Effect of New SEC Settlement Policies
When Judge Rakoff rejected a proposed settlement between Citigroup and the Securities and Exchange Commission in late 2011, because it lacked an admission of wrongdoing, he explained that "the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances."1 Whether in direct response to Rakoff's criticisms or not, the SEC has begun to move away from these "contrivances," by announcing a new policy pursuant to which, in certain cases, defendants will be required to admit wrongdoing in order to settle potential SEC civil actions.
The SEC's announcement suggests that it will seek admissions of misconduct in egregious cases even where doing so may affect the settlement process. Since announcing the new policy in July, the SEC has already obtained multiple admissions of wrongdoing. This move away from the "neither admit nor deny" standard that previously prevailed will have real consequences, and some predict that the policy may harm both the SEC and the companies it regulates.2 Putting aside whether the policy change is good or bad, this article discusses the implementation of the new settlement policy, and will offer a preliminary assessment of the potential impact on internal investigations and cooperation with the SEC that can be gleaned from the first settlements under the policy.
In the first application of the SEC's new policy, the hedge fund Harbinger Capital and Phillip A. Falcone, its founder, admitted to wrongdoing in a list of facts that included, as its final paragraph, a statement that in connection with the "violations described," Harbinger and Falcone "acted recklessly."3 Although the facts described are extensive, and include genuine admissions of wrongdoing (such as that "Falcone improperly borrowed $113.2 million" from the fund in order to pay his personal tax obligation), the filing contains no admission to violations of any specific statute, and no blanket admission to securities fraud.
More recently, in the settlement announced last month between the SEC and JPMorgan Chase & Co., JPMorgan admitted to facts in an order in an administrative proceeding before the SEC. The company "acknowledge[d] that its conduct violated the federal securities laws," specifically, "Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act…."4 Thus, in contrast to the Harbinger case, JPMorgan's settlement included an admission of specific legal violations, rather than admissions only to the underlying facts. That said, the provisions that JPMorgan admitted to violating are the books-and-records provisions of the Exchange Act, which do not generally create a private right of action.5
Impact on Strategy
Although it is not yet clear how often the commission will require an admission from settling parties, companies should be aware of the new policy in deciding whether, when, and how to report the results of their internal investigations, including to the SEC. Companies should also be aware of the guidance the SEC has given thus far. SEC Chair Mary Jo White has explained that the commission may require admissions in cases where a significant number of investors have been harmed or the conduct was "especially egregious," and where the conduct "posed a significant risk to the market or investors."6
When settling with the SEC, a company ought to expect that an admission of wrongdoing may trigger follow-on securities class actions, and may tie the company's hands when fighting those actions.7 This added potential risk will require counsel to manage its investigation of the company, and any discussions with the SEC thereafter, in order to reduce the likelihood that the SEC will demand an admission of wrongdoing, and to minimize the future impact of an admission if one is required.
In practical terms, the new policy does not change the initial steps involved in conducting an internal investigation. Fast and accurate fact gathering will still be of the utmost importance—counsel must still interview the relevant employees and officers of a company that is under investigation, and must still collect and review a sufficient number of documents to understand the issues. What the policy does change is how investigating counsel may handle the facts once they have been gathered. The SEC's new policy necessitates additional caution in the disclosure of information, and careful thinking about when and what to disclose to the government.
Before deciding whether and how to share information with the SEC, counsel must consider, first, whether any wrongdoing discovered is particularly egregious or caused losses of a magnitude beyond those of a run-of-the-mill securities case. That is, counsel must determine whether its investigation has revealed one of the "certain cases" that caused sufficiently widespread harm, or was of a sufficiently serious character, that the SEC may seek an admission. If the facts revealed in an internal investigation indicate that the SEC may require an admission in order to settle, counsel should consider what conduct a company might admit without exposing itself to future legal action to a greater degree than is absolutely necessary.
If an investigation does not reveal widespread, egregious misconduct, the best strategy may be to approach the SEC quickly and attempt to self-report and settle without any admission. Last month, just two days before the JPMorgan settlement was announced, the SEC settled actions for short selling violations with 22 firms, and none of those firms admitted or denied wrongdoing.8 Indeed, the SEC has publicly stated that it will not seek admissions in every case.9 Of course, each case rests on its own facts, and the determination whether any particular facts will make settlement without an admission possible should be made on a case-by-case basis, but settling with the SEC for wrongdoing that was unintentional or caused relatively small losses, as seen in the short selling actions, may not require admissions of wrongdoing.
When an admission will likely be required because of the size or seriousness of a particular case, a speedy investigation and proactive engagement with the SEC may permit a company to negotiate comparatively favorable terms for a settlement. For instance, if an internal investigation reveals reporting failures, either alone or in conjunction with other wrongdoing, an offer to admit to a books-and-records violation may provide a mutually satisfactory resolution. In such a case—as in the JPMorgan settlement—the SEC obtains an admission pursuant to its policy, and the company admits wrongdoing in a way that causes less harm in any follow-on private actions.
In the face of harsher anticipated settlement terms, requiring admissions that would jeopardize a company's ability to fight follow-on civil suits or could even subject it to criminal liability, counsel may elect not to share the results of an internal investigation, but instead to proceed to trial. This approach involves all the usual risks of litigation, and removes the certainty of negotiated admissions associated with a settlement. Despite these potential pitfalls, where it appears that a company will be unable to settle without a significantly damaging admission to wrongdoing, the approach some may choose will be to refuse to share the results of any internal investigation and to force the SEC to investigate and litigate the case.
It remains to be seen how frequently the SEC's new policy regarding admissions of wrongdoing will be applied, and how the admissions the SEC has obtained thus far will impact settling companies in private litigation. What is clear is that companies, and their counsel, must be prepared to adjust to life under these new and more aggressive settlement policies.
Michael B. Mukasey, the former U.S. attorney general and former chief judge of the Southern District of New York, is a partner in the litigation department at Debevoise & Plimpton. Helen V. Cantwell is a partner in the firm's litigation department and was an assistant U.S. attorney in the U.S. Attorney's Office for the Southern District of New York. Philip A. Fortino, counsel at the firm, and Derek Wikstrom, an associate, assisted in the preparation of the article.
1. SEC v. Citigroup Global Markets, 827 F.Supp.2d 328, 335 (S.D.N.Y. 2011).