Rakoff to SEC: Oh yes, it is my job to consider public interest

By Alison Frankel
November 29, 2011

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 & Dowd filed 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 Washington.

Citi counsel Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison didn’t return a call for comment.

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