A NEW YORK LAW JOURNAL SPECIAL SECTION White-Collar

Crime www. NYLJ.com Tuesday, October 9, 2012

Assessing the SEC’s New ‘Neither Admit Nor Deny’ Policy

ment actions without admitting or denying Changing the Policy After 40 Years BY Mei Lin Kwan-Gett, the SEC’s allegations. Now, where there is a Alison Levine parallel criminal case, the SEC will no longer The SEC’s policy change came on the heels and Erin McLeod allow the traditional “neither admit nor deny” of a much-ballyhooed critique by Judge Jed S. language in its federal court consent judg- Rakoff and a subsequent promise by Congress n Jan. 6, 2012, the U.S. Securities and ments or its settled administrative orders. to take a hard look at the SEC’s “neither admit Exchange Commission announced that Given the frequency of parallel SEC and crimi- nor deny” policy. Oit was changing its longstanding policy nal proceedings, practitioners should pay On Nov. 28, 2011, Rakoff rejected a proposed of allowing defendants to settle civil enforce- careful attention to how this abrupt shift in settlement between the SEC and Citigroup Glob- a decades-old practice might affect their cli- al Markets, which sought to resolve securities ents.1 This article discusses the implementa- fraud charges related to the structuring and mar- Mei Lin Kwan-Gett is a partner at Willkie Farr & Gallagher tion of this policy change through its fledgling keting of a collateralized debt obligation.2 There and cochairs the firm’s white-collar criminal defense prac- months and considers the ramifications for was no parallel criminal action. The proposed tice group. Alison Levine and Erin McLeod are litigation associates at the firm. individuals and corporations. SEC consent judgment contained the usual set- Tuesday, October 9, 2012

tlement language whereby—“without admitting treated defendants who made admissions in typically noted that the defendant has “pleaded or denying the allegations of the complaint”— parallel criminal proceedings. guilty to criminal conduct relating to certain Citigroup “consent[ed] to the entry of a Final How the Policy Has Been Implemented matters alleged in the complaint in this action,” Judgment” pursuant to which it agreed to a per- cited to the parallel criminal case, and listed manent injunction from future securities law In announcing that it would no longer allow the specific crimes to which the defendant pled violations, to pay $285 million, and to establish defendants to “neither admit nor deny” the SEC’s guilty.12 In at least 13 out of those 21 cases, the certain remedial measures. Rakoff found that allegations of misconduct where there was paral- consent judgment also either (1) attached a the proposed settlement was “neither fair, nor lel criminal action, the SEC noted that it would statement of facts or a transcript of the plea reasonable, nor adequate, nor in the public inter- henceforth: (1) abandon the “neither admit nor colloquy, or (2) described specific facts to which est,” principally because it lacked an admission deny” language; (2) recite the fact and nature of the defendant has “admitted,” or both.13 of wrongdoing by Citigroup. He argued that: the criminal conviction, Non-Prosecution Agree- In three of the cases against individual defen- the S.E.C.’s long-standing policy—hallowed ment (NPA) or Deferred Prosecution Agreement dants, the consent judgments simply omitted the by history, but not by reason—of allowing (DPA); (3) at the staff’s discretion, incorporate “neither admit nor deny” language. Interestingly, defendants to enter into Consent Judgments any relevant facts admitted during the criminal in two out of these three instances, the defen- without admitting or denying the under- plea allocution, set out in a jury verdict form, dants were convicted after going to trial.14 lying allegations…deprive[d] the Court or included in the criminal NPA or DPA; and (4) Corporate Defendants: To date, we have of even the most minimal assurance that retain the existing prohibition on denying the located six corporate SEC consent judgments the substantial injunctive relief it is being allegations of the SEC’s complaint.9 Significantly, affected by the policy change. The parallel crimi- asked to impose has any basis in fact.3 the new policy does not necessarily require the nal