MONEY PENALTIES

Securities and Futures

Regulators Collect

Many Fines But Need

to Better Use

Industrywide Data

United States General Accounting Office

GAO Report to Congressional Committees

November 1998

GAO/GGD-99-8

United States

General Accounting Office

Washington, D.C. 20548

General Government Division

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Page 1 GAO/GGD-99-8 Fine Imposition and Collection Activities

GAO

November 2, 1998

The Honorable Alfonse M. D’Amato

Chairman

The Honorable Paul S. Sarbanes

Ranking Minority Member

Committee on Banking, Housing, and

Urban Affairs

United States Senate

The Honorable Richard G. Lugar

Chairman

The Honorable Tom Harkin

Ranking Minority Member

Committee on Agriculture, Nutrition, and Forestry

United States Senate

The Honorable Thomas J. Bliley, Jr.

Chairman

The Honorable John D. Dingell

Ranking Minority Member

Committee on Commerce

House of Representatives

The Honorable Robert F. Smith

Chairman

The Honorable Charles W. Stenholm

Ranking Minority Member

Committee on Agriculture

House of Representatives

This report provides the results of our review of fine imposition and

collection activities by the Securities and Exchange Commission (SEC),

the Commodity Futures Trading Commission (CFTC), and securities and

futures self-regulatory organizations (SRO).1

 SEC, CFTC, and SROs may

levy fines as part of the sanctions they impose on firms and individuals

who have violated securities and futures laws and regulations and SRO

rules. Officials of these organizations said that they use fines to remedy the

 

1

SEC and CFTC delegate responsibility to the SROs to enforce financial and reporting requirements

and legal and ethical standards for SRO members. SROs include the national securities and futures

exchanges, registered securities and futures associations, registered clearing agencies, and the

Municipal Securities Rulemaking Board. We do not include the latter two groups in this report.
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current violation and deter future violations. The objectives of our selfinitiated review were to determine (1) the extent to which SEC, CFTC, and

SROs collected fines; (2) the guidance they used to determine fine

amounts; and (3) how SEC and CFTC assess the appropriateness of fines

across their respective industries.

SEC, CFTC, and securities and futures SROs collected most of the over

$400 million in fines imposed for disciplinary cases closed from January

1992 through December 1996. However, the percent of fine amounts

collected and the percent of fines paid in full varied among these agencies.

SEC and CFTC, with federal regulatory authority, both collected over 80

percent of the total amount of fines for the cases closed during this period;

92 percent of SEC’s and 60 percent of CFTC’s fines for these cases were

paid in full.2

 Securities and futures SROs that operate exchanges collected

over 75 percent of the amount of fines for the cases they closed, except for

one futures exchange that had written off two large fines, which reduced

its total amount collected to 54 percent. For the closed cases we reviewed

at all seven exchanges, at least 90 percent of the fines had been paid in full;

five exchanges had over 95 percent paid in full.3

 Exchange members who

do not pay fines risk having the exchange sell their membership, or “seats,”

to cover the fines.

The National Association of Securities Dealers (NASD) and the National

Futures Association (NFA) collected less than 30 percent of the amount of

fines for the cases they closed.4

 NASD and NFA fines paid in full totaled 67

percent and 54 percent, respectively. NASD and NFA do not have the

federal regulatory authority of SEC and CFTC or seats to sell to cover

unpaid fines. NASD and NFA officials told us they recognize that, in some

cases, the fines they impose are not likely to be paid, especially when the

fines are high for such conduct as egregious violations or repeat violators.

Violators may leave the industry either to avoid the fine or because they

are suspended or barred as part of their sanctions. In either case, the

 

2

CFTC officials told us that the large difference in fines paid in full between SEC and CFTC may be

attributed to the difference in the amount of time each has had the authority to impose fines. SEC has

had civil monetary penalty authority only since 1990 (Securities Enforcement Remedies and Penny

Stock Reform Act of 1990), but CFTC has had this authority since its inception in 1975. Thus, CFTC

had older cases in the inventory of cases closed during the period 1992 through 1996 than SEC, and

these cases had a greater chance of being written off. According to CFTC officials, the cases CFTC

closed during this period included 45 cases for which the fines had been uncollectible for a number of

years. Excluding these cases would increase the percent of cases paid in full to over 85 percent.

3

As explained later, although we reviewed all or a representative sample of cases at six exchanges, we

only reviewed judgmentally selected closed cases at NYMEX.

4

NASD and NFA have disciplinary authority over all member securities and futures firms, respectively,

and the firms’ sales representatives.

Results in Brief
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officials said fines help remove violators from the industry and keep them

from returning until they pay their fines.

Some SROs did not maintain automated records to document that their

fines were paid. Such documentation could provide an important internal

control to ensure fines are collected and accounted for.

The extent of guidance for setting fines varied among SEC, CFTC, and the

SROs. SEC and CFTC had statutorily established maximum fines for civil

actions and administrative proceedings. In addition, CFTC published the

factors it considers in setting fines for use by futures SROs in conjunction

with a one-time, congressionally mandated study of futures industry

penalties. All the securities and futures exchanges had prescribed fine

amounts for minor violations of exchange rules and policies. NASD was

the only SRO that had written guidance specifying ranges of fine amounts

for more serious violations. Despite the differences in guidance, SEC,

CFTC, and SRO officials told us they considered specific factors in setting

fine amounts, which were common to them all. These factors included the

seriousness of the violation, the number of repeat violations, and the

precedent set by similar cases.

SEC and CFTC reviewed the adequacy of sanctions at their respective

SROs as part of their regular oversight. When they found inadequate

sanctions, including fines, they recommended actions meant to ensure that

future sanctions would be appropriate. However, each takes a different

approach to analyzing the comparative adequacy of SRO sanctions across

their respective industries.

SEC officials told us that they did not analyze industrywide sanctions data

because such data are not easily quantified and are not meaningful without

additional review. The officials said that they evaluate the comparative

adequacy of SRO sanctions through their routine inspections and regular

meetings with senior SRO officials. However, our analysis of industrywide

sanctions data for the time period we examined showed large differences

in the average fine amounts and number of cases closed among securities

SROs and among futures SROs. These differences cannot be specifically

explained without further reviewing the data. Such an analysis could serve

to indicate the differences between and among SRO performance over

time and could provide SEC an additional systematic, fact-based way to

assess industrywide sanctions.

In contrast, CFTC maintained data and produced reports that could be

used to analyze industrywide sanctions. For example, CFTC’s reports
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showed that the difference we found in average fines at the Chicago

Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT)—

$5,300 versus $23,800, respectively—could be attributed to three fines at

CBOT that were unusually large. CFTC officials told us that they reviewed

industrywide information periodically to identify patterns or trends that

may require further review. However, they did not document the results of

these reviews.

SEC and CFTC are responsible for (1) administering and enforcing federal

securities and futures laws and regulations and (2) fostering fair and

efficient markets for the trading of securities and futures. Securities and

futures laws allow SEC and CFTC to delegate authority to SROs to

regulate and operate the markets in which securities and futures are

traded. SEC and CFTC are responsible for oversight and regulation of the

operations and activities of their respective securities or futures SROs.

Securities and futures SROs operate designated markets, or exchanges, for

the trading of securities or futures. In addition, two SROs—NASD and

NFA—are regulatory associations of registered securities or futures

industry professionals and firms. SEC, CFTC, and the SROs have

enforcement and disciplinary programs and processes for taking actions

against violators of federal securities or futures laws and regulations and

applicable SRO rules. Fines may be imposed as all or part of the sanctions

for these violations.

SEC and CFTC have statutory authority to investigate and prosecute

alleged violations of federal securities and futures laws. Securities SROs

have authority to enforce securities laws, regulations, and their own rules

on their members; futures SROs have authority to enforce their own rules.

Violators may be subject to a variety of sanctions, including fines. Other

sanctions include censures, injunctive orders, bars or suspensions,

rescissions of illegal contracts, disgorgements, and restitutions to

customers.5

SEC has the authority to bring actions against violators of securities laws

in federal district courts or through SEC administrative proceedings.6

These actions may result in money penalties, or fines, against the

 

5

Disgorgement orders require securities and futures law violators to surrender the profits gained or

losses avoided from their illicit activities.

6

The 1990 amendments to federal securities laws provided SEC authority to impose civil money

penalties under the Securities Act of 1933, the Securities Exchange Act, the Investment Company Act

of 1940, the Investment Advisors Act of 1940, and the rules of the Municipal Securities Rulemaking

Board.

Background

SEC, CFTC, and the SROs

Have Statutory Authority to

Impose Fines
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violators.7 Depending upon the seriousness of the violation and whether it

was committed by an individual or a firm, the fines can range from $5,500

to $1,100,000 or up to three times the gross amount of pecuniary gain from

the violation.8

 If the penalty is not paid within a prescribed time, SEC may

request contempt proceedings in federal district court to compel payment

or may refer the matter directly to the Department of the Treasury for

collection.

Similarly, CFTC is provided authority by the Commodity Exchange Act

(CEA) to discipline violators of the act and CFTC regulations through civil

actions in the federal district courts and through administrative actions.

CEA states that fines resulting from these actions may be up to $100,000,

or triple the monetary gain, for any person; or up to $500,000 for any

contract market (futures exchange), officer, or employee. Under a 1992

amendment to CEA, violators are to have their trading privileges

automatically suspended until their fines are paid. CFTC also may initiate

contempt proceedings or may refer unpaid fines to the Attorney General

for collection through actions in federal district court. CFTC officials told

us that they are considering whether to enter into an agreement with

Treasury under which CFTC would refer unpaid debt to Treasury for

collection in accordance with the Debt Collection Improvement Act of

1996.

