THE current range of opinion on the Securities and Exchange Commissionâ??s $550 million settlement in the Goldman Sachs fraud suit lines up closely with that evoked by previous S.E.C. settlements with corporate defendants. Some Americans are outraged that Goldman â??got off easy,â? while others feel the deal could be a model for gaining some measure of justice against those responsible for Wall Streetâ??s meltdown.
Both sides are wrong: at best, such agreements reflect case-specific facts and circumstances; at worst, they are nearly arbitrary. While the government often claims such high-profile deals are of historic significance, they typically have little effect on future cases and do nothing to resolve long-standing conflicts as to how the law should treat misconduct by public companies.
The question of how best to discipline what Chief Justice John Marshall in 1819 called â??an artificial being, invisible, intangible and existing only in contemplation of lawâ? is indeed vexing. A corporation canâ??t be put in jail, its fines are ultimately paid by investors not responsible for the misconduct, and a court order forbidding future violations merely shelves the issue until the next occurrence.
In 19th-century America, permissive incorporation laws and rapid economic development led to the rise of the large corporation, which, in turn, led to a century of expanding federal regulation. Most measures regulated certain forms of conduct and prohibited others, specifying fines for failure to comply. There was little consideration given to questions of when, as a matter of practical legal policy, an artificial entity should be treated as if it were a person.
The S.E.C. wasnâ??t forced to grapple with the issue until 1990, when Congress greatly expanded its power to seek financial penalties from corporate violators. (Before then, companies could shrug off civil orders as a passing embarrassment.)
Initially, however, the agency made infrequent use of this new authority. Its staff saw fining public companies as harmful to shareholders, the very people the S.E.C. was created to protect. It also feared that managers would tap their corporate treasuries to buy their way out of individual liability.
But the public, the press and Congress didnâ??t accept any abstract arguments that corporations shouldnâ??t pay fines for securities law violations, as they did for, say, antitrust violations. Eventually heeding these views, the S.E.C. began to seek money penalties from public companies more frequently, in ever-increasing amounts. As with the recent Goldman settlement, record penalties were presented by S.E.C. officials as illustrating the agencyâ??s resolve to enforce securities laws.
Objections that such settlements only hurt shareholders were partly overcome with the Sarbanes-Oxley act of 2002, which included a provision authorizing the S.E.C. to give civil penalties it collected to injured investors rather than the Treasury. But doing so can put the agency in the same business as class-action lawyers: taking money from current shareholders for the benefit of previous investors, who are deemed somehow more worthy.
In 2006, however, the pro-business tenor of the S.E.C. under President George W. Bush found expression in written guidelines widely seen as intended to provide a principled basis for limiting fines paid by public companies. They emphasized such mitigating factors as a corporate defendantâ??s cooperation with investigators. The commissioners, who have to approve all deals in the end, also now insisted that staff consult them before soliciting settlement offers, apparently to avoid putting themselves in the potentially embarrassing position of rejecting penalties negotiated by the staff. (This policy has now been discarded â?? wisely in my view.)
The S.E.C. under its current chairwoman, Mary Schapiro, is clearly raising the ceiling on the money penalties it will seek from (at least) high-profile corporate wrongdoers. Thus investors will find there is yet another way that management misconduct can cost them. This is defensible if it achieves compelling law-enforcement objectives. But that is where things get muddy.
When, exactly, does fining a public company deter potential future violators, bring attention to the significance of particular forms of misconduct, signal shareholders to throw the (management) bums out, or readjust appropriately the interests of current and former shareholders? And when, on the other hand, does it merely provide a platform for agency self-congratulation?
Do not look to the Goldman settlement for guidance. It concludes a case in which the S.E.C. injected itself into a transaction between large financial entities (Goldman and the banks and funds that bought the subprime-mortgage vehicles it peddled) quite capable of defending their own legal interests. This was an unexplained departure from previous practice. The amount of the money penalty bears no relation to the benefits derived by Goldman from its alleged misconduct (reported as $15 million).
More important, the settlement brings the commission no closer to developing a clear standard when it comes to seeking redress for the behavior that led to the economic disaster. Its settlements with public companies will probably be much like settlements in private litigation, an ad hoc process that defies standardization and sometimes logic. The quality of the evidence, the perceived culpability of the wrongdoer and the partiesâ?? negotiating prowess and appetite for complex litigation will all go into the mix, with unpredictable results.
As for the half-billion paid by Goldman â?? well, given the unfortunate vagueness of the system, itâ??s probably about as good a number as any.
Richard C. Sauer, a former administrator in the Securities and Exchange Commission's enforcement division, is the author of "Selling America Short: The S.E.C. and Market Contrarians in the Age of Absurdity."?
Read Full Article »