A federal appeals court said on March 15 there is a strong likelihood it would reverse Southern District Judge Jed Rakoff’s refusal to approve a $285 million settlement between Citibank Global Markets Inc. and the Securities and Exchange Commission.

The U.S. Court of Appeals for the Second Circuit said Judge Rakoff (See Profile) failed to show proper deference to the SEC’s judgment that the settlement of fraud claims stemming from the sale of mortgage-backed securities was not against the public interest.

Judges John M. Walker Jr. (See Profile), Pierre N. Leval (See Profile) and Rosemary S. Pooler (See Profile) stayed Judge Rakoff’s ruling ordering a trial in the case while the circuit considers appeals by both the SEC and Citigroup. The panel said both parties showed they would probably prevail in their challenges to Judge Rakoff’s decision.

In his Nov. 28, 2011, ruling, Judge Rakoff took issue with the fact that Citigroup settled the case “for pocket change” with no admission of liability, and said it was hard to see “what the SEC is getting from this settlement other than a quick headline.” He also said he lacked a framework for assessing the adequacy of the settlement and told the parties “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.”

The Second Circuit said in a per curiam opinion in U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-5227-cv, that the lower court “prejudges the fact that Citigroup had in fact misled investors.”

Citigroup argued the judge’s logic seemed to overlook the possibility that Citigroup might not settle if it had to publicly admit liability, that the SEC might lose at trial and that “Citigroup perhaps did not mislead investors.”

“A still more significant problem is that the court does not appear to have given deference to the SEC’s judgment on wholly discretionary matters of policy,” the circuit said.

The panel said Judge Rakoff “misinterpreted” certain rulings in holding it was against the public interest to approve a settlement in which Citigroup made no admission of liability, when in fact, those rulings “stand for the proposition that when a court orders injunctive relief, it should insure that injunction does not cause harm to the public interest.”

The circuit also said requiring an admission of liability “would in most cases undermine any chance for compromise.”

Judge Rakoff also had expressed concern that the settlement was unfair to Citigroup because it imposed on Citigroup “substantial relief on the basis of mere allegations…that are neither proven nor acknowledged.”

Judges Walker, Leval and Pooler, however, found that sentiment tough to square with Judge Rakoff’s view of the settlement as amounting to “pocket change” the financial giant is paying as a “mild or modest cost of doing business.”

Another reason why the parties are likely to succeed on the merits, the panel said, is that, “We know of no precedent that supports the proposition that a settlement will not be found to be fair, adequate, reasonable or in the public interest unless liability has been conceded or proved and is embodied in the judgment.”

The panel said Citgroup and the SEC would incur “significant harm absent a stay if they are prevented from settling their dispute and ordered to a prompt trial, as the district court has directed.”

Finally, the court said it had “no reason to doubt” the SEC claim that the settlement was in the public interest.

Robert Khuzami, director of the SEC’s Division of Enforcement, said in a statement, “We are pleased that the appeals court found ‘no reason to doubt’ the SEC’s view that the settlement ordering Citigroup to return $285 million to harmed investors and adopt business reforms is in the public interest. As we have said consistently, we agree to settlements when the terms reflect what we reasonably believe we could obtain if we prevailed at trial, without the risk of delay and uncertainty that comes with litigation. Equally important, this settlement approach preserves resources that we can use to stop other frauds and protect other victims.”

The SEC is represented by Jeffrey A. Berger, Michael A. Conley, Jacob H. Stillman and Mark Pennington.

Brad S. Karp, Theodore V. Wells Jr., Mark F. Pomerantz, Walter Rieman and Susanna M. Buergel of Paul, Weiss, Rifkind, Wharton & Garrison represent Citigroup.