Regulators' No Admission Settlement Policy Under Fire

The longstanding policy among financial regulators to negotiate consent judgments on a “neither-admit-nor-deny” basis is increasingly under fire by critics who believe such settlements are too lenient and may encourage further financial fraud.

On May 17, the U.S. House of Representatives' Committee on Financial Services held a hearing to examine these settlement practices. Among the agencies asked to explain their punitive policies were the Securities and Exchange Commission, the Federal Reserve's Board of Governors, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

The controversy over “no admission” settlements was brought to a boil last November with the case of SEC v. Citigroup Global Markets Inc.

U.S.  District Judge Jed Rakoff of the Southern District of New York rejected the Commission's effort to settle the case, the culmination of a multi-year investigation into activities related to the market for collateralized debt obligations.

Under the proposed consent judgment, Citigroup had agreed to pay $285 million into a restitution fund for investors, establish procedures to prevent future violations, and make periodic demonstrations of compliance to the SEC. Citigroup would agree to these provisions without admitting wrongdoing.

Rakoff refused to approve the consent judgment and ordered that the case move to trial. The court's objections included disapproval of what was called “the SEC's long-standing policy—hallowed by history but not by reason—of allowing defendants to enter into consent judgments without admitting or denying the underlying allegations.” According to Rakoff's ruling, the arrangement was both unfair to Citigroup and not in the public interest.

Legislators at the Congressional hearing were divided on whether “neither-admit-nor-deny” settlements were a shrewd way to expedite restitution or a shirking of responsibility.

Chairman Spencer Bachus (R-AL) said the arrangements insulate against the cost and uncertainty of a trial. “A policy that has federal judges micromanaging federal agencies' exercise of their enforcement authority and requiring lengthy and expensive trials in every instance will not serve the best interests of taxpayers or investors,” he said.

Rep. Maxine Waters (D-CA), however, countered that the frequent use of “neither-admit-nor-deny” settlements can be harmful even if they are expeditious. “The Commission also has a broader responsibility to enforce the rule of law,” she said. “Settlements should never be viewed as just another cost of doing business. When no wrongdoing is admitted it encourages future offenses.”

Robert Khuzami, director of the Division of Enforcement for the SEC, testified that Fiscal Year 2011 was a busy one for the commission. It filed 735 enforcement actions—more than it has ever filed in a single year.  From those, it obtained orders for $2.8 billion in penalties.

“A policy that has federal judges micromanaging federal agencies' exercise of their enforcement authority and requiring lengthy and expensive trials in every instance will not serve the best interests of taxpayers or investors.”

—Spencer Bachus,

Congressman,

Alabama's 6th District

Khuzami said that 75 percent of the SEC's financial crisis-related cases filed against CEOs, CFOs, and other high-ranking executives of companies, were filed as litigated actions. “The fact that such a high percentage of cases are in litigation strongly suggests that some number of settlements were available but rejected by the SEC as inadequate,” he said, adding that the commission has prevailed against defendants in 84 percent of its trials since the beginning of fiscal year 2010.

He defended “neither-admit-nor-deny” settlements, however, as “both common and sound public policy.”

Recent regulatory actions of this sort include a settlement between the CFTC and Goldman Sachs Clearing & Execution, L.P. on March 13, 2012.  Goldman Sachs agreed to pay a $7 million fine for supervision failures, while documenting that it did so “without admitting or denying any of the findings or conclusions.”

If “neither-admit-nor-deny” settlements were eliminated—and cases could be resolved only if the defendant admitted the facts constituting the violation, or was found liable by a court or jury—there would be far fewer settlements “and much greater delay in resolving matters and bringing relief to harmed investors,” Khuzami said.

William Galvin, secretary of the Commonwealth of Massachusetts, testified that “regulation without effective enforcement makes such regulation little more than political rhetoric and, worse, leads to a false sense of financial security for our citizens.”

Galvin said he has long been a critic of settlements that bypass an admission of wrongdoing.  “Too often, the guilty neither admit or deny any wrongdoing and routinely promise not to cheat again until they can come up with a more clever method to do what they just said they would not do again,” he said.

Galvin admitted, however, that “there is a thin line between arriving at a satisfactory settlement and failing to reach any settlement at all.”

SEC'S SETTLEMENT APPROACH

Below is an excerpt from SEC Director of the Division of Enforcement Robert Khuzami's speech on examining the SEC's settlement practices:

Under existing policy, the Division of Enforcement recommends that the Commission settle a case only when our informed judgment tells us that the settlement agreement is within the range of outcomes we reasonably can expect if we litigate through trial. In making that determination, we take into account many factors, including: (i) the strength of the evidence and the potential defenses, including the possibility that the Commission might not prevail at trial, or prevail but be awarded less than the proposed settlement achieves; (ii) the delay in returning funds to harmed investors caused by litigation; and (iii) the resources required for a trial, including, most importantly, the opportunity costs of litigating rather than devoting those resources to investigating other cases.

This approach to settlement serves the important goals of accountability, deterrence, investor protection, and compensation to harmed investors. With respect to accountability, before the Division recommends an enforcement action, Enforcement staff spends months or years building a case by gathering evidence, analyzing relevant documents, interviewing witnesses, and assessing possible defenses. In addition, potential defendants have the opportunity to present their defenses to the Commission in the form of a Wells Submission. Thus, the decision by the Commission to initiate an action—settled or litigated—is made with the benefit of a comprehensive evidentiary record and a full and fair opportunity to evaluate the risks of bringing the action. Moreover, SEC settlements are accompanied by a civil Complaint or an administrative Order Instituting Proceedings where the facts painstakingly gathered by the SEC staff—facts that reveal both the wrongdoing and the wrongdoers—are set forth in great detail. Through this process, we ensure that the decision to settle is an informed one; that wrongdoers are held accountable through the public dissemination of information about their misconduct; that, where appropriate, private litigants are able to utilize the SEC's detailed allegations to assist their own cases; and that the public sees that wrongdoers suffer penalties, bars, and other sanctions at a point in time when the misconduct is still fresh in their minds.

