Statement from SEC Chairman Cox – LAWFUEL – The Law News Network –
Today the SEC is announcing the filing of charges against two U.S. software companies accused of financial fraud. We are simultaneously announcing that these charges have been settled, with the result that in one case, there will be a $50 million penalty against the corporation.
In the other case, while the Commission has settled with the corporation on terms that do not include a penalty against the corporation, we will pursue the individuals responsible for the fraud and seek penalties against them in federal court.
The $50 million penalty against McAfee is consistent with a very recent trend in the SEC?s use of its penalty authority. All but three of the penalties of $50 million or more obtained in Commission settlements since 1986 have been obtained in the last three years.
For instance, in 2002, when the Commission filed its financial fraud case against Xerox, the $10 million penalty we obtained was the largest civil penalty the Commission had ever imposed against an issuer in a financial fraud action.
Because of the sea change that has occurred in the SEC?s use of its penalty authority, the Commission for some time now has been looking with great particularity at the questions of whether, and to what extent, monetary penalties should be imposed on an issuer found to have committed securities law violations.
After much deliberation the Commission has reached unanimous agreement on guidelines that will inform our future actions.
Our intention is that these principles will establish objective standards that will provide the maximum degree of investor protection.
The two settled actions we are announcing today illustrate how the principles guiding our actions will be applied in practice.
The framework for our consideration of the propriety of corporate penalties was grounded in the Commission?s statutory authority as well as in the legislative history supporting that authority. The two most important pieces of legislation guiding our work were the Remedies Act of 1990 and the Fair Funds provision of the Sarbanes-Oxley Act of 2002.
It is our hope that our work will provide a high degree of transparency to the workings of the Securities and Exchange Commission. For it to be effective, our corporate penalty authority should be exercised with the highest possible degree of clarity, consistency and predictability.
The Commission is in unanimous agreement that corporate penalties are an essential part of a comprehensive program of enforcement of our securities laws. A key question for us as we explored the appropriateness of imposing civil penalties on a corporation?as opposed to an individual wrongdoer?was whether an issuer?s violative action resulted in benefit or harm to the shareholders.
Other considerations also come into question. One is the deterrent effect of a corporate penalty in a particular case. Others include the level of harm that was inflicted on society; the extent of corporate complicity in the violation; the presence (or absence) of deliberate, intentionally fraudulent conduct; and the extent of corporate cooperation with authorities.
The principles behind our guidelines are clear. In protecting investors it is important to punish wrongdoers and deter further malfeasance. And it is important not to compound the harm already caused to investors.
I want to thank my fellow commissioners, Cynthia Glassman, Paul Atkins, Roel Campos, and Annette Nazareth, for the hard work they have put in on this initiative. It is a source of particular satisfaction to me that, through careful deliberation, our various views were forged into a single general framework.
I also want to congratulate the head of our Enforcement Division, Linda Thomsen, for her dedication and hard work. She will now give an overview of the two settled actions we are announcing today and of the significance of the statement of principles that we are publishing contemporaneously with the announcement.
Linda, you have the floor.
Statement of Linda Chatman Thomsen
Director of SEC Division of Enforcement
January 4, 2006
Good Afternoon and Happy New Year.
I?d like to spend just a few minutes outlining the underlying facts of the two cases we filed today.
In Securities and Exchange Commission versus McAfee, Inc. the Commission charged McAfee with securities fraud in connection with a scheme to fraudulently overstate McAfee?s revenues during the period from late 1998 through 2000. Without admitting or denying the allegations in the Commission?s complaint, filed earlier today in federal district court in San Francisco, McAfee has consented to the entry of a final judgment that enjoins it from violating the antifraud and other provisions of the federal securities laws, and orders McAfee to pay a $50 million civil penalty. This settlement is, of course, subject to the Court?s approval.
According to our complaint, McAfee engaged in this fraud in order to meet revenue projections and earnings targets. Its violative conduct was egregious and pervasive. The fraudulent scheme, which lasted for over a year and a half, was directed by the company?s chief financial officer and implemented to a large extent by its controller, both of whom have been charged by the Commission in prior civil actions and by the Department of Justice in criminal proceedings. The fraud was implemented and concealed through the use of various artifices and accounting ploys, including:
? secret payments and discounts to McAfee?s distributors as inducement to not return product to McAfee;
? the creation of a wholly-owned subsidiary to repurchase oversold McAfee product from its distributors while guaranteeing the distributors profits on such resales; and
? false entries on McAfee?s books and records and the manipulation of reserve accounts to cover the costs of the distributor payments.
During the time period of the fraud McAfee used its overvalued stock to acquire other companies, capitalizing on the artificial value it had created through its fraud.
In the Commission?s action against Applix, Inc., a company that develops and sells management software, the Commission alleges that Applix engaged in a fraudulent scheme to improperly recognize revenue on two transactions. In the first transaction Applix improperly recognized software licensing revenue under a Dec. 31, 2001, amendment to a reseller agreement. Because the agreement included the right to resell new products, Applix should have recognized the revenue ratable over the twelve month term of the agreement, that is, throughout 2002. Instead, it recognized all of the revenue upfront in 2001, allowing Applix to meet its previously announced revenue goals. By virtue of this conduct Applix understated its net loss for the year. In the second transaction, Applix recognized revenue in the second quarter of 2002 for a contract even though the customer had not accepted the product. As a result, Applix understated its net loss for the quarter by over 30%. Applix has agreed, without admitting or denying the findings in the Commission?s order, to a cease-and-desist order and to certain undertakings to retain a financial policies consultant to review its policies and procedures. Separately, the Commission is suing three individuals, whom the Commission alleges also violated the securities laws in connection with Applix?s fraud.
Let me take just a moment to look at these matters in light of the principles announced today. But before I do so, let me caution that these matters, like every matter the Commission considers, were considered in light of all the facts and evidence. With that caveat, let me run through some of the factors that informed our thinking about penalties in these two cases. McAfee benefited from its conduct, especially through acquisitions made with its inflated stock. Applix did not similarly benefit and there does not appear to be other direct benefits to it or its shareholders by virtue of the fraud. Today McAfee is financially strong and the penalty it has agreed to pay is unlikely to cause McAfee shareholders undue hardship. Applix is a relatively small company and a large financial penalty could have a disproportionate effect on its financial situation with hardship flowing to its shareholders. In McAfee we anticipate penalty monies can be effectively distributed to shareholders injured by the fraud. In Applix it would be difficult to impose a penalty that would be large enough to make distribution to victims practical without causing undue harm to the company and its current shareholders. In McAfee the conduct was pervasive and occurred over a significant time period; in Applix the conduct, while certainly fraudulent, was more limited.
We had terrific staff working on both of these cases and I want to thank all of them. In McAfee the team includes Paul Lane, Robert Peak, Lawrence Renbaum, Yuri Zelinsky, Russell Duncan, Susan Markel, and Antonia Chion. I also want to recognize the cooperation that we received from the United States Attorney?s Office of the Northern District of California and the FBI in this and related matters. On the Applix case the team includes Anthony Jordon, Robert Barry, Celia Moore, Martin Healey and David Bergers.