Consent Decrees and SEC Settlements.

Consent judgments and SEC administrative settlement orders are not the same. Consent judgments are entered by federal courts. SEC administrative settlement orders are final agency actions. These two types of enforcement actions have different requirements and characteristics.

For example, administrative settlement orders are subject to SEC Commission approval. While consent judgments are subject to federal district court approval, administrative settlement orders are approved by the Commission under Rule 240 of the SEC’s Rules of Practice.

Federal courts review all proposed SEC consent judgments before they are entered. The SEC utilizes the federal district court approval process to ensure that the proposed judgment is fair, reasonable, and adequate, that it is not the product of collusion, and that any injunction it contains complies with Federal Rule of Civil Procedure 65(d).

The SEC can seek administrative enforcement or civil enforcement. While administrative enforcement is an option, the SEC has also targeted individuals and entities in federal district courts.

When targeting corporate misconduct, the SEC has targeted:

• Companies,
• Gatekeepers,
• Executives,
• Directors, and
• Employees.

The SEC also enforces antifraud, accounting-control, and disclosure-control requirements of the securities laws and the Exchange Act. This includes targeting failures of corporate governance. The SEC has also pursued enforcement actions targeting issues including, but not limited to:

• Auditor independence, and
• Mandatory partner rotation.

As previously mentioned, the SEC has also pursued enforcement actions targeting insider trading, attempted insider trading, and corporate insiders. As a result, the SEC has the power to target insider trading, and it often pursues cases involving:

• Fraud in the sale of securities,
• Manipulative and deceptive devices,
• Falsification of books and records,
• Failure to supervise, and
• Inadequate internal controls.

The SEC can pursue civil enforcement actions in federal district courts or administrative proceedings before an administrative law judge. The SEC pursues civil enforcement actions in federal district court through its own attorneys, without needing the DOJ to file or litigate them.

How Does SEC Settlement Approval Work in Each Forum?

In SEC v. Citigroup, the Second Circuit outlined the federal district court’s role when approving a proposed consent judgment. When assessing whether to approve a proposed consent decree, Second Circuit courts must:

• Assess if the proposed consent decree is fair and reasonable under the circumstances;
• Assess if the proposed consent decree falls within the court’s jurisdiction; and,
• Review the proposed consent decree under the standards for equitable remedies.

As the Second Circuit notes in Citigroup, when SEC proposed consent decrees contain injunctive relief, courts may also need to review the proposed consent decree under a public-interest standard.

SEC Rule of Practice 240 governs written offers of settlement during administrative proceedings. Rule 240 requires that “any offer of settlement shall be submitted to the interested division, and the interested division shall present the offer of settlement to the Commission with its recommendation, except that, if the division’s recommendation is unfavorable, the offer shall not be presented to the Commission unless the person making the offer so requests.” Staff recommendations of settlement are not binding on the Commission prior to approval and SEC Rule of Practice 240 provides that final acceptance of any offer of settlement will occur only upon the issuance of findings and an order by the Commission.

SEC does not provide a specific rule or procedure that is governing the timing of the SEC’s investigation, prosecution, and any proposed settlement. While there are informal SEC procedures, a general timeline of negotiated settlement is as follows:

• The SEC issues subpoenas and other requests for information;
• The SEC interviews witnesses and gathers documents; and,
• The SEC investigates.

During the SEC’s investigation, the SEC may issue subpoenas, demand documents, and interview witnesses. At this stage of the SEC’s investigation, there is an opportunity to communicate with the SEC, and such communication may allow for the case to be resolved without further SEC action.

Upon completing its investigation, the SEC may seek to levy fines, impose industry bars, or other penalties. At this stage of the SEC’s investigation, the SEC may issue a Wells notice, which provides the targets with an opportunity to file Wells submissions. In Wells submissions, the target may persuade the SEC against levying fines or imposing industry bars or other penalties.

At this stage, negotiating a resolution is one possibility among several for resolving an SEC matter. The SEC continues to resolve matters that involve alleged insider trading and other violations of the securities laws and the Exchange Act.

Will Admissions or Parallel Criminal Proceedings Affect My Settlement?

Most SEC settlements resolve allegations of wrongdoing without an admission or denial of guilt. The SEC’s 2013 admissions policy requires admissions in selected cases involving heightened public accountability and concern. This includes cases where an admission is “required in the public interest,” and cases involving “substantial or egregious” harm to investors or others. While the SEC’s 2013 admissions policy does not apply to all cases, the SEC will likely require admissions in cases that meet its criteria.

Even if the SEC’s 2013 admissions policy does not apply, SEC policy does not preclude the SEC from denying defendants the “neither-admit-nor-deny” treatment after the defendants admit to criminal conduct in related proceedings. With this in mind, negotiated settlements that involve admissions or denials will always carry some risk. Settlement admissions can be used in related private or criminal proceedings, and they will expose the defendants to additional liability in civil litigation.

The federal judiciary generally does not automatically stay SEC civil discovery, and the Supreme Court of the United States has declined to intervene in the judiciary’s decision to deny requests for stays. If parallel criminal proceedings are pending, courts have the discretion to grant a stay, and this is common. With this in mind, parallel criminal proceedings can increase the likelihood of obtaining a stay.

