Should defendants fear new SEC policy on admissions in settlements?
Mary Jo White proved herself to be quite a shrewd strategist on Tuesday, when she made a surprise announcement at The Wall Street Journal’s annual CFO Network Event. The chair of the Securities and Exchange Commission said that the agency would no longer maintain a blanket policy permitting defendants to settle SEC cases without admitting to wrongdoing. “We are going to in certain cases be seeking admissions going forward,” White said, according to my Reuters colleague Sarah Lynch. “Public accountability in particular kinds of cases can be quite important and if we don’t get (admissions), then we litigate them.” White said that in cases involving “widespread harm to investors,” “egregious intentional misconduct” or obstruction of the SEC’s investigation, the agency may insist that defendants accept liability as a condition of settlement.
In an internal email Monday to the staff of the Enforcement Division, co-directors Andrew Ceresney and George Canellos provided a bit more detail than White did in her public remarks. “While the no admit/deny language is a powerful tool, there may be situations where we determine that a different approach is appropriate,” Ceresney and Canellos said in the email, which was provided to me by an SEC representative. “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.”
That sounds like a major policy shift from an agency that has for decades permitted defendants to settle civil cases without admitting or denying the SEC’s allegations. Until last year, after all, even defendants who had already been convicted of financial crimes didn’t have to admit liability in settlements with the SEC. The neither-admit-nor-deny policy, as you know, has lately been criticized by a series of federal judges following the lead of U.S. Senior District Judge Jed Rakoff of Manhattan; and has been aggressively questioned by Senator Elizabeth Warren (D-Mass.). Given the public grumbling about the SEC’s perceived failure to obtain accountability from the financial institutions responsible for the economic crisis, it’s probably not an accident that White announced the agency’s new policy at an event well covered by reporters.
White’s announcement is undoubtedly very smart public relations. By carving out a loosely defined exception to the agency’s old policy (while simultaneously cautioning that “a majority” of cases will still be settled under the neither-admit-nor-deny framework), White bought herself and her colleagues a break from criticism and a dose of goodwill. The new policy permits the SEC chair to look like the tough prosecutor she has been billed as, at least until the next time the agency reaches a neither-admit-nor-deny settlement with a malignant defendant.
But is the policy more than good optics for the SEC? Will it, for instance, have collateral effects in private class actions that parallel SEC cases? Corporate exposure to shareholders in securities class actions usually dwarfs the SEC’s potential recovery, which is limited by statute. If admissions to the SEC translate into liability findings in class actions, the SEC’s policy could be disastrous for businesses facing SEC charges.
I asked 10 securities lawyers – three class action counsel and seven law firm partners on the defense side – about the impact of the SEC policy change on Wednesday. (Three of the defense lawyers commented via email; all but two offered comments without attribution because of client concerns.) You won’t be surprised to hear that shareholder lawyers are optimistic about the impact of the new policy on their cases. “This could make a huge difference,” said Max Berger of Bernstein Litowitz Berger & Grossmann. Berger, his partnerJerry Silk and Steven Toll of Cohen Milstein Sellers & Toll all said that admissions of liability in SEC cases would strengthen their class actions, even if the admissions weren’t, on their own, considered irrefutable evidence of liability to shareholders. (As Toll noted, it’s been so long since the SEC demanded admissions that plaintiffs’ lawyers don’t know for sure how much weight judges will accord such statements in collateral class actions.)
The new policy’s warm reception from plaintiffs’ lawyers is why, in the short term, the SEC will have more leverage in its negotiations with corporate targets. The threat of a demand for admissions – and the collateral exposure defendants would face in private shareholder litigation – means that businesses will probably be more eager than ever to settle with the SEC as long they can avert an admission of wrongdoing. The SEC typically opens talks with an assertion of securities fraud. Defendants used to be secure in the knowledge that negotiations would almost surely end with a complaint citing lesser charges and an agreement that didn’t require any admission of wrongdoing. Now that’s not so sure. So according to defense lawyers, SEC targets will probably make quicker counteroffers in which they agree to higher penalties and more stringent injunctive punishment so long as the SEC drops its demand for admissions. (One lawyer said that corporate boards will have a hard time voting to approve settlements that require admissions, considering that such settlements might subject them to liability in shareholder derivative suits.)
If defendants can’t talk the SEC out of a deal that includes an admission of securities fraud, they and their lawyers will have to think hard about settling fast with shareholders to minimize the impact of a liability finding or concession in the parallel SEC case. That probably means settling the class action even before reaching a deal with – or going to trial against – the SEC.
These defense calculations, of course, depend entirely on how often the SEC demands admissions and how much the agency requires defendants to concede. Every lawyer I talked to agreed on that point. The class action lawyers, for instance, predicted that defendants will try to structure settlements to avoid an admission of reckless or knowing fraud, concessions that would help shareholders satisfy the standard of proof in private securities fraud litigation. An admission of mere negligence, on the other hand, wouldn’t really help shareholders in fraud class actions since negligence doesn’t amount to fraudulent intent. Berger, Silk and Toll all said they’d be disappointed if the SEC permitted defendants to admit only to negligence under the new policy. “Given what the chair said, that she’s going to hold them to a higher standard in egregious cases,” Silk told me, “I don’t see how they can let them admit to the lesser charge of negligence.” One defense lawyer said that any admissions will be strenuously negotiated, with corporations likely insisting on language that limits the facts contained in the SEC’s complaint or else specifies that admissions are only for the purposes of the SEC settlement.
More fundamentally, if the SEC demands admissions only from the Madoffs, WorldComs and Enrons of financial wrongdoing, the new policy won’t have much impact. As I mentioned, the agency already eliminated its neither-admit-nor-deny policy for convicted defendants. Several defense lawyers told me that White’s language in announcing the new policy leaves enough room for discretion that the SEC may end up demanding admissions only from defendants facing criminal charges or negotiating deferred prosecution agreements. “The proof of the sausage is in the making,” said Boris Feldman of Wilson Sonsini Goodrich & Rosati. “In the real world, I don’t think it’s going to change much. The government will mostly play this card when the defendant is hosed anyway.”
If, on the other hand, the SEC pushes for admissions from a broad swath of defendants, the new policy could backfire. Defense lawyers told me that if the agency is dead set on admissions that will have devastating collateral effects in shareholder litigation, their clients may very well choose to go to trial instead of settling with the SEC, figuring that they have nothing to lose. Whatever you think of the SEC’s courtroom skills, the agency isn’t built to staff a lot of high-stakes trials against the best private defense lawyers that money can buy. Thomas Gorman of Dorsey & Whitney, who blogs at SEC Actions, said in an email that he’s worried about too many SEC resources going to a small number of cases in which the agency is demanding admissions. “Cases where (the new) policy is applied (outside those with a parallel criminal case) will be much more difficult to settle and may have to be litigated,” Gorman said. “Overall the new policy, unless applied on a very sparing basis, may well significantly undercut the entire enforcement program.”
The SEC’s White certainly has securities lawyers on both sides buzzing with speculation, though everyone I talked to said we won’t begin to understand the impact of the new policy for at least a year or two. I, for one, can’t wait to write about fallout from the first case in which the SEC demands an admission – or the first case in which the agency has to explain why it didn’t.
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