SEC's New 'Fess Up' Policy Comes With Legal Consequences

For years the Securities and Exchange Commission has allowed defendants to quietly pay a penalty to settle charges and admit to nothing. Now the SEC is pressing some defendants to confess their sins and suffer the legal ramifications.

The SEC's new policy of forcing corporate defendants to admit wrongdoing as a stipulation of settling certain enforcement actions threatens to create a host of new legal headaches with far-reaching consequences for both companies and their directors and officers.

Amid intensified criticism, SEC enforcement staff stated last month that the agency will begin scaling back on its longstanding “no admit, no deny” settlement policy by forcing defendants to own up to their misdeeds in certain egregious cases.

According to an internal memo distributed to the SEC's enforcement staff, the agency stated that the SEC would only require admissions of wrongdoing where it “could be in the public interest.” The memo stated that such factors may include:

Misconduct that harmed large numbers of investors, or placed investors or the market at risk of potentially serious harm;

Where admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or

When the defendant engaged in unlawful obstruction of the Commission's investigative processes.

Companies that are considering whether to enter into a settlement with the SEC or to contest the case in a trial now need to weigh the many legal risks that an admission of wrongdoing could carry with it.

More civil actions surviving motions to dismiss. One broad implication of the new policy is that it could result in more civil actions surviving motions to dismiss in situations where a company or its directors or officers face parallel shareholder or derivative litigation.

In many cases shareholders must satisfy heightened pleading standards if they want to pursue a securities case, meaning they must have concrete evidence to initiate a claim. The higher standard results in a larger number of dismissals for shareholder litigation.

With the SEC's new “admit it” policy, plaintiffs' counsel could use the defendant's admission of wrongdoing in order to satisfy those heightened pleading standards. That means plaintiffs' litigation costs go down significantly, “because they don't have to devote as much time or resources to proving that the defendant committed the offense,” says Michael Volkov, CEO and founder of the Volkov Law Group.

Adverse regulatory consequences. An admission of wrongdoing could also lead to a host of adverse collateral consequences, such as having a license revoked, losing a contract, or being barred from doing business, legal experts say. Furthermore, government contractors that admit guilt could potentially lose their contracts, or face suspension or debarment. There could also be additional litigation associated with those outcomes, says Volkov.

Follow-on criminal proceedings. The number of criminal proceedings brought by the Department of Justice could also increase. This may occur in cases where a company faces an SEC civil action but has no knowledge of a pending criminal action—and may not necessarily even face one, explains Marc Axelbaum, a partner with law firm Pillsbury.

So the question is, if you admit wrongdoing in an SEC case, are you then encouraging prosecutors to go after the company? “I would think that would be the biggest concern,” says Robert Plotkin, a partner with law firm McGuire Woods.

Another concern is whether the SEC would “impute the knowledge of any wrongdoing of the executives onto the company,” says Plotkin. The outcome of that could result in strained relationships between companies and their executives.

Revocation of D&O insurance. Directors and officers who find themselves under investigation will now need to assess whether an admission of wrongdoing would cause them to lose their directors and officers insurance coverage. Having no D&O insurance could have a “very negative consequence” on any director or officer's ability to defend himself in any parallel litigation that may exist, says Sarah Good, a litigation partner with law firm Pillsbury.

D&O insurance, in general, excludes coverage where there has been an admission of guilt, at which point the insurer often will require that any amount previously paid out be refunded to the insurance carrier. “The benefit right now with no admission of wrongdoing is that insurance carriers don't have that admission of fact to be able to get their money back,” says Brian Dickerson, a partner with law firm Roetzel.

Whatever the outcome, the SEC's new policy “certainly isn't going to help people reduce their insurance cost,” says Plotkin.

“I don't think the government is going to be insisting on these admissions in cases where they don't have that much leverage.”

—Michael Volkov,

CEO & Founder,

Volkov Law Group

In addition, companies may also choose not to indemnify their directors, officers, or employees involved in an admission of wrongdoing and require that amounts paid in advance be refunded back to the company. Another disincentive for individual defendants is that admitting guilt could bar them from subsequently serving as an officer or director of another company, or result in them losing their jobs altogether, says Plotkin.

More cases being challenged. Because of the number of legal risks that an admission of wrongdoing could bring, the new policy may also “freeze a lot of companies from wanting to settle with the SEC,” says Dickerson. The argument there is that, if you're now going to be putting time and resources toward follow-on civil cases, “you might as well put those resources toward fighting your case," he says.

The types of cases companies may want to dispute are those in which “the government's case isn't that strong,” says Volkov. “I don't think the government is going to be insisting on these admissions in cases where they don't have that much leverage.”

