Overruled

Edited by Vani Rao

Appeals court says judge erroneously blocked SEC-Citigroup settlement

MC 1A Federal Appeals court on Wednesday, Jun 4, 2014, handed the US Securities and Exchange Commission (SEC) a big victory by voiding a judge’s pathbreaking decision to reject the regulator’s $285-million fraud settlement with Citigroup Inc. (NYSE:C).

The court said US District Judge Jed Rakoff erred in rejecting a $285-million settlement between the SEC and Citigroupover claims that the bank misled investors in a mortgage security.

The Case

The case focused on the SEC’s allegations that Citigroup negligently misrepresented its role and financial interest in the 2007 structuring and marketing of a complex $1-billion package of mortgage bonds sold to investors. The New York-based global bank failed to disclose that it placed financial bets that the investment would fail, and reaped roughly $160 million in profits when that forecast became a reality, the SEC charged.

Under the proposed settlement, Citigroup agreed to disgorge the $160 million, pay a $95 million civil penalty along with $30 million in interest, and make internal oversight changes over a three-year period to guard against future violations. Like many other SEC settlements, the final consent order did not require Citigroup to admit liability or guilt.

Questioning that omission, Judge Rakoff required the SEC and the bank to answer a series of questions, including whether there was “an overriding public interest in determining whether the SEC’s charges are true.” He also asked whether the penalties, which he characterized as “pocket change” for Citigroup, were sufficient to “have a meaningful deterrent effect.”

Judge Rakoff ultimately rejected the settlement, in part because he objected to a decade-old practice by the SEC that, in this case, meant Citigroup neither admitted nor denied wrongdoing as part of the deal. The bank and the SEC argued they had provided Judge Rakoff with ample information to support the basis for the settlement and that the law does not require an admission of wrongdoing in order for a judge to accept a settlement.

The judge’s frustration with the terms of some settlements had emerged before. In 2010, he harshly criticized, but approved, a $150-million settlement between Bank of America Corp. (NYSE:BAC) and the SEC, resolving claims the bank should have disclosed billions in losses at Merrill Lynch & Co. before it was acquired by the bank.

Policy Change

In a 2012 policy change, the SEC limited the “neither admit nor deny” language to deals with defendants who have not already been convicted in related criminal cases.

Rakoff’s 2011 decision reflected widespread dissatisfaction with the SEC’s practice of settling cases against financial institutions without obtaining an admission that anybody within them had broken the law.

Source: www.sec.gov
Source: www.sec.gov

The SEC, under former federal prosecutor Mary Jo White, made a landmark decision to change the agency’s long-standing settlements policy by requiring firms and individuals in some cases to admit wrongdoing to resolve cases or face being taken to court.

But the new policy has been applied sparingly. To date, the SEC—which brings hundreds of cases a year—has only obtained admissions in about half a dozen settlements.

Prosecutors have moved in recent weeks to extract guilty pleas from two major financial institutions. The US Justice Department is pushing BNP Paribas SA to plead guilty and pay more than $10 billion to end a criminal probe into allegations the bank evaded US sanctions. Credit Suisse Group AG (NYSE:CS) pleaded guilty last month and agreed to pay $2.6 billion to end a probe into how its employees helped Americans dodge US taxes. While the court did not directly address the controversy over such clauses, the ruling may add finality to another SEC settlement.

Joining Forces

While Judge Rakoff became something of a folk hero for demanding stronger accountability for Wall Street crimes, the SEC and Citigroup teamed up to appeal his ruling, another troubling example of the close cooperation of entities that should be adversaries.

The SEC argued that Rakoff did not accord their agency “adequate deference” in handling the settlement. Translation: “get off our turf.” Today, after years of anticipation, a three-judge panel of the second circuit agreed with the SEC and Citi.

In so doing, the appeals court panel, all of whom were appointed by Presidents Bill Clinton and Barack Obama, effectively neutered future efforts by judges to play a role in determining the standards of financial fraud settlements like this. According to the second circuit, while judges could check for the legality of the complaint and whether any collusion was involved, the second circuit considered it “an abuse of discretion” for Judge Rakoff to try to get at the truth of the claims.

Grammatical Errors

While the second circuit allows for additional scrutiny at court if there is suspicion of collusion, they say a number of other troubling things: that facts are irrelevant, that a settlement represents a contract between only two parties, and that judges should accept that without any questions. As for the public interest, that is a matter for regulators. The second circuit specifically says the decision on whether the settlement serves that purpose “rests squarely with the SEC”.

Under these standards, it is hard to argue that district courts like Rakoff’s have much of a role to play in potential settlements, but to agree with them. The courts could not expect much cooperation from regulators or banks; they would have to effectively operate a private detective service to ferret out collusion, in order to have any impact on the final ruling. However, given the logic of the rest of their ruling, it mostly extends to checking for grammatical errors.

Death of a Judicial Activism

The ruling was a hard putdown by the second circuit against a judge who they decided searched a little too hard for the truth. And it will have wide impact in future consent decree cases. People believe that is the death of a movement. Judges who had followed Rakoff’s reasoning will now have substantial incentive not to run afoul of the appeals courts.

While the SEC’s transparently close cooperation with Citigroup may trip them up in this case, in the future, they have grabbed a lot of authority to tailor settlements as they see fit.

It’s bad enough when the Congress or the executive branch steals power for themselves at the expense of the courts. However, when a higher court basically does the job for them, the result is a self-inflicted wound that damages checks and balances.

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