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Commentary: Go Ahead, Make the SEC's Day


By Amy Borrus and Mike McNamee

The Securities & Exchange Commission's proposed agreement with MCI (MCWEQ) Inc., formerly known as WorldCom, to resolve financial fraud charges was certainly stunning. At $500 million, MCI's penalty was 50 times larger than the previous record fine in an accounting case. Scale aside, though, the deal announced on May 19 is emblematic of the ways in which the SEC is thinking bigger and acting bolder. Sky-high fines, restitution funds for shareholders, novel legal strategies, and cough-up-the-money moves against miscreant CEOs -- all are becoming commonplace in SEC settlements.

The tougher stance is drawing sniping from both sides. Some critics contend that the SEC's moves might not stand up in court. Defense lawyers worry their clients could be steamrolled unfairly by the agency's aggressive tactics. And many investor advocates carp that penalties should be higher still and note that many fraudsters have yet to be called to account.

Whatever the complaints, though, one thing is clear: The extent of the crackdown has easily exceeded the expectations many had -- either at the height of last year's corporate scandals, or when former Wall Streeter William H. Donaldson took over in February. Ironically, the hang-'em-high stance began under much-criticized former SEC Chairman Harvey L. Pitt. Now, Enforcement Director Stephen M. Cutler has strong backing from Donaldson, who is proving to be a tough cop. Of the agency's hard-nosed approach, SEC Commissioner Harvey J. Goldschmid says: "This is about getting the right message out and creating the right accountability and deterrence." Here's how the SEC is getting its point across:

INNOVATIVE PENALTIES. The record-shattering fine imposed against MCI came just weeks after the SEC and New York Attorney General Eliot Spitzer won steep fines and restitution totaling $1.4 billion against 10 top Wall Street firms over their stock analysts' conflicts of interest. In both cases, the agency drew on a provision in the 2002 Sarbanes-Oxley Act that lets it direct penalty payments to defrauded shareholders. Companies that are still in the SEC's sights now face fines that are exponentially higher than in the past.

EXECUTIVE SQUEEZE. Three years ago, the SEC barred 38 errant executives from ever again serving as officers or directors of public companies. In the first two-thirds of fiscal 2003, the count is up to 105, including two former WorldCom financial execs. And future targets, including former execs from Qwest Communications (Q) International, Waste Management (WMI), HealthSouth (HRC), and Tyco International (TYC) may be forced to disgorge salaries, bonuses, and stock profits as ill-gotten gains -- as was former Citigroup analyst Jack Grubman.

TAXES AND INSURANCE. Egged on by lawmakers outraged that corporations could legally offload their penalties, the SEC got the 10 Wall Street firms to agree not to seek insurance repayment or tax deductions for $487.5 million of their penalties. Similarly, MCI cannot deduct any of its $500 million fine. In all future deals, the agency will insist that companies agree not to recoup penalties from insurers or the IRS.

HARDBALL LEGAL TACTICS. In the past, the SEC tended to settle charges first against companies. Now it's building more cases by targeting individuals while letting companies stew. That makes for stronger cases and increases the agency's leverage. A top official cites Qwest, where the SEC has filed civil fraud charges against eight execs but has not yet sued Qwest, as "the archetypal example."

In some cases, the SEC may be going out on a legal limb. As part of its civil lawsuit against former HealthSouth CEO Richard M. Scrushy alleging fraud, it requested a freeze of his assets. A federal judge rejected that demand. Top SEC officials privately fret that the bar on deducting or claiming penalties won't stand up in court. And defense lawyers say the SEC is sweeping aside standard defenses, such as executives' claims that they relied on advice from counsel and auditors.

So far, few defendants seem willing to test the SEC's new mettle in court. The agency's innovative approaches will send a loud message for the next boom: Those who cook the books may be consumed in the flames. Borrus and McNamee cover the SEC.


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