FINANCIAL TIMES: Regulators must not abandon corporate penalties: “Surveys show that investors have not forgotten the devastating losses from Enron and that they strongly support all types of penalties. Agencies worldwide increasingly use corporate penalties. For example, last autumn Callum McCarthy, Britain's chief regulator, announced the largest monetary penalty ever imposed by his agency against Royal Dutch/Shell.” (ShellNews.net) 13 April 05
By Roel Campos
Published: April 13 2005
It has become fashionable to attack the imposition of corporate monetary penalties by enforcement agencies, such as the Securities and Exchange Commission. Critics argue that the SEC should seek penalties only against individual executives and not against the corporate entity. However, that approach would hamstring the commission, preventing it from obtaining fair results for investors and defendants. The issue is not whether to penalise people or the company, but how to mete out a sanction to each in the right proportion.
If the SEC charged only individuals, causes of fraud would be left unaddressed. For example, a company may have a culture where cheating is tolerated or where internal controls are ineffective. The corporate penalty is in part to punish and shame the company and its officers for those failures and to require remedial action. Corporate penalties also provide deterrence. As a former business executive, I can assure you that no officer or director wants corporate penalties imposed under his or her watch. Penalties against individuals alone produce far smaller recoveries for victims. The sad fact is that individual fraudsters spend the money as fast as they steal it.
Recognising the enormous losses suffered by investors from corporate fraud, Congress in 2002 showed extraordinary wisdom in authorising the SEC to use penalties to help restore investor losses. Corporate penalties now add significantly to overall recoveries (which include private and criminal actions) for defrauded investors, without imposing legal costs. Last year, the SEC recovered more than $3bn (€2.3bn) that will be distributed to investors to offset some of their losses.
Surveys show that investors have not forgotten the devastating losses from Enron and that they strongly support all types of penalties. Agencies worldwide increasingly use corporate penalties. For example, last autumn Callum McCarthy, Britain's chief regulator, announced the largest monetary penalty ever imposed by his agency against Royal Dutch/Shell.
Before imposing penalties the SEC weighs many factors including: harm; presence and duration of fraud; wrongdoer's history; personal enrichment of the wrongdoer; and degree of co-operation. If a corporate penalty would jeopardise a company's financial health, the penalty may be reduced or not imposed. But executives guilty of a fraud can never bargain away charges against themselves in exchange for corporate penalties.
Critics worry that innocent shareholders ultimately bear the cost of corporate penalties, since penalties take cash away from the company. However, consider that almost all corporate penalties amount only to fractions of a cent of company earnings per share. Corporate penalties by themselves are almost never large enough to have a material impact on the share price.
When a fraud is revealed to the public, the share price often goes down, mostly because of investors' worry that company value may be substantially fictitious. However, when a settlement or judgment is announced and corporate penalties are imposed, the share price of the company often goes up. At that point, the market understands that no further fraud or misconduct affecting value has been uncovered.
Even if it is true that corporate penalties at times impose a cost on innocent shareholders, this is a situation that the American judicial system reluctantly accepts. Indeed, when a parent or spouse commits a crime and receives a jail sentence, the innocent family members will surely suffer in not having that person in the household. As a former prosecutor, who argued for prison time for guilty defendants, this fact always weighed heavily on me. I came to realise that I was supporting an accepted system of punishment and deterrence that condones penalties, even if it sometimes causes pain to innocent parties.
When I was a businessman, I did not view government as my enemy. There was more regulation than I liked, but I knew that the US had less regulation than almost any other place on earth. (That is still the case, even after the introduction of the Sarbanes-Oxley corporate reform act.) My real enemy was a competitor who might be cheating and thus obtaining more and cheaper capital to use against my business.
The investing public demands that cheats are punished and that, as far as possible, losses from frauds are restored to victims. Enforcement and sanctions help to maintain the confidence of the investing public in the integrity of the markets and produce the liquidity and low cost of capital that creates America's prosperity.
The writer, a commissioner at the Securities and Exchange Commission, writes here in a personal capacity
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