On June 4, 2014, in a long-awaited but not unexpected opinion (here), the Second Circuit ruled that Southern District of New York Judge Jed Rakoff had improperly rejected the $285 million settlement of the SEC’s enforcement action against Citigroup. Because the case involved the question of whether or not parties may enter into “neither admit nor deny” settlements with the SEC, the Second Circuit’s consideration of the case had been very closely watched. The Second Circuit’s decision appears to preserve the ability of litigants in most cases to enter settlements with the SEC without having to admit to liability. The opinion also represents a strong reaffirmation of judicial deference to the SEC’s discretionary authority to settle its cases.
In its enforcement action, the SEC alleged that Citigroup had made misrepresentations in its marketing of collateralized debt obligations. At the same time the SEC filed its complaint, the parties filed a consent judgment for court approval. Among other things, Citigroup agreed to pay $285 million into a fund to be distributed to CDO investors.
In a November 28, 2011 order (about which, refer here), Judge Rakoff rejected the proposed settlement, holding that it was not fair, adequate, reasonable, or in the public interest because Citigroup had not admitted or denied the SEC’s allegations. Among other things, Judge Rakoff contended that without the admission of liability he was not in a position to assess the settlement. He also characterized the $285 million settlement as “pocket change” for Citigroup. Judge Rakoff put the action on track for trial on the merits. The parties jointly filed motions with the Second Circuit seeking to stay the District Court proceedings and for an interlocutory appeal of Judge Rakoff’s rejection of the settlement.
As discussed at length here, on March 15, 2012, in a sharply worded per curiam opinion, a three judge panel granted the motions to stay and for interlocutory appeal, finding that the parties had carried their burden of showing a substantial likelihood of success on the merits on appeal because the district court did not accord the SEC’s judgment adequate deference. This initial three judge panel did not rule on the merits of the appeal, but set the case on the court’s schedule. Because of the unusual circumstance in which both parties to the case joined together on the appeals issues, the Second Circuit appointed pro bono counsel to advocate for the district court’s order in the appeal.
The Second Circuit’s Opinion
In a June 4, 2014 opinion by Judge Rosemary S. Pooler for a three judge panel, with a concurring opinion by Judge Raymond Lohier, the Second Circuit held that the district court had “abused its discretion by applying an incorrect legal standard in its review.” The appellate court vacated Judge Rakoff’s ruling and remanded the case for further proceedings. (In his concurring opinion, Judge Lohier agreed with the reasoning of the Court but indicated that he thought that the record was sufficient for the appellate court to reverse and to direct the district court to enter the consent decree.)
At the outset, the Second Circuit concluded first that Rakoff had not conditioned his approval of the settlement on a requirement for an admission of liability and that he did not do so “with good reason—there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement between the parties.”
The court then addressed what it called the “far thornier question – that is, what deference the district court owes an agency seeking a consent decree.” After reviewing its own case law on the issue, the Second Circuit said that
Today we clarify that the proper standard for reviewing a proposed consent judgment involving an enforcement agency requires that the district court determine whether the consent decree is fair and reasonable, with the additional requirement that the ‘public interest would not be disserved’ in the event the consent decree includes injunctive relief. Absent a substantial basis in the record for concluding that the proposed consent decree does not meet those requirements, the district court is required to enter the order. (Citations omitted)
The primary focus of the inquiry should be “on ensuring that the consent decree is procedurally proper … taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.”
Having articulated the standard for district court review of a proposed consent order, the Court then specified the three ways in which it believed that Judge Rakoff went wrong.
First, the Court said that:
It is an abuse of discretion to require, as the district court did here, that the SEC establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decree. Trials are primarily about the truth. Consent decrees are primarily about pragmatism…. It is not within the district court’s purview to demand ‘cold, hard, solid facts established either by admissions or by trials’ as to the truth of the allegation in the complaint as a condition for approving a consent decree.
With respect to the absence of admissions or denials, the Second Circuit specifically said that “in many cases, setting out the colorable claims, supported by factual averments by the SEC, neither admitted nor denied by the wrongdoer, will suffice to allow the district court to conduct its review.” Other cases may require an additional showing, as, for example where the district court is concerned that the settlement was the result of improper collusion.
Second, the Second Circuit said that Judge Rakoff had also erred in the way in which he considered the “public interest” in his review of the injunctive relief sought in the consent decree. The Court said that “the district court made no findings that the injunctive relief proposed in the consent decree would disserve the public interest, in part because it defined the public interest as ‘an overriding interest in knowing the truth.’ The district court’s failure to make the proper inquiry constitutes legal error.” (Citations omitted) In making its public interest determination, the district court may not “find the public interest is disserved based on its disagreement with the SEC’s decisions on discretionary matters of policy, such as deciding to settle without an admission of liability.”
Third, the appellate court said that “to the extent the district court withheld approval of the consent decree on the ground that it believed the SEC failed to bring the proper charges against Citigroup, that constituted an abuse of discretion.” The “exclusive right” to decide which charges to bring rests with the SEC.
The appellate court closed its opinion with a reminder that if the SEC chooses to file a civil action and then seeks court approval of a settlement of the action, the agency “must be willing to assure the court that the settlement proposal is fair and reasonable.” Because the district court’s power is required to enforce the settlement, “for the court to simply accept a proposed SEC consent decree without any review would be a dereliction of the court’s duty to ensure the orders it enters are proper.”
Notwithstanding the appellate court’s closing words about the importance of judicial review of the SEC’s consent decrees, the opinion overall is a pronounced endorsement of the need for judicial deference to the SEC’s authority and discretion in deciding whether or not and how to settle an enforcement action. At a minimum, the opinion reaffirms the SEC’s discretionary authority to enter, if it so chooses, into settlements in which the target of the enforcement action neither admits nor demies liability. The court not only said at the outset that “there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement between the parties,” but throughout the opinion signaled that the agency may appropriately use its discretion to enter into a settlement in which the other party neither admits nor denies liability.
Of course, on its own, the agency, under its new Chairman, Mary Jo White, has adopted a new policy in which it has declared that at least in certain cases it will require parties to provide admissions of liability as a condition of settlement, as discussed here. But while the agency may now in certain cases and on its own require the settling party to provide admissions, the Second Circuit’s opinion reaffirms the agency’s authority to enter if it so chooses into a settlement in which the settling party neither admits nor denies the allegations.
Even though the Second Circuit rejected Judge Rakoff’s refusal to accept the Citigroup settlement, his unwillingness to accept the settlement has had a significant impact. It is arguable that the SEC might not have adopted its new policy requiring admissions of liability if Judge Rakoff had not forced the issue onto the enforcement agenda. Judge Rakoff’s concerns have also encouraged other judges to scrutinize SEC settlements and to ask hard questions about the terms on which the SEC has settled.
But while Judge Rakoff’s rejection of the Citigroup settlement may have elevated the debate on these issues, in the end the appellate court flatly rejected Rakoff’s perspective on court’s role in reviewing SEC settlements. Rakoff’s opinion rejecting the settlement was emotional, projected a high moral tone, and reflected a theoretical consideration of the issues. The appellate court’s perspective, by contrast, was (it said itself of agency settlements) “pragmatic.” The appellate court’s opinion also reflected a more restrained and deferential conception of the role of the district court.
While compromises of disputed claims are less satisfying than a determination of issues of fault and liability, the system might grind to a halt if parties cannot compromise, The practical reality is that if the SEC is not free to compromise disputed claims without an admission of liability, then the parties are going to be far less likely to compromise, an outcome that would impose enormous costs on the litigants and burdens on the courts.
Read 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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