Jed Rakoff’s decision to block the proposed $285 settlement between the SEC and Citigroup is very welcome, but also raises all manner of questions about what might happen next.
The ruling is worth reading — as are all Rakoff’s judgments — but at heart it’s pretty simple.
The clever part of the ruling comes at the beginning, where Rakoff notes that the SEC’s complaint against Citigroup employee Brian Stoker includes language about Citigroup which is not included in the complaint against Citigroup itself. According to the complaint against Stoker, Citigroup “knew” that it couldn’t place the synthetic CDO with investors if it had made full disclosures about how it had been put together. But that knowledge of Citigroup’s never made it into the complaint against Citigroup.
That’s important, because the SEC’s stated reason for letting Citi off more lightly than Goldman Sachs is that Goldman had knowing and fraudulent intent (or “scienter”, as it’s known in legal jargon), while Citigroup didn’t. The SEC says that “Goldman Sachs was charged with scienter-based violations of the securities laws”, that “scienter-based violations are worthy of a more significant sanction”, and that Citigroup, by contrast, was guilty only of negligently operating as a fraud.
The most powerful part of Rakoff’s ruling, then, is where he basically demolishes that argument. He shows that the Citi fraud (as alleged by the SEC) was worse than the Goldman fraud, because in this case Citi was itself the beneficiary. (In Goldman’s case, John Paulson was the beneficiary.) And, as he says in footnote 7 (Rakoff loves saving his best stuff for footnotes), the SEC’s “logic is circular”, and nowhere does the SEC “explain how Goldman’s actions were more culpable or scienter-based than Citigroup’s actions here”. On top of that, the SEC extracted admissions from Goldman which it didn’t get from Citi, and also got cooperation from Goldman while “Citigroup has not agreed to cooperate with the SEC in any cognizable respect”.
The problem with Rakoff’s ruling, however, is that he doesn’t — and probably can’t — simply say that Citigroup’s getting off more lightly than Goldman, and strike down the settlement on those grounds alone. So he uses instead a different basis for his decision — that Citigroup is refusing to admit that it did anything wrong.
Indeed, here’s Citi’s statement today, in response to Rakoff’s judgment:
We respectfully disagree with the Court’s ruling. We believe the proposed settlement is a fair and reasonable resolution to the SEC’s allegation of negligence, which relates to a five-year-old transaction. We also believe the settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges.
In English, this says “we’d like to put this whole sorry story behind us, but if you force us to either admit or deny the allegations, we’re going to deny them”. As Rakoff notes, this is far from being the de facto admission of guilt that the SEC is painting the settlement as. And it’s certainly not a de jure admission of guilt, as Rakoff explains:
To be sure, at oral argument, the S.E.C. reaffirmed its long standing purported support for private civil actions designed to recoup investors’ losses. But in actuality, the combination of charging Citigroup only with negligence and then permitting Citigroup to settle without either admitting or denying the allegations deals a double blow to any assistance the defrauded investors might seek to derive from the S.E.C. litigation in attempting to recoup their losses through private litigation, since private investors not only cannot bring securities claims based on negligence, but also cannot derive any collateral estoppel assistance from Citigroup’s non admission/non denial of the S.E.C.’s allegations.
Rakoff says, with great forcefulness, that if the facts of the case are not known, the public interest is not being served. His prose here is worth quoting at length:
The Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.
It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? 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. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. 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.
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 admissions or by trials – it serves no lawful or moral purpose and is simply an engine of oppression.
Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.
One wants to stand up and applaud loudly at this point. But at the same time, one also wonders whether Rakoff hasn’t painted himself into a corner here. In the past, as when the SEC came to an agreement with Bank of America with respect to its takeover of Merrill Lynch, Rakoff rejected a proposed settlement and then finally approved a bigger one. And as far as I can tell, the base-case scenario in this case, too, would normally be that the SEC and Citigroup go off into a corner, come up with something more acceptable to Rakoff, and then get him to accept it.
But Rakoff has drawn a line in the sand, here, and said that nothing will be acceptable to him, if it includes the standard refusal by Citigroup to admit guilt in the matter. The Goldman settlement would fail Rakoff’s test just as much as the Citi one did today. And so it’s not clear what happens next.
One option is that the SEC appeals Rakoff’s decision, and gets it overturned by a higher court. After all, the problem with the decision is that it’s so broadly written that if it were allowed to set some kind of precedent, pretty much every SEC settlement would get thrown out of court. Another option is that, as Rakoff ordered today, the SEC vs Citigroup case goes to trial, where the facts of the matter are determined for the record. That would be a bloody fight, and there’s a decent chance the SEC could lose. Or possibly the SEC and Citi will come to a second agreement, which Rakoff will find acceptable while conveniently forgetting his high-flown rhetoric today.
Rakoff makes a good point that in Citi’s proposed consent to the settlement, its promise “not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis” arguably violates Citi’s First Amendment rights. (I’m trying to find a full copy of the consent; the only version I have is missing that page, but I’m pretty sure that’s the language in it.) But in hinting that the settlement might be downright unconstitutional, Rakoff has raised the stakes so high that it’s far from clear that he can ever lower them again. Even if the SEC comes back with a settlement where Citi offers to pay billions of dollars in damages and fines.