No contest settlements, with a twist

May 2014 | EXPERT BRIEFING | BANKING & FINANCE

financierworldwide.com

On 11 March 2014, the Ontario Securities Commission (OSC) announced new enforcement initiatives, including a new program for no-contest settlements, whereby the “facts are declared by Staff to be true based on its investigation and which are not denied by the respondents”. Formerly, all settlements with the OSC required admissions from the settling party.

This announcement came after an extensive review and comment period, including a report commissioned by the OSC to evaluate the OSC’s settlement policies when compared with the policies of the United States Securities and Exchange Commission (SEC) and in light of the OSC’s mandate (Philip Anisman, ‘No-Contest Settlements and the SEC’s Recent Experience: Implications for Ontario’, 4 June 2013).

What came out of that process was a compromise sure to please no-one.

Since 1972, the SEC has had a policy allowing no-contest settlements, whereby a respondent to a regulatory proceeding may settle with the SEC without admitting liability, so long as the respondent “neither admits nor denies” the allegations forming the basis of settlement (SEC Rules of Practice and Conduct, 17 C.F.R. § 202.5(e)). This policy was borne out of a practice at the SEC, whereby fewer and fewer respondents agreed to make admissions of wrongdoing, but accepted negotiated penalties and restrictions.

In 2011, that dynamic shifted. In a widely reported decision of the Southern District of New York Court, Justice Rakoff roundly criticised the SEC’s practice of no contest settlements and refused to approve a settlement between the SEC and Citigroup Global Markets Inc. (SEC v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (SDNY 2011)). In making his ruling, Judge Rakoff found that despite the language in the settlement agreement that Citigroup “neither admitted nor denied” the allegations, there was “little real doubt that Citigroup contests”. Judge Rakoff identified, among other things, the inability of investors to rely generally upon admissions contained in SEC settlements in companion civil actions (and touched upon criminal proceedings) as part of the basis for refusing to find that this settlement was fair, reasonable and adequate. Without the admissions, Judge Rakoff decided that he did not have a sufficient factual basis to rule that the settlement should be approved.

The SEC and Citigroup appealed the decision to the Court of Appeals for the Second Circuit. The appeal remains under reserve.

In the wake of Judge Rakoff’s decision, the SEC announced that it was changing its policy in cases involving criminal proceedings, where a defendant admitted violations of criminal law (Robert Khuzami, Director of the SEC’s Division of Enforcement, 7 January 2012). In those circumstances, it is the SEC’s stated policy not to offer no-contest settlements.

In late 2013, the SEC refined its policy further at the behest of newly appointed Chair Mary Jo White, and announced that it would no longer enter into no-contest settlements where there is a “special need for public accountability and acceptance of responsibility”, even in the absence of any admission of guilt in parallel criminal proceedings (Council of Institutional Investors fall conference in Chicago, IL, 26 September 2013). The policy change has largely gone unnoticed in the legal press and is opaque in its implementation. The SEC has entered into seven ‘admit’ settlements since the announcement, but has also settled with defendants on a no-contest basis, in circumstances where it might be expected the SEC would require admissions. Since late 2013 for instance, the SEC has entered into no-contest settlements in respect of alleged accounting fraud case with the chairman and interim chief executive officer of AgFeed and a misrepresentation case with a corporate defendant (see Mary Hansen ‘Neither Admit nor Deny Settlements at the SEC’, 31 March 2014). Andrew Ceresney, the co-director of the SEC’s division of enforcement, recently confirmed in a speech that admit settlements will continue to be the exception rather than the rule (Brian Mahoney ‘Admissions of Guilt Won’t become Norm’ Law360, 13 March 2014).

The OSC, by contrast, has historically had a practice of requiring admissions of wrongdoing as a foundation for all settlement agreements. The requirement of a settling respondent to make damaging admissions has created barriers to settlement, often harder to overcome than the penalties sought to be imposed.

The requirement for admissions is particularly problematic in cases where the respondent faces civil or criminal proceedings on the same or similar facts. This dynamic has been exacerbated by the unsettled law regarding the admissibility in civil proceedings of regulatory settlement agreements containing admissions. Recent decisions suggest that the civil courts will hold respondents to the admissions they make in settling regulatory proceedings on the basis that it is an affront to natural justice to permit a respondent to deny in one forum what they have already admitted in another (see Buckingham Securities Corp. v. Miller Bernstein LLP, [2008] O.J. No. 1859; National Bank Financial Ltd. v. Potter, 2012 NSSC 76).

As a result of the reluctance of respondents to settle in the face of civil proceedings, and in the face of a mounting number of contested hearings, the new OSC policy attempts to achieve a balance between competing interests and avoid the recent criticism aimed at the SEC. The OSC’s policy provides that the OSC may be prepared to settle a matter in circumstances where the “facts are declared by Staff to be true based on its investigation and which are not denied by the respondent” and there is an acknowledgement by the respondent that it accepts the settlement agreement as the basis for resolving the proceeding.

In keeping with the SEC’s developing stance, the OSC policy also provides that no-contest settlements will not be available where: (i) the person has engaged in abusive, fraudulent or criminal conduct; (ii) the person’s misconduct has resulted in investor harm which has not been addressed in a satisfactory matter; and (iii) the person has misled or obstructed the OSC’s investigation.

Despite its intended goals, the OSC’s policy may not go far enough to encourage settlement. In circumstances where the courts have been activist in holding respondents to their settlement agreements, language where a respondent does ‘not deny’ allegations declared by the OSC to be true (without accompanying language that it does not admit those allegations) may leave a respondent vulnerable. It remains to be seen how this policy will develop in practice and how the civil courts will treat it. For now, settling parties will need to weigh the benefits and the risks.

Shara Roy is a senior associate with Lenczner Slaght. She can be contacted on +1 (416) 865 2942 or by email: sroy@litigate.com.

Shara N. Roy

Lenczner Slaght