In 2011, Judge Jed Rakoff, presiding over the U.S. District Court for the Southern District of New York, rejected a $285 million settlement between the Securities and Exchange Commission and Citigroup over the allegedly fraudulent sale of mortgage bonds. On Wednesday, a three-judge panel of the U.S. Court of Appeals for the Second Circuit said Rakoff “abused [his] discretion,” overturned his controversial ruling, and clarified the standards by which other settlements should be reviewed.

Rakoff, at the time, objected to the settlement because the fine was, in his words, “pocket change” and complained that it allowed the bank to pay the fine without admitting guilt. The settlement was not “fair, reasonable, adequate and in the public interest,” the critic of the SEC's longstanding “no admit, no deny” policy, said.

The 28-page Appeals Court ruling says the district court could not cite admission of liability as a condition for  approving the consent decree. “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 judicial panel wrote. “The decision to require an admission of liability before entering into a consent decree rests squarely with the SEC.”

The judges then opined on “the far thornier” question of what deference the district court owes an agency seeking a consent decree, writing that it recognizes a “strong federal policy favoring the approval and enforcement of consent decrees,” but also that a district judge is not merely a “rubber stamp.'”

A court evaluating a proposed SEC consent decree for fairness and reasonableness should, at a minimum, assess the basic legality of the decree, whether the terms, including its enforcement mechanism, are clear; whether it reflects a resolution of the actual claims in the complaint; and whether the consent decree is tainted by improper collusion or corruption of some kind, the panel wrote. The primary focus of a judicial inquiry should be on ensuring the consent decree is “procedurally proper,” taking care not to infringe on the SEC's discretionary authority.

“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,” the ruling says. “Trials are primarily about the truth. Consent decrees are primarily about pragmatism [and] are normally compromises in which the parties give up something they might have won in litigation and waive their rights to litigation.”

“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,” the judges added, directly referencing Rakoff's ruling.

The district court was correct to recognized it was required to consider the public interest in deciding whether to grant the proposed monetary settlement, the Appeals Court says. “However, it made no findings that the injunctive relief proposed in the consent decree would disserve the public interest, in part because it defined the public interest as “an overriding interest in knowing the truth,” the judges added. “What the district court may not do is find the public interest disserved based on its disagreement with the SEC's decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability. To the extent the district court withheld approval of the consent decree on the ground that it believed the SEC failed to bring the proper charges against Citigroup, that constituted an abuse of discretion.”

SEC Chairman Mary Jo White, who took charge after that settlement, has directed her staff to move away from that ounce ubiquitous practice of entering into settlements without an admission of guilt. A statement issued by the Commission praised the latest ruling. "While the SEC has and will continue to seek admissions in appropriate cases, settlements without admissions also enable regulatory agencies to serve the public interest by returning money to harmed investors more quickly, without the uncertainty and delay from litigation and without the need to expend additional agency resources,” it wrote.

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