The standard view of the Biden Administration SEC under the leadership of Gary Gensler is that the agency will take a more active enforcement approach than was the case during the prior administration. Two developments in the past few days certainly support this standard view. First, in a speech last week, new SEC Enforcement Division Director Gurbir Grewal indicated that the agency will be requiring admissions of wrongdoing in some enforcement settlements. Second, in a statement the next day, SEC Chair Gensler announced that the agency would revitalize the rulemaking process with respect to rules regarding clawbacks of erroneously awarded compensation. As discussed below, these moves evidence a more aggressive approach to the enforcement of the securities laws. The text of Grewal’s October 13, 2021 speech can be found here. Gensler’s October 14, 2021 statement about the compensation clawback rules can be found here.
Gurbir delivered his comments about a renewed admissions requirement in a speech at an annual Practicing Law Institute conference. In his remarks, Grewal said that the agency will be requiring admissions in cases “where heightened accountability and acceptance of responsibility are in the public interest.” The admissions requirement, where applied, would alter the long-standing approach in which most enforcement action defendants are able to settle their cases without admitting or denying the alleged wrongdoing.
In explaining the reasons for the new approach, Gurbir said that “When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law.” He added that “Admissions, given their attention-getting nature, also serve as a clarion call to other market participants to stamp out and self-report the misconduct to the extent it is occurring in their firm.”
In a separate development, the day after Gurbir delivered his remarks, SEC Chair Gensler announced that the agency had reopened the comment period on proposed rules that would require top executives at publicly traded companies to incentive-based compensation paid to them during reporting periods for which the company subsequently restated its financial statements.
The rules to which Gensler was referring were intended to implement compensation clawback requirements that Congress had mandated in the Dodd-Frank Act. The Act provided that if a company has to revise prior financial statements, executives should return incentive-based compensation paid in the three-year period leading up to the restatement based on the misstated financial, without regard to whether the misstatement was based on fraud. The agency had first proposed ruled to implement the Act’s requirements six years ago, but the rulemaking process was never completed.
In connection with Gensler’s October 14, 2021 statement about the compensation clawback requirements, the agency reopened the comment period for exchange listing requirements for clawbacks of erroneously awarded incentive-based compensation.
In making his announcement, Gensler said that he believes the agency has “an opportunity to strengthen the transparency and quality of corporate financial statements as well as the accountability of corporate executives to their investors.” In support of the compensation clawback, Gensler further noted that compensation is often based on financial results, but occasionally companies have to go back and revise prior financial reporting; as a result, Gensler said, “an executive may have been paid for meeting certain milestones that the company didn’t, in fact, hit.”
Discussion
While both of these developments are interesting, the Enforcement Division director’s comments about the admissions requirement are particularly interesting. Those with long enough memories will recall during the Obama Administration, the SEC under the leadership of Mary Jo White had also implemented an admissions requirement in connection with some enforcement action settlements. There were in fact some high-profile SEC settlements during White’s leadership at the agency in which the defendants was required to admit to wrongdoing in connection with the resolution of the enforcement action (as discussed for example here). But at the same time, White faced public criticism from some members of Congress for not being aggressive enough in seeking admissions. During the Trump administration, the admissions requirement approach was not followed. Grewal’s comments last week signal a return to the admissions requirement practices that were in effect at the agency under Mary Jo White during the Obama administration.
The renewed admissions requirement approach is obviously of concern to current or prospective future enforcement action defendants. These firms and individuals could find their efforts to resolve the actions against them more challenging – with the possibility that the resolution of their action could be significantly more consequential. Admissions of wrongdoing obviously create the risk of significant adverse publicity and attendant reputational harm. The admissions potentially could disqualify the defendant from certain public contracts and have other practical consequences. These possibilities mean that it could be more difficult, more time-consuming, and more expensive to resolve enforcement actions.
The admissions could have other practical consequences. Depending on the form they take and on the substance of the admissions, the admissions could be used against the admitting individual or firm in collateral proceedings, such as for example parallel private securities class action litigation relating to the same circumstances. Indeed, this possibility was a concern when Mary Jo White first proposed the admissions rules back in 2013. One way that defendants sought to protect themselves in connection with the resolution of enforcement actions under SEC Chair White’s initiative was to provide in the settlement documents that nothing in this agreement affects the defendants “right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party.”
One further potential practical consequence of the renewed admissions requirement is the potential impact of the admissions on the availability of D&O insurance for the admitting defendant. The specific question will be whether the admissions are sufficient to trigger the applicable D&O insurance policy’s misconduct exclusion. The wording of these exclusions vary, but they typically preclude coverage for loss arising from fraudulent or criminal misconduct, but only after a final adjudication determined that the precluded conduct had taken place. If the admissions were found to be sufficient to trigger this exclusion, coverage would no longer be available for the wrongdoer, and the insurer could even have the right to try to recover amounts that had already been paid.
On the one hand, there could be reason to be concerned that a settlement involving admissions of wrongdoing represents a “final adjudication,” particularly where the settlement is incorporated into the judgment entered by the court. Further questions would remain in specific cases; for example, the vast majority of enforcement actions these days are administrative proceedings rather than civil proceedings pursued in court. It isn’t clear at all how the analysis would work if the admissions were made in connection with an administrative proceeding.
Much will also depend on what specifically has been admitted. An artfully worded admission could contain concessions that the defendant acted, for example, “improperly,” without making concessions that the defendant engaged in “fraud” or other conduct that would trigger the D&O exclusion. Similarly, if the defendant’s admissions included a statement that nothing in the settlement precludes the defendant from taking legal or factual positions in proceedings in which the SEC is not a party, the defendants could contend that they have preserved the right to argue, for example, in insurance coverage proceedings that they did not engage in the precluded misconduct.
The full contours of many of these issues will only be revealed in the fullness of time. However, the one thing that is clear is that the SEC in the Biden Administration and under the leadership of Gary Gensler is taking a more aggressive enforcement approach than during the prior administration, among other things by returning to policies and practices that were in place during the Obama administration.