SEC wants you to confessSEC Chair Mary Jo White has indicated that the SEC will require that, in certain cases, admissions be made as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in the complaint of its enforcement action.  The move marks a departure from the typical practice at the SEC and many other civil federal regulatory agencies of allowing defendants to settle cases without admitting or denying the charges.  The policy of allowing defendants to neither admit nor deny the allegations has been increasingly criticized for its inherent lack of transparency regarding both the alleged wrongdoing and the corresponding disgorgement and forfeiture penalties.

According to White, the new policy will apply only in select cases, such as those where there is egregious conduct and/or wide spread public interest. While the precise parameters of the new policy have not been specified, White did note that the new policy would be applied on a case by case basis and that for most cases currently settling, the old policy would still apply.

Debate about the old policy began about two years ago, when Judge Jed S. Rakoff rejected a $285 million settlement that the SEC negotiated with Citigroup, in part because the deal included “neither admit nor deny” language.  The SEC has appealed, and the case is pending before a panel of the U.S. Second Circuit Court of Appeals. Since then, a handful of other judges have voiced their discomfort with allowing defendants to pay fines without admitting liability.

In previously defending the old policy, the SEC has argued that most defendants would refuse to settle if they had to admit wrongdoing.  Essentially, companies and executives would rather fight in court than admit liability and face additional liability in parallel civil lawsuits, as well as the added difficulty of losing director and officer indemnification coverage which often pays the legal fees for corporate officers (a benefit which can be lost if the person is found to have engaged in certain wrongful conduct).  Because the old policy facilitates settlement, the SEC argued, it furthered the SEC’s goal of compensating those investors harmed by the alleged actions without the delay of a potentially long trial.

But while this seemingly tougher stance on SEC enforcement may respond to the old policy’s critics, will this change in policy really increase deterrence?  Inevitably, when applied, the new policy will serve to discourage settlement.  However, settlements with the SEC have penalties and other components that have significant deterrent value separate and apart from an admission. Essentially, included among the SEC’s range of tools utilized in negotiating settlements are traditional injunctions prohibiting conduct, equitable remedies such as the required installing of procedures to protect against future transgressions, and importantly, disgorgement and monetary penalties which serve to compensate the investors harmed by the allegedly wrongful conduct.

Even in cases that will ultimately settle, other significant consequences may arise.  For example, if corporate or individual defendants will be asked to admit the detailed allegations of wrong doing typically made in an SEC enforcement complaint, demands will very likely be made to analyze the underlying evidence, which could take a considerable amount of time, and is a process currently avoided by the SEC at the “Wells” stage when most cases are settled.  In the worst case scenario, such a process may cause the settlement process to break down, meaning more potentially large and complex actions heading for trial.  Further, and on the negotiation front, in return for an admission, the SEC will likely have to give up something else in return.  A possible result might be that the SEC will decrease the penalties (and thus, compensation to the harmed investors) it otherwise would have ordered and received.

In light of these potentially significant implications, the SEC will have to tread carefully in implementing the new policy.  While egregious circumstances and the public interest may call for increased action on the part of the SEC, the interests of conserving SEC resources and of compensating the investors whom the SEC is charged to protect, mandate substantial weight in determining how the SEC ultimately handles its enforcement policy.