Monday, July 30, 2007

SEC Fines? Double Whammy for Investors

Do you know how some companies betray shareholder trust by doing such things as back-dating options, such as in these cases involving Brocade Communications and Mercury Interactive? Well, one of the ways in which the SEC routinely responds to such violations is by imposing fines on the companies involved. That's a really absurd response.

Let's analyze the situation for a second. In securities fraud involving investors, such as options back-dating, insider trading and so forth, the primary victims of the crime are shareholders. Who else could it be? If you didn't own the stock at the time of the crime, and don't own it now, you really couldn't care less about any fraudulent transactions involving the stock. So, if we can all agree that shareholders are the true victims of such crimes, let's take this logic one step further.

The owners of a company are its shareholders. When the SEC imposes a fine on a company, the payment of this fine decreases the assets of the company, and therefore its value. If the value of the company declines, so does the value of its stock, which is owned by the shareholders. The result is that in retaliation for a crime the company committed against its shareholders, the SEC punishes those shareholders by decreasing the value of the stock they own. Hmmm... that does not sound like a very equitable form of justice to me. This is basically the equivalent of fining a robbery victim for the crime of getting robbed. If anybody can make a coherent argument against this line of reasoning, I'm listening.

So, what am I saying? Should the SEC let offending companies off the hook? Yes and no. In cases where the injured party are the shareholders, such as the cases I discussed above, I see absolutely no sense in punishing the victim. There are many other cases where the shareholders should rightfully pay for the crimes of the company. For example: patent infringement cases, environmental violations, price fixing etc. The common denominator to all of these is that the shareholders are the potential beneficiaries of such violations, which in fact may increase the value of their stock at the expense of others. In such cases, shareholders should suffer the wrath of the SEC since it is their responsibility to make sure that the management they hire to run their company does so in accordance with the law.

Still, your basic sense of justice may be telling you that somebody must take the blame and suffer the consequences for options back-dating, insider trading and the like. I absolutely agree. The ones that must pay for these sins are the people that actually perpetrated them. Let's face it, it is not the company that back-dated some options, it's an individual, probably an executive, who is responsible for this. That person should stand trial and pay the consequences for his actions. Making shareholders pay for crimes committed against them makes absolutely no sense.

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