Over the past 20 years, civil penalties have become an increasingly important part of the SEC’s enforcement program. The agency frequently imposes large monetary penalties, highlights those penalties in press releases, and touts them in end-of-year statistics. Civil penalties are justified as a necessary deterrent to unlawful conduct and a powerful tool for promoting ethical and legal behavior. But with respect to one category of cases – those involving public companies – civil penalties have always been controversial, because the cost of the penalty is ultimately borne by the shareholders who had nothing to do with the misconduct and indeed may have been harmed thereby. As a result, there has sometimes been considerable friction at the commission over the use of penalties in the public company context.
In the last decade, however, the pendulum has shifted decisively in favor of a penalty regime. Civil penalties are now a routine part of the resolution of most public company enforcement cases. In a recently published study, I analyzed nine years’ worth of data on public company enforcement actions available on the Securities Enforcement Empirical Database (SEED) compiled by NYU’s Pollock Center for Law and Cornerstone Research. The study, which covers the fiscal years (FYs) 2010-2018, shows that penalties are not only routine but a central element in most negotiated resolutions of enforcement actions against public companies, as part of a package of relief that reflects what appears to be a studied compromise between statutory charges and monetary sanctions. One trend, which has become more pronounced over the last several years, is for the SEC and public companies, particularly those in the financial services industry, to settle enforcement proceedings through the entry of in-house administrative orders that include non-scienter-based charges, the payment of a civil penalty, and no individual charges.
Data for FY 2019 are now available and – with one exception, noted below – they confirm the trends observed in the prior nine years. In FY 2019, the SEC brought a record 95 new enforcement actions against public companies and their subsidiaries. That number is a bit skewed because it includes a one-time enforcement initiative – the Share Class Disclosure Initiative (the Initiative) – in which the SEC offered favorable settlement terms to investment advisers that self-reported violations relating to certain mutual fund share class selection issues. Overall, the Initiative resulted in settlements with a total of 95 entities, including 26 public companies. Nonetheless, even excluding the 26 Initiative actions, the SEC brought a total of 69 new actions against public companies in FY 2019,  a number that is in line with the last two FYs, and a significant increase over the earlier years in the study.
The Initiative cases fit the larger trends in three important respects: The settlements included non-scienter-based fraud charges (violations of Sections 206(2) and 207 of the Investment Advisers Act of 1940); no individuals were charged in connection with the wrongdoing; and the cases were brought administratively. The one exception to the larger trend is that the Initiative settlements did not include civil penalties (although they did include some form of disgorgement/restitution). Whether this is simply a one-time aberration or an indication that the commission may be rethinking its overall approach to penalties (two-thirds of the Initiative cases did not involve public companies) remains to be seen.
Looking at the 69 non-Initiative actions against public companies, a few things stand out, all of which are in line with the trends that were observed over the prior years. First, civil penalties are now largely the norm in public company cases: Civil penalties were obtained in 55 of the 68 FY 2019 cases that have been resolved to date, or 80.8 percent (and penalties are being sought in the one unresolved case). Moreover, in five of the 13 cases where penalties were not obtained, the SEC specified in its order that it was not imposing a civil penalty based on the imposition of a criminal fine in a parallel action, meaning that a public company paid a penalty in, or in connection with, 60 of the 68 cases resolved to date (88.2 percent).
Second, almost all of the public company cases in FY 2019 were filed as settled actions. Most SEC actions in general are settled, either at the outset or at some point prior to trial, and a significant number of those cases are settled at the time of filing, but in cases involving public companies the numbers are overwhelming. Sixty-six of the 69 public company cases filed in FY 2019 were filed as settled actions (98 percent). Only three cases were filed as litigated actions; one of these cases settled about six months after filing and in another case the company defaulted. Only one case is currently being litigated.
Third, the public company cases in FY 2019 were overwhelmingly brought in the administrative forum, rather than as federal district court actions. Sixty-two of the 69 cases (89.85 percent) were brought administratively; only seven cases were filed in federal district court, including the three cases that were filed unsettled.
The SEC’s recent administrative turn has been widely noted and criticized because it seems to give the agency an unfair home-court advantage in contested proceedings. But the SEC’s administrative turn is even more pronounced with respect to settled actions than it is with respect to litigated ones, and this is particularly true when it comes to public company cases. There may be efficiency reasons for bringing settled actions administratively, but there may be something else as well: A settlement in an administrative proceeding need only be approved by the commission, whereas a settlement in a federal court action is subject to approval by the court. The decision to go administrative even with respect to settled actions is likely driven in part by a desire to maintain control and discretion over the process.
