Courts more willing to second-guess Wall Street
By Reynolds Holding
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
U.S. courts are growing bolder about second-guessing Wall Street. They have typically trodden softly over corporate financial disputes and settlements for fear of ruffling markets. But the rejection of the Securities and Exchange Commission’s recent $285 million deal with Citigroup is the latest sign that times are changing.
In the late 1970s, a jittery economy led courts to say they wanted to avoid throwing credit markets into confusion or creating “undefinable instability” or “untold and unknown consequences.” So they respected private agreements and refused to rule, for example, that lenders had any obligation to disclose onerous credit terms to borrowers.
In recent years, the approach has left some investors feeling cheated. Several federal courts in the past year alone have stretched to find technical reasons for dismissing complaints about how collateralized debt obligations were sold. But other judges are starting to raise questions.
In 2008, Supreme Court Justice Anthony Kennedy – far from a wild-eyed liberal – berated his colleagues for approving Kentucky’s higher tax rate on out-of-state bonds, arguing it was unconstitutional despite the majority’s desire not to “upset the market.” Last September, a federal judge shocked creditors by refusing to bless their reorganization deal with bankrupt Washington Mutual, ruling it was tainted by possible insider trading. And in August, an appeals court forced investors, against precedent, to cough up gains from the Bernard Madoff Ponzi scheme.
But no jurist has lately roiled the status quo more than U.S. District Judge Jed Rakoff. In bouncing the SEC-Citi CDO settlement last week, he defied legal precedent by refusing to defer much to the regulator’s judgment. His opinion showed little fear of creating market uncertainty, arguing that the public interest is better served by holding companies’ feet to the fire than by quietly settling disputes without any admission of wrongdoing.
The financial sector has been successful at pressuring Congress and regulators like the SEC to blunt rulemaking under last year’s Dodd-Frank law and other financial reforms. And aside from a few biggish settlements, not much blame for the economic crisis has been attached to the industry and even less to the people in it. Maybe it’s not surprising that some in the judiciary are now keen to see more of the sector’s machinations exposed to scrutiny.