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Professor argues judicial oversight needed for fines leveled by SEC

Wednesday, July 24, 2013

LAWRENCE — Since the financial crisis of 2008, attempts to penalize and curb activity that caused the crash have drawn criticism for being too arbitrary and leaving the sentencing to an ineffective agency. Also under scrutiny are regulations that may disproportionately affect small banks and agencies more than larger, repeat offenders. A University of Kansas law professor has authored an article arguing that federal courts should approve or deny penalties on financial wrongdoers, thereby leveling the playing field and creating a more fair economy.

Quinton Lucas, associate professor of law at KU, has authored “Rubber Stamp Review: Federal Court Deference to the SEC.” In the article he argues that by requiring the Securities and Exchange Commission, commonly known as the SEC, to levy transparent, meaningful fines in cases of financial wrongdoing, federal courts can provide a balance to a system in which investors and the public have lost confidence.

“There are cases that are filed all the time. The majority are settled out of court, but is there a way courts can help us avoid what happened before?” Lucas asked, referring to the 2008 financial crisis. “We currently are not seeing sufficient deterrence in white collar crime and related areas. Especially when compared to what could be called traditional, blue collar crime.”

The 2010 Dodd-Frank act was intended to prevent financial malfeasance on a large scale. An unintended consequence has been harshly punishing small banks while allowing massive firms to get away with relatively small fines for large-scale wrongdoing, Lucas argues. He cites two examples. In 2009 Bank of America absorbed Merrill Lynch, which was failing, on the condition it not pay executive bonuses that year. It later paid $3.6 billion in bonuses, and the SEC levied a fine of $33 million. In 2011 the SEC levied a fine of $95 million against Citigroup after it nefariously sold weak investments, which resulted in $700 million of investor loss.

In both cases a federal judge rejected the sentences, stating they were unclear in how the fine amount was reached and not proportionate to the losses suffered. The SEC has appealed, claiming they have sole authority to determine public interest and that courts should simply approve sentences it hands down. Lucas holds federal courts both can and should be able to reject such sentences.

“My argument is that courts don’t have to be a rubber stamp. If they follow the SEC model, that is all they will be,” Lucas said.

He compares the situation to a criminal case. If a defendant makes a plea bargain with prosecutors, it still has to be approved by a judge, preventing overly lenient deals. Federal judges could do the same by reviewing an alleged financial crime, reviewing the statutes that govern it and deciding whether a penalty levied by the SEC is acceptable. Judges should also be able to allow sentences to vary, based on the severity of the wrongdoing, Lucas said.

He proposes a system by which the SEC makes clear a set of criteria through which it set penalties, and why and how it determines fine amounts. Such a system could also return the deterrent factor, making it clear that large recidivist firms will not be able to simply view small fines as a “cost of business.” Such an approach would also help stop small firms from being disproportionately punished for minor misgivings and help businesses as well by making it clear what sort of actions are not tolerable. All of that could ultimately lead to increased consumer confidence and a stronger economy, Lucas said.

The question of whether federal courts can reject SEC penalties is currently before the U.S. Court of Appeals Second Circuit. If the court finds that the federal court overstepped its bounds in the previous cases, the question may come before the U.S. Supreme Court. It is likely that similar cases will continue to crop up in other circuits, Lucas said. Whatever the decision is, he maintains there is a role for courts in ensuring regulation and prevention of financial malfeasance similar to that which led to the global economic crisis.

“If you hold for the SEC, you’re saying that the court has to simply be a rubber stamp,” Lucas said. “If Congress doesn’t want the courts to have a role, they need to rewrite the statutes. There is a way to ensure that effective regulation is happening.”

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