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.”
Certainly, vigilant companies are the main line of defense. If a job candidate has been barred, a background check usually finds enough other career anomalies to scuttle his or her chances. Although recruiters don’t routinely check the SEC site to see if a candidate has been barred, Walt Williams, a partner at executive-search firm Battalia Winston International, says, “We would usually trip over that information in other ways when we check references. If there were any previous problems at all, never mind a bar, they could be withdrawn from consideration.”
But while barred individuals are less likely to be hired directly into large public companies, they can sneak back into executive jobs relatively easily by rising through the ranks at smaller firms, which often don’t perform thorough background checks.
If companies don’t block barred individuals from officer and director posts, chances are slim that the SEC’s spot-checks will. These reviews fail to catch even the most blatant offenders.
Take the case of Marlen V. Johnson. In 1996, a securities-fraud settlement barred Johnson from serving as an officer and director after he was charged with masterminding a stock-manipulation scheme. In late 2002, the SEC filed a motion to find Johnson in contempt of court for serving as president, secretary, and director of publicly traded R&RX Group Inc. (and two previous incarnations of the firm). During his tenure as president of R&RX Group, Johnson filed at least three quarterly reports and one annual report with the SEC, signing each with his own name and listing his position as president of the company. It took the commission at least a year to realize what was happening.
When the SEC finally nailed Johnson, it wasn’t through a spot-check. It was because a “third party provided us with information,” says Jeffrey B. Norris, trial counsel in the SEC’s Fort Worth district office, who prosecuted Johnson’s contempt case. Johnson was also in comtempt for not paying penalties associated with the O/D violation, but the SEC laid that complaint to rest—without collecting the fines.
It’s hard to say how many similar cases exist. “We’ve made these bars more of a central point of our enforcement program,” says Norris. “But I have no idea how often they are being violated.”
The Hunt Is On
Most people who are given an O/D bar would never dare ignore it. But reliance on an honor system has its drawbacks; most notably, it depends on people who have already broken the law to keep their promise. And as the Johnson case shows, those willing to break the law are little deterred by the threat of a contempt charge.
“The system relies on people agreeing to [the bar] and risking severe sanctions if they violate it,” says Hibbard. Moreover, he says the rules assume that most companies would not risk their reputations by allowing a barred individual on their board or in the C-suite, even though they could, legally, hire them for other corporate positions. “It would be a rare public company that would use a back door to put a barred person back into a position of power,” he says.
Still, considering the emphasis the SEC is putting on the O/D bar as an enforcement tool, and with the increasing number of individuals bound to receive one in the coming years, it seems the commission would do well to fix the glaring hole in its new “big stick” policy. After all, anyone who has had SEC enforcement action (such as a bar or a cease-and-desist order) taken against him or her is listed in a database at the SEC. A simple computer program could cross-check those names against the names listed on all SEC filings and annual reports to spot overlap.
One reason the SEC neglects rigorous cross-checking, says Bayless, is that its resources, particularly technology resources, are limited. Another reason is that until very recently, the O/D bar was considered the death penalty of SEC punishments.
But Peloso says there really are no excuses. “The reality is that you’ll never stop people from doing things wrong if they really want to,” he states. “But this is preventable. Public corporations file with the SEC. A computer could pick this up.”
Kris Frieswick is a senior writer at CFO.
Banned for Life
Notable recent officer and director bars.
|Date||Company||Name, Former Title|
|1/22/04 (consented)||Computer Associates International||Lloyd Silverstein, SVP finance|
|12/23/03 (sought)||Vivendi Universal||Jean-Marie Messier, CEO|
|6/5/03 (consented)||Xerox||Paul A. Allaire, CEO;
G. Richard Thoman, CEO;
Barry D. Romeril, CFO
|3/17/03 (sought)||Merrill Lynch (relating to Enron fraud)||Daniel H. Bayly,
Thomas W. Davis,
Robert S. Furst,
Schuyler M. Tilney
|3/11/03 (consented)||ImClone Systems||Samuel Waksal, CEO|
|2/26/03 (sought)||Kmart (drugstore division)||Enio A. Montini Jr., SVP;
Joseph A. Hofmeister, VP
|Various (sought)||HealthSouth||Richard Scrushy, CEO;
Angela C. Ayers, VP finance;
William T. Owens, CFO;
Weston L. Smith, CFO;
Emery Harris, controller and VP accounting