Dickerson says he also expects that more corporate defendants will pursue discovery in order to narrow the scope of any admission of wrongdoing. When the SEC presents a series of allegations that are only going to expose the company to greater liability, pursuing the case through its discovery stage may reduce the amount of allegations a company must admit, he says.

They're "much more likely to go through discovery" to try to show the SEC “why a settlement for an admission of liability would be inappropriate," agrees Good.

SEC'S POSITION

Below is an excerpt from an internal Securities and Exchange Commission e-mail that explains the agency's stance on “neither admit nor deny.”

As you know, the Commission has broad discretion in deciding the terms of settlement in our enforcement actions. Like most civil regulators, the Commission has generally settled its cases without the defendant admitting the allegations of the complaint. Unlike many other civil regulators, though, our settlements also prohibit the defendants from denying our allegations. Settling cases without requiring the defendant to admit the Commission's allegations is often important to achieve the key goals of our enforcement program: deterring misconduct through the imposition of appropriate sanctions; protecting investors by barring wrongdoers from employment and positions that place investors at risk; achieving corporate reform and other relief calculated to prevent future violations; and swiftly returning money to harmed investors. Achieving such results quickly also allows us to deploy our limited resources efficiently and without litigation risk. Recently, we have begun to review our approach to ensure we make full and appropriate use of our leverage in the settlement process, including a discussion of the neither admit nor deny approach. While the no admit/deny language is a powerful tool, there may be situations where we determine that a different approach is appropriate.

We currently do not enter no-admit-no deny settlements in cases in which the defendant admitted certain facts as part of a guilty plea or other criminal or regulatory agreement. Beyond this category of cases, there may be other situations that, after considering the goals set forth above, justify requiring the defendant's admission of allegations in our complaint or other acknowledgment of the alleged misconduct as part of any settlement. In particular, there may be certain cases where heightened accountability or acceptance of responsibility through the defendant's admission of misconduct may be appropriate, even if it does not allow us to achieve a prompt resolution. We have been in discussions with Chair White and each of the other Commissioners about the types of cases where requiring admissions could be in the public interest. These may include misconduct that harmed large numbers of investors or placed investors or the market at risk of potentially serious harm; where admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or when the defendant engaged in unlawful obstruction of the Commission's investigative processes. In such cases, should we determine that admissions or other acknowledgement of misconduct are critical, we would require such admissions or acknowledgement, or, if the defendants refuse, litigate the case.

Of course, we recognize that insisting upon admissions in certain cases could delay the resolution of cases, and that many cases will not fit the criteria for admissions. For these reasons, no-admit-no-deny settlements will continue to serve an important role in our mission and most cases will continue to be resolved on that basis. We will also continue to strongly defend our discretion to reach such settlements in response to inquiries from courts.

Source: SEC.

If You Did It, Admit it

The SEC put the new “fess-up” policy into practice last month when it reached an $18 million proposed settlement with hedge-fund adviser Philip Falcone and his advisory firm Harbinger Capital Partners. As part of the deal to settle charges that Falcone improperly used $113 million in fund assets to pay his personal taxes, he agreed to admit to a set of facts laid out by the SEC. As part of that settlement, Falcone also agreed to be barred from the securities industry for at least five years.

“It is the first concrete example of the SEC actually using the new policy,” says Plotkin. As a result, the case “gives you an idea of how serious these kinds of violations would need to be in order to force an admission,” he says.

The final settlement comes one month after the SEC took the rare step of overruling its own enforcement staff and rejected the original agreement reached with Falcone, which only called for a two-year ban from the securities industry and no admission of wrongdoing. According to Andrew Ceresney, co-director of the SEC's Enforcement Division, “Falcone and Harbinger engaged in serious misconduct that harmed investors, and their admissions leave no doubt that they violated the federal securities laws.”

Another lesson to be drawn from the Falcone case is that the SEC had “a ton of evidence,” says Volkov. That may be a sign that the SEC is going to insist on admissions of wrongdoing in “strong cases or high-profile cases,” he says.

With the Falcone case resolved, attention now turns to the Second Circuit Court of Appeals and whether the court will accept the SEC's $285 million settlement with Citigroup over allegations that the bank misled investors in collateralized debt obligations. In November U.S. District Court Judge Jed Rakoff—who was among the first to challenge the SEC's “no admit, no deny” settlement policy—said the settlement did not meet the legal standard for judicial approval of being “fair, reasonable, adequate, or in the public interest.” Rakoff said that because Citigroup would neither admit nor deny the agency's charges “does not provide the court with a sufficient evidentiary basis to know whether the requested relief is justified.”

Depending on what the Second Circuit does, it could dramatically alter the way cases will be viewed going forward. Big cases like Citigroup are the ones looked at most carefully, says Plotkin, because of the amount of money involved and the number of investors affected, he says. “I imagine at one point they're going to want to make someone an example to deter other people from engaging in similar kinds of conduct.”