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Director of Enforcement Robert Khuzami testifies before Congress on the SEC’s “Neither-Admit-Nor-Deny” Settlement Policy

Posted in SEC News, SEC Settlements: Policy, Issues and Disputes

The past week has been a busy one for those following the debate over the SEC’s policy of accepting a settlement without an admission or denial of the facts. On Monday, the SEC and Citigroup filed their briefs defending the "neither-admit-nor-deny" policy in the appeal of Judge Rakoff’s Opinion and Order refusing to approve their settlement (as discussed here). On Thursday, May 17, 2012, Robert Khuzami appeared before the House Committee on Financial Services to testify about that very policy. In doing so, Mr. Khuzami discussed the Commission’s policy and approach to settling matters and defended the policy and the settlement in the Citigroup Global Markets litigation.

The November 28, 2011 Opinion and Order of Judge Rakoff (which criticized the SEC’s decades-long policy of accepting settlements without an admission of liability as "hallowed by history, but not by reason") not only triggered the appellate litigation, but sparked Congressional interest as well. On Friday, December 16, 2011 (the day after the Commission appealed Judge Rakoff’s decision), the House Committee on Financial Services announced that it would "hold a hearing next year to examine the practice by the Securities and Exchange Commission of settling cases with defendants that neither admit nor deny complaints made by the SEC." At the time, Committee Chairman Spencer Bachus (R-AL) said "[t]he SEC’s practice of using ‘no-contest settlements’ has raised concerns about accountability and transparency," while Ranking Member Barney Frank (D-MA) expressed the view that the practice "raises serious issues."

In his testimony before the Committee on Thursday, Mr. Khuzami began by emphasizing some of the statistics from the last fiscal year, highlighting the record number (735) of enforcement actions brought in FY 2011 (a fact he has previously raised, but has been questioned in some reports) and stressing that over the last three years "numerous cases … involve highly complex financial products, market practices, and transactions where the investor harm is great, the investigatory hurdles are significant, and the perpetrators most elusive." With that background, he turned to the issue before the Committee and explained that the SEC’s settlement policies "serve the critical enforcement goals of accountability, deterrence, investor protection, and compensation to harmed investors."

Mr. Khuzami shed some light on the factors that the SEC considers when deciding to settle a matter:

Under existing policy, the Division of Enforcement recommends that the Commission settle a case only when our informed judgment tells us that the settlement agreement is within the range of outcomes we reasonably can expect if we litigate through trial. In making that determination, we take into account many factors, including: (i) the strength of the evidence and the potential defenses, including the possibility that the Commission might not prevail at trial, or prevail but be awarded less than the proposed settlement achieves; (ii) the delay in returning funds to harmed investors caused by litigation; and (iii) the resources required for a trial, including, most importantly, the opportunity costs of litigating rather than devoting those resources to investigating other cases.

He further explained how the process the Commission goes through during its investigation provides "the benefit of a comprehensive evidentiary record and a full and fair opportunity to evaluate the risks of bringing the action." Furthermore, because the SEC files a civil Complaint or an administrative Order Instituting Proceedings when settling, it is able set forth "the facts painstakingly gathered by the SEC staff – facts that reveal both the wrongdoing and the wrongdoers" in great detail. This allows for an informed decision and "wrongdoers are held accountable through the public dissemination of information about their misconduct; that, where appropriate, private litigants are able to utilize the SEC’s detailed allegations to assist their own cases; and that the public sees that wrongdoers suffer penalties, bars, and other sanctions at a point in time when the misconduct is still fresh in their minds." He added that the immediacy of the sanctions provide deterrence and the settlements provide investor protection and are designed to "return funds to harmed investors with increased speed and certainty."

In what seemed to be a response to Judge Rakoff’s suggestion that the SEC was hoping for "a quick headline" in the Citigroup litigation, Mr. Khuzami explained that "the Enforcement Division has improved its capacity to bring cases to trial, and stands ready and willing to file our cases unsettled where settlement terms are unsatisfactory." To support that assertion, he cited the following statistics

• 75% of the cases against individuals related to the financial crisis were filed as litigated actions, which he claimed suggested that a number of potential were rejected by the SEC as inadequate; and

• 84% of the SEC’s trials since the beginning of fiscal year 2010 produced a successful result for the Commission.