Parallel civil and criminal proceedings may present a potential Fifth Amendment challenge in SEC enforcement matters. The Fifth Amendment, which is entitled to constitutional protection in both civil and criminal proceedings, allows defendants to refuse to answer questions that could lead to a criminal prosecution. When defendants refuse to answer questions during the SEC’s civil discovery process, this can result in an adverse inference that the defendant is guilty in the SEC’s civil case.

The SEC does not prosecute federal securities crimes. Instead, DOJ prosecutors handle federal criminal prosecutions, and they may intervene if a criminal prosecution is warranted. The SEC does not conduct criminal investigations in parallel with its civil investigations. However, the SEC does refer cases to the DOJ when criminal prosecution may be warranted.

Once a criminal investigation commences, SEC investigations and DOJ investigations may proceed in parallel. With this in mind, a defendant’s Fifth Amendment rights become critical if there are parallel investigations, and engaging with counsel is a necessary step. If the target is prosecuted under the securities laws or the Exchange Act, parallel civil and criminal proceedings may have the potential to present a potential Fifth Amendment challenge.

Finally, negotiated settlements that require admissions of wrongdoing will have the potential to expose defendants to additional civil liability and criminal liability. Consent judgments may also be subject to modification upon the SEC’s petition for modification. Thus, parties to consent judgments and administrative settlement orders should thoroughly consider the potential risks associated with their settlements.

Todd Spodek is the managing partner of Spodek Law Group, a second generation criminal defense firm that has been practicing since 1976.

What Remedies Can an SEC Settlement Impose Today?

Civil Penalties

Exchange Act Section 21(d)(3) authorizes the SEC to seek civil penalties for any violation of the Act under a three-tier structure, with the higher tiers reserved for violations involving fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement. Civil penalties will vary depending on whether the SEC chooses to file its enforcement action administratively or civilly in federal district court.

Disgorgement

Exchange Act Section 21(d)(7) expressly authorizes the SEC to seek disgorgement claims. However, in Liu v. SEC, the Supreme Court limited the SEC’s ability to levy equitable disgorgement to net profits that are awarded to the recipients of the wrongful funds. The court noted that “disgorgement is an equitable remedy” and that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under Section 21(d)(5) of the Exchange Act.”

Officer and Director Bars

Exchange Act Section 21(d)(2) also authorizes the federal courts to impose officer-and-director bars. An officer-and-director bar requires the court to find that a defendant’s conduct reveals “substantial unfitness” to serve as an officer or director of a public company. This includes cases where the defendant committed fraud and misconduct.

Administrative Cease-and-Desist Orders

Exchange Act Section 21C authorizes the SEC to seek administrative cease-and-desist orders. The SEC can seek a cease-and-desist order after notice and an opportunity for hearing, and the Commission may publish its findings and enter the order upon finding that the respondent is violating, has violated, or is about to violate a provision of the Exchange Act or a rule or regulation thereunder.

SEC v. Jarkesy

SEC v. Jarkesy held that when the SEC seeks civil penalties for securities fraud, the Seventh Amendment entitles the defendant to a jury trial in federal court, so the Commission may not adjudicate those claims in-house before its own administrative law judges. The Court’s ruling focuses on the difference between statutory and equitable enforcement and also includes implications for both civil and administrative enforcement actions.

Injunctive Relief, TROs, and Asset Freezes

Plaintiffs in SEC enforcement litigation may also seek temporary restraining orders and injunctive relief. Under Federal Rule of Civil Procedure 65(b), the district court has the authority to grant temporary restraining orders without providing prior notice to the defendant. The rule allows the court to grant the temporary restraining order “without notice” only when the application for the temporary restraining order “clearly and specifically shows that immediate and irreparable injury, loss, or damage will result before the adverse party can be heard in opposition.”

The SEC also has the authority to seek asset freezes under the “extreme and emergent circumstances” of asset dissipation during enforcement proceedings. Asset freezes and other injunctive remedies, however, must meet the same standards as TROs and preliminary injunctions.

In addition to these remedies, negotiated settlements may impose other substantive and procedural obligations on the parties involved. While the SEC may waive certain forms of injunctive relief in favor of disgorgement, civil penalties, or other penalties, this is a result of negotiation.

When negotiating with the SEC, all of these remedies must be considered. Our attorneys at Spodek Law Group are familiar with these enforcement measures and the issues at hand, and we can assist with developing a comprehensive enforcement defense strategy.

Can I Modify an SEC Settlement, and How Is It Enforced?

Modifying SEC Settlements

Modifying a negotiated settlement involves different procedures depending on the forum and nature of the settlement.

If you have a consent judgment, modification may be permissible under Federal Rule of Civil Procedure 60(b). This rule grants federal district courts the authority to grant relief from a judgment “any other reason that justifies relief.” Under the rule’s broad scope, parties in SEC consent judgments can pursue motions to set aside judgment for:

• Mistakes,
• Newly discovered evidence,
• Fraud, and
• Other equitable reasons.

