In 2010, when the Securities and Exchange Commission
brought a case against Citigroup for misleading investors about
the bank's exposure to subprime mortgages, the SEC filed the
proposed $75 million settlement in Washington, D.C., federal
court. Judge Ellen Huvelle gave the agency some gruff about the
deal, in which two individual Citi defendants also settled SEC
claims through an administrative action, but she eventually
accepted the settlement without demanding any big changes.
The SEC and Citi must be looking back with regret at those
halcyon days. For reasons the agency has not explained, when it
filed a proposed $285 million settlement with Citi last month,
it opted for the federal court not in D.C. but in Manhattan.
There, the case -- which involves claims that Citi defrauded
investors in a mortgage-backed CDO -- was randomly assigned to U.S. District Judge Jed Rakoff, who has recently been engaged
in a highly-publicized campaign of insisting on corporate
accountability in SEC settlements. The SEC proceeded to
undermine its credibility in Rakoff's court by arguing, as my
colleague Erin Geiger Smith reported, that it's not the judge's role to consider the public interest in SEC settlements.
In a 15-page, eminently quotable exercise in rhetoric
issued Monday, Rakoff pushed the agency into the grave it dug for itself, rejecting not only the proposed settlement but also
the SEC's assertion that he must heed its assessment of the
public interest. "A court, while giving substantial deference
to the views of an administrative body vested with authority
over a particular area, must still exercise a modicum of
independent judgment in determining whether the requested
deployment of its injunctive powers will serve, or disserve,
the public interest," Rakoff wrote. "Anything less would not
only violate the constitutional doctrine of separation of
powers but would undermine the independence that is the
indispensible attribute of the federal judiciary."
Rakoff took particular issue with the SEC's standard
operating procedure of permitting a defendant to settle claims
without admitting to underlying allegations, describing the
agency's strategy as "hallowed by history but not by reason."
The SEC asserted that because Citi did not expressly deny its
allegations the judge and the public could infer their truth.
"This is wrong as a matter of law and unpersuasive as a matter
of fact," Rakoff wrote, adding later in the ruling, "An
application of judicial power that does not rest on facts is
worse than mindless, it is inherently dangerous. The injunctive
power of the judiciary is not a free-roving remedy to be
invoked at the whim of a regulatory agency, even with the
consent of the regulated. If its deployment does not rest on
facts -- cold, hard, solid facts, established either by
admission or by trials -- it serves no lawful or moral purpose
and is simply an engine of oppression."
The proposed settlement, the judge said, offered an obvious
benefit only to Citi; Rakoff wrote that it is "harder to
discern" what the SEC gets from the agreement "other than a
quick headline." (He contrasted the terms of the SEC's $535
million settlement with Goldman Sachs with the proposed Citi
deal, asserting that the Goldman case "involved a similar but
arguably less egregious factual scenario.") The public,
meanwhile, is left with unproven facts and inadequate relief,
according to Rakoff. "How can it ever be reasonable to impose
substantial relief on the basis of mere allegations?" he wrote.
"It is not fair because, despite Citigroup's nominal consent,
the potential for abuse in imposing penalties on the basis of
facts that are neither proven nor acknowledged is patent. ...
And, most obviously, the proposed consent judgment does not
serve the public interest because it asks the court to employ
its power and assert its authority when it does not know the
facts." (Interestingly, the plaintiffs firm Robbins Geller
Rudman & Dowdfiled a proposed amicus brief asking Rakoff to
reject the deal for that very reason.)
Rakoff's ruling suggests that he's not willing to approve a
deal without an admission of wrongdoing from Citi. "The court,
and the public, need some knowledge of what the underlying
facts are: for otherwise, the court becomes a mere handmaiden
to a settlement privately negotiated on the basis of unknown
facts, while the public is deprived of ever knowing the truth
in a matter of obvious public importance," he wrote. But as
Andrew Longstreth has reported for On the Case, there are clear
costs to the public if the SEC demands terms defendants simply
won't agree to.
That was substance of the SEC's response to Rakoff's ruling
Monday. "The court's criticism that the settlement does not
require an 'admission' to wrongful conduct disregards the fact
that obtaining disgorgement, monetary penalties, and mandatory
business reforms may significantly outweigh the absence of an
admission when that relief is obtained promptly and without the
risks, delay, and resources required at trial," enforcement
director Robert Khuzami said in a statement. "It also ignores
decades of established practice throughout federal agencies and
decisions of the federal courts. Refusing an otherwise
advantageous settlement solely because of the absence of an
admission also would divert resources away from the
investigation of other frauds and the recovery of losses
suffered by other investors not before the court."
The agency didn't respond to my specific question about why
it filed the proposed Citi deal in Manhattan rather than in
Citi counsel Brad Karp of Paul, Weiss, Rifkind, Wharton &
Garrison didn't return a call for comment.
(Reporting by Alison Frankel)
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