On February 6, 2009, in her first speech since becoming Chairman of the Securities and Exchange Commission, Mary Schapiro announced a significant policy change intended to restore greater power to the SEC’s Enforcement Staff to negotiate penalties against corporations. In her remarks at SEC Speaks, an event held annually by the Practicing Law Institute, Chairman Schapiro said she is ending the SEC’s twoyear “penalty pilot” program, which had required the Staff to obtain a special set of approvals from the Commission itself before negotiating settlements involving civilmonetary penalties for public companies as punishment for securities fraud. Presumably, the Staff will now revert back to its historical practice of first negotiating with a prospective corporate defendant, and then presenting a final recommendation for the Commission’s approval only after reaching agreement with the company on the proposed settlement terms.
Chairman Schapiro indicated that the new policy was in part a response to Staff complaints that the special procedures required by the pilot program had introduced significant delays into the process of bringing a corporate penalty case; discouraged the Staff from arguing for a penalty in a case that might deserve a penalty; and sometimes resulted in reductions in the size of penalties imposed. “At a time when the SEC needs to be deterring corporate wrongdoing, the penalty pilot sends the wrong message,” she said, adding that removing it will “ensure that justice is swiftly served” to firms that commit “serious acts of securities fraud.”
Chairman Schapiro also said that she has expedited the process for the Staff to obtain permission from Commissioners to launch formal investigations, which come with the power to subpoena witness testimony and the production of documents. Until recently, many formal orders of investigation had to be subject to a full review at a meeting of all five Commissioners, and had to be placed on a calendar weeks in advance. Now, Commissioners will be able to authorize formal investigations by seriatim approval, and in some cases a single Commissioner acting as “duty officer” will be able to authorize them.
While Chairman Schapiro’s announcement may augur for enhanced powers of the Staff and possibly higher corporate penalties, the two-year penalty pilot experiment posed its own set of problems for corporations targeted by the Commission, and the abandonment of that regime at the very least presents new opportunities for prospective corporate defendants to make their case to relevant decision makers at a critical stage when seeking to resolve an ongoing investigation.
Before the pilot program was implemented, the Staff typically brought recommendations to the Commission in two basic scenarios: (1) a proposed settlement to which the prospective defendant had already agreed, supported by a lengthy Staff memorandum describing the evidence and legal issues in the case and recommending that the Commission authorize the settlement; or (2) a recommendation that a non-settled enforcement action be authorized, supported by a Staff memorandum and accompanied by a “Wells” submission from the prospective defendant setting forth the reasons why the Staff ’s recommendation should be rejected or narrowed. Thus, enforcement recommendations generally reached the Commission after the corporation had a full opportunity to present its best arguments, either over the course of lengthy settlement negotiations with the Staff, or through the Wells process in which the prospective defendant had the chance to be heard and challenge the Staff ’s views of the evidence and the law with its own factual presentation and legal analysis.
In contrast, under the penalty pilot program the Staff first sought authorization from the Commissioners to negotiate a monetary penalty within a specified dollar range before entering into settlement negotiations with prospective corporate defendants over the amount of the proposed penalty. In order for the Commission to form a view as to the propriety of a penalty and the range to be authorized in each case, the Staff was required to brief the Commissioners concerning the evidence and potential charges. However, the Staff was not required to permit the prospective corporate defendant an avenue through which it could communicate its own arguments to the Commission as to why more lenient sanctions were warranted, nor was the Staff required to grant the corporation an audience to test the Staff ’s theory of the case.
The principal drawback to the corporation here is obvious – in the absence of the back-and-forth discussion that would otherwise have occurred between the Staff and defense counsel in either a settlement negotiation or aWells process, the Staff ’s view of any case would go unchallenged, and the Commissioners could potentially receive a decidedly one-sided presentation of the case. Additionally, this approach weakened the corporation’s negotiating position once settlement discussions commenced because defense counsel undertook those negotiations already aware that the Commission had authorized a monetary penalty against their client.
Having now abandoned the penalty pilot program, the Commission has freed the Staff to seek a monetary penalty through settlement negotiations with a prospective corporate defendant without prior approval from the Commissioners. This could potentially increase the incidence and magnitude of corporate penalties. Nevertheless, would be defendants will once again have the opportunity to test the Staff ’s views of the evidence and the law before the any recommendation reaches the Commission, either through settlement discussions or the Wells process. In addition, it seemed likely that the pilot penalty program did introduce added delay into the process of effecting final settlements between the SEC and corporations. The continued pendency of a regulatory investigation has its own deleterious consequences for a public company, and a corporation may therefore be better served by a streamlined process that produces a speedier resolution of the investigation.
It also remains to be seen whether the policy change will have any impact on how the Commission applies the guidelines announced in January 2006 by former Chairman Christopher Cox governing whether and to what extent the SEC should seek to impose civil money penalties on corporate issuers in enforcement proceedings. Those guidelines provide that, when deciding whether to impose a penalty on a corporation and if so, how much of a penalty, the Commission should consider two primary factors: (i) whether the company and its shareholders benefited from the fraud, and (ii) the degree to which the penalty will compensate or harm injured shareholders. Chairman Schapiro gave no indication in her recent remarks that the 2006 penalty guidelines would be modified or changed.