Although not directly related to the recent statistics, Mr. Khuzami pointed to a principle from a 1973 Second Circuit Court of Appeals as a reason for the Commission’s historical successes: "the Commission ‘can bring the large number of enforcement actions it does only because in all but a few cases consent decrees are entered.’" SEC v. Everest Mgmt. Corp., 475 F.2d 1236, 1240 (2d Cir. 1973) (emphasis added by Mr. Khuzami).

As for the specifics of the "neither-admit-nor-deny" settlement policy, Mr. Khuzami asserted that they are "the norm," pointing to recent settlements entered into by the CFTC, the Federal Reserve, the FTC and Department of Justice (Civil Division). He highlighted language from Supreme Court decisions that "defendants entering into injunctive consent judgments ‘often admit to no violation of the law," (U.S. v. ITT Continental Baking Co., 420 U.S. 223, 236 n.10 (1975)) and "that it was ‘customary’ that ‘the consent decree did not purport to adjudicate’ the plaintiff’s claims" (Maher v. Gagne, 448 U.S. 122, 126 n.8 (1980)).

Mr. Khuzami explored what might happen if the policy was eliminated (something we previously discussed here):

The reality is that many companies likely would refuse to settle cases if they were required to affirmatively admit unlawful conduct or facts related to that conduct. This is because such admissions would not only expose them to additional lawsuits by private litigants seeking damages, but would also risk a "collateral estoppel" effect in such lawsuits. This means that a defendant could, as a result of the admission in the SEC settlement, be precluded from challenging liability in the private civil litigation. In addition, and most significantly, such an admission can help to establish elements of criminal liability, since many federal securities laws provide for both civil and criminal liability for the same violation. At a minimum, the risks of increased civil and criminal liability that flow from an admission in an SEC action are sufficiently real that defendants are highly unlikely to settle, if at all, until those risks have passed or are quantified and deemed acceptable.

Mr. Khuzami also discussed the specifics of the Citigroup litigation, pointing to the Second Circuit’s decision to grant a motion to stay the lower court litigation while the appeal was pending (as discussed here), which (although not dispositive) stated that the Court knew of "’no precedent’ supporting the proposition that admissions are a precondition for the approval of a consent judgment and finding it ‘doubtful’ that the district court properly deferred to the Commission’s judgment that the settlement was in the public interest." He also explained how "the Commission obtained most of what it could have obtained after a successful trial, including injunctive relief and $285 million in disgorgement, interest, and penalties."

Mr. Khuzami also explained a recent change in SEC policy in that the Commission will no longer include "neither-admit-nor-deny" language in settlements where there is a parallel criminal conviction (as we discussed here).

Mr. Khuzami concluded by summarizing his prepared testimony and stating:

settling enforcement actions in appropriate circumstances allows the Commission to advance its investor protection mandate effectively and efficiently. We agree to settlements when the terms reflect what we reasonably believe we could obtain if we litigate through trial without the risk of delay and uncertainty that comes with litigation. Equally important, this settlement approach provides public accountability closer in time to securities laws violations with a detailed SEC Complaint or Order outlining the facts developed through a comprehensive investigation and identifying the wrongdoers by name. Settlements result in the prompt payment of disgorgement and penalties (which can be returned to injured investors), and the timely imposition of industry bars or other appropriate relief on wrongdoers, which protects investors and sends a strong deterrent message to the public. Our approach also preserves resources that we can use to stop other frauds and protect other victims.

He acknowledged that it "may require some measure of reasonable compromise," but stressed that the policy "is calibrated to redress wrongs committed by securities law violators, preclude wrongdoers from working with the investing public in the future, reform company practices, deter similar misconduct by others, and return funds directly to harmed investors in a timely manner."