In a strongly worded November 28, 2011 opinion (here),
Southern District of New York Judge Jed Rakoff rejected the proposed $285
million settlement of the enforcement action that the SEC brought against
Citigroup Capital Markets. But while he emphatically rejected the proposed
settlement, his opinion may also suggest how the SEC might salvage this situation
without a trial and even how it might structure settlements in the future in
order to avoid the kind of blistering criticism that Rakoff administered in his
November 28 opinion.
In October 2011, the SEC filed a civil enforcement action
against Citigroup in the Southern District of New York and simultaneously filed
a proposed Consent Judgment in which Citigroup offered to pay a total of $285
million (consisting of a disgorgement of profits of $160 million, plus $30
million in interest, and a civil penalty of $95 million). The complaint related
to a billion-dollar fund that Citigroup created that allowed the company "to
dump some dubious assets on misinformed investors." The fund was marketed as
consisting of attractive assets, whereas the fund was arranged to include a
"substantial percentage of negatively projected assets." Citigroup had then
taken a substantial short position in the assets. Citigroup realized profits of
$160 million, while investors lost more than $700 million.
Because Citigroup had agreed to the proposed settlement
and Consent Judgment "without admitting or denying the allegations in the
complaint," Judge Rakoff had in an October 27, 2011 opinion raised a number of
pointed questions about the proposed settlement (about which refer here).
In his November 28, 2011 opinion, Judge
Rakoff stated that he was "forced to conclude that 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
and proven or acknowledged facts whatsoever, is neither reasonable, nor fair,
nor adequate, nor in the public interest." Judge Rakoff emphatically rejected
the SEC's argument that the public interest was not an appropriate
consideration in his assessment of the proposed settlement.
He concluded that the settlement was not in the public
interest because it "asks the Court to employ its power and assert its
authority when it does not know the facts." He added that "an application of
judicial power that does not rest on the facts is worse than mindless, it is
Judge Rakoff added that in a case like this that "touches
on the transparency of financial markets have so depressed our economy and
debilitated our lives," there is "an overriding public interest in knowing the
truth." But instead of establishing what had gone wrong here, the SEC entered a
settlement in which the defendant company neither admitted nor denied the
allegations. He added that the SEC "of all agencies" has "a duty inherent in
its statutory mission to see that truth prevails." The Court, he said, "must
not in the name of deference or convenience, grant judicial enforcement to the
Several different times, Judge Rakoff emphasized the
paramount importance of judicial independence, particularly when it is called
upon to exercise its injunctive power, which, he added, "is not a free-roaming
remedy to be invoked at the whim of a regulatory agency, even with the consent
of the regulated." Without facts, established either by admission or denials,
the use of the court's injunctive powers "serves no lawful purpose and is
simply an engine of oppression."
Judge Rakoff also noted that the proposed settlement left
the defrauded investors "substantially short-changed" as it "deals a double
blow to any assistance the defrauded investors might seek to derive from the
SEC litigation in attempting to recoup their losses through private litigation"
since they "cannot derive any collateral estoppel assistance from Citigroup's
non-admission/non-denial of the SEC's allegations."
Judge Rakoff concluded his opinion by consolidating the
case with a parallel action against the Citigroup official responsible for the
toxic fund and scheduling the case for trial on July 16, 2012.
At lease according to the November 28, 2011 statement of
SEC Enforcement Division Director Robert Khuzami about the opinion, here, the SEC
Enforcement Division is deeply aggrieved by Judge Rakoff's rejection of the
settlement. Judge Rakoff's blistering opinion certainly leaves the parties
with some unattractive choices. It also raises a larger concern that the
SEC might not only have to take this case to trial, but in general might have
to be prepared to take more cases to trial. This could threaten to overwhelm
the SEC's resources and ultimately even lead to less vigorous enforcement as
the increased trial load forces the SEC to conserve resources by bringing fewer
But on further reflection and on closer review, Judge
Rakoff's opinion may offer a way out, both for these parties and for the SEC in
general. In footnote 7 on page 13 of the opinion, Judge Rakoff draws a sharp
contrast between this settlement involving Citigroup and the SEC's earlier
settlement with Goldman Sachs, which Judge Rakoff noted "involved a similar but
arguably less egregious scenario." (For a detailed background on Goldman's
settlement of the SEC action, refer here.)