proceedings included four DPAs, one NPA, In response, the SEC issued several public defendant to admit anything. Khuzami explained and one guilty plea. statements defending its policy and also filed that, even prior to the Citigroup opinion, the In all of the SEC settlements involving a an appeal.4 A day after the SEC appealed, the SEC had been considering whether the policy corporation that had entered into a DPA, the House Financial Services Committee announced should be changed.10 defendants were charged with Foreign Corrupt that it would hold a hearing to discuss whether Since Jan. 6, 2012, the SEC has implemented Practices Act (FCPA) or FCPA-like violations. the SEC should be allowed to enter into settle- this new policy fairly consistently. How the SEC The relevant portions of the consent judgments ments without forcing an admission or denial has executed the change, however, and which in three of the cases are identical, stating that of wrongdoing.5 At the hearing in May 2012, the facts are included or referenced in its papers the company entered into a DPA “in which it SEC’s Director of Enforcement, Robert Khuzami, differs from case to case, defendant to defen- admits, and accepts and acknowledges respon- vigorously defended the SEC’s “neither admit dant, and individual to corporation. sibility for conduct relating to certain matters nor deny” policy, arguing that: Injunctive Actions Settled on Consent alleged in the complaint in this action.”15 How- requiring admissions as a condition of set- ever, the consent judgments neither provide tlement would likely result in longer delays Since announcing the policy change, the SEC the criminal case citation, describe the charges before victims are compensated, dilution of has settled at least 43 injunctive actions—36 resolved therein, nor attach the “Statement of the deterrent impact of sanctions imposed individuals and seven corporations—for which Facts” for which the company explicitly admit- because of the passage of time, and the there were parallel criminal proceedings.11 Of ted responsibility when it settled the related expenditure of significant SEC resources those 43 settlements, 29 defendants signed SEC criminal charges. Notably, the DPAs state that that could instead be spent stopping the consent judgments—23 individuals and six all three companies self-reported their FCPA next fraud.6 corporations—after the policy change. In 27 violations and agreed to continue to cooperate The SEC garnered some support from the of those 29 consent judgments, the SEC omitted with government agencies. U.S. Court of Appeals for the Second Circuit. the “without admitting or denying the allega- In settling the fourth DPA case, however, the In a per curiam opinion staying the district tions of the complaint” language that previously SEC was more demanding. In the FalconStor court proceeding, the Second Circuit found was standard within the opening paragraphs of consent judgment, the SEC required an explicit that the SEC and Citigroup, which shared the the consent judgment. acknowledgement of responsibility for specific SEC’s position, had “a strong likelihood of suc- Beyond removing the “neither admit nor deny criminal misconduct, and stated that FalconStor cess” in their appeal to set aside the district language,” which facts were incorporated into accepted and acknowledged as true the facts court’s rejection of their settlement.7 Although the SEC’s papers and how they were incorpo- and allegations in the Department of Justice’s not a final decision on the merits, the court rated varied from case to case. The nature of (DOJ) criminal complaint.16 Perhaps one expla- pointed out the “significant problem” of a dis- the criminal resolution—by guilty plea, DPA or nation for the harsher treatment of FalconStor trict court’s failing to give “deference to the NPA—and whether the defendant cooperated was that it may not have self-reported its mis- S.E.C.’s judgment on wholly discretionary mat- with the government likely were factors that conduct. ters of policy” and found that it was “doubtful impacted those decisions. The SEC required further admissions in an whether the court gave the obligatory defer- Individual Defendants: When an individ- case against Diamondback Capi- ence to the S.E.C.’s views in deciding that the ual defendant resolved his criminal charges tal Management.17 In that case, Diamondback settlement was not in the public interest.”8 by pleading guilty and had a parallel SEC case had previously entered into an NPA with the DOJ Despite its ardent defense of its policy, how- affected by the policy change—which occurred whereby it admitted to a “Statement of Facts” set- ever, the SEC still decided to change how it at least 21 times—the SEC’s consent judgment ting forth the wrongful conduct of two employ- Tuesday, October 9, 2012

