposition. However it may be characterized, the bottom line with this Act is simply making the penalty fit the seriousness of a violation and its impact on investors. The new Third Tier penalties in particular are designed to have a true deterrent effect on individual and corporate violators, and are likely, as SEC Chairman Shapiro has suggested, to influence the structure of SEC settlements. The Act is structurally significant as well, as it establishes uniformity among all money penalty provisions in the federal securities laws.