The Goldman settlement, he noted, involved a
substantially higher civil penalty (i.e., a $535 million penalty on only $15
million in profits, compared to the proposed Citigroup settlement in which the
company agreed to pay a $90 million penalty on $160 million of profits). But
even more importantly, as Judge Rakoff noted, the consent judgment in the
Goldman case involved an "express admission" from Goldman that the marketing
materials for its toxic securities "contained incomplete information." Judge
Rakoff also noted that the Goldman consent judgment involved remedial measures
beyond those to which Citigroup agreed, and also involved Goldman's undertaking
to cooperate with the SEC in ways in which Citigroup had not.
The contrast that Judge Rakoff drew between the Goldman
settlement and the Citigroup settlement may suggest a way that the SEC and
Citigroup may yet be able to settle this case (and for that matter, for future
parties to try to avoid the objections that Judge Rakoff raised in connection
with this proposed settlement).
First, just as when the SEC and the Bank of America
previously faced Judge Rakoff's rejection of the proposed settlement of the
SEC's action against BofA, it seems that Citigroup is going to have to make a
greater monetary contribution for a proposed settlement to pass Judge Rakoff's
scrutiny. (Judge Rakoff's summary of the sequence of events surrounding the
SEC's settlement with BofA is described here.)
But if the parties want to avoid the July 2012 trial
date, they are also going to have to work out a deal that omits the "neither
admits nor denies" formulation. Judge Rakoff disparaged the SEC's long-standing
practice of including formulations of this type in its enforcement action
settlements as "hallowed by history but not by reason."
In order to reach a settlement that will pass muster with
Judge Rakoff, Citigroup apparently also will have to agree to express
admissions of the type included in the Goldman consent judgment. Citigroup has
an obvious interest in avoiding any admissions, not the least because of the
impact the admissions might have on pending investor litigation. But it is
worth noting that Goldman's admissions to which Judge Rakoff referred
approvingly may not be prohibitive. Goldman admitted only that its marketing
materials contained "incomplete information," and that it was a "mistake" that
the materials did not explain the role of Paulson & Co. in selecting the
assets underlying the toxic securities. As distasteful as Citigroup might find
it to make this type of admission, it would have to be far preferable to facing
Whether or not the parties are able to work out a
formulation that is mutually acceptable and that satisfies Judge Rakoff remains
to be seen. The one thing that is for sure is that if the parties are not able
to work out a revised deal that passes Judge Rakoff's muster, there will be a
very interesting trial in his courtroom next July.
One final thought. I found it particularly interesting
that one of Judge Rakoff's objections to the absence of any factual admission
as part of the settlement was that this absence deprived the investor
plaintiffs the benefit they might hope to derive from the SEC litigation. I am
sure the private plaintiffs' securities bar was heartened by this comment. No
doubt the litigants in this case will be interested to see if there are any
helpful admissions in any forthcoming settlement - as will private litigants
with respect to SEC enforcement action settlements going forward.
Wayne State University Law Professor Peter Henning has an
interesting November 28, 2011 post about Judge Rakoff's opinion on the Dealbook
Among other things, Professor Henning questions whether admissions on the order
of Goldman's would be enough to satisfy Judge Rakoff. David Bario's November
28, 2011 Am Law Litigation Daily article about Judge Rakoff's opinion
can be found here.
Alison Frankel's November 28, 2011 post about the opinion on Thomson Reuters
News & Insight can be found here.
Special thanks to the several readers who sent me links
to Judge Rakoff's opinion.
Here's One for My Friends at the SEC (Who
Could Probably Use a Little Cheering Up): So, a lawyer dies and
goes to heaven. (I know, I know, an implausible opening, but bear with me.) The
lawyer has just walked through the pearly gates and she's surveying the scene.
She sees an old man walking down the street in judicial robes. So she says to
St. Peter, "Who's the old guy in the robes?" And St. Peter says, "Oh, that's
just God. He thinks he's a federal judge."
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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