Securities and futures laws also provide authority for SROs to impose

fines. Section 6 of the Exchange Act provides authority for any registered

securities exchange, such as the New York Stock Exchange (NYSE) or the

American Stock Exchange (Amex), to impose fines and other sanctions on

members who violate securities laws and regulations and SRO rules. In

addition, section 15A provides NASD similar authority as a registered

securities association.

Futures SROs have authority under CEA to discipline and penalize

members for violations of SRO rules. Sections 5a(a)(8) and (9) and 5a(b)

of CEA, in part, require futures exchanges, such as CBOT, CME, or the

New York Mercantile Exchange (NYMEX), to enforce their rules, take

appropriate disciplinary actions, and impose penalties on violators.

Similarly, section 17(b)(8) of CEA authorizes NFA to appropriately

 

7

As discussed later, SEC, CFTC, and the SROs may settle a case, including the fine amount, before the

court or administrative proceeding reaches a final decision.

8

All federal agencies must adjust civil monetary penalties for inflation as prescribed by statute (28

U.S.C. § 2461).
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discipline its members, including imposing penalties for violations of its

rules.

SEC and CFTC enforcement actions and disciplinary decisions of all

securities and futures SROs can be appealed. For example, SEC and CFTC

administrative cases can be appealed to the respective Commission,9 the

federal courts, and ultimately to the Supreme Court. Securities and futures

SRO cases can be appealed to higher authorities within the SRO; SEC or

CFTC, respectively; the federal courts; and the Supreme Court.

SEC, CFTC, and SROs may impose fines and other sanctions against

violators through their specific enforcement or disciplinary processes. SEC

or CFTC may bring actions in federal court or in administrative

proceedings before an administrative law judge (ALJ). SRO disciplinary

proceedings normally are heard by a disciplinary committee or hearing

panel, which may include SRO members; a professional hearing officer; or

a member of the public, depending on the SRO.10

SEC and CFTC enforcement actions may be initiated after investigations

by their respective enforcement staffs of alleged violations of laws or

regulations. Allegations may be identified from customer complaints;

examinations; market surveillance; or referrals from other federal, state, or

foreign agencies. After an investigation, enforcement staff prepare

memorandums to the commission that include the charges against the

alleged violators, any evidence of violations, and recommendations as to

whether further action should be taken. If the commission decides that a

case warrants further action, it can either file a civil suit against the alleged

violator in the federal district court or issue a complaint against the alleged

violator and order a public hearing on the matter before an ALJ. If either

the court or ALJ finds a violation of laws and regulations, it can impose

sanctions, including fines, against violators. According to an SEC official,

determining whether a case is referred to the courts or an ALJ depends

largely on the type of sanction staff want to obtain. For example, a bar

from the industry could be obtained from an ALJ, but only a court could

issue an injunctive order. Many cases are settled before the court or ALJ

renders a final decision when the alleged violator submits a settlement

offer agreeing to sanctions without admitting or denying liability. The

types and amounts of sanctions, including fines, are usually negotiated

 

9

Both SEC and CFTC have five-member commissions headed by chairpersons who are appointed by

the President for 5-year terms.

10Under the Futures Trading Practices Act of 1992, futures SRO hearing panels must have a nonmember

for certain types of proceedings.

How Fines Are Imposed
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between enforcement staff and the alleged violators. Offers of settlement

are not final until approved by SEC or CFTC.

SRO disciplinary cases usually begin as a result of a customer complaint,

compliance examination, market surveillance activity, regulatory filings, or

even an item reported in the press. SROs generally have enforcement

authority over only their members and employees. An SRO’s enforcement

or regulation division is responsible for investigating and prosecuting

disciplinary cases. The enforcement or regulation division is to investigate

possible violative activity and prepare a memorandum outlining the facts

and evidence found by its investigation. The disciplinary committee, SRO

staff, or other authorizing entity is to review the matter and decide

whether to issue a formal complaint against the alleged violator. If they

issue a complaint, a written statement of charges is to be sent to the

alleged violator to which he or she may be required to respond in writing,

either admitting or denying each charge. Upon receiving this response, the

enforcement staff is to schedule a hearing before a hearing panel. In the

hearing, the enforcement staff, acting as prosecutor, and the respondent

can present evidence and witnesses. The hearing panel must then examine

the evidence and decide on each charge and the appropriate sanction. A

written statement of the panel’s decision and sanctions is to be sent to the

respondent.

SRO disciplinary cases also can be settled with the respondent agreeing to

sanctions without admitting or denying liability. SRO officials told us that

settlements are common and are often preferred because they enable the

SRO to conserve investigative and legal resources and still remedy

violations.

In 1997, SEC approved an NASD proposal that cases be heard by a hearing

panel presided over by a professional hearing officer assisted by two

securities industry professionals, instead of being heard by members of

NASD district business conduct committees. The hearing panel’s decisions

may be appealed to NASD’s National Adjudicatory Council (formerly

called the National Business Conduct Committee), SEC, and the federal

courts. Also, in 1996, the Chicago Stock Exchange (CHX) proposed to

institute a disciplinary committee structure, which SEC was considering as

of June 1998. Until this proposal is approved, CHX disciplinary decisions

are to be made by its president and can be appealed to its Executive

Committee.
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Our work focused on the imposition and collection of fines through the

enforcement and disciplinary programs of SEC and CFTC and the

securities and futures SROs. The SROs we reviewed included Amex,

Chicago Board Options Exchange (CBOE), CBOT, CME, CHX, NASD, NFA,

NYMEX, and NYSE. CHX officials told us that CHX and the other regional

securities exchanges delegated their authority to examine the sales

practices of registered broker-dealers to Amex, CBOE, NASD, or NYSE

and administered few disciplinary actions. As a result, we excluded other

regional securities exchanges. We also excluded some futures exchanges

located in New York and those in Minneapolis, MN; and Kansas City, KS,

because they generally administered few disciplinary actions; or most of

their actions involved minor rules violations. Minor violations included

floor conduct, decorum, and recordkeeping violations that normally do not

undergo disciplinary proceedings. The exchanges generally referred to

these violations as “traffic ticket” violations, which are handled through

summary proceedings and involve smaller fine amounts.

We interviewed officials at SEC, CFTC, and the SROs to obtain information

about their enforcement and disciplinary programs and processes,

including their imposition of fines. We obtained copies of SEC and CFTC

regulations, SRO rules, and other documents regarding their enforcement

and disciplinary programs and the imposition of fines. We also obtained

data from SEC, CFTC, and the SROs on cases closed during the 5-year

period January 1992 through December 1996 that included a fine among

other disciplinary actions. Fines collected included cases that were either

paid in full or in part. We used these data to calculate fine collection rates

and other statistics for SEC, CFTC, and the SROs.

SEC, CFTC, and most of the SROs provided us with databases of their

records of fines administered during the 1992 through 1996 period. One

exchange, CBOT, did not maintain its fine collection records for past years

on a computer but provided us with monthly records on hard copy. We

drew a representative sample of 208 CBOT cases for 1992 through 1996

from a database of SRO disciplinary cases maintained by CFTC and NFA.

We then asked CBOT to provide us with the amounts of fines collected on

these sample cases. Another exchange, NYMEX, could not provide us

summary information on fines collected from 1992 through 1996 because it

did not maintain records on its fine collection activity apart from

individual case files. Using the CFTC/NFA database, we drew a

representative sample of NYMEX cases and asked NYMEX officials to

provide the amounts collected. However, they said that it would be very

burdensome for NYMEX to go back to all of the case files to obtain this

information. Therefore, we limited our sample selection to 31 cases from

Scope and

Methodology
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the 1992 through 1996 period and asked NYMEX officials to provide us

case documents and copies of checks so that we could develop

information on NYMEX collection activity. As a result, we could comment

only on the specific NYMEX cases reviewed, which are not representative

of the universe of NYMEX cases for this period. Amex, CBOT, and NYMEX

data also included some records on summary fines imposed for minor

violations that were not provided by other SROs.

To assess the reliability of the fine collection data that SEC, CFTC, and the

SROs provided, we asked officials at each agency whether they had

application controls in place to supervise data entry and safeguard the data

from unauthorized changes. We also asked whether they performed data

verification and testing. Although controls varied across the agencies, the

level of controls seemed adequate for our purposes. In addition, we

performed limited testing on SEC, CFTC, and SRO fine collection data

sets. We examined data fields for illegal entries (out-of-range values) and

illogical relationships between fields in the same data records. We found a

number of deficiencies in individual entries, such as inconsistencies in

how violators’ names were spelled, but they were not material to our

analysis.

To verify that fines reported as paid actually were paid, and to further

assess the accuracy and completeness of fine collection data, we obtained

copies of checks, deposit statements, or other documents showing that

fines had been paid for a small, judgmentally selected sample of closed

fine cases at each agency. We selected cases to provide a range of fine

amounts. To determine the reasons for which fines were waived, voided,

or written off as uncollectible, we reviewed a judgmentally selected

sample of cases involving these attributes at each agency where

applicable.

To determine the guidance SEC, CFTC, and SROs used in setting fines for

serious violations, we selected judgmental samples of cases in which the

same violator had been fined more than once during 1992 through 1996.

