The following article first appeared in the December 2004 SCAS Alert:

When a Dollar (of Disgorgement) Is Worth Millions
By Bruce Carton, Executive Director

More and more often, SEC settlements for odd-looking amounts like "$150,000,001" or "$50,000,001" have been generating questions and interests among our clients: Are these typos? What's up with the extra dollar? The answer is that this one dollar of "disgorgement" is the difference between investors receiving hundreds of millions of dollars a year from SEC enforcement actions or absolutely nothing.

Defendants who settle SEC enforcement actions typically agree to pay disgorgement, civil penalties or both. Disgorgement is the surrender of a defendant's "ill-gotten gains," such as the profits made by a person who has engaged in insider trading. Civil penalties are additional fines imposed by the SEC. Using the insider trading example, a person settling an SEC action who made $100,000 in illegal profits would typically be required to pay an additional $100,000 as a "1X" civil penalty, i.e., one times the amount of the ill-gotten gains. Thus, the defendant would pay $100,000 in disgorgement plus a $100,000 civil penalty, for a total of $200,000.

Prior to the Sarbanes-Oxley Act (SOX), the SEC distributed disgorgement funds from settlements to investors, but sent civil penalties to the U.S. Treasury. Thus, in the example above, the $100,000 paid in disgorgement would have gone to investors and the $100,000 in civil penalties would have gone to the Treasury. If a case involved only a civil penalty, investors received no money from the settlement.

Section 308 of SOX ("Fair Funds for Investors") changed this practice in an important way. Under this Fair Funds provision, if a settlement involving a civil penalty also contains disgorgement, "the amount of such civil penalty shall, on the motion or at the direction of the Commission, be added to and become part of the disgorgement fund for the benefit of the victims of such violation." In cases falling under the Fair Funds provision since its enactment as part of SOX in July 2002, the SEC has routinely directed that the entire civil penalty be distributed to investors.

In many SEC settlements of financial fraud cases, however, there is no clear or calculable element of "disgorgement." As the SEC explained in a January 2003 report to Congress, "some issuer financial fraud and reporting cases do not result in any disgorgement orders because no defendant received a tangible profit causally connected to the fraud." For this reason, the SEC recommended that Congress amend Section 308 so that the SEC may distribute civil penalty monies to injured investors regardless of whether disgorgement is ordered. To date, Congress has elected not to do so.

Recent Settlements
The SEC, however, appears to have found a way around the limitations of the Fair Funds provision to the benefit of investors. In mid-2004, the SEC began to order disgorgement of $1.00 in many cases involving large civil penalties that otherwise would not have benefited injured shareholders, thereby triggering the Fair Funds provision. Indeed, $1.00 disgorgements can be found in high-profile SEC cases including Symbol Technologies ($37,000,000 civil penalty; $1.00 disgorgement), i2 Technologies ($10,000,000 civil penalty; $1.00 disgorgement), Royal Dutch Petroleum ($120,000,000 civil penalty; $1.00 disgorgement), Bristol-Myers Squibb Co. ($150,000,000 civil penalty; $1.00 disgorgement) and Qwest Communications ($250,000,000 civil penalty; $1.00 disgorgement). Thus, as a result of the combined five dollars of disgorgement in these five cases alone, the SEC will be able to distribute a total of $567 million to investors.

So, keep an eye open for those odd-looking SEC settlement amounts--often they will be your cue that big money is on the way to investors.