Do SEC Settlements Prospectively Change Conduct?


By: David Mou

Over the past few years, Judge Jed Rakoff, Federal District Court Judge for the Southern District of New York has been a champion against big banks and the Securities and Exchange Commission (SEC). Most recently, Citigroup and SEC lawyers have been called to court on November 9, 2011 to defend the terms of their $285 million settlement agreement. In September 2009, Judge Rakoff refused to approve a $33 million settlement between Bank of America and the SEC, in part because it forced shareholders to foot the settlement bill. Bank of America and the SEC eventually settled for $150 million. Essentially, Judge Rakoff is articulating a sentiment that SEC settlements should require that defendants admit liability for violations. Critics fear that CEOs who accept will have diminished future employment prospects and that this precedent would open the floodgates of civil litigation. However, by failing to recognize director liability in settlement agreements, executives are let off the hook.

The false dichotomy between the actions undertaken by corporations and the leaders who make them, strikes at the heart of the frustration over the corporate compensation structure. CEOs are rewarded regardless of how their company performs in a particular quarter. Mother Jones recently tracked nine Wall Street Executives who have profited immensely from the boom and bust over the past few years. These executives received bonuses even as the Federal government bailed out their companies. Particularly troublesome is that between 2007 and 2009 every company’s executive compensation structure was equivalent to at least a third of the amount of government bailouts that the company was receiving. Goldman Sachs compensated executives with $53.2 billion between 2007 and 2009 and received $53.4 billion in government funds over the same period. JP Morgan spent $74.6 billion compensating executives and pulled in $98.1 billion in government funds. Bank of America spent $68.9 on executives and took in $63.1 billion in government money, and Citigroup spent $91.2 billion on executives and took in a whopping $373.7 billion.

If the only measure of regulation that Wall Street banks want is the freedom from regulation, then these firms must be allowed to fail and suffer the consequences of their bad investments. The current system allows executives to reap the benefits, regardless of how their companies perform because risk of failure has been socialized by taxpayers via bailouts. These executives should rightfully have difficulty finding future employment, if their firm is found to have settled multiple violations of fraud.

Let me be clear Wall Street banks are integral to the American and global economy, they perform a vital and crucial function. However, they must operate in a regulatory framework that appropriately distributes risk and reward. So what should the government be doing? First and most simply, repeat offenders of the fraud provisions should be precluded from settling without admitting wrongdoing. These companies should be open to greater liability if they continue committing fraud. According to Judge Rakoff, there is an, “overriding public interest in determining whether the SEC charges are true.” The deterrent effects of fraud settlements are non-existent if the companies are repeat offenders over a short period of time or under the same executive leadership. Accordingly, why not require firms to defend the civil litigation consequences of their actions? This would be tremendously costly and would motivate firms to avoid committing fraud in the first place. In addition, it would encourage a degree of transparency if the practices of companies that commit fraud are placed on the public record for the world to scrutinize.

The SEC’s fear of litigation costs argument, quite frankly, is not compelling because plaintiffs in civil suits and class actions would absorb much of the litigation costs once the company accepts liability. The SEC as an institution has a duty to prevent fraud, including litigating to the end against companies, even if that means losing suits. The current policy of settlements only, including for repeat offenders, seems like an even bigger waste of resources if fraudulent conduct is not actually deterred. Settlements of widespread fraud for pennies on the dollar do not comport with the most elementary notions of justice and morality and do not deter fraudulent conduct in the future. Until the cost of committing fraud is increased firms will continue to violate the regulatory regime because the profits reaped will far outweigh the costs of any settlement with the SEC.


About Author

Comments are closed.

Fordham Journal of Corporate & Financial Law