In November 2011, Judge Jed Rakoff of the Southern District of New York ignited a firestorm of commentary and concern among the securities bar by declining to approve a settlement between the SEC and Citigroup in which the bank neither admitted nor denied the alleged wrongdoing. Several other district judges subsequently followed Judge Rakoff’s lead, and the SEC eventually adopted a new policy to require admissions of wrongdoing as a condition to settlement in certain cases. These events appeared to cast doubt on the future ability of parties to enter into the traditional “neither admit nor deny” type of settlement with the SEC and thus posed significant challenges to parties willing to settle actions by the SEC.
On June 4, 2014, however, the U.S. Court of Appeals for the 2nd Circuit reversed Judge Rakoff’s opinion in SEC v. Citigroup Global Markets Inc., holding that the judge had abused his discretion by applying an incorrect legal standard in analyzing the consent decree and setting a trial date. In doing so, the Circuit Court emphasized that a District Court must defer to the SEC’s discretion with respect to structuring consent judgments.
By way of background, the SEC filed a complaint against Citigroup in October 2011, claiming that Citigroup had negligently misrepresented its role and economic interest in structuring and marketing a billion dollar fund, in violation of Sections 17(a)(2) and (3) of the Securities Act of 1933. The SEC claimed that Citigroup had exercised significant influence over the selection of $500 million worth of the fund’s assets — primarily collateralized by subprime securities tied to the U.S. housing market. According to the SEC, Citigroup had itself selected a substantial amount of negatively projected mortgage-backed assets in which Citigroup had taken a short position, while telling investors that the fund’s portfolio was chosen by an independent investment advisor. Citigroup reaped roughly $160 million in profits from the poor performance of its chosen assets, while fund investors lost millions.
After filing the complaint, the SEC filed a proposed consent judgment in which Citigroup agreed to a permanent injunction barring Citigroup from violating Sections 17(a)(2) and (3), disgorgement of $160 million, prejudgment interest, and a civil penalty of $95 million. Citigroup also agreed to refrain from seeking an offset against any compensatory damages awarded in a subsequent investor action and consented to make internal changes designed to prevent similar acts from recurring. The decree contained no admission of guilt or liability. The SEC also filed a parallel complaint against Citigroup employee Brian Stoker alleging Stoker negligently violated Sections 17(a)(2) and (3).
The District Court scheduled a hearing on the matter, presenting the SEC and Citigroup with numerous questions. Judge Rakoff subsequently issued a written opinion on November 28, 2011, refusing to approve the consent judgment. He noted that the proposed consent decree “is 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 under any of these standards.” S.E.C. v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328, 332 (S.D.N.Y. 2011). Judge Rakoff criticized the consent decree because it did not measure up to settlements obtained in other cases. Declining to approve the consent judgment, the District Court consolidated the case with the Brian Stoker action and ordered the parties to be ready to try both cases on July 16, 2012. The S.E.C. and Citigroup immediately filed notices of appeal.
The 2nd Circuit Decision
In its June 4, 2014 opinion, the 2nd Circuit reversed. It first concluded that it had jurisdiction to consider the interlocutory appeal because the District Court’s order threatened irreparable harm: the order prevented the SEC from obtaining an injunction barring Citigroup from violating the Act in the future and requiring Citigroup to take steps to prevent future acts of fraud.
The Circuit Court then determined that the District Court had abused its discretion in refusing to approve the consent decree. The court recognized that while a district judge is not merely a “rubber stamp,” a district court is required to enter an order if it determines that the proposed consent decree is fair and reasonable and that the “public interest would not be disserved” — no adequacy inquiry is appropriate. S.E.C. v. Citigroup Global Markets, Inc., Docket Nos. 11-52227-cv (L); 11-5375-cv(con), 11-5242-cv(xap) (2d Cir. June 4, 2014).
The Circuit Court continued by explaining that 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.” Id. (internal citations omitted). Emphasizing the deference a district court must afford the SEC, the court cautioned that a district court must take care “not to infringe on the S.E.C’s discretionary authority to settle on a particular set of terms.” Id. at p. 21
Thus, the 2nd Circuit reasoned, Judge Rakoff had abused his discretion in requiring that the SEC establish the truth of the allegations against a settling party as a condition for approving the consent decree. It noted that “[t]rials are primarily about the truth. Consent decrees are primarily about pragmatism.” Id. As such, it was not within the district court’s purview to demand “cold, hard, solid facts, established either by admissions or by trials” regarding the truth of the allegations as a prerequisite for approving a consent decree. Id. at p. 22.
Here, the Circuit Court continued, Judge Rakoff likely had a sufficient record before him on which to determine if the proposed decree was fair and reasonable. The job of determining whether the proposed consent decree best serves public interest “rests squarely with the S.E.C., and its decision merits significant deference.” Id. at p. 25. While the district court may consider the public interest, the district court may not 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.” Id. at p. 26. Moreover, Judge Rakoff’s withholding approval of the consent decree because he believed that the SEC failed to bring proper charges against Citigroup constituted an abuse of discretion. The SEC enjoys the exclusive right to choose which charges to levy against a defendant.
Accordingly, the 2nd Circuit vacated Judge Rakoff’s November 28, 2011 order and remanded the case for further proceedings in accordance with the opinion.
The 2nd Circuit’s decision restores a long-used, highly effective settlement tool to the tool box of the SEC and defense counsel. The SEC may well continue to press for admissions as a condition of settling in certain cases in accordance with its new policy and out of concerns to avoid appearing too soft on certain defendants. Nevertheless, in light of the 2nd Circuit’s decision, the SEC need not hesitate to agree to the “neither admit nor deny” formulation out of fear that courts will refuse to approve such settlements. Moreover, the decision should provide defense counsel with a stronger hand in refusing to accede to demands for admissions during the negotiation process, placing them in a better position to hold out for the neither admit nor deny formulation.
The continued viability of neither admit nor deny settlements should also ease the concerns of defendants and their insurers about heightened exposure in follow-on private litigation caused by admissions in SEC settlements.