Wednesday, August 5, 2009

A Quick Thought About SEC Fines

In reading an article in the WSJ today about how the SEC has reworked its rules to allow confiscating executives' pay, even if the executives are not accused of any wrongdoing, something occurred to me. The SEC was founded in the 1930s to act as a protector of shareholders' rights. (Go ahead, laugh.) The idea was that businesses had become so large that their management was effectively kept hidden from the view of their owners. Theoretically speaking, there is nothing wrong with appointing a group of people to enforce laws against corporate fraud. Defrauding one's investors is a violation of their rights, and it is the government's job to defend against such injustice.

This, however, is not what the SEC did then or does now. The SEC concocts a bunch of hoops for managers to jump through, lest they be fined or thrown in jail, ranging from the grotesquely immoral to the just plain silly. The penalty for fraud is typically a corporate fine, paid to the SEC for some reason, and sometimes personal fines and/or jail time for executives depending on the crime. Similar punishments are doled out at the state level by rabid attorneys general like Elliot Spitzer.

What occurred to me is that the crimes are supposed to be violations of shareholders' rights, via mangerial fraud. And the punishment is a fine, which will be paid by who? That fine is coming right out of the shareholders' bottom line. So shareholders get screwed twice: once by the fraudulent management, and then again when the SEC fines them. This is, of course, assuming that any fraud existed in the first place, which may or may not be true.

This is just a little ammunition if you're ever in an argument and someone maintains that the SEC is necessary to protect innocent shareholders from unscrupulous executives.

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