By: Kirill Kan
According to a per curiam opinion issued by the Court of Appeals for the Second Circuit on March 15, 2012, Judge Jed Rakoff’s rejection of the SEC’s $285M settlement with Citigroup is likely to be overturned. In November of last year, Judge Rakoff, United States District Court Judge for the Southern District of New York, firmly rejected the SEC’s proposed $285M settlement with Citigroup over the sale of mortgage-related investments before the financial crisis on the basis that the settlement involved no admission of guilt by Citigroup and provided a sparse record by which to make a proper determination.
Judge Rakoff’s opinion, although criticized by some, raised several valid concerns. One such concern was that accepting such settlements, which involve no admission of guilt, threatens the transparency of markets. See U.S. S.E.C. v. Citigroup Global Markets Inc., 11 CIV. 7387 JSR, 2011 WL 5903733 (S.D.N.Y. 2011). Another concern raised by Judge Rakoff was that in order for a court to properly enforce administrative settlements, even after giving substantial deference to administrative agencies’ views, a court must be satisfied that it is not being used as vehicle to enforce agreements that are “unfair, unreasonable, inadequate, or in contravention of public interest.” See id. Accordingly, Judge Rakoff ruled that because the record lacked adequate grounds for making such a determination it would not be approved.
On appeal, the Second Circuit ruled that Judge Rakoff did not give “due deference” to the S.E.C.’s assessment of the settlement to the public interest. See U.S. S.E.C. v. Citigroup Global Markets Inc., 11-5227-CV, 2012 WL 851807 (2d Cir. 2012). While stating that further arguments will be heard, the Second Circuit suggests that there is a “strong” likelihood that Judge Rakoff’s decision will be overturned. See id.
Striking the proper balance between sanctions large enough to deter opportunistic behavior (that led to the financial crisis) and resolving disputes in a way that will not negatively affect the American public is—in a word—difficult. Rulings such as those made by Judge Rakoff could delay settlement proceedings in a large number of similar mortgage-bond cases arising out of the pre-financial crisis behavior of Wall Street firms. Even worse, such decisions threaten to force the already under-budgeted S.E.C. to litigation, a cash intensive endeavor. Conversely, accepting settlements that are not in line with underlying violations does not serve as a deterrent to repeated violations of the same securities laws. Whether the current regulatory environment will be able to reach the right balance between the Second Circuit approach and Judge Rakoff’s objections remains to be seen.