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Insurance exclusions could be triggered by SEC settlement requirements

Insurance exclusions could be triggered by SEC settlement requirements

A 2-year-old U.S. Securities and Exchange Commission policy that requires companies in some cases to admit wrongdoing to settle agency charges has come under fire for its limited use, but has nevertheless opened the door to litigation and insurance issues.

In a letter, Sen. Elizabeth Warren, D-Mass., told agency Chair Mary Jo White she wants to see the policy used more (see related story).

In response, Ms. White noted that the SEC has obtained admissions in 26 matters encompassing 15 individuals and 25 entities, including admissions from major financial institutions.

Experts say the SEC apparently uses the admission of wrongdoing in cases where conduct is considered egregious and where it may serve as a deterrent to others. Before the policy was adopted in June 2013, the agency had allowed defendants to neither admit nor deny wrongdoing in all settlements.

“It puts parties in a more difficult position,” said Marc J. Fagel, a partner with law firm Gibson, Dunn & Crutcher L.L.P. in San Francisco. “There are implications for admission both in terms of civil litigation and insurance coverage, and it makes it a more difficult calculation for parties considering a settlement with the SEC.”

One benefit of settling is avoiding the expense of a trial, as well as an actual finding of guilt that can be used against a company or person by other parties, Mr. Fagel said.

That is “one of the key tradeoffs in deciding not to try a case,” and having to admit wrongdoing “makes that equation much more difficult.”

Depending on how an admission is framed, it could trigger the fraud or criminal exclusion conduct clause in a directors and officers liability insurance policy, said Kevin LaCroix, executive vice president at RT ProExec, a division of R-T Specialty L.L.C. in Beachwood, Ohio.

As to when the SEC decides to require an admission of wrongdoing, “I think it's one of those subjective decisions that if it looks bad enough, then they're going to invoke it, but there's certainly no clear line of demarcation,” said Dan A. Bailey, a member of law firm Bailey Cavalieri L.L.C. in Columbus, Ohio.

“The better the facts are for the commission, the more stubborn they can be about demanding an admission of liability,” said Christopher F. Robertson, a partner with law firm Seyfarth Shaw L.L.P. in Boston.

There are two criteria, said Jacob S. Frenkel, an attorney with Shulman, Rogers, Gandal Pordy & Ecker P.A. in Potomac, Maryland. One is if the SEC knows the defendants cannot litigate, because a court finding of liability could, if they are a financial institution, disqualify them from participating in U.S. capital markets.

The other instance, he said, involves “those incapable of mounting a defense, most often for financial reasons,” Mr. Frenkel said. “It's easy for the agency to pound its chest when it beats the indefensible.

“The agency has in many respects abandoned in large part its willingness to be thoughtful as a civil enforcer, instead pretending to be a law enforcement agency, which it is not,” said Mr. Frenkel, a former senior counsel in the SEC's enforcement division.

However, the relatively small number of admissions “would at least indicate to me that the SEC has been pretty judicious in applying this announced policy,” said Robbyn Reichman, New York-based co-leader of Aon Risk Solutions' legal and claims practice group.

She added, however, “It's fair to say that the full implications have yet to be seen,” given the relatively small number of admissions.

It is important for businesses to carefully negotiate SEC settlements, Ms. Reichman said. “What we've seen even in the handful of admissions that the SEC has been able to obtain is that these settlements are heavily negotiated, so carefully crafted settlement language is very, very important, especially from the defendant's perspective.”

Such carefully crafted admissions “would have very little value” to plaintiff shareholders in derivative litigation “because they're probably not admitting to something that could be used against them in a parallel proceeding whether it be something civil or criminal,” Ms. Reichman said.

Observers note that in addition to Sen. Warren, the judiciary has criticized the SEC's policy of permitting firms to settle without admitting or denying guilty.

“The political pressure and the pressure from the courts, I think, will not go away,” Mr. LaCroix said.

“There's a decent chance that there will be at least increased discussion between the SEC and the parties that they're investigating about including admissions of wrongdoings in settlements, and I think it may be that threat could encourage one of two possibilities,” said Marc H. Axelbaum, a partner with law firm Pillsbury, Winthrop, Shaw, Pittman L.L.P. in San Francisco.

One is that potential defendants would settle for more money rather than admit wrongdoing, and the second is that the SEC would go to trial if it does not get an admission, Mr. Axelbaum said.

Meanwhile, in a report issued last month, the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness recommends the SEC review its policy and “articulate meaningful standards that provide guidance on when admissions will be required.”

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  • Sen. Elizabeth Warren takes aim at SEC settlement protocol

    A letter from Sen. Elizabeth Warren, D-Mass., to U.S. Securities and Exchange Commission Chair Mary Jo White criticizes Ms. White's job as a regulator, including charging she has not insisted on enough admissions of wrongdoing before permitting firms to settle cases.