Barry J. Pollack and Addy R. Schmitt (Handout)
This month, the U.S. Court of Appeals for the Second Circuit reversed Judge Jed Rakoff’s order refusing to approve a proposed consent decree that would have settled a regulatory enforcement action the U.S. Securities and Exchange Commission (SEC) had brought against Citigroup Global Markets, Inc. See U.S. Sec. and Exch. Comm’n v. Citigroup Global Markets, 11-5227-cv (L) (2d Cir. June 4, 2014). In doing so, the Second Circuit seemed to articulate a narrow and highly deferential standard for district courts to follow when reviewing settlement agreements between government regulatory enforcement agencies and private parties.
The Second Circuit found Judge Rakoff’s approach to reviewing the proposed consent decree between the SEC and Citigroup was more probing than permitted and that he failed to provide the SEC the deference it was owed. Whether or not the Second Circuit’s decision makes sense in the context of the facts and the parties before it, the highly deferential standard of district court review of such consent decrees articulated by the Second Circuit may prove to be overly restrictive when applied in other settings.
Judge Rakoff’s Decision
In 2011, the SEC filed a complaint against Citigroup, alleging both that the company negligently misrepresented its role and financial interest in structuring and marketing a billion-dollar fund, and that, as a result, Citigroup realized approximately $160 million in profits, while investors in the fund lost millions. Shortly thereafter, the SEC filed a proposed consent judgment whereby Citigroup, without admitting or denying wrongdoing, agreed to a permanent injunction barring it from violating certain sections of the Securities Act, disgorgement of $160 million, and payment of $30 million in prejudgment interest and $95 million in penalties.
Rakoff scheduled a hearing on the proposed consent judgment and directed the SEC and Citigroup to answer a number of questions, including why the court should impose judgment where the SEC alleged a serious securities fraud, but Citigroup did not admit wrongdoing; whether there is an overriding public interest in determining whether the SEC’s charges are true; how the amount of the proposed judgment was determined (and why the proposed penalty was so much less than the penalty assessed in another large securities case); how the SEC planned to ensure compliance with the proposed injunction; and why the penalty was to be paid by Citigroup and its shareholders instead of by the culpable individuals.
After consideration of the parties’ written responses to his questions and a hearing on those questions and responses, Rakoff issued an opinion declining to approve the consent judgment and instead setting a trial date. Rakoff found that before he could approve an administrative settlement, he was “required, even after giving substantial deference to the views of the administrative agency, to be satisfied that [the court] is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.”
Rakoff was apparently assessing the proposed consent decree under the “fair, reasonable, adequate and in the public interest” standard, “borrowed” in part from the standard used to review class action settlements as set forth in Federal Rule of Civil Procedure 23(e)(2). Rakoff also held that when a public agency seeks court approval of such a settlement, “the court, and the public, need some knowledge of what the underlying facts are”; otherwise, “the public is deprived of ever knowing the truth in a matter of obvious public importance.” Employing this standard, Rakoff found he could not approve the settlement.
Second Circuit’s Reversal
Reviewing the probing and extensive nature of Rakoff’s questions regarding the proposed consent judgment and his subsequent decision refusing to approve it, a panel of the Second Circuit unanimously reversed his decision. This result did not come as a surprise to many legal commentators, even those critical of the appeals decision. See, e.g., Mike Koehler, Second Circuit Concludes that SEC Settlements Are Not About the Truth, But Pragmatism, FCPA Professor (June 5, 2014, 5:58 AM), http://www.fcpaprofessor.com; Erik Girding, The Second Circuit’s Mistakes in Reversing Rakoff, Conglomerate Blog (June 6, 2014, 1:39 AM), http://www.theconglomerateblog.com.
In its decision, the Second Circuit acknowledged that the District Court’s decision is reviewed under the deferential abuse of discretion standard and noted that a District Court presented with a proposed consent judgment is not “merely a rubber stamp.” Yet, in reversing Rakoff, the Second Circuit proceeded to establish a seemingly highly restrictive standard that the District Court must employ when reviewing a consent judgment involving an enforcement agency. Specifically, the standard established by the Second Circuit requires a determination that the proposed consent decree is fair and reasonable. When the consent decree involves injunctive relief, there is an additional requirement that the “public interest would not be disserved” by the consent decree. Without a “substantial basis in the record” to conclude that these requirements are not met, the District Court must enter the order adopting the consent judgment.
