When violations are discovered by the Securities and Exchange Commission (“SEC” or “Commission”), many investigation subjects (“Subjects”) consider settling with the SEC. This is often the right move, but there are pros and cons to this choice.
The SEC’s priority is investor protection. According to the SEC Chairman, “the sooner harmed investors are compensated, the offending conduct is remediated, and appropriate penalties are imposed, the better.” The major purpose of any settlement offer is to quickly settle issues outside of court. A settlement offer with the SEC however must emphasize appropriate compensation to investors, as well as their future protection.
The SEC favors settlement because it “return[s] money to injured investors more quickly than would be expected in a litigated action.” SEC guidelines recommend investors be compensated promptly and properly. Thus, unless an early settlement offer is made, the SEC will likely take swift litigation action to remedy a violation. The pros of a quick settlement offer include certainty of outcome, saved time, and potential monetary savings. The drawbacks however include the waiver of rights, public disclosure of certain facts, and penalties that could jeopardize individual licensure or the regular course of company business. These factors must be weighed carefully when considering a settlement offer.
The Settlement Offer
A settlement offer may be proposed by the Subject at any time in response to an SEC investigation. As per federal statute, “any person who is notified that a proceeding may or will be instituted against him or her, or any party to a proceeding already instituted, may, at any time, propose in writing an offer to settle.” (17 CFR § 201.240 (a)). Although settlement offers are accepted anytime, the SEC generally wants to conduct a sufficient investigation before considering one. The Commission wants to consider all potential violations and investor outcomes before assessing a settlement offer’s reasonability.
A valid settlement offer must consider current and future investors. The SEC will only settle when, in the judgment of the Commission, the agreement is within the range of outcomes it may reasonably expect if it were to litigate the matter. Settlement offers must include methods to return funds to harmed investors. They generally include a waiver request, future restrictions on securities activities, and a “neither-admit-nor-deny” portion. Although not standard, the SEC will sometimes require the Subject to retract their prior implications of innocence.
The terms of the SEC settlement offer can be negotiated. Subject’s counsel may submit a settlement offer to SEC counsel who will consider whether to recommend it to the Commission. If the offer is not recommended to the Commission, the offer does not go on record.
After accepting an offer, which must be submitted in writing, the SEC will provide to the Subject: an offer of settlement and proposed order instituting an administrative proceeding, a document production certification, district court consent and final judgment, and an escrow agreement concerning the settlement funds. The administrative proceeding and district court consent prevent the Subject from litigating or disputing the violations any further. The document certification and escrow agreement confirm the Subject: 1) has complied with all SEC subpoenas and document requests, and 2) has the ability to comply with the monetary settlement terms.
The settlement makes all terms, conditions, and disclosures final, and the matter may not be pursued any further by the SEC or settling party. Exceptions to this include if the party was not transparent in disclosures, was fraudulent, or committed other violations, in which case the settlement may be considered void.
When all documents are released, the SEC will file and publish a litigation release. Generally, the SEC will file the settlement in administrative proceedings. There is some discussion regarding the constitutionality of this method, and whether its purpose is to avoid judicial review, but it is currently the standard process.
When considering proposing settlement, the financial penalties are a major consideration. In addition to going to court to seek sanctions, the Commission may impose civil money penalties in its own administrative proceedings on any person who violates securities laws. Civil monetary penalties are technically assigned for “each act or omission” as per federal penalty statutes, but the SEC has some leeway regarding the interpretation of that calculation, and what is considered a separate violation.
In proposing a settlement, it is good to look at the SEC’s statutory table of penalties in the Securities Act as a starting point. But keep in mind that administrative law judges are frequently less literal and more common-sense in their interpretation of the number of violations. In your negotiations with the SEC consider that your company’s penalties as assigned by an administrative law judge could be more favorable than those proposed by the SEC. Few individuals decide to appeal the SEC’s decision (which is more time and money) to an administrative court, but this understanding may help with negotiations.
A Subject’s settlement offer typically includes a strong waiver to ensure the matter is settled. The SEC will consider the proposed waiver according to investigation circumstances and may grant or deny the waivers completely, or grant them contingent upon certain conditions. This decision is informed by a recommendation from one or both of the Divisions of Corporation Finance and Investment Management or determined by the staff under delegated authority. All monetary requirements and waivers may be negotiated.
The SEC will often require disgorgement of all ill-gotten funds as part of the settlement offer; when full disgorgement is impossible the SEC may allow partial disgorgement. A disgorgement on the basis of financial hardship and a reasonable waiver of penalties are often granted. The SEC has complete autonomy over both the waiver and settlement offer, and may grant one and deny the other. Parties seeking settlements often, therefore, make contemporaneous settlement offers and waiver requests.
Pros and Cons of a Settlement
A settlement agreement is often in a Subject’s best interest. A Subject receives assurance that the investigation is closed and the matter is settled, a likely end to legal fees, a certainty of the final outcome, and input on the content of the SEC’s public announcement. Essentially the uncertainty is over for the Subjects; they know the outcome of the matter, from punishment to press release.
However, the downside must be considered: the Subject’s mishaps are made public (although the language is “neither-admit-nor-deny,” there is still the permanence of the incident and the perception of violation), there is the payment of fines and/or disgorgements, the potential loss of the ability to receive additional securities licensure, the waiver of certain rights, and/or a loss of future opportunities in the investment field.
Settlement offers should be made only after the Subject recognizes and accepts the rights being waived (17 CFR § 201.240 (c)(4)-(c)(5)). The Securities and Exchange Act of 1934 outlines the rights waived by the offeror once a settlement offer is accepted:
(i) All hearings pursuant to the statutory provisions under which the proceeding is to be or has been instituted; (ii) The filing of proposed findings of fact and conclusions of law; (iii) Proceedings before, and an initial decision by, a hearing officer; (iv) All post-hearing procedures; and (v) Judicial review by any court.
(vi) Such provisions of the Rules of Practice or other requirements of the law as may be construed to prevent any member of the Commission’s staff from participating in the preparation of, or advising the Commission as to, any order, opinion, finding of fact, or conclusion of law to be entered pursuant to the offer; and
(vii) Any right to claim bias or prejudgment by the Commission based on the consideration of or discussions concerning the settlement of all or any part of the proceeding.
(17 CFR 201.240 (c)(4)-(c)(5)). Waiver of these rights is arguably the greatest negative outcome in proposing a settlement offer. All accepted settlement offers are final, and the Subject loses their ability to appeal or prove their innocence in court.
The SEC prefers to make investors whole as fast as possible and with limited uncertainty. The SEC will not accept a settlement offer that is far below what they would expect to receive through the litigation process, nor will they forego proper investigation for the sake of speedy settlement. When making a settlement offer, the Subject must weigh the pros and cons; although they receive certainty of outcome with an accepted offer, they will sacrifice some rights. The Subject may receive some relief through a waiver, but they will also have their name in a public litigation release. A settlement offer is an advantageous solution for a Subject who is likely guilty of various securities violations and wants to control the narrative and be certain of the SEC’s outcome.
Whitney De Agostini specializes in representing witnesses and businesses in SEC and other regulatory investigations. The team of securities attorneys at Wilson, Bradshaw & Cao, LLP assist clients through every step of this process. Whitney can be reached at firstname.lastname@example.org, or 801-368-8297.