Financial Regulatory Forum

SEC move toward admissions of guilt may have only limited impact

By Guest Contributor
June 24, 2013

By Nick Paraskeva, contributing author for Compliance Complete

NEW YORK, June 24 (Thomson Reuters Accelus) – A new enforcement policy to require admissions of guilt in serious civil cases will be a potent weapon for the Securities and Exchange Commission, (SEC), if the agency chooses to use it. The change will appease some of those who criticized the SEC for a tepid enforcement response to the crisis. However, without a transparent process, there will be little way of knowing in which cases the admission is being sought.

Recently-appointed SEC Chairman Mary Jo White this week announced a policy change, to require firms to admit guilt in the most serious enforcement cases. Like other agencies, the SEC has routinely settled cases where a defendant neither admits nor denies wrongdoing. An agreed-upon set of facts is published that describes the nature of the defendant’s actions, the charges being settled, and the agreed penalty.

The new policy can be a serious deterrent if firms believe it will be applied, and have a clear view of violations it will cover. The higher stakes for a defendant of an admission raise the value of compliance to prevent the violation. It also gives the SEC leverage, which could encourage a defendant to co-operate in return for a lighter penalty. If a firm concludes an admission will be sought, it will likely contest the case in court.

As reported in the Financial Times, SEC enforcement directors George Canellos and Andrew Ceresney wrote in a staff memo that “admissions could be in the public interest” in certain cases. These include cases of serious misconduct that harm a large numbers of investors, where the defendant obstructs an SEC investigation, or where an admission “might safeguard against risks posed to the investing public.”

The change is unlikely to have a practical impact on firms until evidence is available of which violations the SEC considers serious enough to merit its use. The first firm required to make an admission of guilt is likely to challenge the action, given the precedent set and discretion available to the SEC not to pursue it. If charges are brought only against small or already-defaulted firms, the deterrent will be less visible.

Private lawsuits

Behind-the-scenes haggling is likely on which actions a defendant will admit. Defense lawyers are likely to want to minimize admissions to areas that are not actionable in private lawsuits. Otherwise, the total legal cost to a firm of settling with the SEC may be a multiple of the headline dollar fine. Firms may negotiate a higher fine or other redress rather than an admission, thus leaving unclear if any admission was removed.

The industry has argued against a general policy of requiring defendants to agree to admissions of guilt. One reason is fear that this provides a plaintiff with evidence to use against them in private lawsuits and class actions. If the SEC applied such a requirement to a deep-pocketed firm, they would have a greater incentive to fight the settlement and to instead take-on the SEC in a contested courtroom battle.

A public fight with regulators is something that firms and their shareholders, are usually averse to. Even on matters of policy difference, many firms submit comments under the umbrella of a trade association. In a contested court case, a firm’s claim of innocence can appear self-serving. The publicity that such a case would generate also subjects the firm to reputational risk, which could hurt its business.

In a recent contested case, the New York State Department of Finance (DFS) charged Standard Chartered with disguising transactions with Iran. The bank strongly rejected the claims and said it would fight these, while embarking on a press campaign against the DFS for acting in isolation without federal regulators. A week later, after large falls in stock price and shareholder pressure, the bank agreed to a $340 million settlement.

At the end of last year, the SEC appealed a court’s rejection of its $285 million settlement with Citi. The court declined to approve the settlement as it did not require an admission of guilt and was too small. The SEC is seeking a review of this decision by the U.S. Court of Appeals for the Second Circuit, claiming that the standard applied was at odds with decades of decisions which had upheld similar settlements.

The SEC has previously argued the benefit of no-admission settlements, claiming a new standard would deprive investors of substantial and immediate benefits It claims that early settlements avoid courtroom delays and the risks of losing at trial, or winning less than the settlement amount. It could also force the SEC to go to trial more frequently, which could result in fewer total cases.

Last year, the SEC stopped allowing civil defendants to neither admit nor deny fraud, if they had already pleaded guilty in a parallel criminal case. This did not apply to the majority of SEC cases, in which there is no criminal charge. The new change will further amend the original policy, at least for more serious cases.

Deflecting criticism

The incremental policy change aims to deflect criticism of the SEC for not being tougher on financial firms and their executives for financial crisis-era violations. The revision also has a benefit of being irrefutable until there has been a period of experience on which to judge it. Concern about unwillingness to take enforcement actions against large firms has also been directed at bank regulators and the Department of Justice.

White has taken a pro-industry stance on policy issues. In June, the SEC proposed a money-market fund rule, revised from the version that her predecessor Mary Schapiro had tried to issue, in a way that made it more palatable for fund sector. Last month, the SEC revised its cross-border derivatives rules to allow reliance on overseas regulators with comparable regimes despite a different approach at other regulators.

On its face, the enforcement change could be seen as a move that the industry would not support. Given the informal context of the Chairman’s remarks and the lack of detail, there has been an unwillingness to comment on it. Further discussion is expected when the policy change is published or enforcement cases issued which reflect the concept.

As reported in April, when appointed by White as new enforcement co-head, Canellos said the SEC would shift its focus away from credit-crisis era cases, to those that currently affect the markets. He also stated that the SEC will bring fewer cases to district court, where their proposed settlements have faced challenges from judges on the level of penalty imposed and the lack of any admission of guilt.

Both White and Canellos have said accounting fraud will be a higher enforcement priority, in a reversion to the pre-crisis period when a significant proportion of SEC cases were against public companies for mis-stating earnings. Such a development will not be unwelcome to Wall Street, given that they comprise a smaller proportion of the potential accounting fraud cases, and will move the spotlight away.

Before confirmation, White testified that strengthening enforcement will be a high priority, adding, “it must be fair, but it also must be bold and unrelenting.” Given White’s prosecutorial and defense background, there is intense interest in the enforcement direction that will be taken. While no large settlement has yet been issued, future ones will be closely scrutinized for admissions of guilt, or the basis for their absence.

(Nick Paraskeva is principal of Reg-Room LLC (www.reg-room.com), which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and nparaskeva@nyc.rr.com. Follow Nick on Twitter@regroom.)

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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