Our samples may not be representative of all SEC, CFTC, and SRO cases

for 1992 through 1996. For the sample cases, we reviewed complaint

documents, investigative memorandums, decision memorandums, and

other case documents.

To determine the extent to which SEC and CFTC assessed the results of

their disciplinary actions, including the fines they imposed, we interviewed

officials at each agency. We also reviewed SEC inspection reports and

CFTC rule reviews.
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We requested comments on a draft of this report from the Chairman, SEC;

the Chairperson, CFTC; and the heads of the SROs. Their written and oral

comments are discussed near the end of this letter.

We did our work in accordance with generally accepted government

auditing standards between October 1996 and October 1998. We performed

our work in Washington, D.C.; New York, NY; and Chicago, IL.

SEC, CFTC, and the SROs collected most of the over $400 million in fines

for cases they closed from 1992 through 1996. The percentage of total fine

amounts collected and the percentage of fines paid in full were relatively

consistent among agencies grouped according to their authorities to

collect fines—SEC and CFTC; the SROs that operate securities and futures

exchanges; and the two remaining SROs, NASD and NFA. SEC and CFTC

have federal regulatory authority to collect fines. Securities and futures

exchange members who do not pay their fines risk having the exchange

sell their membership, or “seat,” to cover the fine. NASD and NFA have

neither federal regulatory authority nor seats to sell to cover unpaid fines.

NASD and NFA officials said they often impose fines that they never

expect to collect because violators leave the industry. For the cases we

reviewed, most fines reported as paid actually were paid, and SEC, CFTC,

and the SROs took action when payment was considered unlikely.

However, some SROs lacked automated recordkeeping systems to capture

and maintain their fine collection activity.

As shown in table 1, SEC collected over 80 percent of the total dollar

amount of fines for cases it closed during 1992 through 1996. It collected

the full amount of the fine in over 90 percent of the cases. CFTC collected

over 80 percent of the dollar amount of fines for cases it closed during

1992 through 1996, and 60 percent of the fines were paid in full. The

percentage of dollars CFTC collected was influenced by two cases with

fines totaling $7.25 million that were paid in full. These two fines

accounted for about one-third of the total dollars fined for the period.

CFTC officials told us that CFTC’s lower percentage of fines paid in full

may be attributed to the longer time its fines may have been outstanding.

SEC has had civil monetary penalty authority only since 1990 (Securities

Enforcement Remedies and Penny Stock Reform Act of 1990), but CFTC

has had this authority since its inception in 1975. Thus, CFTC had older

cases than SEC in the inventory of cases closed during the period 1992

through 1996. These older cases had a greater chance of being written off.

Unlike the SROs, SEC and CFTC may bring enforcement actions in federal

court or institute administrative proceedings before an ALJ. SEC and

SEC, CFTC, and the

SROs Collected Most

Fines, but Collection

Rates Varied

SEC and CFTC Have

Federal Regulatory

Authority to Collect Fines
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CFTC also have the ability to seek court injunctive orders to impose fines

and to collect interest from violators who do not pay. In addition, SEC and

CFTC can refer unpaid fines to the Treasury Department and the Attorney

General for centralized debt collection.

Federal regulator

Number of

closed cases

Percent of

cases paid in

full

Percent of

cases all/part

written off

Total dollar

amount of

fines

Dollar

amount

collected

Percent of

dollars

collected

SEC 534 92% 8% $258,607,797 $215,163,074 83%

CFTC 147 60a 40 21,883,384 17,763,569 81 a

According to CFTC officials, the cases CFTC closed during this period included 45 cases for which

the fines had been uncollectible for a number of years. Excluding these cases would increase the

percent of cases paid in full to over 85 percent.

Source: GAO analysis of data provided by SEC and CFTC.

Overall, as shown in tables 2 and 3, securities and futures exchanges

generally collected a high percentage of fines during 1992 through 1996.

Among the securities exchanges, CHX, NYSE, and CBOE collected 95

percent or more of the dollar amount of fines on their closed cases, and

Amex collected 75 percent. Amex officials told us that all of the amounts

uncollected were written off because the cases related to firms or

individuals that filed bankruptcy or that, as a result of not paying the fine,

were permanently barred or suspended from trading at Amex until the fine

is paid. They said the total dollar amount of fines uncollected included

three large fines of $100,000 each, which reduced the percentage of dollars

collected for Amex. However, Amex, like the other securities SROs,

collected the full amount for 90 percent or more of its fines.

Exchange

Number of

 closed cases

Percent of

cases paid in

full

Percent of

cases all/part

written off

Total dollar

amount of

fines

Dollar

amount

collected

Percent of

dollars

collected

CHX 11 100% 0% $87,350 $87,350 100%

NYSE 195 95 5 9,887,000 9,731,000 98

CBOE 267 90 10 2,629,972 2,487,724 95

Amex 251 93 7 1,721,501 1,298,788 75

Source: GAO analysis of data provided by each exchange.

As shown in table 3, CME collected 85 percent of the amount of the fines

on its closed cases, but CBOT collected only 54 percent. The percentage of

dollars collected was lower for CBOT because of large fines that were

written off. CBOT considered fines in two cases totaling $2.25 million to be

uncollectible, substantially reducing the percentage of total dollars

collected. Excluding these two fines, CBOT’s collection rate for the dollar

Table 1: Fine Collection Rates for SEC and CFTC for 1992 Through 1996

Securities and Futures

SROs that Operate

Exchanges Collect a Large

Amount of the Fines They

Imposed

Table 2: Fine Collection Rates for NYSE, Amex, CBOE, CHX, 1992 Through 1996
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amount of fines would have been about 99 percent. We do not show

information on fine amounts for NYMEX because the 31 cases we

reviewed may not be representative of its actual collection activity. CME,

CBOT, and NYMEX each collected the full amount of 96 percent or more

of the fines they imposed for the cases we reviewed.

Exchange

Number of

closed cases

Percent of

cases paid in

full

Percent of

cases all/part

written off

Total dollar

amount of

fines

Dollar

amount

collected

Percent of

dollars

collected

CME 521 96% 4% $2,776,650 $2,366,950 85%

CBOT 208a 97 3 4,953,800 2,672,438 54

NYMEX 31b 97 3 N/A N/A N/A a

Representative sample selected from 477 cases closed from 1992 through 1996. The estimated

sampling error is ±5 percent at the 95 percent confidence level.

b

Judgmental, nonrepresentative sample selected from about 600 cases.

Source: GAO analysis of data provided by the exchange or NFA.

Members of securities and futures exchanges risk losing their membership

and membership privileges, including access to the exchange trading floor,

if they do not pay these fines.11 Exchange rules generally allow the

exchanges to revoke, suspend, expel, or otherwise terminate and sell a

violator’s membership if fines are not paid within the time period allowed.

Depending on the fine amount, the value of the membership, and the

proceeds from its sale, the proceeds can be used to offset unpaid fines. In

addition, CBOE requires members that lease seats to make a $500 deposit

that can be applied towards any unpaid fines.

As shown in table 4, collection rates for NASD and NFA were generally

lower than those shown in tables 1, 2, and 3 for SEC, CFTC, and the

exchanges. NASD and NFA officials told us they recognize that in some

cases fines imposed are not likely to be paid, especially when the fines are

high for conduct such as egregious violations or repeat violators. Violators

may leave the industry either to avoid the fine or because they are

suspended or barred as part of their sanctions. In either case, fines would

help remove violators from the industry and keep them from returning

until they pay their fines. SEC officials told us that NASD may actually

waive a fine unless the respondent attempts to reenter the industry, and

therefore the fine is not actually collectible except as a reentry fee. Should

 11Exchange officials told us that some seats are leased, and they would not pursue the seat owner for

violations of the lessee. Therefore, the threat of having the seat sold to pay a fine is not always

available.

Table 3: Fine Collection Rates for CBOT, CME, and NYMEX for 1992 Through 1996

NASD and NFA Officials

Said They Never Expected

to Collect Many Fines

Imposed
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the violators apply to reenter the industry, they would first have to pay any

outstanding fines.

NASD collected 24 percent of the total dollar amount of fines on its closed

cases, but 67 percent of the fines collected were paid in full. Similarly, NFA

collected 27 percent of the dollar amount of fines on its closed cases, but

54 percent of the fines collected were paid in full. We could not directly

verify whether these lower collection rates were due to fines that NASD

and NFA never expected to collect or other reasons because we could not

(1) identify cases with unpaid fines and disbarments from the data NFA

provided; or (2) electronically identify these data from the over 4,000 cases

NASD provided. However, NASD cases that were not paid had

disproportionately larger fines than its cases that were paid, an indication

that unpaid fines were set at relatively higher levels. NASD’s average dollar

amount for cases that were not paid was about $59,900 compared to

$12,500 for cases that were paid. About 70 percent of the cases that were

not paid had fines of $15,000 or greater; only about 10 percent of the cases

that were paid had a similar level of fines.

We found similar collection results at NFA. For example, NFA collected 2

of 11 fines that were $100,000 or greater. A CFTC official told us that if

cases involving both an unpaid fine and a disbarment were excluded from

our calculations, NFA’s fine collection rate would be similar to other

futures SROs.

