Jed Rakoff’s fraught decision

By Felix Salmon
November 28, 2011
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.

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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.


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“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.”

Possibly true, on an expansive reading of the First Amendment, though the logical extension is to strike down significant parts of securities laws. There are plenty of ways – think IPO quiet periods, limitations on publicizing offers to buy and sell securities, etc. – that securities laws conflict with the right to speak, even where the communication is truthful (as I think we can all agree that freedom of speech doesn’t confer a right to commit fraud).

Posted by realist50 | Report as abusive

Out of curiosity: why are government institutions allowed to settle cases out of court at all? Presumably, when they go after someone, it is because those they go after have done something quite bad. So why are those bad actors allowed to walk away with their “honor” intact? Don’t they deserve punishment for having done that bad thing simply as a matter of principle?

Posted by Foppe | Report as abusive

The SEC/Citi have an easy enough out. They just have to take out the part about the injunctive relief, and perhaps make the fine bigger to make things look nice. The reason Rakoff can slam them is that the parties are asking for an injunction (and therefore the theoretic possibility of contempt of court charges in the future) as a part of the settlement. The money is a grant from Citi to the SEC. The injunction is a grant from the Court to the SEC. My bet is an appeal to the 2nd circuit, and removal of the injunction portion failing that.

Posted by huadpe | Report as abusive

Foppe, because there is tiny issue of actually proving your claims. Much better in Syria, where the government doesn’t have to bother with such nonsense.

Posted by Danny_Black | Report as abusive

Your argument makes no sense at all, Danny. They should be allowed to settle because they might not be able to prove something? Shouldn’t they at least try first?
As for your allusion to Syria: I’m not sure what your problem is, except to note that you seem to have one.

Posted by Foppe | Report as abusive


You may be wrong about an easy out for SEC/Citi. The court must approve the monetary damages portion of the settlement even if the SEC does not seek an injunction. Rakoff’s reasoning in re the the statutory purpose of the SEC still exists even if injunctive relief is not sought. That is to say, the public interest in establishing a clear determination of whether violations of law occurred still exists and still bars acceptance of the proposed settlement whether or not injunctive relief is sought.

Posted by chris9059 | Report as abusive


They are allowed to settle because there’s no point having trials if the parties agree on the facts. In a criminal case, for example, you can admit guilt as part of a plea agreement, and take an agreed punishment, as an alternative to taking it to trial. If Citi had done the same (admit guilt), then there would be no issue here.


I don’t think the 2nd Circuit will sustain it on appeal if it’s just a rejection of the monetary damages. I think they will demand of the district court an affirmative reason why the amount is grossly insufficient, which since it exceeds Citi’s profits from the sale, is unlikely to hold too much water. Most of Rakoff’s argument really centers around the fact that the SEC is asking for his court to become an agent of this ruling through the injunctive relief, or at least that’s how I read it.

Posted by huadpe | Report as abusive

huadpe: well, yes, but as you point out, what is required for those plea bargains is first, an admission of guilt, and second, a conviction by a judge. In these settlements, we generally see neither, and it is to the latter scenario that my question referred: why are they allowed to settle out of court?

Posted by Foppe | Report as abusive


They’re allowed to settle in court, not out of court. The court has to approve the settlement. And in this case, the court didn’t approve. Often the courts do act as rubber stamps, which is unfortunate, and why Jed Rakoff is my nominee for Judge of the Year.

Posted by huadpe | Report as abusive

Parties can settle out of court; it happens all the time. They could stipulate to a dismissal of the complaint without prejudice under FRCP 41(A)(1)(a) and then enter a letter agreement or similar contractual agreement to settle without court approval. (But, while this is theoretically possible, there is no way that the SEC would do this; enforcement agencies often enter letter agreements or “assurances of voluntary compliance,” but they are generally considered “weaker” — both in terms of enforcement and public perception — than judgments.)

Consent judgments are decrees of the court, but practically speaking, they are simply contracts enforceable under the court’s inherent contempt authority rather than private contracts enforceable by filing a new court action.

The court must approve both the monetary and injunctive terms of a consent judgment. Taking out the injunctive part doesn’t give Citi and the SEC an easy out — if money is proposed in the judgment, the court gets to have a say.

SEC could take an interlocutory appeal on Rakoff’s refusal to enter the judgment. But at this point, Rakoff seems to have made his mind up about Citi and so why not take it to trial?

Posted by _hbw_ | Report as abusive

Just thinking about the litigation optics of this for the SEC…

Citi took a half-a-billion dollar prop short on Class V Funding III. The fact that Citi settled that up for ~$160 million at the expense of the long investors who weren’t given disclosures looks good for the SEC.

But Ambac, a monoline insurer, took the long position on the super senior. Ambac was not just a “sophisticated investor” — its business model included insuring RMBS’s and CDOs and it had a substantial portfolio of CDS. Not sympathetic.

