Be Careful What You Wish For - SEC Penalties Act And 'Southern Union'

In the fallout of the 2007-2008 financial crisis, the Securities and Exchange Commission has been attacked for the size of penalties paid by the industry in settlements with the regulator. Recently, a judge in the Eastern District of New York, Frederic Block, decried the statutory limitation of SEC penalties,1 and Professor John Coffee advocated a substantial increase in the amount of SEC penalties.2 Historically, SEC penalties are relatively recent, and for much of the 1990s posed issues for the SEC, because the potentially criminal nature of the remedy (under a since overruled Supreme Court case) gave rise to a possible double-jeopardy defense in parallel criminal proceedings. Now, with SEC penalties higher than ever—despite the public clamor for even higher penalties—a decision by the Supreme Court last term, Southern Union v. United States,3 again raises the specter for the SEC that when the SEC seeks penalties in "civil" actions, defendants might deserve the constitutional protections afforded criminal defendants.

SEC Penalties

The SEC was first able to seek penalties in cases not involving insider trading in 1990, with the enactment of the Securities Enforcement Remedies and Penny Stock Reform Act or the Remedies Act. Before that, the only monetary sanction available to the SEC in a case not involving insider trading was the equitable remedy of "disgorgement,"4 i.e., recovery of a defendant's unlawful gains. Since 1990, penalties against companies in SEC settled actions have soared, beginning with the $10 million payment by Xerox in 2002. The trend for massive penalties accelerated in the first decade of the 21st century, with a slew of broker-dealers paying more than $1 billion to settle cases alleging conflicts of interest in their research, and mutual funds and advisers paying tens, or even hundreds, of millions to settle market-timing cases.

Still, the maximum penalty amount per violation available to the SEC in federal court actions is a mere $725,000 per violation for corporate defendants, or, if higher, the amount of the defendant's gain from the unlawful conduct. In administrative proceedings (before SEC administrative law judges), the ceiling per violation is the same flat penalty, without the extra wallop of the defendant's gain. The far higher amounts in SEC settlements are presumably based on the premise that the companies committed multiple violations. However, the settled orders in these cases, available on the SEC website, shed no light on the basis for the over-sized penalties. And the findings in the orders instituting proceedings generally do not tie penalties to specific violations.

Despite the sky-high penalties in the research and market-timing cases, SEC Chairwoman Mary Schapiro has pressed for a statutory amendment to increase the maximum penalty for corporations above $725,000, explaining that "statutory limitations on our ability to pursue penalties" influence the SEC's settlements. In a letter to Senator Jack Reed (D-R.I.) last November, Schapiro expressed the need for higher penalties for "the most serious securities law violations." In addition to upping the maximum ceiling more than tenfold, to $10 million, she asked that the statutory maximum be tripled with respect to a defendant's gain, and, in addition, that the SEC be authorized to obtain a penalty based on harm caused to investors. Such losses can be "enormous," she pointed out, in the context of allegedly false financial statements.

Two circumstances may have impelled the SEC's push for a dramatic escalation in penalties. First, the SEC has had to defend its enforcement record in financial crisis cases, including, most notably, its $285 million settlement with Citigroup. Second, the SEC's enforcement...