Regulatory

association

Number of

closed cases

Percent of

cases paid in

full

Percent of

cases all/part

written off

Total dollar

amount of

fines

Dollar

amount

collected

Percent of

dollars

collected

NASD 4,076 67% 33% $113,857,938 $27,068,247 24%

NFAa 91 54 46 3,221,050 881,300 27b

a

Data cover cases closed July 1992 through June 1997.

b

NFA officials said that NFA’s collection rate should be 35 percent. They said the primary difference in

the rates is attributable to open regulatory fine invoices, which NFA includes as paid and we

excluded. NFA cited one firm that had a $200,000 regulatory fine invoice open at June 30, 1997, that

we considered uncollected. NFA reported that it has subsequently collected $155,000 of the fine and

anticipates it will collect the balance.

Source: GAO analysis of data provided by the SROs.

Exchange memberships, or seats, are limited in number and thus have a

monetary value, the loss of which can be used as leverage to enforce the

payment of fines. NASD and NFA memberships are basically unlimited in

number and do not involve seats. Therefore, they do not have a financial

interest that can be sold to pay a fine. However, NASD and NFA

registrations can be suspended or revoked or their members expelled.

Table 4: Fine Collection Rates for NFA and NASD for 1992 Through 1996
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Page 14 GAO/GGD-99-8 Fine Imposition and Collection Activities

Once violators lose their membership privileges, they have little or no

incentive to pay their fines. According to an NASD official, high fines

effectively remove violators from the industry because the violators have

no intention of paying such fines to stay in, or later returning to, the

securities industry. An NFA official stated that violators who fail to pay

their fines also tend to allow their memberships to terminate uncontested.

In an effort to ensure that more fines are paid, NFA has proposed a rule

change that would require respondents who request hearings on

disciplinary charges to post bond, which would be applied toward the

payment of any pending fines. According to CFTC officials, CFTC staff

objected to the proposal because the bond would be used to secure

payment of the fine rather than ensure appearance at a hearing. Further,

the officials said that respondents could be automatically suspended for

failure to post bond, whether they were guilty or not, which could violate

the respondents’ right to due process. As of June 30, 1998, NFA had not

resubmitted the bond proposal to CFTC for its reconsideration.

For the selected cases we reviewed at SEC, CFTC, and the SROs, most

fines reported as paid actually were paid. When SEC, CFTC, and the SROs

determined that collection was unlikely, they took action to write off,

waive, or void fines.

For the selected cases of fines reported as paid (see table 5), we verified

that the amounts actually had been collected. We accepted as

documentation that the fine was paid either a copy of a check that had

been remitted to SEC, CFTC, or an SRO for payment; or other pertinent

documentation, such as a bank deposit slip. We found that in most cases

SEC, CFTC, and SROs had collected the full amount of the fine assessed.

In some cases, SEC and CFTC even collected amounts that exceeded the

assessed fine amount because of interest payments or disgorgements. For

example, three cases at SEC and one case at CFTC involved amounts

collected that exceeded the fine amounts assessed, each of which involved

the payments of interest or disgorgements. However, 3 futures SROs could

not provide documentation to show fines were paid in 4 of the 46 total

cases we reviewed.

Appropriately documenting that fines are paid provides an important

internal control to ensure that the money is collected and accounted for.

SEC, CFTC, and the SROs

Had Collected Most Fines

Reported as Paid and Took

Action When They

Considered Collection

Unlikely

Selected Fines Reported as Paid

Actually Were Paid
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Page 15 GAO/GGD-99-8 Fine Imposition and Collection Activities

Although most SROs recorded fine collection activities for past and

current years on computer files, CBOT kept records on a computer file

only for the current year; records for past years were kept only on hard

copy. Amex kept records of its fine collection activity in a hard copy

ledger. Amex responded to our request for information by incorporating

these data into a computer spreadsheet. NYMEX did not consolidate its

records of fine collection activity but kept records in individual case files.

CHX, which had only 11 disciplinary cases from 1992 through 1996, also

had no computerized records.

Table 5 shows the fine amounts reported as paid and the amounts paid.

Regulator

Number of cases

reviewed

Amount of fines

reported as paid

Amount

documented as

actually collected

 SEC 20 $8,949,768 $8,967,850a

 CFTC 20 6,316,000 6,483,442b

Securities exchange

 Amex 20 312,500 312,500

 CBOE 21 645,246 642,698c

 CHX 3 27,000 27,000

 NYSE 20 3,748,500 3,748,500

Futures exchanges

 CBOT 19 15,600 14,350d

 CME 16 110,600 108,600e

 NYMEX 15 6,700 5,750f

 NASD 15 270,998 270,998

 NFA 9 267,050 258,550g

a

The amount paid includes $6,728 in interest on two fines and $11,354 in disgorgements and interest

on another fine.

b

The amount paid includes (a) $17,000 interest on a fine of $200,000, (b) a $300,000 fine that had

doubled to $600,000, and (c) a $150,000 fine that had not been paid because it had been vacated on

appeal.

c

The amount paid includes a $10,948 fine that the violator was paying in installments. The violator still

owed $2,548.

d

CBOT could not provide documentation for one fine of $1,000 and another of $250.

e

CME waived parts of four fines totaling $3,500. CME also collected $1,500 that had been previously

waived.

f

The amount collected includes a fine that had been reduced from $1,000 to $250 on appeal. The

amount paid includes a $500 fine of which only $300 had been paid.

g

NFA could not provide documentation for one fine of $7,500 and another for $1,000.

Source: GAO analysis of documents provided by SEC, CFTC, and the SROs.

When SEC, CFTC, and SROs assess fines, they give violators a specific

time period in which to pay. For settled cases, SEC, CFTC, and the SROs

generally demand payment at settlement. In cases that are not settled, the

time periods to pay fines varied. SEC said it gives violators 30 days to pay;

CFTC officials said payment dates are subject to negotiation, but they

Table 5: Amount of Fines Reported as

Paid and Amount Documented as

Actually Collected for Cases Reviewed
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Page 16 GAO/GGD-99-8 Fine Imposition and Collection Activities

typically give 10 days to pay. SRO rules prescribe when fines are due. For

example, NYSE gives violators 45 days to pay. Other SROs give violators

from 15 to 30 days to pay. These time frames can be delayed or suspended

when violators request an appeal of the fines imposed. Also, SEC, CFTC,

and some SRO officials told us that when the situation warrants, they can

allow installment plans for payment.

SEC, CFTC, and the SROs continued to seek collection of unpaid fines

using their own internal collection methods when fines were not paid

within the allotted time frame.12 They also initiated other disciplinary

actions for the lack of payment, such as suspensions or temporary

expulsions. When they determined that payment was unlikely, they wrote

off, waived, or voided the fines.

For each case we reviewed in which fines had not been paid in full, the

case files documented why the fines could not be collected. This

documentation showed that the primary reasons that fines were unlikely

to be collected were bankruptcy or failure to locate the respondents.

According to an SRO official, most bankruptcy courts consider SRO fines

to be unsecured debt, which usually has a low priority for payment. This

official said fines owed to SROs in these cases are often discharged by the

courts, making the violators no longer responsible for paying the fines. The

case files also showed other reasons why fines were considered

uncollectible, including that violators had been suspended or barred from

the industry, had their registration revoked, or had been expelled from

membership.

Two SROs, Amex and CME, had voided or waived fines. Amex officials

told us that as a routine recordkeeping practice they void appealed cases

from the Amex database until the appeals process is completed. Before

late 1997, Amex reopened cases under new case numbers when

respondents contested fines.13 We reviewed 11 randomly selected Amex

voided cases and found that 6 of the cases were contested fine amounts

that were assigned new case numbers. Amex voided two cases because the

respondents filed bankruptcy. Amex voided the remaining three cases

because it had mistakenly fined persons for failure to file specific year-end

reports who were not members of the exchange at that time.

 

12A few of the SROs had used professional collection agencies to collect fines. However, SRO officials

said the costs to collect fines using these agencies were high, and the collection agencies’ success rates

were minimal.

13An Amex official told us that in late 1997, instead of assigning new file numbers, Amex began to retain

the same identification numbers, adding a letter “A” designation to indicate cases had been appealed.

Regulators Took Action

When They Considered

Payment Unlikely
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Page 17 GAO/GGD-99-8 Fine Imposition and Collection Activities

CME officials told us that they use waivers mostly for computerized trade

reconstruction (CTR) violations. Waivers release violators from payment

of all or part of their fines, on the condition that they do not commit the

same violation for a given time period. According to a CME official, CME’s

rules do not provide for the use of waivers, but its committees have found

waivers to be an effective compliance mechanism. Waivers are initiated

and granted by a hearing committee on the basis of violators’ presentation

of mitigating evidence and their historical record with the exchange. If the

violators have another violation during this period, the original fines

become due and additional fines can be imposed. CME is to advise CFTC

of its decisions, and the violators are to report the disciplinary action to

NFA. Waivers have worked well for CTR violations, said the official,

because these violations are measurable and can be monitored by

computer. He said that these violations have declined since 1996.

Securities and futures laws set maximum fines for civil actions and

administrative proceedings, but fines can be higher than these maximums

when they involve many violations or when they are based on the profits

generated by the illegal activity. The courts and ALJs set fines, with input

from agency enforcement staff, after considering such factors as the

seriousness of the violation, the number of repeat violations, and the

precedent set by similar cases. These factors were generally documented

in the SEC and CFTC case files that we reviewed. All the securities and

futures exchanges had prescribed fine amounts for minor violations of

exchange rules and policies. For more serious violations, one SRO, NASD,

had written guidance that specified ranges of fine amounts. The factors

that officials from the other SROs told us they used were the same as those

that SEC and CFTC considered in setting fines. At the time of our review,

we could not determine the factors some SROs considered in setting fines

for more serious violations because documentation was not routinely

included in case files. Subsequently, the SROs provided additional

documentation to show the factors they considered in setting fines for

these violations.