If you have a cease-and-desist order, Exchange Act Section 21C(d) allows a respondent served with a temporary cease-and-desist order to apply to the Commission to have the order set aside, limited, or suspended, and to seek review of the Commission’s decision in federal district court. As a result, the Commission has a degree of discretion when considering requests to modify a cease-and-desist order.

When facing an SEC consent judgment or administrative settlement order, any petition for modification or challenge of a final order will be reviewed by a federal court. Exchange Act Section 25 generally authorizes the right to seek judicial review of the SEC’s final orders, although it also outlines a 60-day deadline for filing a petition for review. With this in mind, any party attempting to seek judicial relief will have to strictly adhere to the relevant timelines.

Enforcing SEC Settlements

SEC settlements are civil orders with the power of the judiciary. A defendant who violates an SEC consent judgment or administrative settlement order can face enforcement from the SEC or the Department of Justice (DOJ).

If you have a consent judgment that is violated, the SEC or the DOJ can petition for civil contempt in federal court. The enforcement court will use its inherent contempt powers to enforce the judgment. If the court finds that the violation is willful and not the result of a dispute over a “meaningful ambiguity,” it will hold the defendant in contempt. With this in mind, civil penalties are not off the table in cases involving a negotiated settlement, and defending against contempt charges will be a necessary part of an enforcement defense.

If you have a cease-and-desist order that is violated, then under Exchange Act Section 21(e), the SEC may petition the federal district court to compel compliance with the order. While the enforcement of a cease-and-desist order is an administrative process, failure to comply with the order can have consequences similar to those in civil contempt proceedings. With this in mind, defending against enforcement actions will be a critical part of a negotiated settlement.

What Obligations and Collateral Consequences Survive an SEC Settlement?

Issue Preclusion and Collateral Estoppel

Generally, consenting to an enforcement action does not prevent defendants from asserting affirmative defenses in related litigations. This is because, to qualify for issue preclusion (or collateral estoppel), the issues must have been “actually litigated, determined, and decided in previous litigation.” As a result, consenting to the enforcement action is not the same as losing on the merits. However, if defendants admit to the violations during an enforcement proceeding, this admission may bar them from asserting that issue in related litigation. As a result, the defendant’s consent to the enforcement action, and whether defendants’ admissions are included, should be scrutinized before seeking a negotiated resolution.

Tax Consequences

Internal Revenue Code Section 162(f) generally disallows the deduction of fines and penalties imposed under federal laws by government agencies in relation to criminal penalties or civil penalties for purposes of correcting an “accounting or financial report, or other disclosure.” In principle, this is to prevent companies from receiving a “tax break” for committing misconduct. However, there are several exceptions under Section 162(f). The statute expressly allows the deduction of “amounts paid to a government agency or any state or local government . .. for the purpose of :”

• “Restitution, repayment, or remediation,” provided that the settlement statute specifically identifies the amount as restitution or remediation,
• “Compliance with a court order, a judgment, or a similar agreement,” and,
• “Any amount required to be paid as a result of an agreement to establish a compliance program.”

While Section 162(f) provides these exceptions, there are requirements in place in order to establish an exception. For example, when a company intends to deduct remediation under Section 162(f), the relevant settlement statute must expressly state that it allows for the deduction of “amounts which have the characteristics of restitution, remediation, or disgorgement,” and the specific amount must be established.

SEC Disclosures and D&O Insurance Coverage

Regulation S-K Item 401(f) requires public companies to disclose certain judgments and orders in their proxy statements and annual reports. This requirement extends to judgments and orders for violations of the securities laws that were final ten years before the filing date. With this in mind, when facing an enforcement action, companies and directors need to evaluate their potential disclosure and indemnification obligations.

With regard to D&O insurance coverage for SEC settlements, insurance companies typically exclude coverage for disgorgement payments, fines and penalties, and criminal fines and penalties. Whether an insurance company will pay disgorgement payments, fines and penalties, and criminal fines and penalties, however, depends on the insurance company’s policy language, as well as applicable state law. Companies and directors should consult with their insurance companies to determine whether they have sufficient coverage in the event of a negotiated settlement.

Independent Compliance Consultants and Other Obligations

In exchange for ending an investigation, the SEC may require one or more respondents to pay for independent compliance consultants. A settlement document will detail the scope of the consultant’s engagement and their authority, obligations, deadlines, and the conditions under which the consultants will end their engagement. The obligations of the consultant may be separate and distinct from the obligations that the consultant’s customer must undertake. Finally, the respondent may be required to submit compliance certifications and reports of compliance with the settlement. These documents may include attestations from the CFO or CEO that they have taken all necessary steps to satisfy the settlement obligations.

Finally, any settlement with the SEC has the potential to impact licensing, certification, debarment, security clearance, and reputation. Any company, individual, or professional who is facing an SEC enforcement action should closely assess all collateral consequences of a negotiated settlement.

Get Advice on Your Situation

If you want someone to look at the specifics of your case, Spodek Law Group handles federal criminal defense nationwide from New York and Los Angeles. The firm has been practicing since 1976 and its motto is simple: we owe loyalty to only you. Call 212-300-5196.