(Ambac had its own securities law problems — it got sued by a bunch of pension funds for misleading investors about the extent of its exposure to synthetic CDOs and its RMBS underwriting standards.)

The SEC’s complaint doesn’t name the subordinate investors, but says that they were hedge funds, investment managers and other CDOs. Not a sympathetic bunch.

The bottom line, I think, is that this is not the case — in terms of PR — that the SEC should be trying. Airing the facts will serve the public interest, but I doubt the public has much interest in the woes of a monoline insurer and a collection of hedge funds, other CDOs, and unnamed investment managers.

Now, their action — and subsequent quickie settlement — against JP Morgan about the disclosures for “Squared” at least had Thrivent as a sympathetic duped investor…

Posted by _hbw_ | Report as abusive

What? When are the ratings agencies taking the fall? I think Citigroup ought to get this deal – I am a shareholder. So I think I should get this deal.

Posted by Progdef | Report as abusive

The reason the SEC almost always settles is that they are outgunned. The party they are attempting to prosecute almost always has more lawyers and other legal resources to defend themselves with, and those lawyers are a lot higher paid than SEC lawyers as well.

Basically, the SEC doesn’t have the legal resources or $$$ to actually prosecute a case completey, so they almost always settle for whatever they can get.

Posted by mfw13 | Report as abusive

_hbw_, but as everyone knows when you design a product to fail it always always works out the way you expect and investors are always innocent dupes even when they are being paid millions to do the job of checking their investments. SEC might have a chance as long as they don’t worry too much about the facts.

Posted by Danny_Black | Report as abusive

“The party they are attempting to prosecute almost always has more lawyers and other legal resources to defend themselves with, and those lawyers are a lot higher paid than SEC lawyers as well. ”

The SEC almost always settles because they don’t have the resources to prosecute *lots* of cases. But, the SEC is very capable of prosecuting a major case against a major bank, no matter how many white shoe lawyers that bank hires. Several reasons: (1) the law favors the SEC — it has pre-litigation subpoena power, which means it can have a great case before it even files a complaint and it only has to prove negligence (private plaintiffs have neither advantage); (2) the SEC has very good lawyers — it is still, for a young lawyer especially, very prestigious to work at the SEC; they attract excellent attorneys; (3) the SEC and the government in general receive a huge amount of deference from judges and juries; (4) the SEC may not be able to assign 30 lawyers to a case, but it has 70 years of institutional knowledge and experience and the entire DOJ behind it — the resources of the federal government should never be underestimated.

If the SEC couldn’t prosecute any cases, they would never settle any cases. The ability to obtain good settlements is dependent upon a credible threat of trial.

That’s one reason the SEC might actually do well to take a synthetic CDO case through trial — it would help them up the value on future settlements.

Posted by _hbw_ | Report as abusive

hbw: I don’t see how the presence or absence of public sympathy for aggrieved investors is or ought to be relevant to the Commission’s settlement-litigation decisions. It’s not out of concern for particular aggrieved investors that the public interest would be served by pursuing civil litigation against Citi. Those private interests are served by the investors’ rights to pursue private civil actions. The public has an interest in the truth–i.e. whether and if so how Citi violated securities law. The SEC has for too long weighted this interest lightly, or as assumed that it is sufficiently served by non-admission settlements where the truth is merely implied to the extent money changes hands. The least the SEC could do is give the public some insight into their enforcement decision calculus.

Posted by Sandrew | Report as abusive

Sandrew, it factors through to chances of success in a jury trial surely?

Personally, i would have loved to see abacus go to trial, especially now Paulson is not the omnipotent god who shorted the housing market.

Posted by Danny_Black | Report as abusive

The SEC asked for a $285 settlement? LoL, great freudian slip.

Posted by Anonymous | Report as abusive

Too bad these kinds of court opinions don’t occur more often in the SEC’s cases against small operators and individuals. So Citi may double their penalty from 250mm to 500mm. Big woop. They’re still going to go on making billions in revenue. I on the other hand was literally driven into bankruptcy over non-proved/non-admitted/non-denied allegations. Wish I would have had a Judge Rakoff putting the SEC in their place instead of rubber-stamping everything they wanted.

Posted by Grinder74 | Report as abusive

The way I see Judge Rekoff’s argument, it seems the critical point is Citi’s lack of admission of guilt… and the fact that SEC ‘no guilt’ settlements are standard. Yes he has ‘painted himself in a corner’ but I still applaud his action because the ‘no guilt’ settlement issue might be the central reason that the financial industry has become such a den of fraud and criminality. There have been billions, possibly trillions of settlements paid, but guilt is never admitted (and nobody goes to jail).
The fine amount matters little, an admission of guilt is critical. SEC should be going after an admission of guilt because it would allow the rest of the legal system to work, it allows clients to get their money that was taken in the fraud (possibly even treble damages).

Posted by FinanceChicken | Report as abusive