The immediacy of sanctions offered by a settlement also sends a strong message of deterrence. Quick action by law enforcement communicates to other potential wrongdoers that those who violate the law face swift and certain sanctions. Conversely, the longer the passage of time between misconduct and sanctions, the more diluted the deterrence message becomes.

Similarly, appropriate settlements provide investors with greater protection, since violators are more quickly sanctioned in a manner that decreases the likelihood that they will commit future violations. This minimizes the chance that other investors will be victimized. This is particularly true where the settlement includes associational bars prohibiting violators from continuing to work in the securities industry or from serving as an officer or director of a public company.

Lastly, settlements return funds to harmed investors with increased speed and certainty. Even the strongest case can suffer unexpected outcomes in litigation, creating risk and uncertainty. The risks include not just a potential negative outcome at trial, but also the possibility that the SEC obtains lesser remedies after a successful trial than those being offered in a negotiated settlement. Settlement avoids these risks, and allows for a more expeditious distribution of funds to harmed investors, since the delay inherent in litigation is avoided. Such delays can be quite substantial, given the huge backlog of civil cases awaiting trial in federal courts. Indeed, the most recently available statistics indicate that the median time interval for disposition of civil cases across all U.S. federal district courts ranges from 19 months to 44 months.

We recognize that to achieve appropriate settlements satisfying all four of these goals, potential defendants need to know that we are prepared to litigate cases in the event an appropriate settlement cannot be obtained. For that reason, the Enforcement Division has improved its capacity to bring cases to trial, and stands ready and willing to file our cases unsettled where settlement terms are unsatisfactory. For example, 75 percent of the SEC's financial crisis-related cases filed against individuals, including CEOs, CFOs and other high-ranking executives of companies, were filed as litigated actions. The fact that such a high percentage of cases are in litigation strongly suggests that some number of settlements were available but rejected by the SEC as inadequate. And when the Commission does litigate, our trial teams are largely successful. Our record of litigation victories—we have prevailed against defendants in 84 percent of our trials since the beginning of fiscal year 2010—sends a strong message to defendants and those who may contemplate securities law violations in the future. This approach seems to be working. A recent independent study by NERA Economic Consulting concluded that the median monetary value of the Commission's settlements in fiscal 2011 was at or near its highest levels since the enactment of the Sarbanes-Oxley Act in 2002. All of the above metrics—more litigated cases, more trial victories, and higher monetary settlements—support the conclusion that we settle a case when it makes sense to do so, and litigate when it does not.

Source: SEC.

He was also critical of Judge Rakoff's Citigroup ruling. “While many of the judge's concerns were valid, by rejecting the settlement, he inappropriately substituted his own assessment of those issues for the assessment made by the SEC,” Galvin said. “The SEC must maintain its independence on these issues. Those who champion this judge's view of this settlement should remember that once SEC independence is compromised, a different judge in another case could weaken SEC settlement terms. As an executive agency, in the absence of obvious error, the SEC must be able to decide which matters to investigate, which cases to litigate, which charges to bring, and the terms of any settlements.”

Richard Painter, professor of law at the University of Minnesota Law School and former chief ethics lawyer for the White House under President Bush, said that Congress “should resist the temptation to micromanage SEC decision making in specific cases or even in broad categories of cases.”

Sending a Message

Painter stressed that large monetary settlements—such as the $285 million in the Citigroup case—still “make it clear to most observers that defendants did something wrong.”

“The financial services industry is driven by business reputation, and monetary settlements, coupled with consent decrees prohibiting future violations, send a clear message that conduct was wrong,” he said. “An admission to violating a specific law is not needed to get the point across to the public and to other industry participants.”

Painter pointed out that because of the way the securities laws are written and interpreted by the courts, legal liability may be an open question, even where defendants violated the spirit of the law.

It may not be clear, for example, whether a fraudulent sale of securities took place inside or outside the United States. Another ambiguity could be proving a defendant's intent or recklessness, as opposed to mere negligence (as stipulated under Section 10(b) of the Exchange Act). Even the matter of whether a particular financial instrument falls under the statutory definition of a “security” and whether fraudulent conduct was “in connection with” a securities transaction could be disputed.

“In each factually or legally ambiguous case, the SEC and the defendant must weigh the risks of litigating and losing” Painter said.

There is also the matter of class-action lawsuits, a threat that could make admitting guilt a very expensive prospect for defendants. It is a risk they would avoid by any means necessary.

“Private plaintiffs' lawyers ride on the coattails of enforcement actions, seeking monetary damages that often exceed by many times the monetary payments specified in SEC consent decrees,” Painter said. “Corporate defendants will instead take their chances litigating with the SEC hoping that their enormous litigation resources will beat back the [commission] and also deter private plaintiffs.”

In January, the SEC did retreat from its longstanding policy and announced it will no longer allow “no admission” settlements language for cases involving criminal convictions where a defendant has admitted violations of the criminal law. 

Under the new approach, for those settlements the SEC will eliminate “neither admit nor deny” language from those settlement documents; recite the fact and nature of the criminal conviction or criminal non-prosecution agreements (NPAs) and deferred prosecution agreements (DPAs) in the settlement documents.; and give the staff discretion to incorporate into the settlement documents any relevant facts admitted during the plea allocution or set out in a jury verdict form or in the criminal NPA or DPA.