February 21, 2012 Top Story

Judge Rejects SEC's Position on Citigroup Consent Judgment

The $95 million penalty is "pocket change," the judge says

Sean T. Carnathan

A New York federal court recently dealt a harsh blow to the Securities and Exchange Commission’s (SEC) long-standing approach to settling enforcement actions through consent judgments. If upheld, the SEC may have to change its policy of allowing defendants to settle without either admitting or denying the allegations against them.

Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York recently refused to enter a consent judgment in a settlement deal between the SEC and Citigroup. In doing so, the court called into question a settlement mechanism the SEC has used for decades. In SEC v. Citigroup [PDF], the consent judgment would have returned $285 million to the affected investors.

Citigroup’s Alleged Wrongdoing

The SEC alleged that Citigroup misled investors in a fund it structured and marketed when it failed to disclose that it had played a significant role in choosing the assets for the fund and that it had also taken a short position in $500 million of the $1 billion collateralized debt obligation in the fund.

By taking the short position, Citigroup was effectively betting that half the assets in the fund would decrease in value. As Judge Rakoff summarized the allegations, “Citigroup created a billion-dollar fund . . . that allowed it to dump some dubious assets on misinformed investors.”

The SEC filed its complaint against Citigroup together with a proposed consent judgment. According to the complaint [PDF], the investors in the fund lost around $700 million. In contrast, Citigroup earned $34 million in fees and a profit of $160 million on its short position.

Without admitting or denying the allegations in the commission’s complaint, Citigroup agreed to the entry of a final judgment that enjoins it from violating the applicable provisions of the Securities Act of 1933 and requires it to disgorge $160 million and pay $30 million in prejudgment interest plus a $95 million penalty. In rejecting the settlement, Judge Rakoff called the penalty “pocket change” for an entity as big as Citigroup.

Judge Rakoff Apparently Insists on Admission of Wrongdoing

Judge Rakoff’s rejection of the consent judgment has received attention for two reasons. First, Judge Rakoff stated the standard of review is whether the settlement is “fair, reasonable, adequate and in the public interest.” The SEC argued that the standard of review should not include a determination that the settlement was in the public interest and that, even if the public interest is a relevant consideration, the court should defer to the SEC’s determination.

The SEC argued that protecting the public interest is, after all, the SEC’s job. Judge Rakoff rejected these assertions, and concluded that to employ the court’s injunctive and contempt powers, the court must be satisfied that the judgment is in the public interest.

Second, Judge Rakoff squarely challenged the SEC’s “long-standing policy—hallowed by history but not by reason—of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations.” Judge Rakoff concluded that this practice left the court without a sufficient evidentiary basis to determine whether “the substantial injunctive relief [the court] is being asked to impose has any basis.”

Insisting on Admission of Fault May Prevent Future Settlements

“The standard of care is obviously significant,” says Bart L. Greenwald, Louisville, past cochair of the ABA Section of Litigation’s Commercial and Business Litigation Committee. “The district court devotes considerable attention to supporting its assertion that approval of a consent judgment requires careful analysis of public interest, relying in part on the presence of equitable relief,” he adds. “That said, the settlement here appears to have been in an amount sufficient to address the primary injuries alleged. Moreover, [the consent judgment] does not foreclose private actions.”

“I find it curious that the court focused as much as it did on the absence of an admission of fault by the defendant,” Greenwald continues. “Insisting upon admissions of fault will no doubt greatly complicate the ability to achieve settlement in this type of case,” he concludes.

Does the SEC Really Need a Consent Judgment?

The SEC has powers of its own and enforcement options that do not require it to seek the approval of a court. In fact, in this same matter, the SEC resolved its claims against Credit Suisse Alternative Capital, LLC and Samir H. Bhatt for their involvement in structuring and marketing the fund by bringing and settling an administrative proceeding [PDF] against them. The SEC and Citigroup also could have settled and jointly dismissed the case without entry of a consent judgment. Only by seeking a consent judgment did they involve the court.

“The consent judgment is a powerful tool the SEC uses in carrying out its job of monitoring and overseeing the financial services industry,” says Sara Jane Shanahan, Boston, a securities litigator and member of the Section of Litigation. “In certain cases, the SEC needs to do more than simply impose a fine on financial institutions that break the securities laws,” says Shanahan. “Otherwise, banks might conclude that they can just pay a penalty and continue business as usual.”

The Battle Continues

The SEC publicly announced it appealed Judge Rakoff’s decision to the U.S. Court of Appeals for the Second Circuit and asked both Judge Rakoff and the Second Circuit to stay the proceedings in the district court pending the outcome of the appeal. Judge Rakoff denied the motion. As of this publication, the Second Circuit has not issued its decision. If not stayed or otherwise resolved sooner, the case is scheduled for trial in July 2012.

In the meantime, according to a December 16, 2011, announcement, the U.S. House of Representatives Financial Services Committee may hold hearings on the issue in 2012. It will be an interesting year for the SEC.

Sean T. Carnathan is an associate editor for Litigation News.

Keywords: Securities and Exchange Commission, Citigroup, consent judgment, settlement

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