In June 2013, the Securities and Exchange Commission (SEC)
Chairperson, Mary Jo White, announced that the agency would extract admissions
of wrongdoing from certain defendants in contrast to its longstanding “neither
admit nor deny” policy. On August 19,
2013, the SEC announced a settlement of a case against Philip Falcone and his
advisory firm, Harbinger Capital Partners, that is the first application of the
new SEC policy. While the announcement
provides a broad outline of wrongdoing to which the SEC will deem mandatory
admissions applicable, the case does not establish comprehensive guidelines to
be applied in all cases. Accordingly,
the SEC’s obscure standards for mandatory admissions of fault will undoubtedly
leave potential defendants wondering whether the new admission policy will
apply to them.
Harbinger
Capital Partners is an SEC-registered investment advisory firm owned and
controlled by Philip Falcone. Harbinger is the investment adviser to Harbinger
Capital Partners Special Situations Fund (“SSF”), among other funds. As the
Senior Managing Director and Chief Investment Officer of Harbinger, Falcone had
primary responsibility for all of the investment and business decisions made for
the firm as well as the Harbinger-managed hedge funds. Falcone is a highly successful hedge fund
manager whose substantial wealth largely came from betting against the subprime
mortgage market, which paid-off in 2008 when the market crashed. Under Falcone’s
control, Harbinger’s assets under management peaked at approximately $26
billion in 2008.
During
2008, Falcone deliberately underpaid his personal income taxes by a significant
amount. By July 2009, he was aware that the amount of his unpaid tax liability
exceeded $100 million, but he refused to address the delinquency in a legal
manner. For instance, he failed to liquidate
any of his substantial assets to pay the tax obligation, and he failed to contact
federal and state tax authorities to negotiate installment payments. Rather, he obtained a loan from SSF using his
SSF interest as collateral. This
transaction was plainly improper, as neither the SSF offering memorandum nor
the SSF limited partnership agreement permitted such a loan. Although the SSF operating documents allowed
him to appoint an investor committee to review and approve the related party
loan, he failed to do so. Instead, he
feigned legality by hiring a law firm to given the opinion that the loan was
permissible, but failed to reveal all material facts to the firm.
Falcone compounded his misconduct
by failing to disclose his related-party loan for several months, and even then
it was only as a footnote in SSF’s audited financial statements. During the delay in disclosure, Falcone and
Harbinger solicited investments in new Harbinger funds, which solicitation would
have been adversely affected by the loan disclosure. Failing to disclose the
loan also allowed Falcone to avoid negative publicity of his financial
condition and continue his lavish lifestyle.
Falcone used the loan proceeds to
the prejudice of SSF investors.
Specifically, prior to withdrawing the $113.2 million loan, Falcone and
Harbinger had blocked SSF investors from withdrawing any of their funds for
over one year. When Falcone obtained the money, approximately 60% of SSF
investors had unfulfilled requests to redeem their interests in SSF. In June 2010, a previously imposed lock-up
period ended and more than 80% of SSF’s investors requested redemptions. SSF, however, was unable to meet redemption
requests due to ta lack of available funds caused by Falcone’s improper loan.
In addition to the extensive
admissions, the Consent Judgment entered against the Harbinger defendants also
provides that they “will not make or permit to be made any public statement to
the effect that the Harbinger Defendants do not admit the allegations of the
complaints, or that this Consent contains no admissions of the
allegations.” In a seeming contradiction
intended to preserve some leverage to the defendants to avoid civil liability
to the direct victims of their fraud, the Consent also states that nothing in
the agreement affects defendants’ “right to take legal or factual positions in
litigation or other legal proceedings in which the Commission is not a
party.” Whether this language ultimately
allows defendants who admit fault to limit their admissions to only the SEC
proceedings will certainly be the subject of intensive litigation.
The Harbinger case introduces a
broad outline of circumstances under which the SEC will apply its new policy of
demanding admissions of wrongdoing as part of a settlement. In general terms,
the SEC has identified a category of cases to which a mandatory admission would
be applicable -- defendants who knowingly create schemes to defraud for their
personal benefit to the financial disadvantage of investors in violation of
existing fiduciary duties, and who actively conceal the fraud from investors
and others. Such a broad standard, however, would apply to a large number of
cases brought by the SEC, and it is unlikely the agency intended such a
wholesale reworking of its settlement standards. Rather, it is more likely that the SEC will
refine the standards on a case-by-case basis so that the factors to be
considering in demanding an admission as part of a settlement will develop and
be revealed over a period of time. Accordingly,
while industry members and their attorneys now know the type of case to which
mandatory admissions of fault can apply, their particular circumstances and
level of advocacy remain relevant considerations to whether mandatory
admissions will apply in any particular dispute.
