"But the S.E.C., of all agencies, has a duty, inherent in
its statutory mission, to see that the truth emerges; and if it fails to do so,
the Court must not, in the name of deference or convenience, grant judicial
enforcement to the agency's contrivances." With these words Judge Rakoff
rejected the SEC's proposed settlement in its Citigroup market crisis
case and set it for trial. SEC v. Citigroup Global Markets Inc., Case
No. 11 Civ. 7387 (S.D.N.Y.).
The action against Citigroup is the Commission's latest
market crisis case centered on conflicts of interest and deception tied to the
sale of interests in a synthetic CDO linked to the subprime real estate market.
According to Judge Rakoff, who was asked to approve the settlement (here), the underlying conduct is
far worse than that in the action against Goldman Sachs. That case yielded a
fraud injunction, a record penalty and an admission. The proposed deal with
Citigroup, in contrast, is based on negligence and a far smaller penalty.
Judge Rakoff began his opinion by detailing the standards
under which the Court is to review a proposed consent judgment from a regulator
such as the SEC. The SEC and Judge Rakoff have been down this path before. This
section of the opinion should be boiler plate. Not here. Instead, the Court
accused the Commission of omitting a key concept, flip flopping and misstating
the law in an apparent effort to usurp the role of the judiciary.
The proposed consent judgment must be "fair, reasonable,
adequate, and in the public interest . . ." This standard is quoted by the
Court from a brief filed by the SEC in support of its proffered consent decree
in the Bank of America case. In Citigroup however the Commission
"partially reverses its previous position . . ." omitting the public interest
prong of the test. This is erroneous Judge Rakoff concluded. The Court also
rejected the SEC's back up position that the agency "is the sole determiner of
what is in the public interest . . . [this] is not the law." While an
administrative agency is entitled to substantial deference, the Court must
exercise "a modicum of independent judgment" in evaluating whether it is in the
public interest to issue an injunction. To do less undermines basic separation
of powers principles.
The Court also raises a question about the allegations in
the complaint against the financial institution. Here the opinion quotes a
paragraph from the parallel complaint against Citigroup employee Brian Stoker
which states in part: "Citigroup knew it would be difficult to place the
liabilities (of the Fund) if it disclosed to investors its intention . . .. [to
short it and] Citigroup knew that representing to investors that an experienced
third-party investment adviser had selected the portfolio would facilitate the
placement . . . " of the securities. (emphasis by the Court). This paragraph
"would appear to be tantamount to an allegation of knowing and fraudulent
intent . . . " Judge Rakoff concluded. It was, however, dropped by the SEC from
the Citigroup complaint.
When the proper standards are applied to the proposed
settlement here, the Court concludes that the settlement cannot be approved.
Central to this determination is the omission of any factual predicate for the
serious allegations of wrongful conduct to support the significant relief
sought in the form of an injunction. Judge Rakoff does not specifically demand
that the "neither admitting nor denying" predicate for the proposed settlement
be dropped, although he comments unfavorably on the standard. He does however
require that the Court have "some knowledge of what the underlying facts are:
for otherwise, the court becomes a mere handmaiden to a settlement privately
negotiated on the basis of unknown fact, while the public is deprived of ever
knowing the trust in a matter of obvious public importance."
In reaching his conclusion Judge Rakoff also questioned
the adequacy of the terms of the settlement. For Citigroup it is a good deal,
according to the Court. Whether the serious allegations of fraud are true or
not for the financial institution the settlement is "a mild and modest cost of
doing business." For the SEC it is "harder to discern . .. what . . .[it] is
getting . . other than a quick headline." The real issue, however, is what the
defrauded investors are getting which, according to the Court, is
In the end, the Court concluded that the settlement is
not "reasonable," it is "not fair," and it "does not serve the public
interest." Rather, it is "a cost of doing business imposed [on Citigroup] by
having to maintain a working relationship with a regulatory agency, rather than
as any indication of where the real truth lies . .. " the Court found.
Whether the case will actually proceed to trial remains
to be seen. In Bank of America Judge Rakoff ultimately did approve a
consent decree despite significant misgivings. That approval came only after
the parties furnished the Court with a significant quantity of factual material
and revamped key settlement terms including the procedures to be adopted and
the amount of the penalty. Here neither the Commission nor Citigroup appear
anxious to explain how the substantial allegations of fraud asserted in the
complaint turn into charges of negligence and a fine that is much more modest
than those in similar cases. At the same time the choices appear to be: 1)
Explain to the Court; or 2) Tell it to the jury.
Regardless of the outcome here, perhaps in the future the
SEC will finally begin to match the allegations in its complaints to the
charges and the terms of the settlements. It may also take a page from other
regulators and furnish some explanation in court papers or a press release for
its determinations. It is after all a disclosure agency.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
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