In a break from longstanding practice, the Securities and Exchange Commission has begun seeking admissions of wrongdoing in settlements of select cases featuring certain types of particularly egregious or harmful misconduct.
In a June 2013 memo to their division staff, SEC Enforcement Directors Andrew Ceresney and George Canellos identify three conditions that could trigger requiring such an admission: (i) “misconduct that harmed large numbers of investors or placed investors or the market at risk of serious harm”; (ii) “egregious intentional misconduct”; or (iii) “when the defendant engaged in unlawful obstruction of the commission’s investigative process.”
The departure from the “neither admit nor deny” standard that the SEC has applied for decades has the potential to strengthen private securities actions arising from the same acts. But critics say that it could also reduce the number of enforcement actions because defendant companies may resist such admissions and choose instead to go to trial, thus straining SEC resources.
Observers may not have long to wait before the effects of the shift are known. The SEC obtained its first admission under the new policy in August, when it settled an enforcement action against hedge fund manager Philip A. Falcone and his aptly-named firm, Harbinger Capital Partners. Then, on September 19, JPMorgan Chase acknowledged violating securities laws as part of a long awaited $920 million coordinated settlement with US and British authorities in the much-publicized “London Whale” derivatives case.
The SEC had already charged two former JPMorgan traders, who also face criminal charges, with concealing hundreds of millions of dollars in trading losses when their massive bet on credit derivatives went wrong in 2012. The charges against JPMorgan stem from the bank’s misstatements of its financial result, its failure to properly oversee the traders, and senior management’s failure to inform the bank’s audit committee about its lack of internal controls.
Former policy said to result in efficient settlements
SEC Chairman Mary Jo White said she initiated a review of the “no admit/no deny” policy shortly after taking over for Mary Schapiro, her predecessor, who stepped down as chair earlier this year. Chairman White said that she had “lived with” the issue since her days as a federal prosecutor in Manhattan. While “neither admit nor deny” is appropriate for most actions and would remain a “major, major tool” in the SEC arsenal, Chairman White also said she believes that an admission of guilt serves the public interest in some cases.
Defenders of the policy as previously applied, including Ms. Schapiro and former SEC Enforcement Director Robert Khuzami, have noted that it encourages quick settlements. Without the delay of trial, quick settlements result in fast relief for injured investors. Settlements also allow the agency to avoid litigation and trial risks, as the SEC is an agency of limited resources with neither the time nor the means to regularly combat far more well-heeled Wall Street firms before a jury. Even if settling defendants do not admit wrongdoing, settlements still arguably deter misconduct and allow for corporate reforms.
SEC faces pressure following criticism for performance in financial crisis cases
The SEC’s policy shift comes on the heels of criticism directed at the agency for its handling of settlements in cases arising from the financial crisis, as well as for perceived leniency towards the large institutions that were at the center of the crisis. The shift expands a 2012 change in which the SEC said it would pursue admissions of wrongdoing in actions whose defendants had already made such admissions in parallel criminal cases.
Judges have also emerged as critics-and the SEC has fought to defend its discretion to continue to reach settlements containing the “neither admit nor deny” language. Federal judges are tasked with weighing the fairness of the settlements, and some have questioned the SEC’s traditional policy and demanded more accountability from defendants. For example, in November 2011, Judge Jed S. Rakoff rejected a proposed $285 settlement between the SEC and Citicorp, noting that the agency’s policy is “hallowed by history, but not by reason.” Judge Rakoff remarked that the settlement amount was “pocket change” for Citicorp, and that he was unable to tell if the deal was “fair, reasonable, adequate and in the public interest.” And in 2009, Judge Rakoff similarly rejected an SEC settlement with Bank of America.
This reasoning-and the issue of what constitutes the proper role of judges in reviewing decisions made by executive agencies -will be tested, as the SEC appealed Judge Rakoff’s decision to the Second Circuit. In what is perceived to be a good sign for the SEC, the appellate court granted a request to stay the action, saying the SEC had a “strong likelihood” of success on the merits.
Notwithstanding criticism of the agency’s recent settlements, Chairman White’s new approach is certainly informed by her career as a litigator. As the U.S. Attorney for the Southern District of New York, she earned a reputation as a tough prosecutor of securities fraud and international terrorism cases. She also served as litigation chair at a New York defense firm. During her confirmation hearing, Chairman White pledged tough enforcement of Wall Street-and she is signaling that she intends to follow through.
“There’s no question I share the desire for more accountability in cases where that is warranted,” she told The New York Times after the new policy was announced in June. “I do think there are situations where public accountability is particularly important, and that will be our focus. I don’t want to overstate this-no admit, no deny will still be the way most cases are resolved. But I think it’s an important change.”
New direction could result in more evidence for parallel shareholder securities actions
What does the agency’s new approach mean for private shareholder suits? Defendants who admit fault may open themselves up to liability for their acts in actions brought by injured investors. Shareholder actions could potentially be strengthened by admissions of wrongdoing, as plaintiffs may be able to cite the admission as evidence of a defendant’s culpability.
But the higher bar may actually serve to delay resolution. Rather than settling with an admission and risk exposing itself to greater liability in private investor suits, a defendant may choose to forge on toward trial. In addition, the admissions contained in SEC settlements may be carefully crafted to hew to the specifics of the enforcement action and avoid providing fodder for private litigants. Based on the initial reaction of corporate attorneys, this may be the case with the recent JPMorgan settlement. Another reason to keep admissions narrow is to avoid triggering clauses in directors’ and officers’ liability policies that allow insurers to void coverage of acts stemming from fraud or criminal misconduct.
Shareholders may also see the universe of SEC actions shrink. If the agency is to arm itself effectively for trials against deep-pocketed institutions, more resources and time must necessarily be directed to individual cases. In turn, the agency could be forced to cast a narrower net in its investigation and case initiation. Then again, some companies under investigation may choose to cooperate with the SEC in hopes of averting an admission.
Given the SEC’s limited resources, the agency remains likely to take relatively few of its cases to trial. As Chairman White repeatedly emphasized, the “neither admit nor deny” policy will continue to dictate the agency’s course in the majority of settlements.
Nevertheless, the SEC is displaying a new, but measured, aggressiveness. Observers are awaiting other cases that will be used as examples of the SEC’s effort to demand accountability and responsibility from defendants.