Tuesday, May 28, 2013

SEC and 'No-Admit' Settlements

  • The Wall Street Journal

Why the SEC Needs 'No-Admit' Settlements

The Wall Street regulator would be weaker without them.

Last week, in a letter to the heads of the Securities and Exchange Commission, the Department of Justice and the Federal Reserve, Sen. Elizabeth Warren (D., Mass.) criticized the SEC practice of settling its civil litigation without requiring the defendant to admit wrongdoing. She said this practice reduces the Wall Street regulator's leverage and forces it "to settle on terms that are much more favorable to the wrongdoer."
Ms. Warren's criticism has long been shared by others on Capitol Hill and elsewhere who believe "no-admit" settlements let defendants off without sufficient accountability, obscure the public record, and deprive private plaintiffs the ability to piggyback on admissions to win monetary damage awards.
Several federal judges have also challenged the SEC practice. In one prominent case in 2011, Judge Jed Rakoff of the district court in Manhattan took the rare step of refusing to sign off on a $285 million settlement between the SEC and Citigroupcalling it "pocket change" for the bank. That refusal has been appealed, and a decision is expected soon.
The SEC and defense lawyers counter that no-admit settlements allow the agency to secure prompt and certain sanctions that are comparable to what regulators could reasonably attain through costly litigation—litigation that the SEC might actually lose. They contend that even without admissions, SEC settlements typically involve greater transparency and accountability than civil settlements by other federal agencies, some of which not only don't require an admission but actually allow the settling party to explicitly deny wrongdoing.
Largely overlooked by both sides, however, are two unintended consequences likely to flow from court-mandated admissions of wrongdoing in SEC cases.
First, as in other facets of life, when government policy makes something more difficult and costly, rational people seek alternatives to avoid the increased burden and expense. In the realm of SEC law enforcement, the most obvious alternative would be to settle more cases through the SEC administrative process, which requires no oversight by the courts.
Yet administrative sanctions and consequences have historically been viewed as less severe than federal court judgments. For that reason, defense lawyers often bargain with the SEC to avoid federal court by having their clients' cases resolved administratively. Because administrative settlements involve no judicial scrutiny, they invite the potential for reduced transparency and accountability when compared with settlements that require the imprimatur of an independent federal judge.
A second unintended consequence of mandatory admissions of wrongdoing would be weaker settlements overall. SEC settlements result from intense back-and-forth negotiations over many interrelated terms, with each side seeking the most advantageous result possible on the terms that matter most to them. Like any other negotiation, the parties eventually reach a delicate compromise at a point where each side is willing—just barely—to accept the overall deal.
Among many terms negotiated in an SEC settlement, the no-admit clause is one of the most important to the defense. A policy change requiring an admission of wrongdoing would, in essence, take this settlement term off the table. It would therefore force the SEC to compromise elsewhere in the bargain to maintain the fragile equilibrium that would have prevailed without the admission.
Simply put, given the critical importance of the no-admit clause to the defendant, it is naive to believe the SEC could bargain for the exact same charges, penalties and other sanctions plus a public admission of wrongdoing. Instead, to settle the same case the SEC would have to agree to either less serious charges, reduced financial penalties, shorter industry suspensions, or some combination of the foregoing.
The inevitable end result: Required admissions of wrongdoing but lighter overall sanctions in a less accountable venue—presumably not what critics of current SEC practice have in mind. Those clamoring for admissions of wrongdoing would therefore do well to remember the adage: Be careful what you wish for.
Mr. Ryan, a former assistant director of the SEC's Division of Enforcement, is a partner with the law firm King & Spalding.
A version of this article appeared May 22, 2013, on page A15 in the U.S. edition of The Wall Street Journal, with the headline: Why the SEC Needs 'No-Admit' Settlements.

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