When the Securities and Exchange Commission recently filed enforcement actions against three former executives of i2 Technologies, one of them—former president and CEO Gregory Brady—fired off a press release vowing to "vigorously defend” against the lawsuit and prevail at trial.

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Asserting his innocence, Brady stressed that when the company restated its financial results in July 2003 going back more than four years, neither the company nor its new auditors consulted him on its decision to restate. Brady also took credit for establishing a multi-tiered system of internal controls, adding, "i2 had a revenue recognition group comprised of accountants whose sole responsibility was to ensure the company recognized revenue appropriately."

Dowd

"We will defeat this lawsuit by the SEC in a court before a jury," promised his attorney, John Dowd, of Akin Gump Strauss Hauer & Feld.

The incident has raised questions about how common it is for individuals to fight SEC charges in court, and how wise the strategy is considered.

According to a number of attorneys approached by Compliance Week—all of whom at one time served in the SEC’s enforcement division—it is relatively unusual for an individual to refuse to settle with the SEC and opt for litigation.

However, those attorneys add that it could be a very wise decision. “The statistics are better for the defense bar than you might think,” insists Richard Morvillo, partner with Mayer Brown Rowe & Maw and chair of the firm's Securities Enforcement Group.

The Lesser Evil

Most cases are settled before the SEC brings litigation. According to knowledgeable sources, approximately 60 percent of SEC enforcement actions get resolved even before the Commission’s staff files a lawsuit. In addition, they say, roughly 90 percent of cases are resolved after some sort of litigation is filed.

That’s typically due to fear of an adverse judgment; corporations typically fear market reaction to litigation, or have concerns that it may become increasingly difficult to obtain financing.

Cost also plays a role in the rush to settlement, as individuals and corporations may not have sufficient resources to fight the SEC. Rick Sauer, partner at Vinson & Elkins, says it could cost individuals at least $100,000 and as much as $1 million in a major case to defend themselves against charges. “For many it’s cost prohibitive,” he asserts.

Sauer

Companies are more inclined to settle than individuals, however. That’s because companies may be more willing to pay some sort of fine—even a large one, in some cases—to defuse the issue. “Even if it doesn’t believe the allegations are meritorious,” says Sauer, who spent 13 years with the SEC’s enforcement division, “[settling] is the lesser evil.”

Settlements are also more common when there is a somewhat clear-cut transgression. “Cases where there is significant business risk to the entity or individual tend to settle,” says Morvillo at Mayer Brown.

Executives or other individuals, however, have a lot more to risk, as their careers are generally at stake—many SEC settlements usually result in a permanent or temporary bar from serving with a publicly traded company. “So, they have a much greater incentive to litigate,” he adds.

Negotiations And Sanctions

Most lawyers say the decision to fight charges all the way is not a bad one, asserting that the SEC has a mixed track record when it takes its cases to trial. “A significantly large portion of litigated SEC actions result in judgments against the government,” says Sauer, adding that he estimates this at less than half. Morvillo says the government fares even worse in the Court of Appeals.

Meisner

In addition, experts argue that defendants who choose to go to trial and then lose still do not fare worse than if they settled in the first place. “In many instances, you will find individuals who decide to litigate and lose wind up being penalized and sanctioned on a lesser scale than if they had agreed to a settlement,” insists Derek Meisner, an attorney at Kirkpatrick & Lockhart Nicholson Graham who spent five years with the SEC’s Division of Enforcement.

That’s because judges are sometimes reluctant to impose penalties that are equal to what the SEC was demanding as a pre-condition for settling. Meisner concedes that there is no clear cut reason for this, but does point out that often the SEC demands penalties and sanctions that might exceed what is permitted by statute after litigation. “Many times the amount the SEC demands and ultimately receives in a settlement is a byproduct of negotiations between parties, which can lead to an arbitrary figure,” Meisner elaborates.

In fact, several lawyers theorize that when the SEC files a case or settles, it is seeking to make a major public statement. “One way it can do this is by imposition of a substantial penalty or disgorgement, or a permanent industry or officer and director bar,” says Meisner.

As a result, any settlement being demanded by the SEC would be a critical factor in the decision to settle or go to trial.

If the Commission is seeking a large sum of money and an officer and director bar, it certainly “ups the stakes and gives the dependant a greater incentive to litigate,” says Sauer at Vinson & Elkins.

Indeed, Meisner points out that since Sarbanes-Oxley’s passage, the SEC has been seeking larger monetary penalties; the Commission has also been demanding that executives agree to longer bars from serving as an officer or director than in the past.

These factors have made it more difficult than in the past for the SEC to reach settlements.

Adds Meisner: “If an executive has the resources and believes the SEC has over-stepped its boundaries—both legally and factually—and is willing to withstand the possibility of temporary damage to his or her reputation, it may pay to litigate with the SEC.”

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