Opinion

Alison Frankel

The Stoker verdict and Citi’s settlement with the SEC

By Alison Frankel
August 2, 2012

If you’re the Securities and Exchange Commission, it’s tough to find a silver lining in Tuesday’s jury verdict for Brian Stoker, a onetime midlevel banker at Citigroup. Not only did the eight jurors in federal court in Manhattan determine that Stoker was not liable for misleading investors in a $1 billion collateralized debt obligation, they also offered a backhanded slap at the SEC. “This verdict should not deter the SEC from continuing to investigate the financial industry, to review current regulations, and modify existing regulations as necessary,” the jury said in a highly unusual note accompanying the verdict. For the SEC, which has been roundly criticized for its failure to bring civil charges against executives implicated in the financial crisis, the jury’s note has to read like one more reminder that the public is still waiting for corporate accountability.

But, ironically, the verdict could improve the odds of a 2nd Circuit Court of Appeals ruling that U.S. Senior District Judge Jed Rakoff improperly rejected the SEC’s $285 million settlement with Citi in the agency’s parallel suit against the bank.

As you probably recall, the appeals court has already expressed considerable skepticism about Rakoff’s decision last November to reject the settlement. At the time, Rakoff said he had the right to determine whether the deal was in the public interest. And it wasn’t, he said, because Citi hadn’t acknowledged wrongdoing and was paying what amounted to “pocket change” to make the SEC case go away. The truth matters, Rakoff said in his opinion, and for all he and the public knew, the truth of this case could be that Citi hadn’t actually done anything wrong. For good measure, Rakoff ruled in December that the SEC must proceed with its case even though the agency and Citi filed a joint appeal of his November ruling to the 2nd Circuit.

In March a three-judge panel of the 2nd Circuit reversed Rakoff on the issue of a stay, in a ruling that sent a strong message that he’s wrong on the merits as well. The appellate court said that the SEC – and not a federal judge – has the right to determine whether its settlements serve the public interest. Unless the deal is demonstrably an abuse of the SEC’s discretion, the panel said, the agency is owed deference by the courts. The opinion also quibbled with Rakoff’s call for an end to the SEC’s policy of permitting settlements without requiring an admission from defendants and said he was plain wrong to worry that the deal somehow victimized Citi. The appeals panel concluded that when a separate panel considers the merits of the joint appeal, the SEC and Citi are likely to prevail.

That underlying appeal will be heard at the end of September, with John “Rusty” Wing of Lankler Siffert & Wohl representing Rakoff, who also presided over Stoker’s trial. It’s not clear whether the SEC or Citi will discuss the Stoker verdict at the 2nd Circuit argument. SEC enforcement director Robert Khuzami and Citi lead counsel Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison both declined to comment.

Nevertheless, here’s how the Stoker outcome could help the SEC. At trial, Stoker’s counsel, the brilliant John Keker of Keker & Van Nest, argued both that Citi’s disclosures to a small group of sophisticated CDO investors were adequate and that Stoker was being scapegoated. We don’t know which argument persuaded the jury. But Citi could certainly assert that the SEC’s evidence got a full airing in the Stoker trial, which undermines Rakoff’s assertion that he and the public haven’t seen the agency’s case. The bank’s lawyers at Paul Weiss may also claim that Stoker’s exoneration proves the weakness of the SEC’s evidence – which supports the idea that the SEC was smart to settle for $285 million.

The not-liable verdict also underscores the risk the SEC faces when it goes to trial. Rakoff’s insistence that the SEC should demand admissions from defendants would undoubtedly force more defendants to take their chances at trial. As On the Case contributor Andrew Longstreth has reported, anecdotal evidence indicates that the SEC wins about half of its trials. (SEC spokesman John Nester said that in the last two years the agency has won between 82 and 86 percent of its trials.) With that record – and with Stoker’s exoneration – the SEC could argue to the 2nd Circuit that its decision to settle with Citi and pocket $285 million was well advised. (The agency won’t actually make that argument because it’s too embarrassing, but it’s also reality.)

Rakoff’s counsel could tell the 2nd Circuit that the jury cleared Stoker because it believed more senior Citi officials were actually responsible for deceiving investors in the CDO. (Wing didn’t return my call for comment.) But that’s not nearly as strong an argument as the one he’d have been able to make if Stoker had been found liable, and Wing could have informed the appellate panel that the SEC let Citi off too easily. From the vantage point of the Stoker verdict, $285 million in the SEC’s hands looks to be worth untold liability in Rakoff’s imagination.

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