US securities regulators may emerge with greater power to extract settlements with real teeth in corporate enforcement cases, even after a federal judge has blocked its high-profile settlement with Bank of America Corp. US District Judge Jed Rakoff has twice refused to approve the Securities and Exchange Commission's $33 million settlement over the bank's failure to better disclose bonuses it had authorised Merrill Lynch & Co, which it was acquiring, to pay.
Rakoff has faulted the SEC for appearing to let the bank off too easily, and dismissed as nonsensical why the bank would agree to pay anything without admitting it had done anything wrong. Governance experts said the case will strengthen the SEC's hand in future settlements, as the agency tightens oversight and tries to rebuild a reputation for aggressiveness after a slow year for enforcement. It may also prompt more transparency by companies, even without formal acknowledgement of wrongdoing.
"It is absolutely appropriate for a judge to question the amount and the context of a settlement," said Hillary Sale, a professor at the Washington University in St. Louis School of Law. "In theory this increases the SEC's negotiating power. The SEC can say, we can't settle because the courts won't let us."
In the Bank of America case, executives said they relied on lawyers' judgements as to what bonus details should be revealed. Yet the bank did not waive attorney-client privilege, meaning the names of the decision makers remained secret. An exasperated Judge Rakoff questioned why the SEC would agree to this.
"If the company does not waive the privilege," the Manhattan judge wrote, "the culpability of both the corporate officer and the company counsel will remain beyond scrutiny. This seems so at war with common sense." In 2006 guidelines for assessing corporate penalties, the SEC said it would focus mainly on the degrees to which companies benefited from their wrongdoing, and to which penalties could help or further harm injured shareholders.
It also, however, said it would consider several other factors. Among them: the intent of the perpetrators, and whether complicity in the supposed violations was widespread. "The SEC decided that in the case of disclosure violations, penalties should be substantially allocated to the responsible officers who caused the disclosure violations," said John Coffee, a law professor at Columbia University in New York.
"Otherwise," he said, "you are doing something that is perverse - shareholders have gotten inadequate disclosure, and as a result you put a penalty on the corporation that falls on shareholders. So they are being punished twice." Permitting companies to remain opaque on disclosure also does a disservice to achieving justice, according to James Cox, a law professor at Duke University in Durham, North Carolina.
"This robs the settlement of its social message and erodes the enforcement efforts themselves," he said. "Settlements have too frequently become means of closing files rather than serving the ends of justice or policies behind securities laws. Public policy is sacrificed for expediency."
Bank of America has maintained that its disclosures on Merrill bonuses did not mislead investors. A spokesman, Larry Di Rita, said the bank showed shareholders "the strategic logic of the Bank of America and Merrill Lynch combination, and we believe that is what shareholders were voting for."
Not everyone agrees. The Charlotte, North Carolina-based bank faces a congressional inquiry, a probe by New York's attorney general, and many shareholder lawsuits whose outcomes depend in part on who knew what, and when. More revelations could hurt the bank.
"The more facts that companies have to disclose, the easier it would be to sue," said Tamar Frankel, a professor at Boston University School of Law. "After all, if a company says it, then what else would you need? It's a confession."
In its fiscal year ended September 30, 2008, the SEC extracted $1 billion of fines and ill-gotten gains through enforcement actions. That is the lowest sum since frauds at Enron Corp and WorldCom Inc in 2001 and 2002 led to a tightening of governance measures, including creation of the Sarbanes-Oxley Act.
The decline comes even though the number of SEC enforcement actions has held fairly steady this decade, typically between 500 and 700 a year. Since Mary Schapiro took over as chairman, however, the rate of enforcement actions has jumped 30 percent over the same period last year.
This month, SEC enforcement chief Robert Khuzami unveiled new powers at the agency, including a greater use of subpoenas. "We need to be vigorous advocates for investors," he said. Sale, the Washington University law professor, said the Bank of America case could cause civil fines in other SEC cases to rise, and lead to more disclosures that could be used against companies in private litigation. The alternative would be more litigation with the SEC, which she said would not necessarily be a bad thing.
Being more careful about disclosures "is a cost of being a publicly-held company, which we have not fully explored in part because companies have been less than fulsome over the years in their disclosures," she said.
A get-tough approach would help the SEC after it missed imprisoned swindler Bernard Madoff's estimated $65 billion Ponzi scheme, according to Coffee, who is scheduled to teach a white-collar crime seminar with Judge Rakoff at Columbia this fall.
"They thought getting a $33 million penalty would make them look like the tough cop again," Coffee said. "In Rakoff's last analysis, he is applying to the SEC the same rule they have always applied to corporations - namely, sunlight is the best disinfectant."