With respect to the charges, the FY 2019 public company cases are not quite evenly divided between those involving fraud charges (33 of 69) and those involving non-fraud charges, which include books-and-records violations, FCPA cases, and a few miscellaneous charges (36 of 69). Of the 68 cases resolved to date, penalties were imposed slightly more often in fraud cases (27 of 32, or 84.3 percent) than in non-fraud cases (28 of 36, or 77.7 percent), which makes sense given that fraud is generally considered to be a more serious offense. But if we take account of those cases where a penalty was not obtained specifically because of the imposition of a fine in a parallel criminal action, things even out, and even tilt the other way. Penalties were not imposed for this reason in one fraud and four non-fraud cases. If these cases are looked upon as being, effectively, penalty cases the numbers go to 87.5 percent in fraud cases (28 of 32) and 88.8 percent in non-fraud cases (32 of 36).
With respect to the fraud charges, the federal securities laws include various anti-fraud provisions, some of which require a showing of scienter and others which require only a showing of negligence. Scienter-based fraud charges are generally considered more serious than non-scienter-based fraud charges because they are based on intentional misconduct and can have onerous collateral consequences. In FY 2019, there were only nine scienter-based fraud cases against public companies, which is close to the average number over the nine years in the study. Penalties were obtained in six of those cases (66.6 percent), although in one of the three cases where penalties were not obtained, the reason was because of the imposition of a criminal penalty, so the effective figure may be 77.7 percent.
But while the number of scienter-based fraud cases involving public companies has remained relatively stable over the past 10 years, the number of non-scienter based fraud cases has grown exponentially, both in real terms and in relation to the scienter-based cases, a trend that has increased in recent years. In FY 2019 there were 24 non-scienter-based fraud cases involving public companies (including the one still unresolved case). Penalties were obtained in 21 of the 23 non-scienter-based cases resolved to date (91.3 percent), and penalties are being sought in the one unresolved non-scienter-based matter. Overall, there has been a significant trend towards charging non-scienter-based fraud while imposing a civil penalty in public company cases.
Finally, when it comes to charging individuals in public company cases, the data for FY 2019 confirms a trend that was observable over the nine years of the study. While critics often point to the lack of individual charges in SEC enforcement actions, individuals do in fact get charged even in public company cases, albeit in a minority of such actions. But overall, the study showed a decline over the years in the number of individuals charged in public company cases or related actions: In the first four years of the study, individuals were charged in just under 40 percent of the cases (or in related actions); in the last five years of the study, the number had dropped to 17.5 percent. The decline continued in FY 2019: Individuals were charged in only nine of the 69 public company enforcement cases or in related actions (13 percent).
Civil penalties against public companies have always been controversial, but they are now commonplace. To the cynic, the penalty regime appears to be a studied compromise, in which public companies are allowed to settle SEC enforcement actions with reduced charges and no individual liability in exchange for a payment. This allows the SEC to trumpet a strong enforcement program by pointing to a big monetary fine. It also allows public companies and their executives to avoid more serious and onerous sanctions, along with the collateral consequences thereof, by paying a fine using other people’s money.
 The SEED data is publicly available and can be accessed at http://www.law.nyu.edu/centers/pollackcenterlawbusiness/seed.
 SEED defines public companies as those that trade on a major US exchange and their subsidiaries.
 Cases include new actions filed by the SEC and exclude follow-on proceedings and delinquent filings cases.
 Violations of Section 206(2) of the Advisers Act do not require a showing of scienter. See Sec v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992). The SEC has long taken the position that violations of Section 207 also do not require a showing of scienter. See, e.g., IMO Jamison, Eaton & Wood, Investment Advisers Act Release 2129, May 15, 2013. However, following the entry of the initial set of orders in the Initiative, the DC Circuit issued an opinion in Robare Group, Ltd. v. SEC which casts doubt on whether a violation of Section 207 can be based on merely negligent conduct.
This post comes to us from Professor David Rosenfeld at Northern Illinois University College of Law. It is based on his recent article, “Civil Penalties Against Public Companies in SEC Enforcement Actions: An Empirical Analysis,” available here.