The SEC is making a significant change to its Enforcement Program, which could negatively impact any company or person attempting to settle an enforcement action with the agency. SEC Chair Mary Jo White stated that the Agency is going to change the way it settles enforcement actions, modifying its current, sometimes criticized “neither admit nor deny” policy. Now, in select cases, the Commission will require respondents to admit wrongdoing as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in its enforcement action complaint. This new policy, when applied, will significantly increase the costs for any bank, corporation, or individual that settles with the SEC.

While the new policy will purportedly apply only in select cases, such as those where there is egregious conduct and/or wide spread harm to public investors, according to Ms. White, the SEC has not yet delineated the precise parameters of the new policy. The new SEC Chair did note that the SEC would apply the new policy on a case-by-case basis. For most settling cases, the current policy probably will still apply, but it will be difficult if not impossible for a corporation, bank or individual to determine what policy will be applied to it at the outset of an SEC investigation. Moreover, if pressure on the SEC continues, the SEC could expand the policy, with negative consequences for business. For the time being, those being investigated by the SEC should argue that their case falls within the traditional policy because it is neither egregious nor does it touch on an issue of wide spread harm to the public.

Traditional policy: “Neither admit nor deny”

The “neither admit nor deny” policy traces its roots to the early days of the SEC’s Enforcement Division in the 1970s. Under that policy, settling defendants can resolve a Commission enforcement action by submitting to the jurisdiction of the court but neither admitting nor denying the typically detailed allegations of wrongful conduct in the Agency’s complaint. While this permits settling defendants to avoid admitting liability, it does not permit them to deny it either. To the contrary, under Commission policy, settling defendants are not permitted to deny the allegations of wrongdoing asserted in the complaint. Thus, under the current policy, the public is informed of the SEC’s views of the conduct in the complaint, but unlike a criminal case where there is a guilty plea, there is no admission by the settling party that those claims are correct, and thus private litigants cannot use the settlement against the settling party in private civil litigation.

Last year the Commission modified its policy, indicating that where there is an admission or adjudication of guilt the “neither admit nor deny” policy would not apply. This would typically arise where there is a parallel criminal action in which the party pled, or was found, guilty. To date, the SEC has applied this modification on an inconsistent basis.

The SEC designed its traditional policy to facilitate cooperation and settlement while permitting the agency to achieve its statutory goals. If defendants are required to make admissions of wrongdoing or fault, it can expose them to significant additional liability in parallel civil damage actions. For corporate defendants this can result in millions of dollars in potential liability, making them understandably reluctant to settle. Individuals may face the same liability and the added difficulty of losing D&O coverage which often pays the legal fees for corporate officers— a benefit that can be lost if the person is found liable. Avoiding these difficulties can facilitate settlement to the benefit of both the party under investigation and the Commission.

Facilitating settlement has long been crucial to the SEC’s Enforcement Program, as it is considered mutually beneficial to both the public and the purported wrongdoer. Settlement permits the party under investigation and the Agency to conserve scare resources, but also achieves some measure of justice and public accountability. The new policy could change all that and dramatically reduce the number of settlements, harming America’s businesses, but also preventing the SEC from achieving its broad regulatory objectives because it will be mired in more intensive litigation.

Impact of new policy requiring admission of facts and/or violation of laws

The new policy may expose banks, corporations, and individuals to substantially increased liability while simultaneously undermining the SEC’s ability to conduct its mission, depending on how it is administered. In announcing the policy, Ms. White gave little definition to how the new required admission policy would work. While she noted the agency would apply the new policy in “egregious cases,” such cases are already treated differently under the existing policy since such conduct will likely result in criminal charges, making the “neither admit nor deny” approach inapplicable. On the other hand, if the SEC applies it only where there is “widespread” harm to the public, it is at best unclear how it would be administered, as that test is inherently vague. For example, in declining to enter the SEC’s proposed settlement in a market crisis action against Citigroup, and criticizing the application of the “neither admit nor deny policy” to that case, U.S. District Judge Jed S. Rakoff noted that there was widespread interest in the case1. At the same time, the agency chose not to charge intentional wrongdoing but allege only negligence despite factual allegations that the court described as serious. Requiring admissions of wrongdoing under such circumstances would seem incongruous at best given that the Commission did not find the conduct intentional or egregious. The Citigroup case remains on appeal over Judge Rakoff’s ruling2. As it stands, those being investigated by the SEC should consider arguing that their conduct does not fall within the scope of the new policy, because it is neither egregious nor does it cause widespread harm to the public.

If the new policy is applied to a significant number of cases, and actual admissions of wrongdoing are required as in a criminal guilty plea—as opposed to simply admitting an error as in the SEC’s settlement with Goldman Sachs over the ABACUS 2007-AC1 transaction—the policy could undermine the ability of SEC Enforcement to fully implement its statutory obligations3. While Ms. White stated in announcing the policy that it would not cause delay, achieving that result seems at best problematic. If corporate or individual defendants are going to be asked to admit the detailed allegations of wrongdoing typically made in an SEC Enforcement complaint, they should demand the ability to analyze the underlying evidence, a practice which is not routinely permitted under the efficient “neither admit nor deny” framework. Not only could this take considerable time, it is something the agency is typically very reluctant to permit. If it causes the settlement process to break down, this can only mean that more actions are heading for trial. All of this would substantially increase the risks and costs to the entity or individual being investigated , but would also tax the resources of the Agency and limit the number of other investigations and cases it can handle.

The already difficult task of litigating with the SEC and the structural advantages the SEC possesses within the investigatory framework could further compound the problem. As it stands, the SEC provides cooperation credit to corporations or individuals who cooperate with its investigations. If an entity or individual foresees greater potential for an admission of wrongdoing, and the subsequent treatment of the admission in civil suits that would follow, they will be incentivized not to cooperate with the SEC and roll the dice at trial.

In the end, the new policy may be a “lose-lose” for everyone. Defendants in SEC enforcement actions may find themselves litigating complex and difficult actions to avoid the collateral consequences of potential liability in civil damage actions and perhaps the loss of D&O coverage. The SEC may be forced to prioritize its caseload, picking and choosing the investigations and actions it will pursue, while ignoring others. That could effectively compromise the mission of the Agency’s enforcement program.

This development needs to be monitored carefully, both to see how the SEC implements this new practice and to determine whether FINRA and state securities regulators will modify their enforcement practices to coincide with the SEC. Should you or your company become the subject of an SEC enforcement proceeding, early consultation with counsel is essential.