ees.18 The SEC consent judgment attached therein. Although one would expect the fact action might use an admission to an internal that same Statement of Facts and also stat- that a defendant had already made admis- controls charge in a SEC consent judgment ed that Diamondback “admits the facts set sions in the criminal proceeding to render to argue that a corporation and its officers forth in the [attached] Statement of Facts.” the duplication of those admissions in the or directors had an “intent to defraud” plain- The lone corporate guilty plea case SEC proceeding a mere redundancy, that is tiffs or that defendants had “knowledge” of involved Provident Capital Indemnity. In not always the case. It is important to note alleged fraud, inferable from the absence April 2012, PCI pled guilty to criminal fraud that the SEC’s cases, while parallel to the of sufficient internal controls. Or a plaintiff charges relating to the issuance of bonds.19 In criminal cases, often do not overlap perfectly. might file a action arguing that the connection with that plea, PCI admitted to a They may involve a different combination corporation’s officers and directors breached “Statement of Facts” detailing its misconduct. of defendants, a different time period, or, their fiduciary duties. In PCI’s subsequent consent judgment with most importantly, different charges. For that A recent shareholder derivative suit pro- the SEC, it acknowledged that the company reason, defendants must carefully weigh the vides an interesting backdrop. On Nov. 4, had pled guilty to specific criminal charges possible ramifications of this new policy 2010, the SEC and the DOJ simultaneously contained in an indictment and admitted as and any admissions made—explicitly or filed charges against and settled with Tide- true the same “Statement of Facts,” which implicitly—when settling parallel criminal water and its subsidiary for alleged FCPA was attached.20 and SEC charges. violations. The DOJ charged Tidewater’s Exceptions: Although the SEC has fairly Admissibility of Settlement Documents: subsidiary with violating the anti-bribery consistently removed the “neither admit nor Although Federal Rule of Evidence 408(a) pro- and books and records provisions of the deny” language from settlement agreements hibits the admission of settlement documents FCPA.28 The SEC charged Tidewater with entered into after Jan. 6, 2012 where there to prove liability in subsequent litigation, violating the FCPA’s anti-bribery, books and were parallel criminal proceedings, there are some courts have held that settlement agree- records, and internal controls provisions.29 at least two exceptions.21 In both instances, ments are admissible for other purposes— Tidewater “neither admitted nor denied” the the defendant signed a consent judgment such as to show intent and knowledge under SEC’s allegations in the consent judgment. after the policy change “without admitting Rule 404(b). The Second Circuit upheld a dis- Subsequently, shareholders filed a derivative or denying the allegations of the Complaint.” trict court’s decision to admit as Rule 404(b) suit against Tidewater’s officers and board Notably, however, both of those defendants evidence a prior SEC consent judgment to members.30 The district court dismissed the were cooperating with the government. show that the defendant had knowledge of complaint in its entirety, finding no evidence Administrative Proceedings the SEC’s reporting requirements involved that the officers and directors had breached in the judgment.24 Similarly, the Tenth Cir- their fiduciary duties to the company. Nota- Since Jan. 6, 2012, the SEC has settled at cuit held that a district court had properly bly, the parties in the derivative suit heavily