The federal securities laws provide maximum penalties in a three-tiered

structure for SEC civil actions and administrative proceedings to address

violations of the laws and regulations. The principal penalty provisions are

Section 20 of the Securities Act, Sections 21A and 21B of the Exchange

Act, Sections 9 and 42 of the Investment Company Act, and Sections 203

and 209 of the Investment Advisers Act. In the first tier, the amount of the

fine is not to exceed the greater of $5,500 for a natural person or $55,000

SEC, CFTC, and

the SROs Have

Considered a Variety of

Factors in Setting

Fines

Maximum Fines Set by Law

for SEC and CFTC
B-275115

Page 18 GAO/GGD-99-8 Fine Imposition and Collection Activities

for any other person,14 or the gross amount of pecuniary gain to the

defendant as a result of the violation.15 If the violation involved fraud,

deceit, manipulation, or deliberate or reckless disregard of a regulatory

requirement, the second tier provides that the amount of the fine is not to

exceed the greater of $55,000 for a natural person or $275,000 for any other

person, or (in civil actions only) the gross amount of pecuniary gain to the

defendant as a result of the violation. If the violation involved fraud, deceit,

manipulation, or deliberate or reckless disregard of a regulatory

requirement and directly or indirectly resulted in substantial losses or

created a significant risk of substantial losses to other persons or (in

administrative proceedings only) resulted in substantial pecuniary gain to

the person who committed the violation, the third tier provides that the

amount of the penalty is not to exceed the greater of $110,000 for a natural

person or $550,000 for any other person, or (in civil actions only) the gross

amount of pecuniary gain to the defendant as a result of the violation. The

provisions governing the imposition of fines in a judicial proceeding and an

administrative proceeding are generally the same, with differences relating

to the consideration of pecuniary gain, noted above. Civil penalties for

insider trading violations are defined separately and are not to exceed

three times the amount of the profit gained or loss avoided by the inside

trader. A person who controls an inside trader may be liable for a penalty

not to exceed the greater of $1,100,000 or three times the amount of the

profit gained or loss avoided by the inside trader.

Section 6 of CEA provides CFTC the authority to impose fines in

administrative proceedings of not more than the higher of $100,000 or

triple the monetary gain resulting from the violations. Section 6c provides

CFTC the authority to seek penalties of $100,000 or triple the monetary

gain for each violation of the futures laws and regulations through civil

actions in federal district court. In addition, Section 6b provides CFTC the

authority to impose fines of up to $500,000 for failure of a contract market

(an exchange or board of trade) to enforce its rules or for any official or

employee of a contract market who violates the futures laws and

regulations.16 In setting a civil penalty, CEA requires CFTC to consider the

appropriateness of the penalty to the gravity of the violation.

 

14As defined in Section 3(a)(9) of the Exchange Act, the term “person” means a natural person,

company, government, or political subdivision, agency, or instrumentality of a government.

15All penalties were increased to adjust for inflation as required by the Debt Collection Improvement

Act of 1996.

16In determining the amount of the penalty under this section, CFTC must consider the gravity of the

offense and, in the case of a contract market, whether the amount of the penalty will materially impair

the market’s ability to carry on its operations and duties.
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Page 19 GAO/GGD-99-8 Fine Imposition and Collection Activities

SEC officials told us that courts and ALJs primarily consider the

seriousness of the violation, the number of repeat violations, and the

precedent set by similar cases in setting fines for securities law violations.

In addition, securities laws provide guidance on factors to consider in

setting fines. In administrative proceedings, the amount of the fine SEC

may impose is to be based upon the level of intent of the violator and a

determination that the fine is in the public interest. In SEC’s determination

of whether the imposition of the fine is in the public interest, the statute

provides that it may consider the following: (1) whether the act or

omission involved fraud, deceit, manipulation, or deliberate or reckless

disregard of a regulatory requirement; (2) the harm to others, resulting

either directly or indirectly from the act or omission; (3) the extent to

which any person was unjustly enriched, taking into account any

restitution made to persons injured by such behavior; (4) previous

violations; (5) the need to deter the defendant and other persons from

committing such acts or omissions; and (6) such other matters as justice

may require.17 Further, the statute provides that SEC may consider the

respondent’s ability to pay on the basis of evidence submitted by the

respondent in determining whether the penalty is in the public interest. In

a civil proceeding, the statute does not contain the public interest test.

We found documentation in the case files for 12 of 14 judgmentally

selected SEC cases that showed the courts and ALJs used a variety of

these factors to set fines. However, the documentation for each of the 12

cases showed that the courts and ALJs primarily considered the violators’

illicit financial gain and the precedent set in other cases to set the fines.

For example, one firm was fined $1.9 million because SEC established that

this was the amount of the pecuniary gain the firm illicitly obtained from

its customers. In another case, the court fined a large brokerage firm

$850,000. SEC documents showed that the court set the fine at this level

because other brokerage firms had been fined similar amounts for similar

violations. Most of the case files contained documentation showing that

SEC considered the sanction imposed, including the fine, appropriate to

deter repeat violations and to deter others from committing the same

violation.

 1715 U.S.C. § 78u-2(c).

Factors SEC Considered in

Setting Fines Were

Generally Documented in

Case Files Reviewed
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Page 20 GAO/GGD-99-8 Fine Imposition and Collection Activities

CFTC has identified certain factors that it considers when determining the

amount of a fine. In November 1994, CFTC completed a study of the

futures industry’s fines and provided the report to Congress.18 In

conjunction with this study, CFTC published a policy statement containing

the major factors that have influenced CFTC in its civil money penalty

assessments. These include the gravity of the offense, financial condition

of the violator, and other considerations. Table 6 lists each major

consideration and its influencing factors. CFTC published this list to

provide a coherent statement of what it considers in setting fines, to

enhance the public’s awareness of these considerations, and to provide

insight into the possible future application of such authority.

Major considerations Influencing factors

Gravity of the offense —whether the violation involved fraud,

manipulation, or affected market integrity

—whether the violator acted intentionally or

willfully

—whether the violator acted in concert with

others

—number and duration of violations

—whether the violator benefitted from

wrongdoing

—whether the violations resulted in harm to

victims

—whether the violator attempted to cure

violation, disclosed wrongdoing, or provided

restitution

Financial condition —net worth of the respondent

—business viability

Other considerations —sanctions imposed in similar cases

—prior misconduct

—collectibility of the penalties

—double jeopardy

—conservation of CFTC resources

Source: CFTC Policy Statement Relating to Its Authority to Impose Civil Money Penalties and Futures

SROs’ Authority to Impose Sanctions, Nov. 1994.

Our review of a judgmental sample of 16 CFTC cases showed that CFTC

followed these guidelines in setting fine amounts. Eleven of the 16 cases

had documentation showing that CFTC considered the precedent set in

similar cases, the violator’s net worth, or various other case circumstances

to determine fine amounts. In most cases, CFTC accepted the alleged

violators’ offers of settlement because the agreed-upon fine amounts and

other sanctions were deemed appropriate given the violations and because

the offers were similar to amounts accepted in previous cases. For

 

18A Study of CFTC and Futures Self-Regulatory Organization Penalties, Commodity Futures Trading

Commission (Washington, D.C., November 1994).

Factors CFTC Considered

Were Generally

Documented in the Case

Files Reviewed

Table 6: Factors CFTC Considers in

Setting Fines
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Page 21 GAO/GGD-99-8 Fine Imposition and Collection Activities

example, CFTC fined one large firm $925,000 for various violations,

including failure to properly segregate customer funds and failure to

diligently supervise employees and their trading activities. CFTC stated

that the fine was appropriate because the violations were more significant

than similar violations committed by another large firm that had previously

been fined $725,000.

Securities and futures exchanges have rules that contain specific fine

amounts for violations of exchange rules and policies, referred to as minor

violations. These minor violations include infractions of reporting, record

retention, or floor decorum requirements. Minor violations are subject to

smaller fines and are not considered serious violations of securities and

futures laws because they do not cause the same financial harm.

The fines for minor violations on securities and futures exchanges

generally ranged from $25 to $5,000, and in exceptional cases may be as

high as $10,000. For example, at Amex individuals violating recordkeeping

requirements are to be fined $500 for the first violation, $1,000 for the

second violation, and $2,500 for subsequent violations. For member firms,

fines for this violation and its reoccurrence were $1,000, $2,500, and

$5,000, respectively. At CBOT, individuals violating floor conduct rules

could be fined, depending on the activity, from $25 to $500, with fines

increasing for subsequent offenses. CBOT’s Floor Conduct Committee has

discretion to increase fines when minor rule violations are excessively

repeated, up to a maximum fine of $5,000.

NASD was the only SRO that had written guidelines, NASD Sanction

Guidelines, for setting fine amounts for more serious violations. NASD

officials told us that NASD has had these guidelines for over 10 years. The

12 NASD districts are to use these guidelines to decide appropriate

sanctions, including fines, for particular violations. In May 1993, NASD

made the guidelines available to its members to provide them the fine

schedule and information on other actions to be taken for specific types of

violations. NASD revised these guidelines, effective May 1998.

