As a follow up to our post of December 15, where we asked whether settling enforcement actions might become harder after Judge Jed Rakoff rejected the recent settlement between the SEC and Citigroup, one thing is clear, it will certainly be harder for the SEC to settle cases before federal judges like Rakoff who may be troubled by settlements in which a defendant is allowed to neither admit nor deny liability when accused of securities fraud.
The Washingon Post story on Judge Rakoff’s order accusing the SEC of misleading him and the federal appeals court, by among other things, failing to give him notice of the SEC’s emergency request to the appeals court to stop the judge from rejecting the Citigroup settlement, may have gotten for the SEC the opposite kind of attention it wanted when it first announced what it thought was a great settlement. If Rakoff turns out to be right, this new and unwanted attention may come from federal judges who may begin to question more thoroughly both the SEC’s motives and tactics in settling such cases. For the SEC, this could mean having to conduct longer investigations with an eye toward expecting to have a long trial, or, alternatively, foregoing court actions and opting for administrative actions. In the future, to avoid federal judges questioning such settlements, the SEC may decide its easier to take the latter route.
The Securities and Exchange Commission’s Director of Enforcement, Robert Khuzami, today, issued a press release regarding a New York federal district court’s recent rejection of an SEC’s settlement with Citigroup. Khuzami announced that the SEC is appealing the lower court’s ruling to the U.S. Court of Appeals for the Second Circuit.
In the Citigroup case, U.S. District Judge Jed Rakoff refused to accept a settlement between the SEC and Citigroup in a case involving the bank’s sale of mortgage-backed securities that cost investors almost $700 million in losses while the bank garnered profit of about $160 million. Rakoff ruled that the underlying allegations were ‘unsupported by any proven or acknowledged facts,’ and rejected a $285 million settlement between the SEC and Citigroup. The SEC claimed that the settlement reasonably reflected the relief it would likely have gotten had it won at trial.
Khuzami’s press release argues that Rakoff has created a “new standard” that is “at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. ” He is correct that courts have routinely approved SEC settlements in which a defendant does not admit or expressly deny liability, thus providing incentives for both the SEC and defendants. However, Citigroup’s failure to acknowledge wrongdoing is actually what bothered Judge Rakoff. Rakoff concluded that the settlement “is neither fair, nor reasonable, nor adequate, nor in the public interest.”
In a period when the public has become ever more skeptical about the fairness of financial bailouts and deals between governmental agencies and banks, Judge Rakoff’s decision appears to channel that same skepticism. Might this be the beginning of the end of the SEC’s practice and policy of settling cases with defendants without requiring the defendant to admit to liability of some kind, even if modest? For at least one judge, that appears to be the case. And, if it is the beginning of a trend, this could mean more trials and fewer settlements. If so, the danger of changing the SEC’s settlement approach to these cases could prove time consuming and expensive not just for the SEC and defendants but also for federal judges like Judge Rakoff.