Deal or No Deal


While it stretches the bounds of imagination to think of Mary Jo White as bald and with a small soul patch beneath her lower lip, she and her fellow Commissioners at the U.S. Securities and Exchange Commission (“SEC”) have recently morphed into a role akin to Howie Mandel in his popular television show “Deal or No Deal.”  The Commissioners’ more aggressive role in rejecting settlement deals agreed upon by SEC staff and defendants has led to early successes for the Commission, but could lead to unintended negative consequences going forward.  SEC staff has reached multiple settlements that were agreed upon in principle, but which were later rejected by the Commissioners.  This policy shift risks creating strife between the SEC staff and the Commissioners, while needlessly expending scarce resources on duplicative work and, potentially, on unnecessary trials.  To alleviate this problem the Commissioners need to more clearly outline to the SEC staff the settlement parameters they will accept for securities violations.

In response to criticisms of past settlements, the Commissioners have publicly stated a policy shift towards a more stringent settlement policy.  Recent settlement rejections by the courts have instigated the policy change.  In 2011, Judge Jed Rakoff of the Southern District of New York refused to approve a $285 million dollar settlement agreed upon by Citigroup and the SEC because there was no admission of guilt.  While the SEC opposed Judge Rakoff’s settlement rejection on grounds it exceeded his authority of judicial review, the agency has recently changed its policies to align with Judge Rakoff’s critiques.  This summer, Chair White announced a policy change, stating, “We are going to in certain cases be seeking admissions [of wrongdoing]going forward.”  This policy change away from the SEC’s standard “neither admit nor deny” boilerplate language was heralded as granting additional bargaining leverage to the SEC while negotiating settlements.

But this about-face may cause consternation not only for white-collar defense lawyers, but also for the SEC staff with whom they are negotiating.  The implementation of the new guilt admission policy has led the Commissioners to be more hawkish regarding all settlements presented to them for approval.  This adds another element of uncertainty in a process that is already much more art than science.  During settlement discussions dialogue exists between the affected parties, with the SEC staff sitting between the Commissioners and the defendant. The changed policy greatly affects the staff’s ability to negotiate in good faith with defendants and reach agreements in principle.

In July, following this policy shift the SEC Commissioners rejected a settlement that had been agreed upon in principle between SEC staff and the defendants.  Phil Falcone and his hedge fund, Harbinger Capital, inappropriately loaned Falcone money and let preferred investors exit the fund during the financial crises.  The proposed settlement included an $18 million fine, but allowed Falcone to remain in control of investors’ money.  The Commissioners rejected the deal as being “too weak.”  One month after the settlement’s rejection, the SEC staff, Falcone, and the Commissioners reached a more stringent penalty that included an admission of guilt and a five-year industry ban.

Uncertainty in the settlement process continues to abound.  While the SEC was able to extract a much better settlement from Falcone, SEC staff is still finding it difficult to know what settlement agreements the Commissioners will find acceptable.  Just in mid-September, the Commissioners rejected a proposed settlement with Bruce Bent and his son, the former managers of the Reserve Primary Fund that infamously “broke the buck” following the Lehman Brother’s bankruptcy.  After months of negotiation between the Bents and the SEC staff, the Commissioners rejected the settlement that was agreed upon in principle.  While the Bents are accused of misleading investors during the financial crisis, the agency could be accused of misleading the Bents during their negotiations.  It is unclear what the next step will be in this process, and whether the SEC will again be able to obtain a better settlement, as in the Falcone case, or will be forced to go to trial.

While the policy change is new, there does not appear to be effective communication from the Commissioners to the SEC staff regarding acceptable parameters for settlements.  Continued rejections of the SEC staff’s proposed deals could lead to acrimonious relations between the SEC staff and the Commissioners and an unwillingness of defendants to negotiate.

The SEC staff is in a handcuffed position that could lead to frustration and discontent between parties working toward the same goal.  The staff has an obligation to protect investors but only has limited resources to carry out this mission.  Complicating matters, the Commissioners who they work under have recently changed the settlement policy, but have not effectively informed staff members of what they find acceptable within this new framework.  This creates frustrating ping-pong negotiations, rather than collective action.

Defendants could stop engaging in extensive settlement negotiations if settlements continue to be regularly rejected by the Commissioners.  For Defendants, the negotiations will come to be viewed as disingenuous and a waste of time.  This chilling effect will lead to less information exchange between the SEC staff and defendants, and potentially less effective enforcement.

It would be unwise for the Commissioners to use settlements agreed upon in principle with SEC staff as a stalking horse to extract more stringent penalties.  The success in the Falcone case may embolden the Commissioners to use settlements agreed upon in principle as a baseline to impose stiffer penalties.  But this policy would be unwise.   If an accused party elects to go to trial rather than continue to negotiate, the SEC will devote scarce resources for an extended period of time, delaying the administration of justice and moving the case towards a far more uncertain outcome.  Notwithstanding the SEC’s recent success in the Tourre trial and the lower burden of proof for civil cases, obtaining a guilty verdict in complex and nuanced securities cases is extremely difficult.  The SEC’s preference for settlement is grounded in reason, whereas playing a game of chicken with a defendant is not.

The Commission’s new, more stringent settlement precedent now being enforced is obviously a better deterrent of securities malfeasance going forward.  But, if the Commissioners continue to press their luck voting “No Deal” and failing to effectively communicate settlement parameters to their SEC staff, they risk negating the new enhanced deterrence features and harming their enforcement abilities.


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Fordham Journal of Corporate & Financial Law