Last week the Securities and Exchange Commission (“SEC”) announced it had entered into its first deferred prosecution agreement (“DPA”) with an individual.  The announcement is interesting for two reasons.  It reflects the increasing tone of law enforcement the Commission is taking in its enforcement proceedings, and it raises the question (as with so many SEC settlements) as to what the defendant is really gaining by falling on his sword rather than challenging the allegations on the merits.

The case arose from a fraud at the Connecticut hedge fund Heppelwhite Fund, LP (the founder of which, Berton Hochfeld, was criminally convicted earlier this year).  The SEC entered into a DPA with Scott Herckis, the former administrator of the fund and the person who first reported the wrongful conduct to the government.  Herckis, a CPA, had no experience as a fund administrator prior to working with Heppelwhite.  At Hochfeld’s direction, he transferred monies from a capital account to personal accounts under Hochfeld’s control.  Over time, these transfers led to Hochfeld’s capital account having a negative balance.  When Herckis raised this issue, Hochfeld reassured him he would pay the funds back.  Herckis also discovered a discrepancy between the net asset value ("NAV") of the fund between its internal reporting and that of its prime broker.  To resolve this discrepancy, Herckis hired an outside consultant to examine the issue.  Herckis eventually resigned as administrator and then contacted government authorities. In other circles, he might rightfully be called a whistleblower.

By entering into a DPA, the Commission is striking the posture of a law enforcement agency – the tough “cop on the beat” that Mary Jo White promised Congress.  Deferred prosecution agreements are a common tool in criminal law, but generally have not been used in civil proceedings (the SEC’s first DPA with an entity was only entered in 2011).  The fact that these agreements went seemingly undiscovered for nearly 80 years by every former Commission and Enforcement Director suggests they may be out of place in a civil enforcement agency.  (Even the use of the word “prosecution” is somewhat strained in a civil context.)

The DPA is also striking for the nature of the underlying settlement.  Herckis agreed to pay a significant figure of “disgorgement,” even though none of the monies he received as fund administrator could rightly be called ill-gotten.  He also agreed to a five-year bar from the securities industry, and to the significant limitations and reporting requirements of the DPA itself.  In short, even though no penalty was assessed, he consented to relief that was every bit as onerous, if not more so, than if he litigated his case and lost.  He also gave up the chance to defend his conduct, which seemed at most negligent, and claim the mantle of whistleblower. 

As with the SEC’s new penchant for requiring admissions in settlements, we will have to wait and see the extent to which DPAs become a common fixture in the civil enforcement landscape.