Southern District Judge Jed Rakoff had blocked the settlements between the SEC and Citigroup Global Markets
Southern District Judge Jed Rakoff had blocked the settlements between the SEC and Citigroup Global Markets (NYLJ/Rick Kopstein)

Southern District Judge Jed Rakoff’s denial of a settlement agreement between the Securities and Exchange Commission and Citigroup in 2011 was vacated Wednesday morning by the U.S. Court of Appeals for the Second Circuit.

A three-judge panel said Rakoff (See Profile) applied the wrong standard when he blocked a consent decree between the SEC and Citigroup Global Markets over mortgage-backed securities on Nov. 28, 2011, and set a trial date.

The ruling by Judges Rosemary Pooler (See Profile), Raymond Lohier (See Profile) and Susan Carney (See Profile) follows a March 2012 decision by a circuit motions panel staying Rakoff’s order to proceed to trial.

The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets, 11-5227-cv.

The SEC and the bank had come to terms over allegations Citigroup had misrepresented its role and influence in a billion-dollar fund collateralized by subprime securities that were tied to an imploding housing market. The commission had accused the bank of misleading fund investors that the portfolio was selected by an independent investment advisor, and investors suffered millions of dollars in losses while Citigroup was reaping some $160 million in profits short selling the very same investments.

As part of the settlement, Citgroup agreed to pay $285 million in disgorgement, prejudgment interest and civil penalties, agreed to injunctive relief and promised to make internal changes to prevent such situations in the future.

Rakoff criticized the consent decree signed by the parties as the latest in a series of cases in which the SEC alleged serious securities fraud for which the defendant admitted no wrongdoing—a practice he said was “hallowed by history but not by reason.”

Rakoff also questioned why culpable individuals were not held responsible and Citigroup and its shareholders had to pay the penalty. He said the decree was “neither fair, nor reasonable, nor adequate, nor in the public interest.”

The SEC asked the Second Circuit to reverse and petitioned for a writ of mandamus ordering Rakoff to approve the settlement. A motions panel of Judges Pooler, John Walker (See Profile) and Pierre Leval (See Profile) stayed Rakoff’s ruling on March 15, 2012, finding that there was a likelihood the parties would succeed on the merits.

Because there was no adversarial briefing, the motions panel also appointed John Wing, partner at Lankler, Siffert & Wohl, as pro bono counsel to argue Rakoff’s position.

Writing for the circuit Wednesday, Pooler said, “Today we clarify that the proper standard for reviewing a proposed consent judgment involving an enforcement agency requires the district court to determine whether the proposed consent decree is fair and reasonable, with the additional requirement that the ‘public interest would not be disserved,’”—language from the U.S. Supreme Court decision of eBay, Inc. v. Merc Exchange, 547 U.S. 388 (2006).

She said the circuit was omitting “adequacy” from the standard as borrowed from the class action context but “particularly inapt in the context of a proposed SEC consent decree.”

On remand to Rakoff, she said the judge, in assessing the “fairness” and “reasonableness” of a consent decree, may need to make additional enquiries of the parties, but it can only go so far.

“The primary focus of the inquiry, however, should be on ensuring the consent decree was procedurally proper, using objective measures … taking care not to infringe on the SEC discretionary authority to settle on a particular set of terms.”

“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,” Pooler said.

Oral argument was heard at the circuit on Feb. 8, 2013, with Deputy General Counsel Michael Conley of the SEC representing the commission and Brad Karp, a partner with Paul, Weiss, Rifkind, Wharton & Garrison for Citigroup.

The circuit expressed concern about taking the interlocutory appeal and said it didn’t want to get into the business of reviewing every case where a judge balks at accepting a settlement.

Pooler wrote that, in order for a court to take an interlocutory appeal of the denial of a settlement, a party must show they have effectively been denied injunctive relief and that denial will result in irreparable harm.

“That standard is satisfied here,” she said.

Seth Taube, a former SEC enforcement prosecutor and special assistant U.S. Attorney in the Southern District who heads Baker Botts’ securities litigation practice, said that although Rakoff was reversed, the judge made his point.

“The irony is that the SEC has caught up with Judge Rakoff’s concept even though the circuit reversed him—the SEC has since adopted a policy, in certain serious cases, of insisting on an admission of wrongdoing,” said Taube, who is not involved in the Citigroup case. “The other interesting piece of the case is, it’s really about a division of powers between the branches of government: the circuit is basically saying it’s the executive branch that decides what’s in the public interest and, in most cases, the judiciary must respect that decision.”

“The decision gives a court very limited ability to say an SEC consent judgment is not reasonable.”

In a statement, SEC Enforcement Director Andrew Ceresney said the agency was pleased. He said the SEC will continue to seek admissions of wrongdoing in appropriate cases but recognized that reaching settlements without admissions sometimes enable regulatory agencies to return money more quickly to harmed investors.

Dennis Kelleher, president of Better Markets, a Washington-based group that advocates strict financial regulation, applauded the appeals court for citing previous law making clear that judges should not merely “rubber stamp” agreements but ensure they are fair and reasonable.

Kelleher said the group looked forward to Rakoff’s analysis in future proceedings of whether there was collusion to reach the deal or an effort to mislead the judge about the scope and terms of the settlement.