You’d be forgiven if you’d forgotten at this point, but way back in Obama’s first term, the SEC once investigated and sued Citigroup for its involvement in a collateralized debt obligation deal.  As the SEC said in its complaint, Citigroup told investors that a CDO fund had been populated with assets selected by an independent investment advisor.  Instead, though, the SEC said, Citi itself seleted a substantial  amount of negatively projected mortgage-backed asset in which Citigroup had taken a short position.  Basically, Citi made $160 million by taking a short position in pre-selected assets and making misrepresentations to induce investors to take a long position in the same assets.  Or so the SEC said.  Consistent with general federal agency practice, Citi was allowed to neither admit nor deny the allegations.  It was a big hoo-ha.

The case was filed as a proposed settlement on October 19, 2011, and submitted to Judge Jed Rakoff in the Southern District of New York.  Under the deal, Citi would pay $160 million in disgorgement, $30 million in prejudgment interest, and a $95 million civil penalty.  Judge Rakoff had a fit, and a lot of questions.  Among them:

• Why should the Court impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?
• How was the amount of the proposed judgment determined?
• How does the SEC ensure compliance with the proposed injunctive relief?
• Why would the penalty be paid by Citi and its shareholders rather than the culpable individuals involved?
• How could a securities fraud of this nature and magnitude be the result of mere negligence?

He refused to approve the settlement, and set a trial date.  Both sides appealed and sought a stay of Judge Rakoff’s order, first from him directly, and also from the U.S. Court of Appeals for the Second Circuit.  The Second Circuit concluded that the SEC demonstrated a strong likelihood of success on the merits, because Rakoff had not accorded the SEC’s judgment adequate deference, and granted the stay.

And there it was left, for 2½ years.  Lots of other district judges took up Rakoff’s mantle, and refused to approve a number of other settlements between federal agencies and their litigation opponents.  Rakoff wrote a long essay in the New York Review of Books about the financial crisis and prosecutors’ failure to prosecute.  He also submitted to a winding Huffington Post interview in which he minimized the SEC’s resource concerns.  As he said, “The U.S. attorney’s office from the Southern District of New York, which has brought some of the great fraud cases of the last 50 years, has never exceeded 14 human beings in the fraud unit.  That’s the unit I was in. The SEC has hundreds, if not thousands, of people.”  The SEC itself partially changed its policy on admissions in settlements, and started to demand some in appropriate cases.

And yet, it turns out Judge Rakoff was wrong the whole time.  By essentially insisting on admissions to the facts alleged in the SEC’s complaint, Rakoff exceeded his authority as a district judge.  According to the Second Circuit today, here is what a court evaluating a proposed SEC consent decree for fairness and reasonableness should assess: (1) the basic legality of the decree, (2) whether the terms of the decree, including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind.  Of course, a district court may need to make additional inquiry to ensure the decree is fair and reasonable.  But the primary focus should be on ensuring the decree is procedurally proper and take care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.

As the court said, 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.”   Judge Rakoff had found an “overriding public interest in knowing the truth.”  The Second Circuit didn’t deny that interest, but put it in context.   It said, “Trials are primarily about the truth.  Consent decrees are primarily about pragmatism.”

The SEC was probably right to give itself some flexibility on its settlement policy.  It can be a hidebound institution when left to its own devices.  And I suspect its leaders are happy tonight knowing that district courts have a bit less flexibility in assessing those settlements going forward.  But make no mistake.  By letting this final opinion sit for as long as it did, the Second Circuit gave the win to Judge Rakoff.  It’s a different world now thanks to his overreaching approach to the Citi case.  Funny how things work out.