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Why the SEC’s ‘Neither-Admit-Nor-Deny’ Settlement Criteria is Seriously Flawed: Two Clear Examples

Four years ago, I wrote of my extreme frustration over the SEC's settlement with the two Arthur Andersen partners who planned and supervised the 2001 audit of WorldCom. Six years after the fact, the SEC's slam-dunk case was settled with little more than slaps on the wrists: both auditors were suspended from practicing before the SEC for three years (as if they would have been hirable anyway); no penalties were assessed; and worst of all the settlement provided that both auditors would "neither admit nor deny" (NANDy) any breaches of professional conduct.

Lo and behold, the SEC's often-used NANDy policy became national news when Judge Jed Rakoff of the Federal Court of the Southern District of New York threw out the SEC's $285 million settlement with Citigroup. He did so in part because NANDy meant that he did not have established facts for determining whether the monetary amounts agreed to were appropriate.

The Rakoff decision clearly got the attention of the public, and inevitably Congress would have to show some interest. On May 17th, Robert Khuzami, the SEC's Director of the Division of Enforcement, presented written testimony in which he laid out a defense of the SEC's longstanding practice of including the NANDy provision in virtually all of its settlements. (Mr. Khuzami clearly was not trying to provide more than one side of the argument, but only to justify the SEC's practices; which is why I believe that "defense" is the appropriate descriptor.)

"[T]he Division of Enforcement recommends that the Commission settle a case only when our informed judgment tells us that the settlement agreement is within the range of outcomes we reasonably can expect if we litigate through trial. [bold italics supplied] In making that determination, we take into account many factors, including:

(i) the strength of the evidence and the potential defenses, including the possibility that the Commission might not prevail at trial, or prevail but be awarded less than the proposed settlement achieves;

(ii) the delay in returning funds to harmed investors caused by litigation; and

(iii) the resources required for a trial, including, most importantly, the opportunity costs of litigating rather than devoting those resources to investigating other cases."

In the entirety of that written testimony, I found no mention of any of the other "many factors" that the SEC might take into account. Thus, if this is all the SEC considers, then it must perforce be concluded that SEC litigation policy has been reduced to nothing more or less than profit maximization. The sole objective of profit maximization may be fine and good for a private litigator, but the mission of a government agency must certainly be more than that. At bottom, enforcement must show concern for producing fair and just outcomes to society as a whole. There is not a breath of that in Mr. Khuzami's testimony.


Justice versus Cash Flow

Not being a lawyer, I don't feel qualified to either comment directly on the quality of Judge Rakoff's reasoning for rejecting the Citi settlement; or on that of the appeals court, which reversed it. But, the message the SEC seems to be ignoring at its peril is not Judge Rakoff himself, but the public reaction to his decision. That reaction is frustration with enforcement policies that seem to focus only on the number of cases sent through the pipeline, and the money collected at the end.

Mr. Khuzami, the public wants justice. And, justice in the eyes of the public often requires adjudication. This is not economic, as much as it is sociological. The general public has been victimized by high-profile financial wrongdoers, and victims have a right to expect that their victimizers will have their comeuppance. Conversely, a significant deterrent to wrongdoing should be that victimizers will expect to be humiliated if they are exposed.

A comeuppance can also have a rehabilitative effect. One of the German sayings that my mother had me memorize went something like this: "Self-recognition is the first step toward improvement."* We know that works for (some) individual violators of securities law – witness the post incarceration mea culpas of Sam Antar, Michael Milliken, Ira Fastow to name a few who have tried hard to make positive gestures out of contrition. On the other side of the coin, look at the recidivism rates of the too-big-to-fail banks whom the SEC allows to settle with NANDy and a monetary fine.

I see at least two other problems with NANDy that Mr. Khuzami should have addressed. First, how can we know whether the SEC isn't being run by racketeers, seeking easy targets to shakedown without having to actually prove allegations to an impartial judge or jury? Second, and relatedly, if the SEC believes there is any sort of reasonable possibility that a defendant could prevail at a lawful trial, then how does it serve the public interest to settle – just in order to avoid that possibility? This is the mentality of a private litigator, and it does not become a public servant to have that attitude.

