The United States Court of Appeals for the Second Circuit yesterday vacated a closely-watched 2011 decision by U.S. District Court Judge Jed Rakoff rejecting a $285 million fraud settlement between Citigroup Inc. and the U.S. Securities and Exchange Commission (SEC), on the grounds that the District Court "abused its discretion by applying an incorrect legal standard in its review." The Second Circuit decision indicates that parties who are seeking to resolve disputes with the SEC should feel more confident that settlement agreements that neither "admit nor deny" wrongdoing will be honored by District Courts.
Judge Rakoff had rejected the settlement between the SEC and Citigroup because Citigroup neither admitted nor denied wrongdoing in settling allegations that the bank failed to disclose to investors that it had bet against a collateralized debt obligation (CDO) while simultaneously marketing the CDO to investors. A panel of the Second Circuit disagreed with Judge Rakoff’s reasoning: "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. Trials are primarily about the truth. Consent decrees are primarily about pragmatism."
Inherent in the Second Circuit’s decision is that trial courts are required to accord the SEC "adequate deference" in reviewing and approving proposed consent judgments in SEC enforcement actions. The Second Circuit clarified that the proper standard for reviewing a proposed consent judgment involving an enforcement agency requires that the district court determine that the proposed settlement is "fair and reasonable" with the additional requirement that the "public interest would not be disserved." The Second Circuit held that it is inappropriate for a district court to find that the public is necessarily disserved where the “SEC decid[es] to settle without requiring an admission of liability.”
The Second Circuit also clarified that a district court need not analyze whether a consent order is "adequate" prior to approving a settlement. Such a requirement, while appropriately applied to class action settlements, is "inapt" in the context of a proposed SEC consent decree, the panel said. Finally, while the District Court did not condition its approval of the consent decree on an admission of liability, the Second Circuit was clear that doing so would be clear error: "there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement between the parties. The decision to require an admission of liability before entering into a consent decree rests squarely with the SEC"
In addition, the Second Circuit underlined the importance of "neither admit-nor-deny" settlements, stating: "In many cases, setting out the colorable claims…neither admitted nor denied by the wrongdoer, will suffice to allow the district court to conduct its review," and noting that these settlements allow defendants "a means to manage risk." The "risk" identified by the Second Circuit would include the very real risk that future private plaintiffs would file follow-on suits after the defendant’s admission of wrongdoing in a settlement with the SEC.
Yesterday's decision is particularly important in light of SEC Chair Mary Jo White’s recent statement that the SEC intends to seek admissions of wrongdoing in more cases.1 The decision empowers targets of SEC investigations to push for resolutions that do not require them to admit wrongdoing in their negotiations with the SEC, and should be considered in future discussions and negotiations with the SEC and other enforcement agencies.