least 12 cases pursuant to administrative admitted a CFTC (U.S. Commodity Futures cited the criminal DPA, which attached the orders that omit the previously standard Trading Commission) consent judgment “Statement of Facts” to which Tidewater “neither admit nor deny” language and, as for the limited purpose of showing intent admitted, but did not rely on the consent a result, the defendant explicitly admits to to defraud and knowledge of false misrepre- judgment, perhaps because of its “neither the factual findings therein.22 In those cases, sentations, noting that “[t]he admissibility of admit nor deny” language. the respondents had previously pled guilty such evidence is within the sound discretion Collateral Estoppel Effect of Admissions in parallel criminal proceedings. In another of the trial judge.”25 Findings of fact made in in Settlement Documents: In defending the case, the SEC settled with administrative orders have also been found SEC’s “neither admit nor deny” policy, Khuza- in an administrative order where Goldman admissible in arbitrations.26 mi noted that “many companies likely would admitted the limited factual findings that However, other cases have held that con- refuse to settle cases if they were required were part of a parallel civil action by the sent judgments including the “neither admit to affirmatively admit unlawful conduct or Massachusetts Securities Division, while nor deny” language are not admissible even facts related to that conduct” because “such otherwise neither admitting nor denying the as Rule 404(b) evidence. For example, the admissions would not only expose them to SEC’s findings.23 This resolution is interesting Fifth Circuit found that the trial court had additional lawsuits by private litigants seek- on two fronts. First, although the parallel case erred in admitting a consent judgment under ing damages, but would also risk a ‘collat- was a civil regulatory proceeding, the SEC Rule 404(b) where the decree “specifically eral estoppel’ effect” in subsequent lawsuits insisted on equivalent factual admissions. neither admitt[ed] nor den[ied] any act of resulting from such admissions.31 The general Second, Goldman was allowed to parse the any kind” and was “evidence solely [of] the rule is that a settlement agreement does not SEC’s facts—admitting some while not admit- fact that [the defendants] consented to entry have collateral estoppel effect on subsequent ting others. of the injunctions.”27 litigation brought by a third party because Collateral Consequences The effect of admissions made in settle- the issues were not “actually litigated.”32 A ment papers with the SEC is particularly consent judgment or administrative order It is not yet clear how courts presiding relevant in the FCPA context, where private may be “conclusive, however, with respect over private civil litigation will treat the omis- plaintiffs may allege that a company’s direc- to one or more issues, if the parties have sion of the “neither admit nor deny” language tors failed to ensure that the company had entered an agreement manifesting such an from settlement documents and the concomi- adequate internal controls to prevent illegal intention.”33 Thus, parties’ intentions as set tant admissions or acknowledgements made payments. Thus, a plaintiff in a securities forth in the settlement agreement are key Tuesday, October 9, 2012

to determining whether a consent judgment Jointly Announce Hearing on SEC Settlement io, 318 F. Supp. 2d 199, 201 (S.D.N.Y. 2004). collaterally estops a party from relitigating a Practices (Dec. 16, 2011). 27. United States v. Cook, 557 F.2d 1149, 1152, factual issue resolved therein.34 6. Robert Khuzami, Dir. Div. of Enforcement, 1155 (5th Cir. 1977). Where SEC consent judgments expressly SEC, Testimony on “Examining the Settlement 28. United States v. Tidewater Marine Int’l, contain “neither admit nor deny” language, the Practices of U.S. Financial Regulators,” at 5 10-CR-770 (S.D. Tex). parties’ intent is clear that the decree should (May 17, 2012). 29. SEC v. Tidewater, 2:10-CV-04180 (E.D. not have preclusive effect because there are 7. Citigroup, 673 F.3d at 166. La). no admissions. As explained by Rakoff in Citi- 8. Id. at 163, 165. 