• SEC's Demand for "Admissions" Simplifies Recoveries for Professional Investors
  • October 16, 2013 | Authors: Michael J. Hampson; Lawrence M. Rolnick
  • Law Firm: Lowenstein Sandler LLP - Roseland Office
  • The SEC’s amendment to its “neither admit nor deny” settlement policy - requiring some defendants to admit wrongdoing when settling enforcement actions - could be advantageous to professional investors bringing private actions for securities fraud.

    Historically, the SEC settled enforcement actions against companies and individuals who were alleged to have violated the federal securities laws by requiring consent judgments in which the defendants “neither admit nor deny” the allegations in the SEC’s complaint. The SEC defended this practice before Congress as recently as May 2012, stating that “[t]here is little dispute that if ‘neither admit nor deny’ settlements were eliminated, and cases could be resolved only if the defendant admitted the facts constituting the violation, or was found liable by a court or jury, there would be far fewer settlements, and much greater delay in resolving matters and bringing relief to harmed investors.”

    This past June, however, newly-appointed SEC Chair and former federal prosecutor, Mary Jo White, announced that in certain cases the SEC will require settling defendants to admit wrongdoing. It will no longer permit those defendants to “neither admit nor deny” the SEC’s allegations. The SEC has not abandoned the neither-admit-nor-deny settlement altogether, but it is clear that those companies and individuals whose conduct the SEC views as particularly egregious will not be allowed to settle without an admission of wrongdoing, especially when a large number of investors have been harmed by the misconduct. The SEC has reportedly indicated that it will also seek admissions of wrongdoing to assist investors in future investment decisions and to send a message to the market.

    This change in policy was recently demonstrated by the SEC in a settlement with JPMorgan in the “London Whale” case. In connection with the settlement, JPMorgan has admitted that in early 2012, traders in its Chief Investment Office intentionally understated mark-to-market losses on a multibillion-dollar synthetic credit portfolio that was designed as a hedge against the corporate debt market. The discovery of the understated losses resulted in JPMorgan restating its financial results for the first quarter of 2012. The SEC has filed an enforcement action against two former JPMorgan traders who are alleged to have understated the losses on the synthetic credit portfolio. Although JPMorgan is not a named defendant in that enforcement action, it separately agreed with the SEC to pay a $200 million penalty and to the imposition of a cease-and-desist order in which it admitted wrongdoing. Specifically, JPMorgan admitted that “its conduct violated the federal securities laws” and that it had ineffective internal accounting and disclosure controls.

    Settlements in which the defendant admits wrongdoing can be beneficial to professional investors who have been harmed by the wrong that the SEC is prosecuting. Professional investors who bring private actions for securities fraud - or who opt out of existing class actions to enhance their recoveries - are required to plead particular facts demonstrating that the company’s representations were false, that those misrepresentations were materially misleading, and that the company’s representatives acted with the requisite state of mind in making those misrepresentations. If a defendant has admitted wrongdoing in a consent judgment terminating an SEC enforcement action or an administrative cease-and-desist order, private plaintiffs can use the admission to establish wrongdoing in a subsequent civil action.

    Not all admissions of wrongdoing in SEC settlements will be useful to private litigants. Savvy defendants will seek to avoid admissions that will be used in subsequent private actions, or may only admit violating the books-and-records provisions, and not the antifraud provisions, of the securities laws. Nevertheless, the SEC’s change in settlement policy is a positive development for private plaintiffs, potentially adding a new arrow to the proverbial quiver of a professional investor seeking to bring a claim against a company that has committed securities fraud.