SEC Wants Execs to Pay Fines Out of Their Own Pockets

The Securities and Exchange Commission is refusing to approve fraud settlements with companies and executives unless the defendants agree to pay civil penalties out of their own pockets.

But the change in policy, which the SEC quietly made two months ago, may not go far enough to avoid a watering-down of agency sanctions, some critics say.

The SEC first required that violators pay their own civil fines -- rather than have insurance pick up the costs -- in April with the $1.4-billion settlement covering 10 major brokerages accused of issuing biased stock research, Commissioner Harvey Goldschmid said.

“It’s critical when we take money for a civil penalty, which involves a serious wrong, the money not circle back into the hands of those who have been involved in the wrongdoing,” he said in an interview.

The SEC also applied the policy to the $3-million fine against six former top Xerox Corp. executives in an overall $22-million settlement this month of alleged accounting fraud.

But the new policy does not cover other settlement payments, such as disgorgement of alleged ill-gotten gains. In the Xerox case, the executives were responsible for the $3 million in civil fines, but the company -- effectively, the shareholders -- paid the $19 million that remained and the executives’ legal fees. Xerox said it was required to indemnify the six executives under corporate bylaws.

SEC Chairman William H. Donaldson, unhappy with the Xerox arrangement, said the agency would investigate the practice of companies’ paying any securities fraud penalties on behalf of their executives.

“In my mind, this just isn’t good public policy,” Donaldson said in a speech June 5. “This is an area in which we may need to consider ways to bring about reform.”

Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) has complained that previous SEC settlements were often tax deductible for the companies involved. Grassley also told the SEC that defendants shouldn’t use insurance to pay their settlement costs.

Although likely to be popular with investors and Congress, the SEC policy change may make it harder for the agency to settle cases, some experts said.

Defense lawyers say they probably will take more cases to trial if the SEC insists on requiring defendants to pay a greater portion of the settlement.

“When there are amounts to be paid and the commission seeks to foreclose insurance and indemnification, then the cost of settlements goes up,” said Andrew Vollmer of Wilmer, Cutler & Pickering.

Former SEC enforcement director and federal judge Stanley Sporkin said he was “troubled” by the SEC’s shift because one of the reasons companies buy insurance is for covering these types of settlements.

“It seems to me that the only person who benefits by this is the insurance company, and I don’t see why they should get a windfall,” said Sporkin, who headed the agency’s enforcement division from 1974 to 1981. “For the SEC to come out and say you can’t get insurance for these things, I think they are going pretty far.”

Goldschmid, one of two Democrats on the five-member SEC, also said last week that the agency should consider requiring defendants in settlements to admit they violated securities laws rather than use boilerplate language that they don’t admit or deny wrongdoing

Goldschmid declined to detail his suggestion. “I was not suggesting a conclusion but raising an important issue, and at this point we just have to consider it and work it through,” he said.