Second Circuit Vacates Judge Rakoff’s Rejection of SEC Settlement: Consent Decree “Fair and Reasonable” Even Without Admission of Wrongdoing

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D&O insurers should be mindful of a recent development in the Second Circuit that could have implications for D&O insurers.  The developments stem from a key decision in the Southern District of New York in 2011.  On November 28, 2011, in a surprising and much-publicized decision, Judge Jed S. Rakoff refused to approve a consent decree jointly proposed by the SEC and Citigroup Global Markets.  See SEC v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (S.D.N.Y. Nov. 28, 2011).  The consent decree required Citigroup to pay $285 million and refrain from future Securities Act violations after allegedly misrepresenting the company’s structuring and marketing of a billion dollar fund largely collateralized by subprime securities.  During the settlement hearing, Judge Rakoff asked, among other things, why the court should approve a consent judgment in which Citigroup neither admitted nor denied any of the “serious securities fraud violations” alleged by the SEC.  Apparently unpersuaded by the parties’ response, Judge Rakoff concluded that the proposed settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest … because it does not provide the court with a sufficient evidentiary basis to know whether the requested relief is justified[.]”   According to Judge Rakoff, “when a public agency asks a court to become its partner in enforcement … the court, and the public, need some knowledge of what the underlying facts are[.]” Unsurprisingly, the SEC and Citigroup appealed.

 Last week, applying an “abuse of discretion” standard, the Second Circuit vacated and remanded Judge Rakoff’s decision.  SEC v. Citigroup Global Markets Inc., ___ F.3d ___, 2014 WL 2486793 (2d Cir. June 4, 2014).  Among other things, the Second Circuit concluded that it was “an abuse of discretion to require … that the SEC establish the truth of the allegations against a settling party as a condition for approving the consent decrees.”  As the court explained, “[t]rials are primarily about the truth.  Consent decrees are primarily about pragmatism. … It is not within the district court’s purview to demand cold, hard, solid facts, established either by admissions or by trials as to the truth of the allegations in the complaint as a condition for approving a consent decree.” 
 
Although the Second Circuit noted that other cases may require more of a showing (such as where a district court suspects a consent decree has been entered into as a result of improper collusion between the SEC and the settling party), such circumstances did not appear to be present here.  Indeed, the Second Circuit noted that Judge Rakoff, “with the benefit of copious submissions by the parties, likely had a sufficient record before it on which to determine if the proposed decree was fair and reasonable.”  Of course, if Judge Rakoff “deem[ed] it necessary” on remand, the Second Circuit noted he could ask the SEC and Citigroup to provide “additional information sufficient to allay any concerns … regarding improper collusion between the parties.” 
 
If Judge Rakoff’s decision had been affirmed, meaning that SEC consent decrees likely would need to include party admissions to the wrongful acts alleged, then the “personal profit” and/or “fraud” exclusions typically present in D&O policies would be triggered, as “final adjudication” language often incorporated into those exclusions would be satisfied.  D&O insurers’ exposure, therefore, would be significantly limited in such matters, with defense costs likely presenting the only exposure.  Thus, the Second Circuit’s reversal significantly blunts, if not outright kills, the immediate trigger of the personal profit and/or fraud exclusion(s) which could have been available to insurers had Judge Rakoff’s decision been affirmed. 

Despite potentially disarming the “personal profit” and “fraud” exclusions, the Second Circuit’s decision does not affect a typical D&O policy’s “loss” definition.  The amounts due from the insured in the usual consent decree, which include mostly fines, penalties, and disgorgement, arguably fall outside the typical “loss” definition.  As a result, while the Second Circuit’s decision may be disappointing to D&O insurers, other strong coverage defenses such as the definition of “loss” continue to be viable with respect to both consent decrees and any parallel civil actions that exist.

Topics:  Chevron Deference, Citigroup, Collateralized Debt Obligations, Consent Decrees, D&O Insurance, Enforcement, Enforcement Actions, Insurers, Interlocutory Appeals, Judge Rakoff, Mortgage-Backed Securities, Risk Management, SEC, SEC v Citigroup

Published In: Civil Procedure Updates, Civil Remedies Updates, Finance & Banking Updates, Insurance Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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