Already considered one of the most severe civil penalties for securities violations, officer and director (O/D) bars have been embraced by the Securities and Exchange Commission with a new zeal. Too bad they aren’t being enforced with equal enthusiasm.
The numbers reflect very good intentions. Last year, the SEC requested 170 bars, which prohibit individuals from holding a position as an officer or director of a publicly traded company. That’s up from 126 bars in 2002, and only 51 in 2001—a threefold increase over two years.
The dramatic rise suggests the agency is fed up with miscreant corporate directors and officers. “The increase in bars is a very important message to the markets,” says Stephen Hibbard, chair of the securities and corporate governance litigation group at Bingham McCutchen LLP. “It shows that the SEC takes these sorts of [securities-law violations] very seriously.”
Language in the Sarbanes-Oxley Act of 2002 is making it easier for the SEC to get O/D bars against offenders. Previously, unless an offender agreed to a bar as part of a settlement, bars were granted by independent federal judges following extensive discovery and a trial at which the defendant was found guilty of violating securities law. The bars were granted infrequently, and only for the most egregious conduct. Now, the SEC itself may impose a bar through a proceeding before its own administrative law judge, a process that is expedited and involves very limited discovery, according to David Bayless, a partner at Morrison & Foerster LLP and a former head of the SEC office in San Francisco.
“This is really a reversal of all the jurisprudence that has gone before,” says John F. X. Peloso, senior counsel at Morgan, Lewis & Bockius LLP and a former chief trial counsel for the SEC in New York. “Sarbanes-Oxley changed the rules 180 degrees,” he notes.
Sarbanes-Oxley also lowered the threshold for imposing the penalty. The SEC must now show only that the individual in question is “unfit” to be an officer or director, rather than “substantially unfit.” “Unfit can now be defined as someone who isn’t doing the job well,” says Hibbard, “as opposed to doing the job wrong.”
But once a person has been barred from the boardroom, the SEC does almost nothing to keep him out. “I’m not aware of any systematic procedure by which these people are tracked,” says Bayless. “They may do it on an ad hoc basis if a group of SEC lawyers is interested in a particular offender.” But overall, he says, catching violators “is a problem.”
According to John Heine, an SEC spokesman, the commission performs random spot-checks on periodic reports, such as 10-Qs and 10-Ks, during which reviewers check the officers’ and directors’ names against the SEC database of enforcement actions to ensure that the individuals have been truthful in disclosures requiring them to list any disciplinary actions taken against them. (It performs these reviews on all initial public offering documents, says Heine.) The SEC does not keep figures on how many of these name checks it runs on 10-Qs or 10-Ks, or on how many individuals it has caught violating an O/D bar using this method. Instead, it believes the onus is on companies to ensure that barred individuals are not offered board posts or executive positions. “A company can call us or check our Website if it wants to find out if someone has been barred,” says Heine. “One would hope that companies are paying attention to that.”