Securities Law

Judge's rejection of SEC's $285 million settlement with Citigroup voided by 2nd Circuit

In a carefully wrought and long-awaited rebuke to U.S. District Judge Jed Rakoff, who for several years has commanded cases and bully pulpits for sharp criticisms of government’s failure to pursue those responsible for huge financial scandals, the New York-based 2nd U.S. Second Circuit Court of Appeals has ruled that he failed to give “significant deference” to the Securities and Exchange Commission in its settlement with Citigroup Inc., Reuters reports.

Rakoff has a significant background in dealing with financial fraud—as a federal prosecutor, a big-firm defense lawyer and as a judge in the Southern District of New York—and has complained in speeches and judicial opinions that the public deserves to know the “truth” behind settlements that begin with allegations of what could amount to serious crimes and settle on the basis of promises and cash.

Citigroup was settling claims that it misled investors about a $1 billion collateralized debt obligation in 2007 based on mortgages, while at the same time betting against the debt as the housing market flagged. Citigroup agreed to pay $285 million to settle the allegations.

Rakoff complained that for Citigroup to “neither admit nor deny” charges brought by the SEC in a civil enforcement action left him with too little information to judge the settlement, and he rejected the deal. He applied a standard developed in earlier cases, saying the settlement was neither “fair, nor reasonable, nor adequate, nor in the public interest.”

A three-judge panel of the appeals court—Rosemary Pooler, Raymond Lohier and Susan Carney—hammered at Rakoff’s decision, which was rife with thorny separation-of-powers issues. When Rakoff determined that the 2nd Circuit did not have jurisdiction for an interlocutory appeal by the SEC, the agency took the unusually strong measure of filing a writ of mandamus. The appeals court then stayed Rakoff’s order pending today’s ruling.

The appeals court opinion (PDF), written by Pooler, noted that “adequacy” belongs in the context of class actions and is “particularly inapt” for an SEC consent decree; and that on remand, Rakoff might make further inquiries of the parties about “fairness” and “reasonableness,” but the “primary focus of the inquiry should be on ensuring the consent decree was procedurally proper, using objective measures.”

As for concerns about “the public interest,” a court should make a simple determination of whether it is “disserved” by the settlement, for example by barring private litigants from pursuing claims independently of relief in the consent decree.

“What the district court may not do is find the public interest disserved based on its disagreement with the SEC’s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability,” Pooler wrote.

“It is an abuse of discretion to require, as the district court did here, that the SEC establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decrees,” the opinion said.

Rakoff’s efforts, however, have gained traction in other ways. For example, last June, SEC Chairwoman Mary Jo White announced the agency would begin requiring admissions of wrongdoing in serious cases.

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