The Second Circuit emphasized that Rakoff erroneously applied an “adequacy” requirement, like that found in Rule 23(e)(2), when approving a consent judgment in an SEC regulatory enforcement action. The court also held that Rakoff misapplied the “public interest” requirement. While the appellate court determined that an adequacy requirement “makes perfect sense” when reviewing a class action settlement—which generally precludes future claims—those concerns are not present in the context of a consent decree because potential plaintiffs are free to bring their own actions and, where there is no private cause of action, the SEC is the entity charged with representing the victims and bears the political liability if it fails to adequately meet those responsibilities.
The Second Circuit also determined that Rakoff failed to establish that the proposed injunctive relief was not in the public interest, in part because he defined that interest as an “overriding” interest in learning the truth. Instead, the appellate court directed Rakoff to consider whether the proposed consent decree disserved the public interest by, for example, barring private litigants from pursing their own claims independent of the relief provided by the consent decree. Finally, the Second Circuit stressed that responsibility for determining whether the proposed consent decree serves the public interest “rests squarely with the SEC” and the agency’s decision is entitled to “significant deference.”
As with all appellate decisions, SEC v. Citigroup must be analyzed not just with respect to whether or not it makes sense in the case the court had before it, but also how the precedent being set may be applied in the future to other contexts. There are circumstances where the Second Circuit’s relatively restrictive standard may prove to be overly deferential to the government and inappropriate. In cases where an enforcement agency is proceeding against a far less-sophisticated party and/or a party with significantly fewer resources than Citigroup, more involvement by the District Court may be desirable.
The Second Circuit held that the District Court’s primary focus should be on whether the consent decree is “procedurally proper”—for example, assessing the basic legality of the decree, and determining whether the terms of the decree are clear, whether the decree resolves the actual claims in the complaint, and whether the decree is tainted by improper collusion or corruption—all the while “taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.” According to the Second Circuit, absent some sort of collusion, an agreement by the litigants demonstrates the fairness of the resolution and provides sufficient protection against an unfair consent decree such that more searching judicial review is not warranted.
While the court did not develop what it meant by collusion, it seemed to suggest that in almost all cases, settlements are the product of arm’s-length’s negotiation, not coercion, and thus deserve a strong presumption of being a fair and reasonable settlement that is necessarily in the public’s interest. This may well be true when the counter-party to a regulatory enforcement action is a sophisticated entity like Citigroup, with resources to obtain the advice of highly competent counsel and the resources and ability to litigate a settlement not perceived to be in that entity’s interest.
However, many smaller, less sophisticated entities and individuals frequently find themselves on the wrong end of a regulatory enforcement action. They may be facing monetary penalties that will bankrupt them. Indeed, the mere cost of litigating against the governmental agency may bankrupt them. And, they may not even have the ability to assess in an informed way their likelihood of prevailing, even if litigation were an economically viable possibility. This may be particularly true when the parties have yet to engage in formal discovery, as was the case before Rakoff.
In such circumstances, the fact that the defendant has “agreed” to a consent decree as the best of its untenable options, rather than giving rise to a presumption of fairness and reasonableness, may instead present a situation that requires the very type of scrutiny that Rakoff desired to give to the Citigroup settlement. The inherently coercive nature of the vastly unequal bargaining power of the parties makes any presumption that the proposed consent decree is fair and reasonable unwarranted. In such cases, the legal presumption established by the Second Circuit would be nothing more than a legal fiction. It would be unfortunate in our view if the Second Circuit’s decision in SEC v. Citigroup is read to restrict a district court’s ability to consider such inequality and ensure that the consent agreement is actually—not just presumptively—fair and reasonable.
Barry J. Pollack is a member and Addy R. Schmitt is counsel of Miller Chevalier Chartered in Washington, D.C.