SEC Enforcement Actions are Down While Penalties Are Up

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The Securities and Exchange Commission (SEC) has announced that the number of their new enforcement actions in the last fiscal year have fallen by some 9 percent, according to The first reaction might be pride in enacting Sarbanes-Oxley (SOX) back in 2002. It makes corporate executives more responsible for the actions of their organizations. SOX also increased the transparency of corporate financial reporting for the benefit of investors and regulators alike.

SOX has been in force since 2002, but the reason for the drop in enforcement cases is that the agency is dealing with temporary staffing reductions brought about in a recent federal budget crunch, according to the Washington Post. Its fiscal year ended September 30th, like other federal agencies but has produced “solid result for investors,” according to SEC Chairman Christopher Cox.

Congress has funded the agency, but cost overruns stemming from the construction of their new headquarters put the agency in a budget bind. The agency's work was carried out without 155 employees last year, including 43 less enforcement division staff. The Washington Post reports that the SEC had 3,696 employees in 2006, with 1,189 in the enforcement division. The hiring freeze has been recently lifted and there are plans to restore some of the currently unfilled positions.

Analysts questioned the fact that Cox told Congress that no more resources were needed to handle its 130 stock option backdating cases under investigation last summer. Analysts further hope that the agency can be spared further budget cuts and the budget be expanded to include merit raises for current staff, according to the Washington Post.

The SEC took 574 enforcement actions in fiscal year 2006 and 91 of those cases were against shell companies failing to file regular financial reports, according to the Washington Post. reports that although these cases might have taken less time to prosecute involving fewer resources, these delinquent filing cases like these have taken priority over more rigorous cases.

Enforcement actions hit a high in fiscal 2003, with 679 cases and fiscal year 2006 is 15.5 percent less. Cox remains positive, telling, “This has been a banner year for enforcement. The SEC went 10-0 in trial court wins this year—our first perfect year in memory. This indicated the SEC is bringing the right cases, and getting solid results for investors and for taxpayers.”

The SEC's budget remained at $888 million last year, according to the Washington Post. Congress has funded the agency but cost overruns stemming from the construction of their new headquarters led to a budget shortfall and hiring freeze last year, the Washington Post reports. Duke law professor James D. Cox told the Washington Post, “You get what you pay for. It's been clear in the history of the SEC that as the budget goes, so goes enforcement.” Professor James D. Cox is not a relation to SEC Chairman Cox.

Lynn E Turner told the Washington Post, “Given the budget cutbacks in the number of people in the SEC's enforcement arm, and the ongoing corporate scandals, all investors should be worried. It will put much of the enforcement burden on the shoulders of investors, just as existed before Enron was exposed, contributing to investors losing tens of billions of dollars.” Turner was the SEC's chief accountant but is now chief of research at a private firm.

Some of the higher exposure cases made this year included a settlement against American International Group (AIG) of $800 million in February, without them admitting or denying the allegations of the SEC complaint. The complaint alleged the company's reinsurance transactions were designed to falsely inflate their loss reserves by some $500 million, as well as other material misstatements.

Fannie Mae settled with the SEC for $400 million in May as well. The SEC complaint alleged improper hedge accounting practices involving the estimation and maintenance of the company's Loan Loss Reserve, as well as the classification, valuation and consolidation of certain securities transactions. Their restatement involving an $11 billion reduction in revenue helped make the SEC's case.

On a positive note, SEC Chairman Cox announced that WorldCom investors would receive up to $150 million in distributions from the WorldCom “Fair Fund.” The entire $750 million penalty was paid into the “Fair Fund” in April 2004 when the reorganized company came out of bankruptcy protection. All “Fair Fund” funds will be returned to investors under SOX Section 308. This is the first installment of distributions.

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