The old guidelines, which were effective for the cases included in our

review, provided specific fines and other sanctions for 47 securities

industry violations. For example, the guidelines provided fines that ranged

from $5,000 to $50,000 for unauthorized transactions. For the sale of

unregistered securities, the guidelines provided fines ranging from $2,500

to $50,000. The actual fine to be imposed generally depended upon several

mitigating or aggravating factors that could increase or decrease the fine

beyond the limits set forth in the guidance. For example, when NASD

Securities and Futures

Exchanges Have Fine

Schedules for Minor

Violations

NASD Has Written

Guidance for Setting Fine

Amounts for Serious

Violations
B-275115

Page 22 GAO/GGD-99-8 Fine Imposition and Collection Activities

considered the specific fine amount to set for unauthorized transactions, it

was to evaluate 10 factors, including whether the violator attempted to

conceal the misconduct or repeated the violation. The objective of the

guidelines was to guide the various district committees in an effort to

achieve greater consistency, uniformity, and fairness when imposing

sanctions, not to prescribe fixed fine amounts or sanctions for particular

securities violations.

NASD’s revised guidelines increased maximum fine amounts for some

violations. For example, maximum fines for unauthorized transactions

increased from $50,000 to $75,000. Other maximum fine amounts, for

violations such as the sale of unregistered securities, remained the same.

The new guidelines also grouped particular violations under 11 summary

categories.

We reviewed 19 NASD cases to determine if the fines imposed fell within

the ranges prescribed by NASD guidelines. We found that in 17 of the 19

cases, the fines imposed fell within the range prescribed. For example, one

case involved a broker who had been fined $50,000 and barred from the

securities industry for repeated unauthorized transactions violations.

These are the maximum sanctions prescribed by the guidelines. In this

case, NASD noted that the two actions imposed will serve to deter any

future or similar conduct by others who may be inclined to engage in

similar violations.

In one case in our sample that fell outside the fine range set by the

guidelines, we found a $225,000 fine that had been imposed against a

broker-dealer for unauthorized transactions and failure to supervise its

employees. The maximum fine amount established for unauthorized

transactions is $50,000 and $25,000 for the failure to supervise. NASD’s

files showed that NASD had noted various deficiencies in three separate

examinations of the broker-dealer; thus, it had imposed a higher fine than

the guideline amounts. In the other case, we found that NASD imposed a

$400,000 fine on a brokerage firm for extensively selling various securities,

including derivatives, which were unsuitable for clients. The maximum

fine for this violation, according to NASD sanction guidelines, was $50,000.

The case file also noted that the firm lacked written supervisory

procedures and failed to adequately supervise its registered

representatives, which had a maximum fine of $25,000. The case file

referred to potential losses for this firm’s customers of about $14 million,

which may have influenced the fine amount, but the case file did not

document a specific reason why the fine exceeded the NASD prescribed

amounts.
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Page 23 GAO/GGD-99-8 Fine Imposition and Collection Activities

Unlike NASD, other securities and futures SROs do not have specific

written guidance for setting fines for more serious violations. Officials at

these SROs told us that they prefer to have flexibility when setting fine

amounts for violations. The officials said they set fines on a case-by-case

basis, relying on the recommendations of enforcement attorneys and the

discretion of an ALJ or disciplinary committee, rather than on prescribed

guidelines. They said that they consider a variety of factors to determine

fine amounts, including the type and seriousness of the violation; the

respondent’s prior disciplinary history; the monetary precedent set by

other similar or like cases; and the illicit financial gain, if any.

For the judgmentally selected cases we reviewed at Amex, NYSE, CBOE,

and CHX to determine how they set fines for their more serious violations,

the documentation these SROs initially provided us did not always show

that they considered the factors listed above. SRO officials told us that in

many cases, particularly involving settlements, the internal discussions

that lead to agreed-upon fine amounts are not documented. Amex, CBOE,

and NYSE officials told us they prepared memorandums for each case,

which provide the basis for the sanctions imposed. The officials said that

the memorandums discuss possible sanctions, including ranges of fines,

the current violation, the violator’s disciplinary history, and precedent set

in similar cases. At the time of our review, Amex, CBOE, and NYSE did not

provide us these memorandums for various reasons, including that they

were contained in the complete case files, which had already been

archived offsite; or that they contained sensitive information.

Subsequently, Amex and NYSE provided sections of these memorandums

that showed the reasons why fines were assessed for the cases not already

documented. CBOE did not prepare these memorandums until 1996 and

did not have them for the cases we reviewed.

Of the 16 cases we reviewed at Amex, 13 files had supporting

documentation to show the factors Amex considered when setting fine

amounts. Each of the 13 cases involved Amex Rule 590 violations, which

Amex considers minor rule violations. For example, Amex fined a broker

$50 and $300, respectively, for his first two decorum violations and

imposed a $500 fine when he failed to wear the proper attire a third time.

Documentation in the file showed that Amex considered that the latest

violation was a repeat occurrence. The broker was assessed the highest

amount established by the minor rule violations fines schedule for

decorum violations. The remaining three Amex cases had fine amounts of

$30,000, $50,000, and $200,000 and involved serious violations of Amex

rules or the federal securities laws. Apart from noting the type and

seriousness of the violations, the case file information we reviewed for

Other Securities and

Futures SROs Allow More

Flexibility in Setting Fine

Amounts

Securities SROs
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Page 24 GAO/GGD-99-8 Fine Imposition and Collection Activities

these three cases did not show how Amex arrived at each fine amount.

However, the precedent memorandums that Amex provided us later

showed the reasons why the fines were set, including precedent set in

similar cases and the respondent’s disciplinary history.

All of the 13 cases we reviewed at NYSE were for violations of securities

laws. Six of the 13 cases had documentation to show how NYSE arrived at

the fine amounts set in each case. Subsequently, NYSE provided precedent

memorandums for each case that showed the reasons why fines were set

for the remaining seven cases. Specifically, NYSE considered the firms’

disciplinary history and precedents set in similar cases to determine the

current fine amounts. For example, one broker-dealer firm was assessed a

$250,000 fine and an undertaking for failing to maintain appropriate

procedures of supervision and for failing to register its securities

representatives and traders.19 The documentation in this case file showed

that NYSE considered the firm’s prior investigative and disciplinary

history, which included a previous fine of $5,000 for the same violation and

the firm’s continuing and repeated failures to comply with previous

compliance stipulations.

Of the 20 case files we reviewed at CBOE, none of the cases contained

documentation to show how CBOE arrived at setting the fine amounts.

The documentation in the case files detailed only the types of violations

and other sanctions imposed, such as undertakings. For example, as a

result of a joint CBOE and NYSE investigation, one firm had been fined

$450,000 for various securities violations. The case file contained

information on the violation and sanctions imposed, which also included

an undertaking to retain an outside consultant to review and report on the

firm’s systems and procedures. CBOE files contained no documentation to

show what factors were considered when the $450,000 fine was set. CBOE

officials told us that since late 1996, they have required each case to have a

precedent memorandum that documents the reasons fines are set.

The three cases we reviewed at CHX did not contain documentation to

show how the exchange set the fines.20 CHX officials told us that the files

did not contain documentation because CHX cases are normally concluded

after the respondent makes a monetary offer to settle the case. They said

 

19An undertaking is a specific action that the violator is required to take, such as prepare written

supervision procedures.

20CHX had 12 cases involving fines over the 5-year period we reviewed. One of these cases was pending

and 11 were settled. Because CHX officials told us that these cases had no documentation for fine

amounts, we reviewed only three to verify the lack of documentation.
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Page 25 GAO/GGD-99-8 Fine Imposition and Collection Activities

they accept only settlements that are based on precedent set in previous

cases.

CFTC’s policy statement published after its 1994 penalties study included

factors that futures SROs are to consider as guidance in determining fines.

The SRO guidance contains the same factors that CFTC reported it

considers in determining fines (see table 5). The policy statement also

identifies other factors that the SROs indicated to CFTC that they

consider, including the particular commodity involved or any pending

disciplinary actions by CFTC or another SRO concerning the same offense.

It states that these factors together should guide the SROs in determining

the sanctions to impose on a case-by-case basis. It also suggests that

futures SROs develop criteria consistent with their own regulatory

experience and minimal standards of fairness for the fines they impose.

For the cases we reviewed at CBOT, CME, and NFA, we found little

documentation to show how these SROs set fines, including whether they

considered the factors CFTC suggested. All nine cases we reviewed at

NYMEX included documents showing the factors considered in setting

fines. Also, CME was the only SRO that had developed additional criteria.

Two of the four cases we reviewed at CBOT had documentation that

showed CBOT explicitly considered the disciplinary history of respondents

to set fines as suggested by CFTC. Other than listing the type of violation,

the factors that CBOT considered in setting fine amounts for the remaining

two cases were not documented.

In addition to CFTC’s guidance, CME has rules that list the sanctions

available for major offenses, including a maximum fine of not more than

$250,000. However, CME’s rules do not address the method for

determining the dollar amount of fines or for choosing which sanctions to

impose. Only 1 of the 10 case files we reviewed at CME contained

documentation that provided some rationale for the fine imposed. In that

case, CME imposed an automatic fine of $5,000 on a violator who

repeatedly exceeded a trading limit. Upon review, CME later reduced the

fine to $1,000 because the violator exceeded the limit by only 0.3 percent

and took corrective actions. We could not determine what factors CME

considered in the remaining nine cases.

