This month the Securities and Exchange Commission got a strong endorsement of its ability to independently reach settlements with defendants in its enforcement actions.

After sitting on the case for two-and-a-half years, the U.S. Court of Appeals for the Second Circuit finally issued an opinion in favor of the SEC in its high-profile appeal involving a proposed settlement with Citigroup Global Markets.

 The SEC's appeal followed U.S. District Judge Jed  Rakoff's November 2011 order in which he refused to approve a $285 million agreement between the SEC and Citigroup. While the holding is a significant victory for the SEC and backs its view of how a regulatory agency's proposed settlements should be reviewed by the judiciary, policy changes and other developments over the past two-and-a-half years prove that Rakoff's judicial activism in this area will still have a lasting effect.

To recap, the SEC's appeal resulted from an attempt to settle an enforcement action in which the SEC alleged that Citigroup structured and marketed a $1 billion collateralized debt obligation, exercised significant influence over the selection of $500 million of the assets included in the CDO portfolio, and then “took a proprietary short position against those mortgage-related assets from which it would profit if the assets declined in value.” Citigroup did not disclose to investors its role in the asset selection process or that it took a short position against the assets it helped select.

Citigroup agreed to settle the case by paying a total of $285 million—$160 million in disgorgement, $30 million in prejudgment interest, and a $95 million penalty. As per the SEC's standard practice, Citigroup would not have to admit any guilt in the matter, nor could it publicly deny the allegations, under the terms of the settlement.

Although the SEC noted that the Citigroup settlement was the third largest financial crisis enforcement action ever, Rakoff was hardly impressed when the settlement was presented to him for approval. The judge took the very bold step of rejecting the parties' settlement proposal because the court had “not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment.” He found that he could not approve the settlement as it was “neither reasonable, nor fair, nor adequate, nor in the public interest,” adding that the 40-year-old SEC policy that allowed settlements without any admissions was “hallowed by history, but not by reason.”

Shortly after the controversial ruling, the SEC asked the Second Circuit to review Rakoff's decision, beginning what turned out to be a two-and-a-half year wait for the court to issue its opinion. Meanwhile, pressure began to build from multiple sources for the SEC to reconsider its settlement policy.

[Rakoff's] view that defendants settling with the SEC should admit to the allegations against them is now, and will be going forward, the SEC's policy in many significant cases.

A string of other federal judges quickly followed Rakoff's lead and either rejected or raised serious concerns about proposed SEC settlements in which the defendants were not required to admit any wrongdoing. In February 2013, U.S. Senior District Judge John Kane (D-Colo.) became at least the sixth federal judge to follow Judge Rakoff's reasoning when he rejected the SEC's proposed settlement with Bridge Premium Finance and certain of its executives. “I refuse to approve penalties against a defendant who remains defiantly mute as to the veracity of the allegations against him,” Kane wrote.  “A defendant's options in this regard are binary: He may admit the allegation or he may go to trial.”

Next, the U.S. Congress began to pressure the SEC on the issue. In May 2013, Sen. Elizabeth Warren (D, Mass.) asked SEC Chairman Mary Jo White to advise Congress on whether the SEC had ever actually conducted any internal research or analysis “on trade-offs to the public between settling an enforcement action without admission of guilt and going forward with litigation as necessary to obtain such admission.”  White responded that the SEC's “neither-admit-nor-deny” settlement policy was under review and, in June 2013, she announced that the agency had decided to revise its policy.

In an e-mail to SEC staff that month, then-enforcement directors Andrew Ceresney and George Canellos explained that while “neither-admit-nor-deny” settlements would continue as a common practice, admissions would be required in ‘‘certain cases where heightened accountability or acceptance of responsibility through the defendant's admission of misconduct may be appropriate, even if it does not allow us to achieve a prompt resolution.” They added that such cases would include ones in which the defendant engaged in “egregious intentional misconduct,” obstructed an SEC investigation, or engaged in “misconduct that harmed large numbers of investors.” In several SEC settlements since this change in policy—including cases against billionaire Philip Falcone in August 2013, as well as JPMorgan Chase in September 2013—the SEC has demanded and obtained admissions as part of its settlements.

Truth vs. Pragmatism

Nearly a year after the SEC's change in policy, the Second Circuit finally issued its opinion in the Citigroup case. Finding in favor of the SEC, the court first clarified that the question before it was not whether Rakoff had required Citigroup to admit liability as a condition for approving the settlement. The court stated that Rakoff had never actually required that, and “with good reason—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 such an admission rests squarely with the SEC, the Second Circuit wrote.

Rather, the Second Circuit stated, the key question before it was what deference a district court owes an agency that is seeking approval for a settlement, otherwise known as “consent decree.” The court clarified that the proper standard for a district court presented with a proposed consent degree is to determine whether the consent decree is fair and reasonable—with the additional requirement that the “public interest would not be disserved” if the proposed consent decree includes injunctive relief. 

The court added that in determining if a settlement is fair and reasonable, its primary focus during the inquiry should be on ensuring that the consent decree is procedurally proper, for example that its terms are clear, it does not suggest collusion, and it resolves the dispute, among other things. The Second Circuit also wrote that the lower court must take care not to infringe on the SEC's discretionary authority to settle on a particular set of terms.

Finally, the Second Circuit held that it was an abuse of discretion for Rakoff to require that the SEC establish the “truth” of the allegations against Citigroup as a condition for approving the consent decree. “Trials are primarily about the truth.  Consent decrees are primarily about pragmatism,” the Second Circuit explained. Although the district court must assure itself that the public interest would not be disserved by any injunctive relief sought in the settlement, “the job of determining whether the proposed SEC consent decree best serves the public interest, however, rests squarely with the SEC, and its decision merits significant deference.”

The Second Circuit's opinion was a long time coming, but it was worth the wait and the battle for the SEC. Ceresney stated, following the release of the opinion, that the SEC was quite pleased that the Second Circuit reaffirmed the traditional concept that lower courts should treat the terms of the SEC's proposed settlements with significant deference. Ceresney stated that while the SEC will continue to seek admissions in appropriate cases under its new policy, “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.”

For the SEC, the Citigroup opinion is an important victory that should allow it to settle more cases in the future without fear of judicial interference. Although Rakoff's crusade to change the way that district courts review the settlements of regulatory agencies such as the SEC ultimately failed in the Second Circuit, his view that defendants settling with the SEC should admit to the allegations against them is now, and will be going forward, the SEC's policy in many significant cases.

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