A judge rejects an SEC settlement and the world was never the same.
Three years ago, Judge Rakoff of the Federal District Court in Manhattan rejected Citigroup’s $285 million settlement with the SEC for fraud charges surrounding the issuance of mortgage-backed securities. The SEC appealed. Three weeks ago, the Second Circuit Court of Appeals vacated Judge Rakoff and approved the settlement. That would seem to be the end of the story.
Why Rakoff Rejected the Settlement
Judge Rakoff said he refused to approve the SEC settlement, in part, because without “proven or admitted facts” he was unable to “exercise even a modest degree of independent judgment.” He also cited the Commission’s failure to extract an admission of guilt. In fact, the SEC offered no evidence of how the $285 million figure was even decided.
Why the Court of Appeals Overruled Him
The federal appeals court held that Judge Rakoff “abused” his discretion “by applying an incorrect legal standard” to the case. In the opinion the court also declared that “there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement.” Perhaps most telling was the pithy statement that “Trials are primarily about the truth. Consent decrees are primarily about pragmatism.”
Does it Matter?
Vacated or not, Rakoff’s unorthodox decision to stand up to the SEC will have a lasting impact. While he may have lost his battle to force transparency in the SEC settlement process, he may have won the war—at least partly.
The amount of attention and press garnered by the case and resulting scramble by the SEC to address the media concerns, may have changed the way the SEC approaches settlement negotiations. In fact, under its new chairwoman, Mary Jo White, the Commission has reversed its policy of allowing companies to avoid admitting or denying wrongdoing and has explicitly stated that they would force admissions (at least in particularly egregious cases).
So Judge Rakoff’s original decision to question the SEC’s settlement methodology may have inspired other members of the bench to question their perceived role as “rubber-stamps” for SEC settlements. In fact, the very nature of fine and settlement calculation will continue to come under scrutiny.
Even now rumors are swirling that one governmental agency is considering the largest penalty ever against a bank for criminal violations of economic sanctions, that such a large action will not in turn lead shareholders to seek retribution against management seems improbable.
Are we entering a period where consent decrees must bear some connection to actual damages or some other relevant objective measure as defined by the regulatory body itself or by law? Or will regulatory bodies continue to have autonomy in each case when it comes to such determinations? And will defendants feel that they have the right to demand an accounting to defend themselves in such actions? Only time will tell.