Corporate Fraud Cases Decline
For the first time since corporate fraud emerged as a national issue, enforcement actions by the Securities and Exchange Commission are slipping -- down 14.7% in the current fiscal year.
Regulators are unsure what’s driving the trend, but it has triggered speculation that the crackdown on corporate crime may be having an effect on executive behavior.
SEC Chairman William H. Donaldson called the decline “encouraging.”
Donaldson was quick to add that it was too early for the SEC to declare victory in the war on corporate corruption. “One swallow a summer does not make,” he said in a recent interview.
Securities lawyers and other SEC observers think that the spectacle of executives being handcuffed and hauled off to jail has sobered many would-be cookers of the books. Regulators say there is no way to prove that.
“It’s difficult to measure your deterrent effect,” said Linda Thomsen, deputy enforcement director at the SEC.
In the nine months ended June 30, the SEC imposed 378 enforcement actions against companies and individuals. These included fines, forced returns of profits, suspensions of corporate directors, asset freezes and other punishments.
In the same period last year, the SEC tallied 443 enforcement actions.
At the current pace, the SEC will log 504 actions for the 2004 federal fiscal year ending Sept. 30. That would compare to 679 enforcement actions in fiscal 2003 and 598 in fiscal 2002, when the surge in penalties began.
Before that, penalties hovered at a lower level, totaling 484 in 2001. The following year, a series of scandals at Enron Corp., WorldCom Inc. and other companies made corporate wrongdoing a broad public concern.
Some experts speculate that the pace of SEC sanctions reveals more about changing enforcement strategies and a load of complex cases than it does about corporate ethics.
Under Donaldson, SEC investigators have invested more time than in the past to explore potential problems in entire industries, a tactic that has possibly contributed to the dip in the overall number of enforcement actions.
The approach represents a bid to answer critics who say the agency has deployed its limited, if growing, resources in a scattershot manner and failed to spot emerging problems.
The SEC’s image took a beating last year after revelations of widespread trading abuses in the mutual fund industry. The scandal was exposed not by the SEC but by New York Atty. Gen. Eliot Spitzer.
Donaldson has made it a pet goal to improve the SEC’s ability to anticipate problems, such as by conducting methodical sweeps of industries suspected of misbehavior.
In recent months, investigators have examined the use of stock options by high-tech companies, bookkeeping practices in the video game industry, statements of oil and gas reserves by energy firms and possible manipulation of subscriber numbers by cable companies, according to SEC officials. (The SEC, in keeping with a long-standing policy, declines to discuss details of any of its ongoing investigations.)
Beyond that, the agency has pursued what some describe as a demanding enforcement agenda.
After the late start against mutual funds, enforcers came in aggressively, imposing 31 actions in the last nine months against errant fund companies, including fines, lawsuits and forced returns of profits.
The SEC also has leaned hard on companies to cooperate with its investigations -- fining Lucent Technologies Inc. $25 million and Bank of America Corp. $10 million for failing to do just that. And it sent a stinging message to major accounting firms when it hit Ernst & Young with a six-month ban on performing audits for new, publicly traded companies after it found that it flouted the rules of auditor independence when it formed a joint business with client PeopleSoft Inc.
Indeed, SEC enforcement numbers have been rising in select areas, such as freezing assets the agency considers at risk for investors and suspending trades in stock where it is concerned about fraud.
“Any lawyer who practices in this area will tell you that the Division of Enforcement has never been busier,” said William R. Baker III, a securities attorney with Latham & Watkins in Washington and a former associate director of the division.
A snapshot of the numbers does not take into account the current mix of cases or the reality that they may be a lagging indicator, in the sense that some of the actions come after long-term investigations, he said.
“You really have to look at the cases themselves to draw meaningful information,” Baker added. “That’s really the marker of how busy the [enforcement] division is -- the quality of the cases, not the number.”
Others chalk up the decrease in enforcement actions to scared-straight executives at big companies. Reforms brought by the Sarbanes-Oxley law of 2002 -- including a provision that senior officers risk jail time if they certify phony financial results -- have forced bosses to think twice about questionable financial schemes, some say.
“I’m seeing the behavioral modification out there,” said Larry Barcella, a specialist in white-collar crime at the Paul, Hastings law firm in Washington and a former federal prosecutor. “Corporate executives who in the past didn’t really think they needed to talk to white-collar counsel now want to talk.”
Despite the drop in SEC enforcement actions, however, many still view the agency as outgunned in the battle against fraud.
“You’ve got to assume that the SEC catches only a fraction of what’s going on out there,” said Michael Perlis, a Los Angeles securities lawyer and former assistant director of the SEC’s enforcement division. “So even if people get 20% better, there still should be more than enough unethical activity to keep them busy.”
In the interview, Chairman Donaldson said he was “continually amazed” at the cases of wrongdoing brought to the agency’s attention -- many of them by small-time con artists, and not major companies.
He cited pyramid schemes, which rely on an expanding base of new investors to pay off those who got in earlier, and “pump-and-dump” strategies in which promoters hype a stock, often on the Internet, and then unload their shares before the price plunges.
“It’s just a continuing flow of that, and that doesn’t seem to be slowing down at all,” Donaldson said.
Asked whether he thought that scandals of an Enron-like scale were still lurking, the chairman chose his words with care: “I guess I can say I hope not. But I don’t want to go out on a limb and say there isn’t one -- because just as sure as we’re sitting here, something will pop up tomorrow.”
