During a March 9, 2021 industry conference, one of the four current U.S. Securities and Exchange (“SEC”) commissioners floated a new approach to calculating penalties for corporate misconduct. Caroline A. Crenshaw, who was tapped by President Donald Trump last June to fill one of the Democratic slots on the Commission, told attendees at the Council of Institutional Investors virtual conference that the SEC needed to revisit its approach to assessing corporate penalties, and implement a new approach that tailored penalties to the “egregiousness of the actual misconduct,” accounted for all benefits of the misconduct that accrued to the corporation, and eliminated consideration of potential adverse impacts on shareholders. If ultimately accepted by the Commission, Crenshaw’s proposed approach would likely result in materially greater penalties for corporate misconduct.
The SEC’s current approach to assessing corporate penalties has been in place since 2006. This approach is based on the presence or absence of a direct benefit to the corporation as a result of the violation, and the degree to which the penalty will recompense or further harm the injured shareholders. Under this approach, the Commission considers only direct and material benefits to the corporation when determining the potential scope of unjust enrichment the corporation derived from the misconduct. The relationship between the benefit and the penalty is proportional, so that the greater the unjust enrichment, the greater the penalty. However, if the misconduct harmed shareholders, the 2006 guidance instructs that this is the “weakest case” for imposing a corporate penalty, even if the misconduct otherwise benefitted the corporation.
According to Crenshaw, this “myopic” and “flawed” approach routinely undercalculates corporate penalties in two ways: First, by failing to account for the intangible and economic benefits the corporation received from its misconduct, merely such benefits are “difficult to quantify with exact precision;” and second, by limiting corporate penalties if the misconduct harmed shareholders. In her view, corporate penalties should account for the “total benefit” derived from the misconduct, including such intangible benefits like an unearned good reputation, the impact of “dripping bad information out through multiple disclosures over time,” or the impact of the corporate fraud on the market. Moreover, rather than serving as an excuse to underestimate penalties, Crenshaw said that violations that more difficult to detect and quantify in fact warrant higher penalties.
Crenshaw characterized shareholder harm as a red herring, observing that shareholders “rarely  realize harms or gains by things that happen on a particular day, especially if they hold the shares for a period that exceeds the duration of the event’s impact.” Crenshaw argued shareholder impact was an “external factor” that should not inform the Commission’s penalty calculation, especially because it tends to undermine the deterrent value of the penalty by allowing corporations to decrease penalty amounts based on both actual and potential harm to shareholders, notwithstanding any unjust enrichment the corporation derived from its misconduct.
Crenshaw also briefly covered the availability of cooperation credit, reiterating the SEC’s longstanding position that cooperation credit requires more than merely responding to information requests and conducting internal investigations. Rather, corporations seeking credit must proactively identify and remediate harm, and must make every effort to do this before the misconduct comes to the Commission’s attention. This means having an effective compliance apparatus in place, and appropriately escalating and addressing issues and violations exposed by that apparatus.
Crenshaw’s remarks are the sentiments of one SEC commissioner and do not represent binding Commission policy. Nevertheless, they constitute an important reference point for corporations looking to stay ahead of the compliance curve. If the Commission does update its current approach along the lines she suggests, which seems more likely than not given both its vintage and the current administration’s stricter enforcement stance, corporations could see an increase in penalties, which could expand as a result of the SEC’s analysis of the scope of benefits it considers when determining the value of unjust enrichment to include both economic and intangible gains as a result of misconduct. Penalties could also increase because they would no longer be offset by adverse shareholder impact. Regardless of whether the Commission modifies its approach, corporations are always well advised to review their current compliance programs to ensure an effective infrastructure is in place to proactively identify, report, and remediate securities law and other violations.