Once again, U.S. District Judge Jed Rakoff is squaring off against the Securities and Exchange Commission over its decades-old practice of settling with defendant corporations who "neither admit nor deny" wrongdoing.
That formulation -- long unquestioned by the federal judiciary -- has been targeted in several recent cases before Rakoff, who is currently overseeing the SEC's $285 million settlement with Citigroup Inc over its role in selling mortgage-related assets.
The SEC's critics would welcome a closer examination of the regulator's enforcement methods, which they see as going easy on corporate defendants and failing to give the public enough information about the underlying allegations. Some would prefer that the commission suit up for a trial rather accept a settlement in which the defendant does not admit wrongdoing.
But would more SEC trials actually serve the public interest? Not everyone is convinced.
At a time when the commission is operating under severe budget constraints, some legal experts argue, the SEC is wise to settle and avoid a protracted and costly trial that the agency could lose.
"I think it's better to have these cases resolved," said Richard Painter, a professor at the University of Minnesota Law School. "We know what's wrong and not. If they drag it out, we get a trial three or four years from now."
The SEC has also compiled a checkered litigation record in recent years. In 2010, it lost the first insider-trading trial involving credit-default swaps against a former Deutsche Bank executive in Manhattan federal court.
Thomas Gorman, a Dorsey & Whitney partner who runs the SECActions blog, said that by his count, the SEC has won about fifty percent of its trials over the last two years. By contrast, the Department of Justice wins about 90 percent of the time.
"Fifty percent is not a terribly great track record for a prosecutor," said Gorman.
SEC spokesman John Nester said that the agency's winning percentage is "significantly higher than 50 percent, but it's also the case that securities litigation often involves complex matters and conduct that is open to interpretation under the securities law."
The "neither admit nor deny" formulation originated about 40 years ago, according to Stanley Sporkin, who directed the SEC's enforcement division from 1974 to 1981, and served as a federal judge in Washington, D.C., from 1985 to 2000. During the 1960s, Sporkin said, companies that settled with the commission often refuted the allegations in press releases, so the commission began insisting that settling defendants not deny what the SEC alleged.
When companies pushed back, the SEC came up with a compromise that allowed settling defendants to state that they also did not admit to the wrongdoing.
The formulation is considered crucial for corporations who fear that admission of wrongdoing will expose them to liability in private litigation. For example, after the SEC settled with Goldman Sachs over a lack of disclosures related to the selling of certain collateralized debt obligations, investors and shareholders filed lawsuits against the bank involving the same CDOs. An admission of liability in the SEC case would have been devastating for the bank's defense in the private cases, say defense lawyers.
"Surely if the SEC starts requiring admission of culpability it's going to make settlements more difficult because there are going to be collateral consequences," said Daniel Hurson, a former SEC enforcement attorney now in private practice at his own law firm.
"To require admissions of wrongdoing would slow down the commission considerably," Sporkin said.
But Rakoff -- a Clinton appointee who is widely considered one of the most influential federal judges in the country -- has repeatedly made headlines by slowing the commission down. Two years ago, he rejected a $33 million settlement between the SEC and Bank of America over disclosures related to its purchase of Merrill Lynch. He complained that the fine was too small, that no individuals were charged and that the deal unfairly hurt Bank of America's shareholders. After the parties revised the agreement and increased the fine to $150 million, Rakoff reluctantly approved it.
In March, Rakoff also questioned aspects of the SEC's settlement with Vitesse Semiconductor Corp and some of its former officers over an accounting fraud. Although he ultimately approved the agreement, he took the opportunity to criticize the SEC's practice of permitting defendants to neither admit not deny charges against them.
'STEW OF CONFUSION AND HYPOCRISY'
In the current action, the commission has alleged that Citigroup Global Markets misled investors about the role it played in selecting the underlying assets in a $1 billion CDO. The bank also hid the fact that it made bets against those assets, the SEC charged. But in settling the case last month, Citigroup neither admitted nor denied any wrongdoing.
True to form, Rakoff issued a written order telling the SEC and Citigroup to be prepared to answer several questions about the settlement at the Nov. 9 hearing, to determine whether it is "fair, reasonable, adequate, and in the public interest."
His first question: How can he enter a judgment in a case in which "the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?"
Rakoff, a former federal prosecutor, has raised the issue before. In a written opinion in the Vitesse case, he pointed out that the Department of Justice almost never offers criminal defendants the opportunity to deny charges as part of a guilty plea. He wrote that the commission's formula has resulted in a "stew of confusion and hypocrisy unworthy of such a proud agency as the SEC. The defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the SEC; but, by gosh, he had better be careful not to deny them either."
Adding that the court "ultimately is obliged to determine whether such a practice renders any given proposed consent judgment so unreasonable or contrary to the public interest as to warrant its disapproval," the judge left open the possibility that he would revisit the issue in a later case. It appears that case has arrived.
Painter, of Minnesota Law School, said he understands Rakoff's concerns, but said the public can judge for itself the facts of the case, which are laid out in the SEC's complaint. He also said that the size of the settlement speaks for itself.
"I know it may not sound like a lot compared to the bank's revenues, but that's a big chunk of change," Painter said. "You don't just cough up $285 million to the SEC because you think you didn't do anything wrong."
(Reporting by Andrew Longstreth)
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