SEC’s Crenshaw urges rethink on setting corporate fines

Mar 12, 2021
Commissioner sees need for change in emphasis from 2006 framework

SEC member Caroline Crenshaw has called for the commission to refocus how it assesses penalties imposed on companies for violations, with more attention being paid to the misconduct involved and issuer co-operation with the agency. 

Speaking at a Council of Institutional Investors conference earlier this week, Crenshaw said the commission has in the past placed too much emphasis on factors such as whether the company’s shareholders benefited from the misconduct or whether they would be harmed by the penalty.

‘This approach is fundamentally flawed,’ she told the online audience. ‘This approach, more concerningly, could allow companies to profit from fraud as it unnecessarily limits the commission’s ability to craft appropriately tailored penalties that more effectively deter misconduct. If we are going to confront the novel issues today’s markets present and deter ever-more complicated and hard-to-detect frauds, we must revisit our approach.’

Crenshaw’s comments were based on a framework the SEC spelled out in 2006 in which it said the appropriateness of a corporate penalty – as distinct from the individuals who commit a violation – is based on two main considerations:

  • ‘The presence or absence of a direct benefit to the corporation as a result of the violation’
  • ‘The degree to which the penalty will recompense or further harm the injured shareholders.’

The commission also detailed several additional factors it said should be considered in determining whether to impose a penalty on the company:

  • ‘The need to deter the particular type of offense’
  • ‘The extent of the injury to innocent parties’
  • ‘Whether complicity in the violation is widespread throughout the corporation’
  • ‘The level of intent on the part of the perpetrators’
  • ‘The degree of difficulty in detecting the particular type of offense’
  • ‘[The presence] or lack of remedial steps by the corporation’
  • ‘[The extent] of co-operation with [the] commission and other law enforcement.’

Crenshaw criticized as a ‘myopic approach’ focusing on whether a company’s shareholders benefited from misconduct or whether they will be harmed by the assessment of a penalty because the costs may be passed on to them. She argued that corporate penalties should be linked to the egregiousness of the misconduct, not just the benefit or impact on the shareholders: ‘It is common sense and bedrock to our law enforcement regime that worse conduct comes with stiffer penalties.’

Crenshaw explained that the thinking behind assessing whether a violation created an improper benefit on shareholders is based on the view that it is unfair to impose a penalty if shareholders will be harmed by doing so unless they also benefited from the violation.

But corporate-benefit calculations are incomplete, she said, because the shareholder benefit arising from a violation is not just based on the assets the company gained as a result of its violation, nor is it just based on the inflated stock price shareholders enjoyed. Rather, she added, corporate benefits include economic and intangible benefits the company enjoyed while the market was unaware of the violation.

‘How do we identify and measure the benefits conferred by a good reputation, or determine the impact of dripping bad information out through multiple disclosures over time? How do we adequately measure the impact fraud has on the market?’ Crenshaw asked.

‘Does undisclosed fraud effectively reduce a company’s capital costs? And what if there is a stock buyback during the period the share price is inflated? Does that harm shareholders because the company is spending money to repurchase its stock, or does it actually further benefit them by potentially raising earnings per share?’

Another overlooked benefit is the one all investors receive by encouraging companies to obey the law or face penalties, Crenshaw added. ‘I disagree with the notion that a corporation should pay any less of a penalty simply because the total benefit it received from its misconduct is difficult to quantify with exact precision,’ she said. ‘If that were the case, corporations might actually profit from their fraud. That is a bad outcome and not what the securities laws were intended to achieve.’

Crenshaw said it’s not clear to her that SEC penalties harm investors, and that she would be interested to see any data or studies regarding this point. If penalties are sufficiently tough that they motivate the company to remediate problems, beef up internal controls, clarify lines of responsibility and focus on accountability, it is likely to go on to generate higher profits for shareholders, she said.

The solution is to take more account of other factors included in the 2006 statement, Crenshaw suggested. For example, this means looking at the degree to which a company self-reports, co-operates with investigations and self-remediates violations.

‘Co-operation provides companies with a potential path toward reducing or, perhaps, entirely avoiding penalties because it promotes and protects investors’ long-term interests. Issuers should take note that the commission takes co-operation and self-reporting seriously,’ she said, adding that co-operation has to be meaningful by involving proactive identification and remediation of wrongdoing and holding individuals accountable.

The commission should also focus on setting penalties based on the misconduct at issue, taking into account the extent of harm to victims and, if known, the number of harmed investors, Crenshaw said: ‘Penalties should be higher for violations that cause more harm, either on their own or in the aggregate when considering their frequency. Similarly, we should also impose higher penalties on violations that are more difficult for us to detect.’

Sign up to get stories direct to your inbox
Cs logo Cs logo
Loading