In March of this year, I gave a speech to the Council of Institutional Investors suggesting that the SEC should reconsider its approach to assessing penalties against corporate wrongdoers.[1] Over the years, Commissioners have had different views about when corporate penalties further the goals of incentivizing compliance with securities laws and creating a level playing field for market participants.[2] As I explained in March, it is a flawed approach to place too much emphasis on corporate benefits and the burden a corporate penalty may impose on shareholders.

Corporate benefits are notoriously difficult to quantify. If we limit penalties to only those benefits that are easy to count, we will invariably undercount, leaving the corporation in a potentially better economic position for having committed the violation. That is precisely the wrong outcome to advance our goals of punishing misconduct and delivering effective specific and general deterrents. Paying a penalty cannot be just a cost of doing business.

And the imprecision of measuring corporate benefits is not just a result of complexity. Corporate defendants strategically release bad news in ways that dampen or obscure the market’s reaction. The resulting change in stock price therefore may not be an effective way to measure corporate benefits. Today’s enforcement action against The Kraft Heinz Company (“Kraft”) highlights this problem. In my view here’s why penalties should not be constrained by a mechanistic approach to corporate benefit:

Kraft first announced the SEC’s investigation to the public on February 21, 2019, at the same time that it announced a dividend cut and a $15.4 billion write down of goodwill in certain reporting units and intangible assets. Kraft also stated that it recorded only a $25 million increase in cost of products sold in connection with its response to the SEC’s investigation. The company further stated that it did not expect the matters under investigation to be “material to its current period or any prior period financial statements.” Its stock price fell following this announcement. But, Kraft’s release of all this negative information at the same time obfuscated what portion of the stock drop resulted from news related to its potential SEC violations versus the other significant issues.

Later, on May 6, 2019, Kraft announced that it planned to restate its financials for fiscal periods 2016, 2017 and the first three quarters of 2018, as it was nearing completion of an internal investigation into its procurement division. According to Kraft’s press releases, the company now believed that the misstatements were not “quantitatively material” and that “[t]he findings from the investigation did not identify any misconduct by any member of the senior management team.” Then, on June 7, 2019, Kraft filed an annual report containing the restated financial results, with the errors totaling $208 million, not just $25 million, and reiterated that it did not identify any misconduct by any members of senior management. But I note we announced a settlement with a former Chief Operating Officer of Kraft for negligent misrepresentations and accounting violations. Corporate claims of lack of senior management involvement or materiality could also dampen the stock price reaction to negative news and affect a corporate benefit analysis.

We did not charge Kraft based on these statements, but these facts present a useful opportunity to highlight a practice that is far from unique. Academic research describes releasing confounding news along with bad news as “information bundling.” A recent analysis determined that it results in dramatically fewer successful recoveries by private securities litigants who, unlike the SEC, must prove that corporate stock price losses were directly attributable to the specific bad news.[3] In this study researchers also concluded that information bundling resulted on average in $21.17 to $23.45 million lower recoveries for shareholders.[4]

In considering the appropriate penalty to impose in actions brought by the SEC, I am concerned about corporate issuers benefitting from information bundling. To the extent corporations thereby make it more difficult to measure corporate benefit, that merely reinforces my inclination in setting penalties to focus more heavily on other factors, such as punishing misconduct and effectively deterring future violations.