Does The SEC Demand More In Settlement Than It Can Get At Trial?

When the Securities and Exchange Commission (SEC) brings charges, counsel must decide whether it is better to negotiate a settlement or put the SEC to its proof at trial. In view of the costs, delays and uncertainties of trial, a securities practitioner might naturally assume that the SEC is willing to settle for less than it is likely to get after a hearing. This article analyzes SEC administrative proceedings involving scienter-based1 fraud charges against individual respondents over the most recent three-year period.2 Surprisingly, this article finds that in these cases the SEC has, on average, insisted on significantly harsher sanctions in settlement than it obtained after a hearing.3

Piper Capital Dramatically Illustrates The Disparity.

The recent Initial Decision (ID) in Piper Capital Management, Inc., et al., No. 175 (Nov. 30, 2000), displayed a gross disparity between the harsh sanctions imposed on a respondent who settled and the minimal sanctions imposed on an allegedly equally responsible co-respondent who went to trial. In that case, the SEC's Division of Enforcement charged a mutual fund and its key managers with fraud. The fund manager, Mr. Bruntjen, settled with the SEC, but the remaining respondents went to trial. At trial, the division claimed that Mr. Bruntjen's co-manager, Ms. Goldstein, was equally responsible for the alleged fraud violations. Id at 8. Although the ALJ found against Ms. Goldstein, the ALJ imposed far lighter sanctions on her than the SEC had required from her settling co-manager:

Goldstein Trial Outcome:

Cease-and-Desist Order

Formal Censure

No penalty

Bruntjen Settlement:

Cease-and-Desist Order

Barred w/ right to reapply after 5 years

$100,000 penalty

The author suspected that this disparity was not a fluke, but reflected a pervasive pattern in which the SEC seeks harsher sanctions in settlement than it is likely to get at trial.

Sanctions In Settled And Litigated Cases.

To test this hypothesis, the author reviewed all administrative settlements accepted by the SEC and all IDs issued by ALJs, as reported by the SEC on its web-site for the three-year period from January 1, 1998 through December 31, 2000. To ensure that only fairly comparable cases were considered, only cases meeting the following criteria were included:

Respondent was a natural person (typically a registered representative);

Respondent was charged with fraud under Section 17(a)(1) of the Securities Act and/or Section 10(b) of the Exchange Act;4

The proceeding was brought under Section 15(b)(6) of the Exchange Act, which authorizes the SEC to suspend or bar the respondent from association with a broker or dealer;5

The proceeding was neither a "follow on" based upon an earlier civil injunction or criminal conviction, 6 nor purely a failure-to-supervise case.7

To ensure that the cases in the two groups could be fairly compared, these objective criteria were rigorously applied on a consistent basis; 8 cases were not included or excluded on the basis of subjective judgments.9

Harsher Sanctions In Typical Settlements.

The results of this analysis are striking. During the three-year period studied, SEC ALJs decided cases involving 40 individuals (see Table A) and the SEC accepted settlements from 96 individuals (see Table B) which met the foregoing criteria. For litigated cases, SEC ALJs imposed an average time-out sanction of 1.62 years (1.69 years if appeals to the SEC are included). However, for settled cases meeting these identical criteria the SEC obtained an average time-out sanction of 3.55 years, more than double what it obtained after trial.10

The disparity between settled and litigated cases has sharpened. During the more recent half of the period under study (i.e., the period after June 30, 1999) the SEC settled with 41 individuals for an average time-out sanction of 3.50 years (Table B). During this same period, however, SEC ALJs decided cases involving 22 individuals and imposed an average time-out sanction of 1.05 years (Table A).

The disparity between sanctions imposed in settled and litigated cases is statistically significant (i.e., it is not the result of random error). Statistical analysis11 indicates that the difference in time-out sanctions is highly statistically significant: there is less than a 1/1000 probability that the disparity for the period under study is attributable to chance.

The SEC, ALJs Disagree On Level of Sanctions.

It is clear from this study that the SEC and its ALJs disagree on the level of sanctions that are appropriate in fraud cases. In the absence of such a disagreement, the disparity found here would not exist unless settled cases tended to involve more egregious conduct (warranting more severe sanctions) than litigated cases. There is no reason to believe that this is true. To the contrary, it is likely that the litigated cases tend to involve more egregious conduct because respondents facing more severe sanctions have a greater incentive to bear the costs and inconveniences of litigation.12

Nor is the disparity found here explained by the Division having lost its riskiest cases at trial. After eliminating from the analysis those cases in which the SEC failed to prove fraud or get a time-out sanction, a significant disparity in sanctions nevertheless remains. For the subset of cases involving 28 individuals in which the Division obtained a time-out sanction after trial, the average time-out sanction was only 2.42 years.

This disparity from the 3.55 years imposed in settled cases is also statistically significant13 and confirms that, even when SEC ALJs impose time-out sanctions, they tend to impose lesser sanctions than the SEC would require in settlement.

Conclusion.

Securities practitioners should be aware that, at least in fraud cases against individual respondents, the SEC and its ALJs disagree as to the appropriate level of sanctions, with the SEC insisting on significantly harsher sanctions in settlement than it is likely to get at trial.

TABLE A

REMEDIAL SANCTIONS IMPOSED BY ALJs

Initial Decision

Respondent

Time-Out Sanction

Years

No. 119

1/12/98

Vernon T. Hall

Stanley E. Hargrave

Jerome B. Vernazza

Suspended for 6 months

Suspended for 6 months

Suspended for 6 months

0.5

0.5

0.5

No. 121

2/24/98

Al Rizek

Barred for 2 years

2.0*

No. 127

7/21/98

Orlando J. Jett

Barred with no right to reapply specified

5.0

No. 130

8/11/98

Sidney H. Stires

Suspended for 90 days

0.25

No. 134

1/7/99

J. Stephen Stout

Barred with no right to reapply specified

5.0

No. 135

1/28/99

Brett G. Brubaker

Suspended for 6 months

0.5

No. 137

3/5/99

Michael A. Usher

Michael Zaman

George T. Hellen

Daniel R. Lehl

William A. Moler

Barred with no right to reapply specified

Barred with no right to reapply specified

Barred with no right to reapply specified

Barred with no right to reapply specified

Barred w/ right to reapply in 18 months

5.0

5.0

5.0

5.0

1.5

No. 138

3/24/99

Nicholas P. Howard

Suspended for 3 months

0.25

No. 139

3/30/99

Javed A. Latef

Larry A. Stockett

Suspended for 3 months

Barred with no right to reapply specified

0.25

5.0

No. 140

4/1/99

Terence M. Coxon

Alan M. Sergy

Suspended for 3 months

Suspended for 3 months

0.25

0.25

No. 144

7/22/99

Fu-Sung Peter Wu

No time out imposed

0.0

No. 147

8/6/99

John J. Kenny

Barred with no right to reapply specified

5.0

No. 148

9/21/99

Sandra Simpson

Daphne Pattee

Barred with no right to reapply specified

Barred with no right to reapply specified

5.0

5.0

No. 151

9/30/99

Richard B. Feinberg

Alan S. Feinberg

No time out imposed

No time out imposed

0.0

0.0

No. 156

1/12/00

Larry J. Bagwell

Connie L. Bally

No time out imposed

No time out imposed

0.0

0.0

No. 158

1/27/00

Richard Hoffman

No time out imposed

0.0

No. 160

1/31/00

Michael...

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