The new Chair of the Securities and Exchange Commission, Mary Jo White, has indicated that the agency will implement new and aggressive enforcement policies, while treading lightly in its rulemaking efforts.
Since the start of her tenure, Chair White has repeatedly promised to oversee an “unrelenting” enforcement regime that uses aggressive prosecutorial tactics. An important example is her announcement that the Commission would require certain parties to admit wrongdoing in connection with settling SEC charges, marking a significant departure from historical “neither admit nor deny” settlement practice. The Director of the Enforcement Division, Andrew Ceresney, has made clear that the Commission would require admissions in cases involving (1) “egregious intentional misconduct,” (2) the obstruction of an SEC investigation, or (3) “misconduct that harmed large numbers of investors.” This shift from the agency’s “neither admit nor deny” policy suggests that the SEC will seek greater corporate accountability for alleged wrongdoing.
Of critical importance, SEC Enforcement Director Ceresney has indicated that the SEC will not be dissuaded from seeking an admission of wrongdoing by the collateral consequences of such admission on a corporation and its shareholders. Admissions open the door to a myriad of potential private lawsuits, potential suspension and debarment issues for government contractors in the United States and overseas, and other potentially devastating consequences for corporations – none of which may prevent the SEC from seeking an admission.
In connection with the admissions policy announcement, Chair White confirmed the SEC’s increased willingness to go to trial against companies. Prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), the SEC could bring administrative proceedings for penalties against broker-dealers and investment advisers, but not public companies. Following the enactment of Dodd-Frank, the SEC now has authority to seek a civil monetary penalty in an administrative proceeding against any individual or company.
This change means the SEC may opt to litigate on its home field through an administrative proceeding, where there are substantial procedural advantages for the SEC, such as abbreviated discovery for defendants and no right to a jury trial. Notably, Chair White also has stated that the SEC will push for higher penalties because of the purported, although unproven, deterrent effect of large corporate settlements and penalties. Monetary penalties have skyrocketed. Whether the deterrent effect has increased commensurately – or decreased as larger penalties are shrugged off by the markets – is debatable.
What is not debatable is that corporate executives, as well as gatekeepers, are being met with increasing scrutiny by the SEC. In a recent case involving allegations of accounting fraud, the SEC took the unusual step of charging a former audit committee chairman with scheming to avoid or delay disclosure of the fraud. This type of aggressive enforcement against an independent director indicates that the SEC will not observe prior boundaries and, instead, will scrutinize the decisions of boards and directors while applying a hindsight bias.
As a counterbalance to the SEC’s toughened enforcement agenda, Chair White has indicated that the agency will pursue rulemaking initiatives that are likely to be more accommodating to companies and market participants, particularly when compared to the post-financial crisis emphasis on increasing penalties and regulatory restrictions. Dodd-Frank, in particular, mandated aggressive deadlines for rule promulgation by the SEC and other agencies; as a result, rules were arguably issued without sufficient consideration as to their effects on corporations and markets, and tended to focus on increased penalties and engender increased regulatory burden.
Although the SEC faces continued pressure to implement extensive rulemaking under Dodd-Frank, Chair White has indicated in various roundtable discussions that she will be careful in her rulemaking to consider the economic and practical effects on corporations, even if that means the SEC will take longer to promulgate rules.
Accordingly, the SEC now appears to be in a streamlining mode, and is inviting public companies to assist the agency in creating rules. In a recent press release announcing the SEC staff’s report on public company disclosure requirements, Chair White stated that the agency increasingly will seek input from companies about how to make the disclosure rules “work better for them.” In particular, the agency indicated that in seeking to improve disclosure effectiveness and efficiency, it would attempt to minimize duplication with existing disclosure requirements, thereby reducing the burden on corporations.
The agency also reiterated its dedication to considering the administrative and compliance costs associated with disclosure requirements.
Implications and Considerations for Boards
1. Reconsider Corporate Risks of Trial. The “neither admit nor deny” settlement policy encouraged corporations to settle because it allowed corporate defendants to forgo time-consuming and expensive litigation while simultaneously avoiding the reputational harm and collateral consequences that would come from an admission of wrongdoing.
Now that a “neither admit nor deny” settlement may no longer be available, boards of directors will need to evaluate the risk of going to trial against the SEC versus the certainty of negative consequences of admitting to liability. For some companies, such as government contractors or those faced with significant shareholder litigation, the consequences of admitting to liability in a settlement with the SEC may be far too grim, prompting boards and company management to choose to litigate.
In exercising their fiduciary duties, directors may determine that taking a matter to trial is in the best interest of the company, unlike determinations in the past that may have yielded to a strong aversion to litigating with the SEC. As a result of this shift in the risk calculus, the stigma of going to trial against the SEC will likely diminish. The corporate landscape will likely evolve so that trials against the SEC may become more common and generally be viewed as part of the “cost of doing business” – just as large corporate fines arguably are viewed today.
As has always been the case with litigation, being prepared to try the case may increase settlement leverage in discussion and lead to a more favorable settlement. In addition, forcing the SEC to play its hand at trial may be advantageous to companies because (1) certain allegations may be difficult to prove, (2) the SEC remains resource-limited and (3) pursuing a matter to trial may allow greater opportunities to rebut alleged misconduct than are allowed with a “neither admit nor deny” settlement. In situations where settlements are necessary, boards will want to carefully consider the details of any admission of wrongdoing to manage the possible collateral effects, including consequences for private litigation and government contracts.
2. Shore Up Compliance Programs. In light of the recent enforcement action against a former audit committee chairman, public company boards should ensure that their compliance programs are robust, and that their gatekeepers are following corporate compliance policies and procedures to the letter. Board members should be sure that the company is properly vetting complex accounting issues and ensuring that significant accounting judgments are well-documented. When boards observe potential red flags, they should follow up to investigate, which may include engaging outside counsel to conduct an independent investigation.
Boards should be seen to take on these difficult issues directly and to oversee the company’s response to them. A record that demonstrates an active board will certainly facilitate a more favorable outcome for boards and shareholders alike.
3. Increase Participation in Rulemaking. Given the stated willingness of the SEC to address the views of companies and market participants in its rulemaking, public company boards should become active participants in shaping the emerging policies. Currently, the SEC is considering rulemaking on a number of proposals with far-reaching consequences, including:
soliciting comments on proxy advisory firm services (such as those provided by ISS and Glass Lewis), including “potential conflicts of interest that may exist for proxy advisory firms and users of their services, and the transparency and accuracy of recommendations by proxy advisory firms”; and
the “modernization and simplification” of Regulation S-K, the primary regulation of the SEC’s IPO and ’34 Act disclosure regime.
Boards should consider, together with company management and counsel, the utility of participating and commenting on rulemaking matters in light of company business objectives. This can be accomplished by working indirectly through board organizations and trade associations or working directly with the SEC by submitting comments to the SEC during the rulemaking process. Counsel may facilitate the process by coordinating a response that is market-driven and takes into account what actions peers and other participants are taking.
Both avenues should be explored and utilized by boards in order to shape agency rules and minimize the regulatory burdens on corporations.