United States: Admitting Guilt: The SEC’s New Settlement Policy

On June 18, 2013, Securities and Exchange Commission Chair Mary Jo White announced that the SEC will require certain respondents to admit wrongdoing as a condition of settling enforcement cases brought by the Commission. This shift marks an important departure from the agency's longstanding practice of allowing parties to settle civil enforcement actions without admitting or denying liability, and could have a substantial impact on the resolution of key enforcement matters.

Even before its Division of Enforcement was created in 1972, the SEC settled actions through consent decrees in which respondents neither admitted nor denied the agency's factual allegations. Other governmental agencies use a similar process to settle their civil enforcement actions.

This early version of the SEC's "neither admit nor deny" policy had no force outside of the proceeding in which it was entered, permitting settling defendants to make public statements denying altogether the charges against them. The Commission viewed this as a threat to the integrity of its proceedings, deeming it "important to avoid creating, or permitting to be created an impression that a decree is being entered or a sanction imposed, when the conduct alleged did not, in fact, occur."

Accordingly, the Commission in 1972 announced its new policy "not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the [underlying] allegations." Beyond express denials, the Commission also expressed concern with a respondent's mere silence, stating that "a refusal to admit to the allegations is equivalent to a denial, unless the defendant or respondent states that he neither admits nor denies the allegations." That rationale and resulting policy change established the "neither admit nor deny" standard.

The new policy allowed individuals and entities to assert that they never admitted to the conduct at issue in the SEC matter, precluding any collateral estoppel, as a party could settle with the SEC and still litigate liability with investors or shareholders in separate cases.

It also mitigated reputational harm in the investor community, and among lenders and insurers. Additionally, individuals who are not forced to admit liability are protected against summarily losing director and officer insurance and corporate indemnity. At the same time, the policy helped the SEC by limiting lengthy trials, conserving resources and allowing the Commission to more quickly provide relief to investors.

Attacks On The Old Policy

Despite these mutual benefits, the "neither admit nor deny" policy has been criticized. That criticism became particularly pointed in the wake of the financial crisis, amid public calls for increased accountability and harsher penalties for financial institutions accused of wrongdoing. One critic of the policy has been Judge Jed Rakoff of the Southern District of New York, who has issued a series of opinions in cases involving the SEC's request for approval of settlements (CI, 2/28/2012).

Judge Rakoff's challenge to the policy quickly garnered attention among lawmakers in Congress and the SEC, and has proven to be a catalyst for change. That change first came in January 2012, when the Commission announced it would no longer permit "neither admit nor deny" settlements where the respondent had already been convicted in a parallel criminal proceeding or otherwise admitted guilt. The tension inherent in not requiring a defendant who has already admitted to criminal misconduct to also admit misconduct in a civil case had clearly been underscored by Judge Rakoff.

Although the SEC's 2012 policy modification represented a fundamental shift, it applies to only a small percentage of enforcement cases and arguably has had little practical impact. After all, a defendant that has already been criminally convicted gives up little by admitting to civil liability.

The June 2013 Shift

Sen. Elizabeth Warren, D-Mass., made waves at her first Senate Banking Committee hearing by challenging a number of federal regulators for what she called their failure take to trial more cases against financial institutions. Sen. Warren subsequently wrote in May 2013 to several regulatory chiefs—including Chair White— asking for any analysis their agencies had conducted regarding "the cost to the public of settling cases without requiring an admission of guilt rather than pursuing more aggressive actions." White responded in early June that she was "actively reviewing the scope of the Commission's neither-admit-nor-deny settlement policy with the leadership of the Division of Enforcement to determine what, if any, changes may be warranted and whether the SEC is making full appropriate use of its leverage in the settlement process."

Chair White later announced that the SEC would require certain respondents to admit wrongdoing as a condition of settling enforcement cases. An internal Enforcement Division communication reportedly stated that the Division will consider seeking an admission when it has evidence of:

  • Egregious intentional misconduct
  • Misconduct that harmed or had the potential to harm large numbers of investors
  • Obstruction of the Commission's investigative processes

Implications Of The Revised Policy

The true impact of the new policy will depend on the depth and breadth of its application, which will be decided on a case-by-case basis. Mere weeks after the policy change, the SEC announced an $18 million settlement in which Philip A. Falcone and his hedge fund Harbinger Capital Partners LLC admitted wrongdoing.

At the same time, the Commission clearly remains committed to the "neither admit nor deny" policy. Indeed, even as it announced the 2013 revision, the SEC defended the old policy as an important part of its enforcement arsenal that would still be widely available. Chair White applauded the SEC's prior use of the policy as a means to "settle quicker," to eliminate litigation risk and to "get money out quicker" to investors. In May, new Enforcement Division Co-Director Andrew Ceresney likewise defended the legacy policy as an important way for the SEC to obtain secure relief for investors, to conserve and effectively manage its enforcement resources and to manage its litigation risk by settling cases that it might not win at trial.

A key open question is whether the staff will take the position that mandated admissions are always a real possibility in settlement negotiations, or only in special circumstances. If they take the former stance, more cases against entities will likely move to trial because the concomitant collateral estoppel price may be enormous—as an admission of liability can fuel the claims of private investors or shareholders.

Admissions of liability by an entity can also have collateral impacts in licensure processes, result in increased insurance premiums and could limit a company's ability to contract with governmental organizations.

Individual defendants accused of serious misconduct will likewise face a lesser-of-two-evils dilemma in this new environment. In addition to the professional and reputational harm associated with an admission of guilt, individuals who admit misconduct risk triggering D&O insurance policy exclusions that can deprive them of the coverage that is the lifeblood of any defense they mount in related private actions.

As for immediate impact on entities and individuals subject to the agency's enforcement activity, the new policy will, at a minimum, provide added impetus for firms to enhance their proactive training and compliance activities—lest they be placed in the unenviable position of having to admit wrongdoing in order to settle an SEC matter.

Similarly, the threat of personal admissions will surely help in-house counsel and compliance officers catch the attention of executives and employees, who now have even more incentive to stay on the straight and narrow.

In addition, the scope of these worries may expand as industry players wait to see if the Financial Industry Regulatory Authority and/or state securities regulators bring their own enforcement policies in line with the SEC's revised approach.

The new policy also presents the Commission with difficult choices. An overly aggressive application of the policy may carry significant costs, including hindering the prompt resolution of cases; losing trials that could have been settled; and losing the opportunity to investigate more claims of wrongdoing as resources are shifted to support trial work.

While the true impact of the policy change remains to be seen, one thing is certain: The mere possibility of being forced to admit wrongdoing as a condition of settlement injects a very unwelcome dose of uncertainty for enforcement targets. For companies and individuals that find themselves in the SEC's crosshairs, it is a new and troubling day.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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