On June 4, 2014, in SEC v. Citigroup Global Markets, Inc., No. 11-5227, the U.S. Court of Appeals for the Second Circuit shot down District Judge Jed Rakoff’s effort to make judicial approval of the substance of SEC settlements part of the process of approving SEC consent decrees with enforcement action defendants. It also soundly rejected the notion that a reasonable settlement between the SEC and enforcement defendants in the public interest requires some admission of facts or liability by the defendants. You can see a copy of the decision here.
For many years, the vast majority of SEC enforcement actions have been resolved by consent injunctions, together with other ancillary relief, such as “disgorgement” and civil penalties, agreed upon by the parties. The parties negotiate the violations of law to be alleged, and the injunctions almost uniformly order that the defendants not violate those provisions of law in the future. For years, it was a generally accepted practice that such settlements and consent decrees be entered into without the defendants either admitting or denying the violations alleged. The huge costs of litigation and trial, as well as the risks of failure, are avoided by both parties, and the actual merits of the claims – whether the allegations are supported by sufficient evidence to prove them – would remain unresolved by agreement.
Judge Rakoff was not happy with just such a settlement in this case. The case involved allegations that Citigroup Global Markets, Inc. (CGMI) misrepresented the nature of its participation in the structuring and marketing to investors of a $1 billion portfolio of collateralized debt obligations by failing to disclose that Citigroup played a role in selecting 50% of the portfolio, and pre-arranged to short those securities Complaints were filed against CGMI and one of its mid-level employees, Brian Stoker. The SEC and CGMI agreed to a settlement in which negligence-based violations of sections 17(a)(2) and (3) of the Securities Act of 1933 would be alleged, a consent injunction would be issued by the district court barring future violations of those provisions, CGMI would pay $160 million in “disgorgement” of alleged profits as well as $30 million in prejudgment interest, and CGMI would pay a civil penalty of an additional $95 million. CGMI agreed to the settlement “without admitting or denying” any of the allegations.
Stoker would not agree to a settlement and went to trial, probably because the SEC insisted that any settlement include an order barring him from future employment in the securities business. The two week jury trial was a disaster for the SEC. Stoker was found not liable on all of the SEC allegations.
Before his appointment to the Bench, Judge Rakoff spent some time as a federal prosecutor in the office of the U.S. Attorney for the Southern District of New York, including two years as Chief of the Business and Securities Fraud Prosecutions Unit. He apparently was not pleased with the SEC’s settlement decision. The issuance of a consent injunction is a judicial act, and Judge Rakoff concluded he should not do so until he was satisfied that the court was “not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.” SEC v. CGMI, 827 F.Supp. 2d 328, 332 (S.D.N.Y. 2011). He forced the SEC and CGMI to answer specific questions about the justifications for various aspects of the settlement, and pointedly challenged the decision to allow CGMI to settle “without admitting or denying” liability. By doing so, he placed at issue the SEC’s discretion to use the settlement framework that had been used in SEC enforcement cases for decades.
Judge Rakoff’s insistence that he not serve as “a potted plant” in the review and approval of the settlement and proposed consent injunction struck a chord with other judges. Following his decision, several other judges in the Southern District and around the country began to question whether SEC “neither admit nor deny” settlements were appropriate. It also struck a chord with the public and the Congress. All of a sudden, the SEC was bombarded with suggestions that its willingness to accept “neither admit nor deny” settlements was inconsistent with its oversight of the public securities markets. Not the least of these were the private plaintiffs’ bar, which now saw the possibility that SEC settlements could provide them with evidence of wrongdoing, which in turn would increase the settlement value of follow-on private securities actions against the defendants.
Although top SEC enforcement officials defended the pragmatic need for “neither admit nor deny” settlements, in a response not likely to win a “Profiles in Courage” award, the SEC blinked and SEC Chair Mary Jo White announced on June 18, 2013 an increased focus on obtaining admissions in settlements, even though “neither admit nor deny” settlements would remain the norm. She said the SEC would require admissions “in certain cases where heightened accountability or acceptance of responsibility through the defendant’s admission of misconduct may be appropriate.” That led to much discussion about the likelihood of increased litigation with the SEC because defendants would be loathe to admit facts or liability that could be used in ensuing private damage actions against them.
The Second Circuit’s decision may, and should, quell these rumblings. The appellate court soundly rejected Judge Rakoff’s notion that courts should sit in judgment of the wisdom of the SEC’s settlement choices, noting that “federal judges – who have no constituency – have a duty to respect legitimate policy choices made by those who do.” “What the district court may not do is find the public interest disserved based on its disagreement with the S.E.C.’s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability.”
The court also clearly rejected Judge Rakoff’s notion that SEC settlements are inadequate if they fail to establish facts about the allegations: “It is an abuse of discretion to require, as the district court did here, that the S.E.C. establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decrees.” “It is not within the district court’s purview to demand ‘cold, hard, solid facts, established either by admissions or trials’ … as to the truth of the allegations in the complaint as a condition for approving a consent decree.” In reaching this result, the court noted that SEC settlements are supposed to be compromise resolutions of disputes: “Consent decrees are primarily about pragmatism…. Consent decrees provide parties with a means to manage risk.”
This was a “bet the company” case for the SEC, and plainly is the right result. Although the SEC faced a severe challenge to its enforcement program, it weathered the storm. “Neither admit nor deny” settlements are a practical necessity; the agency simply cannot litigate a large portion of its cases. It would be a terrible burden to have to do so, and, frankly, its increasing difficulty in getting verdicts of liability in tried cases would likely be exacerbated. Now we must wait to see whether the Division of Enforcement has the wisdom (and self-knowledge) to realize that its new policy of requiring admissions in settlements is best left as a the rare exception that proves a much more sensible rule.
June 4, 2014
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