Securities and Exchange Commission (SEC) Chairman Mary Jo White signaled that the agency will be making a major policy change by requiring the settling party to make admissions in certain cases. At the Wall Street Journal CFO Conference on June 18, White emphasized that the SEC’s longstanding and broadly-applied “no admit, no deny” settlement model benefits the agency, the public and shareholders by efficiently resolving enforcement matters, and that it will always be a major tool in the SEC’s arsenal. However, White said at the conference, “I have reviewed the policy and the practice, and we are going to in certain cases be seeking admissions going forward. Public accountability in particular kinds of cases can be quite important.”

The new policy troubles the securities defense bar, and with good reason. It would give the SEC considerably more leverage in enforcement actions, for one. And more enforcement actions would lead to litigation. Companies would be far less likely to cough up a fine and sign on the dotted line to quickly put enforcement actions behind them if such agreements yielded public admissions of wrongdoing that could fuel follow-on shareholder suits and even criminal actions.

Rakoff’s Role

In a memo from the SEC’s Enforcement Division co-directors George Canellos and Andrew Ceresney to division staff, they expanded on White’s comments. They said the SEC would require admissions of wrongdoing where it would be in the public interest, such as in cases involving “misconduct that harmed large numbers of investors or placed investors or the market at risk of potentially serious harm; where admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or when the defendant engaged in unlawful obstruction of the Commission’s investigative processes.”

Such criteria would surely apply to SEC settlements related to the mortgage crisis such as the Citigroup mortgage-backed securities case. In November 2011, Southern District of New York Judge Jed Rakoff famously and controversially rejected the proposed $285 million settlement of an SEC enforcement action against Citigroup alleging negligent misrepresentation that led to $700 million in losses for investors. Rakoff said that although the SEC allegations were tantamount to an allegation of knowing intent, the SEC settled without requiring an admission as to the claims.

The case is an example of rising judicial scrutiny of the “no admit, no deny” policy. In January, U.S. District Judge John Kane of the District of Colorado rejected an SEC settlement in a Ponzi scheme case because the defendant “remains defiantly mute as to the veracity of the allegations.” And a federal judge in Washington, D.C., in December 2012 rejected a proposed SEC settlement with IBM related to internal Foreign Corrupt Practices Act controls. “I’m not just going to roll over like the SEC has,” Judge Richard Leon said at one point in a hearing in the case.

“If the SEC continues to worry about judges rejecting settlements it reaches that don’t include admissions, it will logically tend to apply its new policy more broadly, so how the 2nd Circuit rules [on Rakoff’s Citigroup order] is still very important,” says Douglas Greene, a shareholder at Lane Powell.

Last Word

Rakoff ordered the case to trial, reasoning that absent any “proven or admitted facts” about Citigroup’s conduct, the court did not have enough information to determine whether the settlement meets the criteria of being fair, reasonable, adequate and in the public interest. His opinion set off a firestorm around the SEC’s reliance on “no admit, no deny” settlements.

Both the SEC and Citigroup appealed and in March 2012 the 2nd Circuit issued a per curiam opinion granting a stay of the district court proceedings. Perhaps previewing its eventual ruling, the 2nd Circuit wrote, “It is not … the proper function of federal courts to dictate policy to executive administrative agencies.” The court said the SEC and Citigroup “have a strong likelihood” of succeeding in overturning Rakoff’s order.

“It would be ironic if in the end the 2nd Circuit reverses Judge Rakoff and then we’re left with this policy at the SEC that, at least in certain cases, would require exactly what Judge Rakoff wanted,” says Marc Axelbaum, a partner at Pillsbury Winthrop Shaw Pittman.

Grinding Halt

In February oral arguments, it seemed that the appeals panel might ask Rakoff to reconsider the settlement in light of the information he has after presiding over the trial and acquittal of a former Citigroup manager connected to the same scheme. Such an outcome could allow the appeals court to sidestep the no-admissions issue.

Also in oral arguments, the lawyer representing Rakoff in the appeal stressed that he was not seeking to require defendants to admit liability. Rakoff’s Citigroup order said the injunctive power of the judiciary must rest on “facts—cold, hard, solid facts” to serve a lawful or moral purpose.

The SEC hasn’t yet addressed the type of admissions it would seek under the new policy—admissions of liability versus admissions of underlying facts or portions of a claim. As a Citigroup lawyer said in the 2nd Circuit proceeding, requiring admissions of liability would make enforcement “screech to a grinding halt.”

“That’s going to be a pivotal issue because the effect on a private case, and conceivably on a criminal case too, could be determined by the nature and the scope of the admission,” Greene says. “There could be modest admissions the SEC seeks that don’t have significant adverse consequences on the related litigation.”