Trends in SEC Enforcement

Use of Pre–Wells Notice White Papers in SEC Investigations.

Generally speaking, a respondent has no formal opportunity to address the SEC staff’s legal and factual positions until a Wells notice is issued. The Wells notice, if disclosed voluntarily for business or legal reasons, may attract significant media attention and can spur immediate stock price and sales declines, as well as investor and consumer reaction. Over the past several years, the SEC has offered respondents the opportunity to be more active participants in the pre–Wells notice investigation process through the submission of white papers on issues or questions raised during the course of the investigation. It is not clear whether this shift is part of a formal mandate or simply favored by current senior officials. In any event, these white papers are written submissions on legal or factual issues raised by the staff and may contain factual and legal arguments, as well as supporting material such as relevant documents and expert reports.

The white paper process is, generally speaking, voluntary. Agreeing to submit a white paper may be advantageous for some companies and not for others. Experienced counsel should assess the pros and cons and provide a recommendation that fits the situation. Pros include: 1) the ability to explain complex facts, especially helpful in very complex or esoteric accounting or securities areas where the white paper allows the respondent to address the staff’s legal and factual positions head-on, allowing for market context and pragmatic flavor that could lead the staff to a different conclusion; 2) the opportunity to avoid adverse publicity, since no white papers have been disclosed to the public to date and there is little risk of adverse publicity by their submission; and 3) a better sense of the staff’s theories, giving the respondent a better grasp of the scope and direction of the investigation, as well as offering access (in some cases) to certain information in the staff’s investigative file that ordinarily is not made available until after a Wells notice is served.

The cons of submitting a white paper also need to be carefully evaluated. They include: 1) cost, as white papers can be lengthy and even involve expert reports, requiring time, legal fees, and human capital costs; 2) cooperation, as the white paper process places an increasing burden on the participant to be cooperative and forthcoming, which might not be ideal depending on the case; 3) moving target concerns, as the white paper process could lead to many follow-up questions, changing staff theories, and subsequent white paper submissions, as well as help the staff refine its legal and factual theories and potentially strengthen its position; 4) binding positions, meaning that unless otherwise agreed, the staff will likely take the position that any statements in the white paper are admissible as admissions against interest or for impeachment purposes in later proceedings (although the case law is still evolving on this point); 5) discoverability in third-party civil litigation, as any communications with the SEC, including white papers, are theoretically discoverable in such actions; and 6) parallel government investigations, since the white paper submission could potentially be used in a parallel investigation by the Department of Justice or other government agencies.

Overall, assuming a company has strong facts and legal positions on its side, a white paper can offer an opportunity to avoid a Wells notice. The above facts should be weighed on a case-by-case basis to determine the optimal path for best protecting the respondent’s interests.

SEC Settlements and Admission of Liability.

In SEC v. Citigroup Global Markets, Inc. [827 F. Supp.2d 328 (S.D. N.Y. 2011)], the court refused to approve the settlement of an enforcement action where Citigroup settled “without admitting or denying liability.” Following this and other, similar decisions, it was not clear whether or under what circumstances the SEC would continue settling cases without admission of liability or wrongdoing. As a result, the SEC made an official pronouncement of its position, stating that, while settlements without admission of liability were still available, the SEC would no longer accept such settlements in cases where 1) a large number of investors have been harmed or the conduct was egregious, 2) the conduct posed a significant risk to the market or investors, 3) admissions would aid investors in deciding whether to deal with a particular party in the future, or 4) reciting unambiguous facts would send an important message to the market (see Mary Jo White, “Deploying the Full Enforcement Arsenal,” speech at Council of Institutional Investors Fall Conference, September 26, 2013, http://1.usa.gov/1n1ud0O).

While most cases continue to be settled without an admission of liability, respondents who choose to settle with such an admission should carefully consider the ramifications. These include the impact of admitting liability in the face of parallel government investigations and civil litigation on the same subject matter. In addition, an admission of liability could have an impact on the coverage positions taken by directors and officers (D&O) insurers, including the fraud exclusion generally included in such policies.

SEC Enforcement Actions Filed in Administrative Courts.

Prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), SEC administrative courts were limited to enforcement actions against persons registered with the SEC and affiliated with SEC-regulated industries. There are critical procedural safeguards available to respondents in federal court that are absent in administrative proceedings. First, the administrative law judge (ALJ) overseeing these proceedings is hired by the SEC staff and paid by the SEC. On top of that, the first-level appeal from an ALJ ruling is to the full commission—the same commission that authorized the formal order of investigation in the first place. Procedurally, there is no right to a jury trial, and there are time limits as to how long after the case is filed the ALJ decision must be issued, often putting a heavy burden on counsel to quickly prepare a defense. In addition, the federal rules of evidence do not apply, and the defense has no right to depose witnesses who have previously provided sworn testimony to the SEC.

Given the uneven playing field set forth above, and the expanded remedies available under Dodd-Frank, the SEC began filing more and more enforcement actions in administrative courts. In 2015, the SEC filed 76% of its enforcement actions against public company defendants as administrative proceedings (Cornerstone Research, “SEC Administrative Proceedings Increase as Constitutional Challenges Continue,” January 12, 2016, http://bit.ly/1OApxoW). Unsurprisingly, the SEC won more than 90% of its cases filed in administrative courts the previous year, as opposed to only 69% in federal district courts (Jean Eaglesham, “SEC Wins With In-house Judges,” Wall Street Journal, May 6, 2015, http://on.wsj.com/1AKOxEH). Respondents in these administrative actions are in an uproar, especially individuals not in the securities business or directly regulated by the SEC, such as alleged insider traders and public company executives. These respondents have filed suit in federal court seeking a ruling that the administrative actions are unconstitutional on two grounds: 1) the ALJs presiding over such actions were appointed in violation of Article II of the U.S. Constitution, since they are not appointed by the president or even the commission; and 2) the above-mentioned lack of procedural safeguards afforded to the respondents in defending these claims. The only two federal courts addressing these cases on the merits thus far have found that the ALJ appointments likely violate Article II and have enjoined the administrative proceedings [Hill v. SEC, 2015 WL 4307088 (N.D. Ga. June 8, 2015); SEC v. Duka, 1:15 Civ. 357 (RMB) (S.D. N.Y. August 3, 2015)]. The executive branch is currently examining the appointments issue as to the SEC, as well as other federal agencies. In the meantime, the SEC has proposed implementing some procedural safeguards to address, at least in part, respondents’ concerns (SEC Press Release 2015-209, “SEC Proposes to Amend Rules Governing Administrative Proceedings,” September 24, 2015, http://1.usa.gov/1LiiiXZ). These include a willingness to adjust the timing of proceedings in appropriate cases and to permit parties to depose witnesses as part of discovery.