30. Strong v. Taylor, 11-CV-329, 2012 U.S. group, “[a]s a matter of law, an allegation that is 9. Robert Khuzami, Dir. Div. of Enforcement, Dist. LEXIS 91097 (E.D. La. July 2, 2012). neither admitted nor denied is simply that, an SEC, Public Statement by SEC Staff: Recent 31. Khuzami, supra note 6, at 5. allegation.”35 Indeed, where there is no admis- Policy Change (Jan. 7, 2012). 32. See Restatement (Second) of Judgments sion and no evidence of intent to be bound col- 10. Khuzami, supra note 6, at 6-7. See, §27 Cmt. E (1982). laterally, courts will not give preclusive effect e.g., SEC v. Galleon Mgmt., 09-CV-8811-JSR 33. See id. to consent judgments.36 (S.D.N.Y.) (Consents of Kumar and Shankar); 34. See In re Chinnery, 181 B.R. 954, 960-61 SEC v. Longoria, 11-CV-0753-JSR (S.D.N.Y.); (Bankr. W.D. Mo. 1995). Conclusion SEC v. Cutillo, 09-CV-0208-RJS (S.D.N.Y.); SEC 35. Citigroup, 827 F. Supp. at 333. After several months under the SEC’s new v. Lanexa Mgmt., 10-CV-8599-JSR (S.D.N.Y.). 36 See, e.g., In re Cenco Sec. Litig., 529 F. “neither admit nor deny” policy, the SEC has 11. These statistics represent the number of Supp. 411, 415-16 (N.D. Ill. 1982). been fairly consistent about removing the lan- settlements that we were able to locate as of guage from its settlement papers when there is Aug. 8, 2012. a parallel criminal action, but has dealt with the 12. See, e.g., SEC v. Mityas, 12-cr-00133-CBA corresponding “admission” of facts in myriad (E.D.N.Y.); SEC v. Ashbury Capital Partners, 00- ways. Sometimes there is nary a mention of the CV-7898 (S.D.N.Y.). facts or charges covered by the criminal case, 13. See, e.g., SEC v. Eshbach, 12-CV-00244 while at others there is a lengthy description of (C.D. Cal.); SEC v. Kluger, 11-CV-01936 (D.N.J.); both facts and charges. Not surprisingly, coop- SEC v. Fraser, 09-CV-00443 (D. Ariz.). eration with the government appears to yield 14. SEC v. Longoria, 11-CV-0753-JSR (S.D.N.Y.) gentler treatment. It is too soon to tell whether (Consents of Fleishman, Jiau and Pfaum). the SEC’s policy change will dampen settlement 15. See SEC v. Biomet, 12-CV-00454 (D.D.C); rates or whether the “new” consent judgments SEC v. Orthofix Int’l, NV, 12-CV-00419 (E.D. will be given preclusive effect in collateral litiga- Tex.); SEC v. Pfizer, 12-CV-1303 (D.D.C.). tion. But the SEC’s policy shift certainly gives 16. See SEC v. FalconStor Soft- defendants caught up in parallel proceedings ware, 12-CV-3200 (E.D.N.Y). reason to negotiate the precise language of their 17. SEC v. Diamondback Capital Mgmt., 12- settlements with care. CV-00409 (S.D.N.Y.). 18. Press Release, U.S. Attorney’s Office, ••••••••••••••••••••••••••••• U.S. Attorney Announces Agree- 1. See “Policy Re Consent Orders An- ment with Diamondback Capital Management, nounced,” SEC NEWS DIGEST, Issue No. 72-227, LLC to Pay $6 Million to Resolve Insider Trad- at 2 (Nov. 28, 1972); 17 C.F.R. §202.5(e) (2012). ing Investigation (Jan. 23, 2012). 2. SEC v. Citigroup Global Mkts., 827 F. Supp. 19. United States v. Provident Capital Indem- 2d 328, 329-30 (S.D.N.Y. 2011) (JSR); (Oct. 14, nity, 11-CR-14 (E.D. Va.). 2011 Consent of Citigroup, found at 11-CV- 20. SEC v. Provident Capital Indemnity, 11- 7387). CV-045 (E.D. Va.). 3. Id. at 332. 21. See id. (Consent of Castillo); SEC v. 4. See Robert Khuzami, Dir. Div. of Enforce- Fraser, 09-CV-00443 (D. Ariz.) (Consent of ment, SEC, Public Statement by SEC Staff: O’Brien). Court’s Refusal to Approve Settlement in 22. See, e.g., In re Peter Madoff, Admin. Proc. Citigroup Case (Nov. 28, 2011); Press Release, File No. 3-14963 (July 26, 2012). SEC, No. 2011-265, SEC Enforcement Director’s 23. In re Goldman, Sachs, Admin. Proc. File Statement on Citigroup Case (Dec. 15, 2011); No. 3-14845 (April 12, 2012). SEC v. Citigroup Global Mkts., 673 F.3d 158 (2d 24. See United States v. Gilbert, 668 F.2d 94, Cir. 2012). 97 (2d Cir. 1981). 25. Wegerer v. First Commodity of Boston, 5. Press Release, The Comm’n on Fin. Servs., Reprinted with permission from the October 9, 2012 edition of the NEW YORK 744 F.2d 719, 724 (10th Cir. 1984). LAW JOURNAL© 2010 ALM Media Properties, LLC. All rights reserved. Further Leaders of Financial Services Committee duplication without permission is prohibited. For information, contact 877-257- 26. See, e.g., Bear Stearns v. 1109580 Ontar- 3382 or [email protected]. # 070-04-12-12