The U.S. Securities and Exchange Commission announced recently that it had settled insider trading charges with Diamondback Capital Management LLC. As required by a recent SEC policy change, the proposed settlement appears to be the first not to include a representation that the defendant “neither admits nor denies” the SEC’s charges.

Under the proposed settlement, Diamondback agreed to pay more than $9 million and consented to a judgment that permanently enjoins it from future violations of federal anti-fraud laws. In itself, the settlement is not unusual. As the New York Times reports, however, this settlement marks “a departure from the SEC’s historical practices” because it “does not include language that the fund ‘neither admits nor denies’ any wrongdoing in the case.”

The Diamondback settlement appears to have roots in a new SEC policy prohibiting companies that admit to fraudulent conduct in parallel criminal proceedings from settling SEC charges without admitting guilt of the same conduct.

In the Diamondback case, the company entered into a nonprosecution agreement with the U.S. Department of Justice which contains an agreed statement of facts acknowledging that certain Diamondback employees traded securities based on material nonpublic information. As a result of this admission, Diamondback was not permitted by the SEC to settle charges on a “neither admit nor deny” basis.

There has been widespread speculation — by Reuters and the Washington Post, et al. — that the SEC’s policy change and the Diamondback settlement are, in fact, reactions to criticism from federal district court judges who have questioned the adequacy of the facts typically admitted in consent judgments.

The SEC vigorously denies that there is a tie between the new policy and this heightened judicial scrutiny of SEC settlements. Nevertheless, in the Diamondback case, the SEC took the unusual step of obtaining from the company an agreed statement of facts, which it reportedly submitted to the court for consideration in weighing up the proposed settlement agreements.

Those looking for a template for the factual allegations the SEC might include in future settlement will be sorely disappointed: the proposed agreement is not yet publicly available and, we have been informed by the SEC that it will not become available unless and until the presiding judge approves the settlement.This lack of transparency is uncharacteristic in SEC matters, and it comes as a surprise in a case pending in the same district where Judge Jed Rakoff in November derided the SEC for failing to make clear that the public interest was served by a proposed settlement.From what we know about the proposed Diamondback settlement, it appears the case may be a harbinger of a new era in SEC settlements. The takeaways are simple: (1) where a company admits to criminal conduct, the SEC is prepared to stick to its new policy of prohibiting regulated entities from settling charges on a “neither admit nor deny” basis; and (2) regulated entities should be prepared to negotiate and submit to the court more fulsome factual allegations in support of a proposed settlement agreement.

Undercover investigative techniques, such as wiretaps, which have long been a staple in racketeering and narcotics investigations, are now being used by DOJ in white collar investigations.  In a speech on November 4, 2010, Lanny Breuer, Assistant Attorney General of the DOJ’s Criminal Division, said that DOJ has “begun increasingly to rely, in white collar cases, on undercover investigative techniques that have perhaps have been more commonly associated with the investigation of organized and violent crime.”  Brueur also noted that DOJ has strengthened the Office of Enforcement Operations, which reviews and approves all wiretaps, and as a result the number of wiretaps authorized – in all cases – “has gone up.”

DOJ has already used wiretaps and other undercover investigative techniques in several recent white collar investigations.  In January 2010, for example, 22 individuals were indicted for FCPA violations.  The indictments followed what Brueur described as the DOJ’s “most extensive use of undercover law enforcement techniques in an FCPA investigation.”  Wiretaps were also used in the insider trading cases against Raj Rajaratnam. 

These “new” techniques in white collar investigations mean that DOJ is relying tools other than those traditionally associated with white collar cases, such as voluntary disclosures or whistle blowers.  Companies should take notice that DOJ has “stepped up [its] white collar investigations and prosecutions.”  Indeed, according to a recent OECD report (link to from prior post), DOJ stated voluntary disclosures of FCPA violations are a “source of a significant proportion of investigations, but not the majority.” 

With DOJ’s intention to be more proactive in white collar investigations, and the tools available to it, companies should be one step ahead of potential investigations by having a robust and effective compliance program.  Not only will an effective compliance program both deter and detect illegal conduct, prosecutors consider the effectiveness of  compliance programs in making charging decisions and a court’s determination of an appropriate sentence.   

The proposed changes to the U.S. Sentencing Guidelines (USSG) that went into effect on November 1, 2010 further explain how business organizations can protect against illegal conduct by its employees and mitigate the effect of such conduct.  While the USSG have not been mandatory since the Supreme Court’s 2005 decision in U.S. v. Booker, the same factors a court considers in sentencing a company are considered by federal prosecutors when deciding whether to charge a company. 

The changes to Chapter 8 of the USSG (dealing with Business Organizations) offer another incentive for companies to revisit and revise their compliance programs.  The major changes affecting compliance programs are discussed below:

Effective Compliance and Ethics Program.  After a company detects criminal conduct, it “shall take reasonable steps to respond appropriately to the criminal conduct and to prevent similar criminal conduct, including making any necessary modifications to the organization’s compliance and ethics program.”  Reasonable steps to respond to the conduct can include “providing restitution to the identifiable victims, as well as other forms of remediation” and “self-reporting and cooperation with authorities.”  A company may also decide to retain “an outside professional advisor to ensure adequate assessment and implementation of any modifications” to the compliance program.

Direct Reporting Obligations.  To take advantage of a 3 point reduction in culpability score, there must be a “high-level” person who has responsibility for the compliance program with direct reporting obligations to the company’s governing authority (e.g. an audit committee).   

Early Detection of the Offense.  Also to take advantage of a 3 point reduction in culpability score, the compliance program must detect “the offense before discovery outside the organization or before such discovery was reasonably likely.”  Simply having a compliance program is not sufficient.  Companies should train employees on the compliance program, maintain an internal hotline to report violations, and periodically assess the effectiveness of the program.   

Prompt Reporting. Also to take advantage of a 3 point reduction in culpability score, the organization must promptly report the offense to appropriate government authorities.  Unfortunately a “prompt” report is not defined, but the revisions to the Application Notes provide that a company “will be allowed a reasonable period of time to conduct an internal investigation” and that reporting is not necessary if the company “reasonably concluded, based on the information then available, that no offense had been conducted.” 

No Involvement in the Compliance Program by Individuals Who Condoned or Were Willfully Ignorant of the Offense.  Also to take advantage of a 3 point reduction in culpability score, individuals who are responsible for the compliance program must not have “participated in, condoned, or [been] willfully ignorant of the offense.”  The Application Notes to the General Application Principals, which were unchanged by the recent amendments, define an individual as “willfully ignorant” if he or she “did not investigate the possible occurrence of unlawful conduct despite knowledge of circumstances that would lead a reasonable person to investigate whether unlawful conduct had occurred.”