FAQ

FAQ: Why admission of guilt is now built into SEC settlements

In September 2013, JPMorgan Chase & Co. settled fraud charges brought by the U.S. Securities and Exchange Commission and three other regulatory agencies by agreeing to pay nearly a billion dollars in penalties. The SEC's $200 million portion of the settlement was one of the largest penalties in the commission's history. What really grabbed headlines, however, was that JPMorgan executives admitted to doing something wrong. As part of its SEC settlement, JPMorgan admitted to misconduct during massive 2012 trading losses, including "woefully deficient accounting controls" and failure by senior management to keep the company audit committee up to date.

For decades, defendants settling cases with the SEC got away with paying fines without admitting or denying any wrongdoing. In some cases, after agreeing to a settlement they issued press releases distancing themselves from any misconduct and suggested that regulators were guilty of being overzealous. But in June 2013, the SEC changed its settlement approach and in some cases requires defendants to admit wrongdoing.

This FAQ is part of SearchCompliance's IT Compliance FAQ series.

What prompted the SEC to change its "neither admit nor deny" settlement approach?

The SEC followed a "neither admit nor deny" settlement model for decades, but a number of judges began criticizing the procedures following the financial meltdown of 2008. In November 2011, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York refused to approve the commission's $285 million settlement with CitiGroup Global Markets Inc., writing that without an admission or denial of fault he did not have any "proven or admitted fact upon which to exercise even a modest degree of independent judgment." He argued that the policy of accepting settlements without admissions serves defending parties' "narrow interests."

In 2012, the SEC started to change its approach to settling cases with defendants who had already pled guilty in a related criminal case. To encourage greater accountability in such cases, the SEC began to require admission of guilt in settlement agreements.

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What are the benefits of requiring an admission of wrongdoing in SEC settlements and agreements?

Requiring an admission of fault or wrongdoing establishes greater public accountability -- an important part of a settlement's deterrence function, SEC Chair Mary Jo White told attendees of a Wall Street Journal CFO Network conference on June 18, 2013. Absent an admission, defendants can sidestep accountability and chalk fines up to the cost of doing business, White said.

What's more, SEC Commissioner Luis Aguilar has noted, requiring an admission of wrongdoing brings the commission's civil enforcement practices in closer alignment with criminal procedures.

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In what types of SEC settlements will the commission require defendants to admit wrongdoing?

The SEC retains the discretion to determine which cases require an admission of wrongdoing. Agency officials have described possible candidates as cases involving "egregious intentional misconduct," obstruction of an SEC investigation, or misconduct that harms or puts at risk a great number of investors. In a speech at the Council of Institutional Investors conference in Chicago on Sept. 26, 2013, SEC Chair Mary Jo White spelled out four potential scenarios:

  • Cases in which a large number of investors were harmed or conduct that was otherwise egregious.
  • Cases in which the conduct posed a significant risk to the market or investors.
  • Cases in which admissions would help investors deciding whether to deal with a particular party going forward.
  • Cases in which stating unambiguous facts would send an important message to the market about a particular case.

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What do critics of the SEC admission of wrongdoing requirement say?

If required to admit fault, some defendants would obviously be less inclined to settle fraud cases with the SEC, preferring to go to trial. Some companies might fear that an admission of fault could be used against them in other lawsuits, including criminal suits.

In May 2012, SEC Enforcement Division Director Robert Khuzami told lawmakers that "requiring admissions as a condition of settlement would likely result in longer delays before victims are compensated, dilution of the deterrent impact of sanctions imposed because of the passage of time, and the expenditure of significant SEC resources that could instead be spent stopping the next fraud."

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How has the new settlement approach been applied?

Since announcing the change in settlement policy in June 2013, the SEC has closed two high-profile cases in which it required defendants to admit fault. The first was an $18 million settlement with Philip Falcone and his hedge fund, Harbinger Capital Partners LLC. Falcone was required to admit fault for misconduct that harmed a large number of investors. Interestingly, Falcone had agreed to an earlier settlement in which he had not been required to admit wrongdoing, but the SEC overturned the earlier settlement after changing its procedures.

In September 2013, JPMorgan Chase & Co. was required to admit wrongdoing for egregious misconduct, including misstating financial results and operating without effective internal controls to prevent traders from over-valuing investments to hide trade losses. Specifically, the company had to admit to the facts underlying the SEC charges and publicly acknowledge that it broke federal securities laws. In a global settlement with the SEC and several other regulatory agencies, JPMorgan had to pay $920 million in penalties.

The bank's admissions were key to the commission's new accountability focus, SEC Enforcement Division Co-Director George Canellos said at the time. The commission "required JPMorgan to admit the facts in the SEC's order -- and acknowledge that it broke the law -- because JPMorgan's egregious breakdowns in controls and governance put its millions of shareholders at risk and resulted in inaccurate public filings," Canellos said in a public statement.

A few months after the SEC officially announced its new settlement approach, Commissioner Luis Aguilar said that he expected future admissions requirements to become stronger. In an address to the 20th Annual Securities Litigation and Regulatory Enforcement Seminar in Atlanta, he said that "the focus should go beyond having defendants only admitting facts, but also accepting fault for their misconduct and admitting to having violated specific provisions of the law."

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Falcone, Harbinger Capital agree to SEC settlement

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Let us know what you think about the story; email Ben Cole, site editor. For more regulatory compliance news and updates throughout the week, follow us on Twitter @ITCompliance.


This was first published in November 2013

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