SEC will punish companies, not shareholders: the more a company benefits from accounting fraud, the bigger the financial penalty will be.

In early January, the Securities and Exchange Commission's (SEC) new chairman, Christopher Cox, announced guidelines for penalizing companies that engage in accounting fraud--an issue that has angered corporate executives and divided the SEC's five commissioners over the past few years.

In his first major policy decision as chairman, Cox said the commission would impose monetary fines in cases where companies profit from a violation and punishment is necessary to deter violations by other companies. In addition, the more a company benefits from accounting fraud, the stiffer the penalties will be. But Cox said the SEC also would consider "the degree to which the penalty will recompense or further harm the injured shareholders." The SEC also said it would consider how widespread complicity in the fraud was within the company.

"The imposition of a corporate penalty is most appropriate in egregious circumstances, where the culpability and fraudulent intent of the perpetrators are manifest," the SEC stated.

Finally, it said that companies that aid the commission in its investigation and quickly take remedial steps would be more likely to avoid financial penalties.

According to agency officials, the guidance will help companies and their lawyers better understand how to stay within the bounds of the law and deter executives from breaking the rules. More than three-quarters of enforcement cases end in settlement, which has made it difficult for outsiders to assess how the SEC determines sanctions.

"It ought not to be a matter of what the judge had for breakfast as to whether the penalty is higher or lower," Cox said. "There needs to be horizontal equity from case to case." Securities experts praised the move for giving companies more clarity and transparency about regulators' point of view.

A Commission United

The guidelines, which continue the stiff regulation and tough enforcement legacy of Cox's predecessor, William H. Donaldson, were approved unanimously by the SEC's five commissioners. According to The New York Times, the unanimous agreement came after 40 hours of meetings, during which the commissioners and two staff members reviewed the legislative history of the laws that gave the SEC the right to impose financial penalties on companies.

To issue the new standards, media reports said Cox had to win over the two Republican commissioners, Paul Atkins and Cynthia Glassman. The two have argued that levying penalties against companies sometimes has negative consequences for investors, forcing businesses to pay fines that could have been used to hire more staff or develop new products. For years, the SEC largely accepted the argument that a company's shareholders were the biggest victims in financial fraud and that levying a fine in an SEC civil case would only punish stockholders. Before 2003, the SEC assessed only three penalties topping $50 million, all against securities firms.

However, Enron and WorldCom changed that viewpoint, and the Sarbanes-Oxley Act of 2002 paved the way for large penalties--such as the $750 million fine levied against WorldCom--as a deterrent to corporate crime. Instead of collecting fines in the federal Treasury, the SEC now stores them in "Fair Funds" to pay injured shareholders.

The SEC's new guidelines support penalties. The SEC says it will strike a balance between current shareholders, who will bear the brunt of any penalty, and past shareholders, whose losses will be eased by Fair Funds. "We have to ask, 'If I take money from this entity, who am I hurting?'" said a senior SEC staffer. "But we also have to ask, 'Who will we help?'"

Among the factors regulators will consider in imposing financial penalties: whether the company's fraud led to some benefit for shareholders, the deterrent effect, whether the fraud was intentional, whether the fraud involved many top managers, whether the violation harmed innocent investors, and the level of cooperation the company gives authorities. Regulators said companies can reduce their chances of a fine by cooperating with investigators and by cleaning house, including firing management.

Different Offenses, Different Response

At the same time it introduced its new guidelines, the SEC also charged two technology companies with accounting fraud and announced different penalties, illustrating the regulators' new philosophy about when fines should be imposed.

The commission said software company McAfee Inc. had engaged in fraudulent accounting that enabled it to make acquisitions using overpriced shares. McAfee is charged with overstating its revenue and profit by more than $600 million from 1998 to 2000, largely through channel-stuffing in which distributors were persuaded to order products they did not need or want. The SEC slapped it with a $50 million fine and said it was strong enough to survive the large penalty, which would be distributed to shareholders. Regulators called the company's actions "pervasive" and said they occurred over a significant time period. The company, without admitting or denying the allegations, accepted a court injunction barring it from future violations of securities laws. Its former chief financial officer and former controller are awaiting trial on criminal charges.

Applix Inc., also charged with accounting fraud, settled without paying penalties or fines. The SEC said the smaller software company did not benefit as much from an accounting fraud and that shareholders would be harmed by any penalty. Applix accepted a lesser punishment than McAfee--a cease-and-desist order from the SEC requiring it to hire an independent consultant to oversee its financial policies. The commission noted that the conduct was limited and the company's board had acted quickly when it learned of improper accounting in 2002. However, former executives still face SEC action, according to the Times.

While big penalties make headlines, they are rare. Until April 2002, the SEC had not fined a public company more than $10 million, according to Bloomberg News. Penalties since then, however, include a record $750 million fine paid by WorldCom, $250 million from Qwest Communications International, and $150 million from Bristol-Myers Squibb Co. In 2005 alone, the SEC imposed more than 15 penalties of $10 million or more, including a $300 million penalty against Time Warner Inc.

Still, as of November 2005, the SEC said it had only fined 25 companies during the past 3 years--out of 2,000 cases against public companies.

Making CEO Pay, Perks Public

The Securities and Exchange Commission (SEC) wants companies to reveal more about the pay and perks they give their top executives.

The SEC proposed rules in mid-January that, if adopted, would require companies to more fully and clearly disclose what they are paying top executives. The disclosure rules aim to expose so-called stealth forms of pay such as deferred compensation, retirement benefits, severance deals, tax payments, and perquisites. The rules would affect how information is presented in annual reports, proxy statements, and registration statements.

For the first time, companies would be required to include tables in annual filings showing the total yearly compensation for their chairman, chief financial officer (CFO), and the next three highest-paid executives, according to the Associated Press. The actual effects on the bottom line of their pay packages, including stock options, also would have to be spelled out. Currently, companies disclose pay in tables and text published in the proxy statement, a document made available to investors before the annual company meeting.

"This information is information that shareholders have a right to know," said Commissioner Cynthia Glassman.

The SEC rules--which would represent the first major changes in pay disclosure since 1992--would also require:

* Detailed compensation information for the chief executive officer (CEO), CFO, the three other highest-paid executives, and the directors

* Disclosure of total executive perks--such as country club memberships--that add up to at least $10,000 (The current level is $50,000 or 10 percent of an executive's salary and bonus.)

* New disclosure tables for executives' retirement benefits and the compensation of company directors, including details about executive severance benefits, stock options, and deferred-compensation agreements

* Explanation of the objectives behind executives' compensation. Annual filings must include sections written in plain English on executive pay.

Christopher Cox, SEC chairman, said it is not up to the government to decide how much companies should pay CEOs or whether pay should be linked to performance. But if markets are to work, he said, investors need "comprehensive but also comprehensible information" about the amount and structure of executive pay.