United States: Parties that Settle with the US SEC May Face Greater Collateral Legal Risk

Originally published April 15, 2010

Keywords: SEC, settlement proposal, SEC investigation, admissability, Pentagon Capital

Two recent developments suggest an increased collateral legal risk for persons and entities that enter into settlements with the US Securities and Exchange Commission (SEC). First, the SEC recently has suggested that it may release official statements detailing the facts underlying an investigation and settlement as part of the settlement process. Second, a recent federal district court decision from the Southern District of New York held that certain fact-finding documents created in connection with an SEC settlement were not inadmissible hearsay but instead were admissible in a federal court proceeding. Together, these two events suggest that SEC settlements may well lead to fact finding documents that later could be admissible in civil litigation or regulatory proceedings.

Statement by SEC Enforcement Director

On April 1, 2010, SEC Enforcement Director Robert Khuzami informed the Bureau of National Affairs of a potential change in the handling of statements of fact in connection with settlements. An SEC statement of fact is a document separate from the settlement proposal that publicly provides detail on the SEC investigation. Khuzami stated that the SEC is "considering the costs and benefits of providing such a statement of facts on a more frequent basis. The potential benefits include increased transparency to investors and the markets and enhanced guidance to companies and individuals about the conduct underlying the violation."1


In seeking court approval for a settlement, the SEC's enforcement division does not typically include statements of facts gathered during the course of its investigations, unless the court requests such a statement. However, the SEC's historical practice of submitting settlement proposals without statements of fact may not be enough for some courts. Southern District of New York Federal Judge Jed Rakoff, the judge who presided over SEC v. Bank of America Corp., S.D.N.Y., 10 Civ. 0215 (JSR), indicated an unwillingness to approve SEC settlements without more information about the SEC's investigative findings. The SEC's consideration of increased use of statements of fact may be in direct response to this judicial concern, and it calls into question the impact of those statements on subsequent litigation. 

Under the 1976 Second Circuit decision in Lipsky v. Commonwealth United Corp.,2 SEC settlement consent decrees typically are not admissible in civil litigation against a party to the settlement because the consent decrees are akin to a plea of nolo contendere — i.e., they are not true adjudications of the underlying issues. While this general rule has historically meant that entering into a settlement would not have significant collateral legal consequences, a few courts have considered the admissibility of formal statements of fact in subsequent litigation. Those that have considered the admissibility of statements of fact are divided.

In 1996, a district court in Pennsylvania effectively limited Lipsky by ruling that SEC findings and conclusions were admissible to prove liability despite the federal rule of evidence barring the admissibility of evidence obtained during the course of settlement negotiations.3 Conversely, a 2008 district court decision in Georgia reached the opposite conclusion, noting the "chilling effect" that allowing SEC findings into evidence in future civil litigation would have on the SEC's ability to settle cases.4 Considering both of these prior decisions, a federal district court in the Southern District of New York recently ruled in Sec. & Exch. Comm'n v. Pentagon Capital Mgmt PLC that certain SEC factual findings are admissible evidence. While this case considered somewhat unique factual circumstances, it has nonetheless heightened the concern that SEC factual findings could be admissible into evidence in subsequent litigation and regulatory proceedings.

The Pentagon Capital Decision5

On March 29, 2010, United States District Court Judge Robert Sweet of the Southern District of New York ruled that certain documents detailing an SEC investigation were admissible against the SEC under Fed. R. Evid. 803(8)(C). The defendants sought the admission of these documents, which detailed how other individuals and entities were already aware of the market timing of certain mutual funds, as a defense to the claim that defendants deceived such individuals and entities.

The decision represented a battle between two seemingly conflicting rules of evidence: Fed. R. Evid. 408, the rule barring the admission of evidence obtained in the course of settlement negotiations, versus Fed. R. Evid. 803(8)(C), the rule allowing the admission of public records setting forth factual findings resulting from a legal investigation. The court found that the documents fell within the public records rule and hence were not inadmissible hearsay. The court further found that the admission of the documents into evidence did not implicate the concerns underlying the exclusion of settlement negotiations from evidence.

In admitting the documents into evidence, the court agreed with the 1996 Pennsylvania district court decision that the SEC's findings were rendered as a part of the SEC's independent obligations to enforce securities laws and not as a part of the settlement negotiations. The court also agreed with the Pennsylvania district court that a stipulation contained in the fact-finding documents that the documents are not binding in future proceedings does not control their admissibility as evidence.

The court looked to the rationale underlying the settlement negotiation rule to distinguish its decision from cases that barred similar evidence; here, the documents were being offered as a "shield" to protect defendants from potential liability rather than as a "sword" to prove liability. Because the policy behind the settlement negotiations rule is to encourage settlements and preclude their use for establishing liability against the parties who settled, the court found that the rule was inapplicable where evidence was being offered to refute a factual allegation.

Implications and Conclusions

Increased Exposure to Liability. An increase in publicly released factual information concerning SEC investigations would undoubtedly increase the risk of related private civil actions where the plaintiffs would otherwise have had no factual basis for filing suit. With this increased risk would come defendants' increased reluctance to settle SEC investigations. Even if the findings were not admissible against the settling entity, they might be admissible against affiliated entities or individuals for whom the settling party may have indemnity obligations.

Chilling Effect. Increased public disclosure of the results of an SEC investigation will be a factor to be considered in deciding whether to settle a matter with the SEC. In deciding whether to settle with the SEC, persons and entities now have to consider the risk of increased public disclosure of SEC findings, increased reputational harm, and the increased risk that such disclosures may be admissible in other proceedings. Such an analysis could result in fewer settlements and a greater burden on the SEC's investigative system.

Prolonged Negotiations. The complaints, consent decrees, and other publicly filed documents emerging from an SEC investigation can be the subject of extensive negotiation. The addition of another document, the statement of facts, would simply add another layer to these already extensive negotiations.

Admissibility Concerns. The Pentagon Capital decision stands for the proposition that SEC findings are admissible. While the district court limited its holding to a situation where the statements were not introduced as a "sword" to prove liability, this limitation will have no affect on admissibility against affiliated parties. Under the framework of the decision, Rule 408 still places certain limitations on the admissibility of statements of fact, however, plaintiffs undoubtedly will seek to further expand the circumstances under which these statements are admissible. Indeed, plaintiffs may cite the fact that the court agreed with the Pennsylvania district court that the SEC's findings, even when used as a "sword," are independent and not part of the actual settlement negotiations.


1. Yin Wilczek, SEC Might Add More Statements of Facts In Future Settlements; Move Not Welcomed, The United States Law Week, 78 U.S.L.W. 2591 (2010).

2. Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893-94 (2d Cir. 1976).

3. Option Resource Group v. Chambers Dev. Co., Inc., 967 F. Supp. 846, 850 (W.D. Pa. 1996).

4. Carpenters Health & Welfare Fund v. The Coca-Cola Co., No. 00-CV-2838, slip. Op. (N.D. Ga. Apr. 23, 2008).

5. Sec. & Exch. Comm'n v. Pentagon Capital Mgmt PLC, No. 08-CV-3324, slip Op. (S.D.N.Y. Mar. 11, 2010).

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Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

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