In each of the nine cases we reviewed at NYMEX, documentation showed

that NYMEX considered the seriousness of the violation and the

disciplinary history of the respondents as suggested by CFTC. For

example, one case involved a member firm that had been fined $240,000 in

1994 for being undercapitalized. Documentation in the case file showed

Futures SROs
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Page 26 GAO/GGD-99-8 Fine Imposition and Collection Activities

that NYMEX considered that the firm had been warned of its

undercapitalization since 1992. The file showed that NYMEX levied the

$240,000 fine because the member firm had failed to notify it of the firm’s

continued adverse financial status and also failed to meet the capital

requirements required of NYMEX member firms.

NFA officials told us that they use CFTC guidance to set fines. Only 6 of

the 14 cases we reviewed at NFA had documentation of the rationale for

the fines imposed. For example, the hearing panel reduced a fine in one

case, although the offense was serious and it was a repeat violation,

because the violator had taken mitigating actions.

Both SEC and CFTC, as part of their regular SRO oversight, reviewed the

adequacy of disciplinary program sanctions and found some inadequate

sanctions. However, each takes a different approach to analyze the

comparative adequacy of SRO sanctions across their respective industries.

SEC officials told us that they do not analyze industrywide data but instead

use the results of their regular SRO inspections and meetings with senior

SRO officials to assess overall SRO performance. However, analyzing

industrywide data to identify changes in SRO performance over time could

provide SEC an additional systematic, fact-based way to assess the

comparative adequacy of SRO sanctions. In contrast, CFTC officials told

us that they reviewed industrywide sanctions data periodically to identify

patterns or trends in futures SRO performance that may require further

review. However, they said that CFTC did not document the results of

these reviews.

SEC officials told us that they review the disciplinary program of each

securities SRO during their regular oversight inspections. They said they

review a selected sample of cases to identify patterns of inadequacy in

disciplinary sanctions, including fines. CFTC officials said that they review

every disciplinary case included in their inspection period at each futures

SRO during routine rule enforcement reviews. The reports for the reviews

we examined showed that both agencies found patterns of inadequacy and

recommended actions the SROs could take to improve their disciplinary

programs including preventing future inadequate sanctions.

For example, 18 of the 19 SEC inspections of SRO enforcement

departments performed in 1995 and 1996 included reviews of the adequacy

of sanctions imposed by Amex, CBOE, NYSE, and 11 NASD Districts.21 The

 21During the 2-year period one inspection was completed for enforcement departments of Amex, NYSE,

CBOE, and NASD Districts of San Francisco (District 1), Los Angeles (District 2), Kansas City (District

4), Dallas (District 6), Atlanta (District 7), and Boston (District 11). Two inspections were completed

SEC Does Not Analyze

Fines Industrywide,

and CFTC Does Not

Document its

Industrywide Analysis

SEC and CFTC Oversight

Reviews Found Inadequate

Sanctions
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Page 27 GAO/GGD-99-8 Fine Imposition and Collection Activities

reports for 11 of the 18 inspections indicated that SEC either found SRO

sanctions to be adequate or found no deficiencies. Reports for six

inspections found some sanctions inadequate and recommended ways to

ensure that future sanctions would be adequate. One inspection found the

SRO improperly accepted an offer of settlement by a violator who had

already ignored the terms of settlement and denied his guilt. SEC

inspection reports completed on the market surveillance departments at

NYSE, Amex, NASD, CBOE, and the regional exchanges (Boston,

Cincinnati, Chicago, Pacific, and Philadelphia Stock Exchanges) also

included comments on the adequacy of sanctions imposed. For example,

in a 1996 inspection report, SEC found that an exchange’s sanctions were

inadequate in three cases, and it recommended ways to ensure that future

sanctions would be adequate. SRO officials told us that they have taken

actions to correct the deficiencies SEC identified in both enforcement and

market surveillance departments.

CFTC reviewed the adequacy of sanctions, including fines, during at least

one rule enforcement review for each of the nine futures exchanges.22

CFTC found that fines were adequate at six of the exchanges and

inadequate at one exchange, for which it recommended ways to improve

future fines. Two of the exchanges had no disciplinary actions. Futures

SROs told us that they had taken action to correct the deficiencies

identified.

Apart from these reviews, CFTC officials told us that they also review all

SRO disciplinary action notices filed with CFTC to evaluate the adequacy

of the sanction. If the sanction appeared inadequate, they said they

conduct a further review and may take action, if necessary. In one case,

CFTC reviewed the sanctions imposed by CBOT at the expiration of the

March 1996 wheat futures contract. CBOT had issued letters of reprimand

to six members for trading after the close of the market. CFTC concluded

that (1) the letters of reprimand were inadequate because they were not

commensurate with the gravity of the violation, and (2) CBOT failed to

follow CFTC guidance on imposing effective penalties. CBOT responded

that the Commission lacked authority under CEA to institute a review of a

CBOT disciplinary proceeding and that the CBOT disciplinary committee

 for NASD Districts of Chicago (District 8), Denver/Seattle (District 3a/3b), New Orleans (District 5),

New York (District 10), and Philadelphia/Washington, D.C. (District 9). According to SEC officials, SEC

completed one inspection for each regional exchange during this period.

22These nine exchanges included the Chicago Board of Trade; Chicago Mercantile Exchange; Coffee,

Sugar, and Cocoa Exchange; New York Cotton Exchange; Kansas City Board of Trade; New York

Futures Exchange; New York Mercantile Exchange; Minneapolis Grain Exchange; and the Philadelphia

Board of Trade.
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Page 28 GAO/GGD-99-8 Fine Imposition and Collection Activities

did consider the CFTC guidance in imposing the penalties. In an opinion

and order issued November 6, 1997, the Commission concluded that the

letters of reprimand issued by CBOT were inadequate in light of the

seriousness of the violations alleged. CFTC directed CBOT to reopen the

proceedings against the violators and either reach new settlements or

augment its prior investigations, as appropriate, and conduct full

disciplinary hearings consistent with the requirements of CFTC rules.

SEC officials told us that they do not use industrywide data to assess

comparative SRO sanctions because such data are not easily quantified

and are not meaningful without additional review. They said that they use

routine inspections of the surveillance, investigatory, and enforcement

programs of securities SROs and discussions with SRO officials to

determine the comparative adequacy of sanctions. They described SEC’s

routine inspections of SROs’ enforcement programs as follows:

SEC reviews randomly selected files of SRO enforcement cases. For each

case file reviewed, SEC analyzes, among other things, the adequacy of the

resolution of the disciplinary action. In assessing the adequacy of the

resolution, SEC considers a number of factors, including the existence of

previous violations by the subject, the level of cooperation, and the

amount of financial losses caused by the violation. SEC also reviews any

fine schedule contained in the SRO’s rules, either as a part of the SRO’s

minor rule plan or general disciplinary rules. If SEC considers that the fine

or sanction imposed in the case is questionable, SEC ensures that the

sanction is consistent with the SRO’s own fine schedule. If SEC still

believes that the fine or sanction is inadequate, although consistent with

the SRO’s schedule, SEC will compare the SRO’s fine schedule with the

fine schedules of other SROs and will determine whether the fine is

consistent with industry norms. In addition, in concluding whether the

sanction is inadequate for purposes of the inspection report, SEC gathers

information on past fines at the SRO and on current and past fines at other

SROs for the type of violation. Such information is found in current and

past inspection files maintained by SEC and also may be periodically

requested from the SROs.

In addition, SEC officials told us that they meet quarterly with senior SRO

officials to discuss, among other things, recent enforcement actions of the

SROs. They said that because SEC meets with all the SROs on a regular

basis and routinely inspects each SRO’s enforcement program, SEC is able

to assess the consistency of the enforcement and disciplinary activities

both within each SRO and among the SROs.

SEC and CFTC Approaches

to Assessing Sanctions

Industrywide Differed
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Page 29 GAO/GGD-99-8 Fine Imposition and Collection Activities

The industrywide information we collected for table 2 shows large

differences among the securities SROs in the number of cases closed and

the average dollar amount of fines imposed. For example, CBOE and Amex

had over 250 cases closed from 1992 through 1996; NYSE had 195 cases

closed and CHX had 11. Also, the average amount of NYSE fines was about

$51,000; the average for CHX was $8,000. These disparities may represent

differences in SRO rules, relative size, and the types of violations and other

sanctions involved, or the presence of a few unusual fines. SEC officials

told us that each securities SRO is an individual membership organization

with its own rules, whose disciplinary committees impose sanctions,

including fines, based primarily on the precedents of cases within that

SRO, and differences are to be expected. However, without an analysis of

the information, the disparities cannot be specifically explained.

SEC officials said their periodic inspections and meetings with SRO

officials provide a more substantive, although subjective, view of the

industry. This “bottom-up” approach analyzes and compares the results of

individual SRO inspections to identify differences among the SROs.

Although we agree that industrywide data may be difficult to quantify and

need further review to be meaningful, as discussed above, the data can still

be used as an indicator of the differences between and among SRO

performance over time. Analyzing industrywide data could provide SEC a

“top-down” approach that could supplement SEC’s reviews and provide a

systematic, fact-based way to assess industrywide sanctions.

