Second Circuit Vacates And Remands SEC v. Citigroup

June 4, 2014

The United States Securities and Exchange Commission ("SEC") and Citigroup Global Markets Inc. ("Citigroup") appealed from the November 28, 2011, Order of the United States District Court for the Southern District of New York ("SDNY") (Jed S. Rakoff, J.) refusing to approve a settlement between SEC and Citigroup. On March 15, 2012, the United States Court Of Appeals For The Second Circuit ("2Cir") stayed the Order

On June 6, 2014, 2Cir found that SDNY abused its discretion by applying an incorrect legal standard in its review; and, accordingly, 2Cir vacated and remanded to SDNY for further proceedings. United States Securities and Exchange Commission v. Citigroup Global Markets, Inc. (2 Circuit, 11‐5227‐cv (L) June 4, 2014).

Settling Down

On October 19, 2011, the SEC announced  that it had charged Citigroup with misleading investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market in which Citigroup bet against investors as the housing market showed signs of distress. The CDO defaulted within months, leaving investors with losses while Citigroup made $160 million in fees and trading profits.  

In a proposed Consent Judgment presented to SDNY, Citigroup agreed to: 

  1. permanent injunction barring it from violating Securities Act Sections 17(a)(2) and (3);
  2. disgorgement of $160 million in net profits gained from the cited conduct;
  3. $30 million in prejudgment interest; and
  4. $95 million civil penalty. 
Citigroup also agreed not to seek an offset against any compensatory damages awarded in any related investor action. Citigroup consented to make three years of internal changes to prevent a recurrence of the cited conduct. Notably absent from the proposed Consent Judgement was any admission of guilt or liability.

Rakoff Monkey Wrench

On November 28, 2011, Judge Rakoff, refused to approve the proposed Consent Judgement United States Securities and Exchange Commission v. Citigroup Global Markets Inc. (SDNY, Opinion and Order, 11-CIV-7387, November 28, 2011).  In rejecting the proposed settlement, Judge Rakoff noted:

As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup's position in this very case.

Of course, the policy of accepting settlements without any admissions serves various narrow interests of the parties. In this case, for example, Citigroup was able, without admitting anything, to negotiate a settlement that (a) charges it only with negligence, (b) results in a very modest penalty, (c) imposes the kind of injunctive relief that Citigroup (a recidivist) knew that the S.E.C. had not sought to enforce against any financial institution for at least the last 10 years (d) imposes relatively inexpensive prophylactic measures for the next three years. In exchange, Citigroup not only settles what it states was a broad-ranging four-year investigation by the S.E.C. of Citigroup's mortgage-backed securities offerings, but also avoids any investors' relying in any respect on the S.E.C. Consent Judgment in seeking return of their losses. If the allegations of the Complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business. . .

SEC Unhappy Camper

In a December 15, 2011, press release titled "SEC Enforcement Director's Statement on Citigroup Case," then SEC Division of Enforcement Director Robert Khuzami stated:

Last month, a federal district court declined to approve a consent judgment because, in its view, the underlying allegations were 'unsupported by any proven or acknowledged facts.' As a result, the court rejected a $285 million settlement between the SEC and Citigroup that reasonably reflected the relief the SEC would likely have obtained if it prevailed at trial.

We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits. . .

Khuzami further opined that the court was

incorrect in requiring an admission of facts - or a trial - as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. . .

Khuzami pointedly took issue with the prospect that the courts would no longer sanction SEC settlements where a defendant does not admit liability. Apparently, Khuzami feared that the detriment of such a judicial prerequisite to approving settlements would over-burden the SEC by reducing the number of cases likely to settle and prompting increasing numbers of resource-consuming trials.   For Khuzami, a by-product of such a compulsion to resolution by trial would be that:

other frauds might never be investigated or be investigated more slowly because limited agency resources are tied up in litigating a case that could have been resolved.

Finally, Khuzami bristled at the court's references to the substantial size of Defendant Citigroup. The Director of Enforcement argued that " the law does not permit the Commission to seek penalties based upon a defendant's wealth." 

Greener Pastures:Khuzami departed the SEC in 2013 and is now a partner in Kirkland & Ellis LLP law firm's Government & Internal Investigations Practice Group. As noted on that law firm's website:

In 2013, Kirkland was named a "go-to" firm in the Corporate Counsel survey, "Who Represents America's Biggest Companies?" for the twelfth consecutive year. 

On Hold

On December 15, 2011, the SEC filed a Notice of Appeal seeking a ruling by 2Cir that would reverse Judge Rakoff's rejection of the proposed consent judgment and his order directing the parties to prepare for trial in July 2012. 

On March 15, 2012, 2Cir set aside Judge Rakoff's rejection of the settlement.

2Cir's Rationale

Below find extracts (with page noted after each quote) from the 2Cir Opinion:

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 proposed consent decree is fair and reasonable, with the additional requirement that the "public interest would not be disserved," eBay, Inc. v. MercExchange, 547 U.S. 388, 391 (2006), in the event that the consent decree includes injunctive relief. Absent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.

We omit "adequacy" from the standard. Scrutinizing a proposed consent decree for "adequacy" appears borrowed from the review applied to class action settlements, and strikes us as particularly inapt in the context of a proposed S.E.C. consent decree. . .

Page 19 of the Opinion

In particular, today's majority opinion makes clear that district courts assessing a proposed consent decree should consider principally four factors: "(1) the basic legality of the decree; (2) whether the terms of the decree,including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind. . .

Page  29 of the Opinion


It is an abuse of discretion to require, as the district court did here, that the S.E.C. establish the "truth" of the allegations against a settling party as a condition for approving the consent decrees. Citigroup I, 827 F. Supp. 2d at 332‐33. Trials are primarily about the truth. Consent decrees are primarily about pragmatism. . .

Page 21 of the Opinion


The job of determining whether the proposed S.E.C. consent decree best serves the public interest, however, rests squarely with the S.E.C., and its decision merits significant deference. . .

Page 24 - 25 of the Opinion


The district court correctly recognized that it was required to consider the public interest in deciding whether to grant the injunctive relief in the proposed injunction. Citigroup I, 827 F. Supp. 2d at 331. However, 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." Id. at 335. The district court's failure to make the proper inquiry constitutes legal error.

Page 25 of the Opinion


To the extent the district court withheld approval of the consent decree on the ground that it believed the S.E.C. failed to bring the proper charges against Citigroup, that constituted an abuse of discretion.

Page 26 of the Opinion


For the courts to simply accept a proposed S.E.C. consent decree without any review would be a dereliction of the court's duty to ensure the orders it enters are proper.

Page 28 of the Opinion

Bill Singer's Comment

No matter how 2Cir parses its explanations, the Opinion  relegates federal district court judges to the role of a clerk, who is more or less now mandated to rubber stamp whatever the SEC desires. As such, our nation's bankrupt regulatory policy continues unabated. The never-ending expediency of tepid settlements by Wall Street's cops shows no signs of ending. 

Having turned back one federal judge's principled rejection of a settlement, the SEC could well be emboldened to permit the big boys to write out large checks for fines, which are ultimately paid by public shareholders, and without one word of meaningful admission of wrongdoing. Public advocates and industry reformers should not be celebrating today; but Wall Street's Too-Big-To-Fail are likely popping the corks. Now, they can set up a spreadsheet and do the cost-benefits analysis:  It's wrong but if we did it anyway, it would only cost us $X.  


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