September 10, 2013

SEC Requires First Admission of Wrongdoing Under Revised Settlement Policy

Holland & Knight Bulletin
Allison Kernisky

On August 19, 2013, the SEC announced that it settled with a hedge fund and its manager (the defendants) and required them to admit wrongdoing. In the consent, the defendants admit to a series of facts, including that the manager took a $113.2 million loan from the fund to pay his personal taxes and failed to disclose the loan to investors for five months; that the defendants secretly favored certain customer redemption requests at the expense of other investors; and the defendants conducted an improper short squeeze in certain distressed bonds. The settlement does not immunize the defendants from any future criminal proceedings and prohibits the defendants from publicly denying liability. Further, the defendants cannot contest the facts in any future proceedings involving the SEC based on the same set of facts. While the consent stops short of finding that the defendants' actions constituted a violation of the law, the SEC required the defendants to admit that they acted "recklessly." But the settlement does not bar the defendants from taking different legal or factual positions in proceedings in which the SEC is not a party.

The settlement is the first under the SEC’s revised settlement policy that was announced in June 2013. This new directive changed the SEC’s traditional practice of allowing defendants to settle without admitting or denying the charges to now require an admission of wrongdoing in certain cases. As part of the August 2013 settlement, the manager will pay $6.5 million in disgorgement, $1 million in prejudgment interest and a $4 million penalty. The fund will pay a $6.5 million penalty. The consent expressly prohibits the defendants from paying the penalties through insurance or seeking a tax deduction for payments made. The manager will also be barred from the securities industry for five years, after which time he will be eligible to reapply. Only time will tell if this equates to a lifetime ban since reapplying with an admission of wrongdoing on his record may be problematic. However, the settlement allows the manager to remain an associated person of the fund and related entities in order to satisfy investor redemption requests even though the fund is not allowed to raise new capital. Further, the settlement does not prohibit the manager from continuing to serve as chairman and chief executive officer of a publicly traded investment fund.

Before it is final, the court must approve this settlement. The suit stems from two complaints the SEC filed against the defendants and related funds in the United States District Court for the Southern District of New York in June 2012. The complaints alleged violations of Section 17(a) of the Securities Act of 1933; Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and Sections 206(1), (2) and (4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The settlement comes a month after the SEC rejected an earlier settlement the Division of Enforcement had reached with the defendants. While no explanation was given why it rejected the previous settlement, it appears that the SEC and its new Chair Mary Jo White were not pleased with a settlement that would have imposed half the penalty and only a two-year ban on the manager without an admission of wrongdoing. The consent helps illustrate what similar settlements will look like in the select, egregious cases in which the SEC chooses to apply this policy; it may also signal a new era of increased second-guessing by the SEC of it staff's settlement recommendations. Companies and individuals required to admit wrongdoing in order to settle with the SEC will want their legal counsel to carefully negotiate and craft any factual admissions in order to best limit possible future liability.

SEC v. Falcone, No. 1:12-cv-05027 (S.D.N.Y.) and SEC v. Harbinger Capital Partners, LLC, No. 1:12-cv-05028 (S.D.N.Y.)

To view the consent, go to:

Related Insights