CFTC officials told us that they use industrywide data to supplement their

oversight reviews of the futures SROs. They said that they have maintained

a computerized database of SRO disciplinary actions since 1986.23 They

said they use the database to assist them in their oversight of futures SRO

disciplinary programs and to analyze and assess performance between and

among SROs. CFTC produces 42 statistical reports and 3 summary reports

from the database, which can be sorted and analyzed in a number of ways:

by respondent; SRO; type of violation; or the sanction imposed, including

fines.

CFTC officials said they do biweekly reviews of these statistical and

summary reports to identify patterns or trends in individual or

industrywide SRO disciplinary actions that might call for further CFTC

review. The officials said that some differences in sanctions across the

industry can be attributed to an SRO’s size. However, when one SRO’s

 

23CFTC officials said they updated the database in 1995, and the new database contains all futures SRO

disciplinary actions since 1990.
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Page 30 GAO/GGD-99-8 Fine Imposition and Collection Activities

sanctions relative to other SRO’s sanctions change, they said CFTC

examines the data further to determine if the differences can be readily

explained or they notify CFTC examiners to closely review the individual

SRO’s sanctions in subsequent examinations, called rule enforcement

reviews. However, these officials said that they do not document their

industrywide reviews of SRO sanctions data and, thus, had no evidence to

show the effects of such reviews.

In its one-time 1994 study to assess the consistency of fines for various

violations industrywide, CFTC reported that it could not do so because

such an analysis was difficult using econometric means. However, CFTC

had not yet updated its database of disciplinary actions, and the study did

not focus on particular types of violations. Instead, it focused on broad

categories of violations that could make the violations too unlike each

other to allow anyone to reach conclusions about consistency of fines.

For our review CFTC used its database to produce the 42 statistical

reports for the same 1992 through 1996 time period we selected, which

showed all the sanctions imposed by each futures SRO, including the total

amount of fines. A CFTC official said the data showed that CBOT fines,

which are fairly consistent from year to year, were unusually high during

this period because of three fines totaling about $4.25 million. This

information helps to explain the large differences that we found in the

average fine amounts at CME (about $5,300) and at CBOT (about $23,800)

during this period, which we developed from information in table 3.

However, this does not indicate the appropriateness of the fines at either

SRO.

SEC, CFTC, and the majority of the SROs collected most of the total dollar

amounts of the fines they imposed and took action when fines could not be

collected. NASD and NFA officials attributed their lower fine collection

rates to the many fines they imposed that they did not expect to collect

because violators leave the industry. However, they did not have readily

available data for us to verify this assertion. Automated recordkeeping

systems would not only provide improved verification but could help

SROs, particularly those with large numbers of disciplinary cases, more

efficiently capture and maintain the information necessary to track and

analyze their fine collection activities.

Evaluating the relative benefits of having specific guidelines for fine

amounts, as NASD does, or allowing discretion in setting fine amounts

based on the facts and circumstances of a particular case, as the other

regulators do, was beyond the scope of our review. We noted that the

Conclusions
B-275115

Page 31 GAO/GGD-99-8 Fine Imposition and Collection Activities

specific guidelines made it easier for us, as reviewers, to assess the fines

for compliance. However, most SROs prefer flexibility and do not always

provide complete documentation on the basis for the fines imposed.

Therefore, it becomes more important to ensure that this flexibility is

resulting in fines that are appropriate to the facts and circumstances of

particular cases.

SROs in the same industry basically do similar business and have many

overlapping members, despite the differences in their rules and

membership requirements. The large differences that we found in the

number of closed cases and average fine amounts among the SROs may be

readily explained by such factors as the relative size of the SRO; the types

of violations and the other sanctions involved; or the presence of a few

very large fines, as CFTC demonstrated. On the other hand, determining

the reasons for the disparities may require further, more detailed reviews.

Analyzing industrywide data could provide SEC an additional tool to

identify disparities among SROs that may require further review. In

contrast, CFTC has the information it needs to do industrywide reviews

and says it does them. However, because it does not document the results,

CFTC cannot ensure that any questionable patterns or trends in overall

disciplinary actions are appropriately addressed in follow-up reviews and

any needed corrective actions are taken. One way for CFTC to document

the results of its industrywide reviews would be to prepare periodic

reports to the Chairperson or other interested CFTC commissioners and

staff.

We recommend that the Chairman, SEC, analyze industrywide information

on disciplinary program sanctions, particularly fines, to understand

possible disparities among the SROs and identify ways to improve SRO

disciplinary programs. We also recommend that the Chairpersons, SEC

and CFTC, require that the results of these analyses be appropriately

documented. Further, we recommend that the Chairpersons encourage

SROs to maintain automated records of their fine collection activities that

are appropriate for the number of fines they impose.

SEC provided oral technical comments on a draft of this report, which we

have incorporated where appropriate. In addition, SEC provided written

comments (see app. I), in which it generally agreed with our findings and

conclusions. However, SEC stated that comparing SRO performance based

on its detailed inspections provided more substantive results than

analyzing industrywide sanctions data. SEC also stated that the

enforcement and disciplinary programs of the SROs vary too widely in

subject and scope to be amenable to quantitative analysis of industrywide

Recommendations

Agency Comments and

Our Evaluation
B-275115

Page 32 GAO/GGD-99-8 Fine Imposition and Collection Activities

sanctions data. We recognize that such quantitative analysis, by itself,

would not provide information necessary to recommend improvements in

SRO disciplinary programs and would need to be supplemented by

detailed inspections. However, analyzing such data can provide a

systematic, fact-based way to identify disparities or changing trends

among SRO disciplinary programs, such as those we demonstrated, that

may indicate areas that need additional review. It might also be used, as

CFTC demonstrated for the statistics we developed on futures SROs, to

dispel concerns about seemingly large differences in outcomes. Further,

over time, differences in the subject and scope of SRO disciplinary

programs are likely to be identifiable in the statistics, and any further

analysis could focus on variances from these identified relationships in the

sanctions data among the SROs.

CFTC officials provided oral comments on a draft of this report. In

addition to technical comments, which we incorporated where

appropriate, they provided information to explain their low rate of fines

paid in full relative to SEC. We have included this information in the

report. Also, CFTC officials provided an explanation of how they use the

futures SRO’s sanctions data they collect, which we included in the body

of the report. We also adjusted our draft recommendation accordingly.

Further, in commenting on our draft recommendation to require SROs to

maintain automated records of fines, they said that they could encourage

but could not require the SROs to maintain automated records. We revised

our draft recommendation language accordingly. CFTC agreed with our

revised recommendations.

We also obtained oral comments from all the SROs included in our review,

except NYMEX, which did not respond to our request. The SROs provided

technical comments, which we incorporated where appropriate. In

addition, the securities SROs provided documentation not previously made

available to us to explain how they set fines. Amex and NFA commented

that our methodology understated their fine collection rates. We

incorporated their explanations for the differences in the report.
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Page 33 GAO/GGD-99-8 Fine Imposition and Collection Activities

We will provide copies of this report to SEC, CFTC, the SROs, and other

interested committees and organizations. We will also make copies

available to others on request. Major contributors to this report are listed

in appendix II. Please call me on (202) 512-8678 if you have any questions

about the report.

Richard J. Hillman

Associate Director, Financial Institutions

and Markets Issues
Page 34

Contents

1 Letter

Appendix I 36

Comments From SEC

Appendix II 39

Major Contributors to

This Report

Table 1: Fine Collection Rates for SEC and CFTC for

1992 Through 1996

11

Table 2: Fine Collection Rates for NYSE, Amex, CBOE,

CHX, 1992 Through 1996

11

Table 3: Fine Collection Rates for CBOT, CME, and

NYMEX for 1992 Through 1996

12

Table 4: Fine Collection Rates for NFA and NASD for

1992 Through 1996

13

Table 5: Amount of Fines Reported as Paid and Amount

Documented as Actually Collected for Cases Reviewed

15

Table 6: Factors CFTC Considers in Setting Fines 20

Tables

Abbreviations

ALJ administrative law judge

Amex American Stock Exchange

CBOE Chicago Board Options Exchange

CBOT Chicago Board of Trade

CEA Commodity Exchange Act

CFTC Commodity Futures Trading Commission

CHX Chicago Stock Exchange

CME Chicago Mercantile Exchange

CTR Currency Transaction Report

NASD National Association of Securities Dealers

NFA National Futures Association

NYMEX New York Mercantile Exchange

NYSE New York Stock Exchange

SEC Securities and Exchange Commission

SRO self-regulatory organization
Page 35 GAO/GGD-99-8 Fine Imposition and Collection Activities
Appendix I

Comments From SEC

Page 36 GAO/GGD-99-8 Fine Imposition and Collection Activities
Appendix I

Comments From SEC

Page 37 GAO/GGD-99-8 Fine Imposition and Collection Activities
Appendix I

Comments From SEC

Page 38 GAO/GGD-99-8 Fine Imposition and Collection Activities
Appendix II

Major Contributors to This Report

Page 39 GAO/GGD-99-8 Fine Imposition and Collection Activities

Michael A. Burnett, Assistant Director

Joan M. Conway, Senior Evaluator

David P. Tarosky, Senior Evaluator

Carl M. Ramirez, Social Science Analyst

Barry L. Reed, Social Science Analyst

Rosemary Healy, Senior Attorney

Angela Pun, Evaluator

May L. Lee, Computer Specialist

General Government

Division,

Washington, D.C.

Office of General

Counsel

Chicago Field Office

San Francisco Field

Office
Page 40 GAO/GGD-99-8 Fine Imposition and Collection Activities
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