The Case of Spencer Barasch

If I haven't yet managed to persuade you that the SEC settles with a NANDy much more often than it should, perhaps the case of Spencer Barasch will bring you over to my side. Ironically, the SEC NANDy-settled its case with Barasch just days before Mr. Khuzami testified to Congress. Here are some of the facts I have pieced together from the recent Commission Order Instituting Proceedings, a March 2010 report by its inspector general, David Kotz, on the matter, Congressional testimony of the inspector general, and reports in iWatch News and NYT.

Spencer Barasch was an associate director of enforcement in the SEC's Forth Worth office from 1998 – 2005. In total he had worked for 20 years at the SEC. In April 2005, he left the SEC to join a law firm in Dallas. "Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines," said Barasch, when asked why he was so insistent on representing Robert Allen Stanford.

According to the Commission's Order Instituting Proceedings, between 1998 and 2003, "…[Barasch] participated personally and substantially in several decisions relating to" the investigation of Stanford's $7 billion Ponzi scheme that decimated the savings of thousands. A report by the Commission's Inspector General goes even further: that he played a big part in delaying and limiting the agency's investigation.

Federal laws prohibit former federal officers and employees from knowingly seeking to influence or appear before any agency on a matter in which they had "participated personally and substantially" during their federal employment. Such actions also constitute "improper professional conduct" under Rule 102(e) of the Commission's rules of practice. Yet, after leaving the SEC, Barasch repeatedly attempted to represent Stanford, even though he was told by the SEC's ethics office that his previous involvement with the Stanford case prohibited him from doing so. Nonetheless, within two years of his departure from the SEC, Stanford hired Barasch to represent it in connection with the SEC's investigation.

Barasch didn't notify the SEC, and according to the Commission's Order, Barasch even went so far as to communicate with the SEC staff working on the Stanford case "with the intent to influence them."

Ultimately, in January 2012, Mr. Barasch avoided criminal prosecution and agreed to settle the case brought by the Department of Justice by paying the maximum civil penalty of $50,000. His lawyer stated, "At no time has he [Barasch] compromised his honor or ethics, and we vigorously dispute any suggestion to the contrary."

Finally, on May 24th, Mr. Barasch NANDy-settled with the SEC, only agreeing to be barred from practicing before the SEC as an attorney for one year. No monetary fine, no nothing. Mr. Barasch's lawyer stated that his client chose to settle only "… to avoid the expense and uncertainty of protracted litigation."

* * * * *

If there has ever been a case where the SEC could have sent an unequivocal message to the audit profession by prosecuting the auditors to the fullest extent of the law, Worldcom was it. Moreover, the public has a right to know how WorldCom's auditors violated the basic standards of their profession without allowing any sort of equivocation to be a part of the story.

The Barasch case is particularly notable because of the message the SEC is sending to its own staff: if you act no more egregiously than Barasch, the downside risk is pretty low: a one-year sabbatical from SEC clients plus 10% of the salary you hope to make in the private sector. And, your lawyer can thumb his nose at the SEC for you.

Unlike the WorldCom auditors case, I have no feel for its merits; but if it was not a slam-dunk, then that's even more reason why the SEC should have felt obliged to take it to trial. What I do know is that Barasch was no ordinary respondent: he was a former SEC staff member for goodness sake. What does it say when we allow a member of the fraternity to get off with hardly a slap on the wrist – and with his dignity apparently intact?

Finally, neither of these cases was about the money. So, what was the point of bringing the cases, and then settling for nothing more than a symbolic victory – just two more cases to put in the 'win' column?

NANDy is just not right, especially when the harm to society has been great and felt by a broad swath of the citizenry. We have a legitimate wish for the legal process to fully run its course, justice and a modicum of closure. The SEC should provide all of these things; even if it risks leaving money on the table because the SEC lacks the resources to make its case in court. It that's the situation, then it is what Mr. Khuzami should have been telling Congress.


*Selbsterkenntnis ist der erste Schritt zur Besserung.

1 Comment

  1. Reply Independent Accountant June 6, 2012

    I have opposed these types of SEC “settlements” for over 30 years! The SEC is hopeless!

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