by Bruce Carton
A little known office established just six months ago within the Securities and Exchange Commission seems to have hit its stride this summer, producing tangible results for investors and possibly signaling the end of six years of frustration for the SEC.
Since 2002, the SEC has struggled mightily (and publicly) to develop some efficient way to return more than $9 billion in settlement funds to injured investors. Although the SEC still has as much as $5 billion that it must distribute to investors, its new Office of Collections and Distributions, created in February, has announced six Fair Funds settlement distributions since June 2008, with three of those coming in a one-week period in August. The presence and focus of this new office, and these encouraging recent developments, suggest that the SEC may have finally turned the corner on an issue that has troubled companies and investors alike for years.
The Commission’s long struggle to distribute its Fair Funds settlements to investors springs from two changes in federal law that combined to create an enormous—and probably unforeseen—challenge. SEC Fair Funds settlements consist primarily of “disgorgement” (the return of ill-gotten gains) and civil penalties paid by the defendant, with the overwhelming majority of these funds coming from civil penalties imposed against corporations. Prior to 1990, however, civil penalties against corporations did not exist; the SEC’s penalty authority was essentially limited to cases against individuals in insider-trading cases. In 1990, Congress passed the Securities Enforcement Remedies and Penny Stock Reform Act, which gave the SEC the authority to seek civil penalties from entities—including corporate issuers. For the next dozen years, these civil penalties remained of little interest to investors because they were routinely quite small and, unlike disgorgement funds, went not to investors but to the U.S. Treasury.
The significance of civil penalties in SEC cases changed dramatically in 2002 with the passage of the Sarbanes-Oxley Act. Specifically, Section 308 (“Fair Funds for Investors”) authorized the SEC to add the amount of any civil penalty to its disgorgement fund for the benefit of the victims. That change created a way for investors to benefit for the first time from civil penalties obtained by the SEC against corporations.
It seems unlikely that the proponents of Section 308 anticipated the serious operational challenges that this provision would soon present to the SEC. When SOX was enacted in 2002, the largest civil penalty the SEC had ever imposed was $10 million against Xerox Corp. in April 2002. The new wave of high-profile and huge fraud cases that began to break in 2002—cases such as WorldCom and Enron—put immense pressure on the SEC to do something to deter such conduct. In July 2003, the SEC finalized a settlement with WorldCom that included an unheard-of $750 civil million penalty, which the court observed was “75 times greater than any prior such penalty.”
The unprecedented size of the civil penalty imposed against WorldCom represented a paradigm shift in the size of civil penalties. With numerous accounting scandals emerging on the heels of WorldCom and investor confidence growing shaky, the SEC followed the WorldCom settlement with huge civil penalties in many other cases. Indeed, the SEC imposed disgorgements and penalties totaling an astounding $1.68 billion in 2004 and $1.95 billion in 2005.
Because of Section 308, however, now the SEC’s work no longer ended when the case was settled. Rather, each new settlement and civil penalty brought with it a daunting task that the SEC and its staff were ill-equipped to handle: actually getting those huge sums of money out the door to legions of injured investors.
By 2005 it was clear that very little of the billions of dollars in penalties that the SEC was imposing and collecting was actually being paid to investors—as little as 2 percent, according to a July 2005 article in the Wall Street Journal. In August of that year, the Government Accountability Office found that the SEC had applied the Fair Funds provision in 75 cases totaling more than $4.8 billion, and had collected money in 73 of the cases—but had only paid out a total of $60 million to investors. These numbers did not escape the notice of new SEC Chairman Christopher Cox, who joined the SEC that same month.
In 2007, Cox publicly acknowledged that the SEC’s distribution of funds was a concern and that the SEC needed to improve upon its effort. The SEC attributed some of the problem to the lack of centralized management, which limited the development of standardized policies and controls. Without that centralized approach, dozens of SEC staff attorneys settling cases around the country all had to figure out, largely independently, how to distribute millions of dollars to thousands of shareholders.
Another challenge was simply manpower. The same attorneys responsible for investigating and bringing cases were also responsible for getting the funds distributed. One SEC official estimated that during peak periods, the Fair Funds workload on any particular case could consume about 50 to 75 percent of a staff attorney’s time.
The logjam started to break in March 2007, when the SEC announced its plan to create a new, specialized office with the full-time mission of returning funds to investors. That plan became reality in February 2008, when the SEC announced that a new office, the Office of Collections and Distributions, had been formally established and staffed with a director, Dick D’Anna, and a deputy director, Lynn Powalski. The SEC added that the office would face the task of distributing no less than $5 billion then waiting to go out to investors, and that it expected the office to grow to 34 professional staff members by the spring of 2008.
Since February, the SEC’s new office has begun centralizing and professionalizing the distribution of its Fair Funds settlements. It eliminated the need for staff attorneys completing a settlement (and who may have had no prior experience with distributing funds) to continue supervising that process.
The latest returns are encouraging. Since June, the SEC has announced Fair Funds distributions in six of its settlements: Banc of America Capital Management ($103 million); Banc of America Securities ($26 million); Spear & Jackson ($5.6 million); Vivendi Universal ($48 million); Janus Capital Management ($18 million); and Putnam Investment Management ($40 million).
OC&D tells Compliance Week that $500 million in Fair Funds distributions have gone out so far this year, and that a number of additional “significant distributions” are in the pipeline for later this year. It also confirmed that the office has grown to a staff of 37 people, including 11 attorneys, 12 legal support staff, two accountants, three auditors, and staff responsible for tracking financial and other case management information. OC&D also emphasized that the SEC’s recent successes in this area were the result of its ongoing, collaborative effort with the SEC Division of Enforcement, and that OC&D had been instrumental in helping to improve and enhance the distribution process.
If OC&D can continue to build upon its recent successes, the roughly $5 billion dollars in Fair Funds settlements that has been collected and not yet distributed by the SEC could finally make its way to investors in the near future. It’s been a long time coming, but when we’re talking about $5 billion, late is certainly better than never.
Originally published in Compliance Week. Reprinted with permission. © 2008 Financial Media Holdings Group, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.