SEC Files Historic Appeal of Judge Rakoff's Citigroup Settlement Rejection

December 16, 2011

On December 15, 2011, the Securities and Exchange Commission ("SEC") filed a Notice of Appeal in SEC v. Citigroup Global Markets, Inc. (11 Civ. 07387 (JSR)). This rare and historic step puts the SEC in the position of appealiing to the United States Court of Appeals for the Second Circuit from an Order entered on November 28, 2011, in the Southern District of New York by Judge Rakoff that rejected a proposed consent judgment that the parties presented to the district court and which directed the parties to prepare for trial in July 2012.

Khuzami Press Release

In a December 15, 2011, press release titled "SEC Enforcement Director's Statement on Citigroup Case" , 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 takes issue with the prospect that the courts would no longer sanction SEC settlements where a defendant does not admit liability. Apparently, Khuzami fears 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.

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 seems to bristle at the court's references to the substantial size of Defendant Citigroup. The Director of Enforcement argues that " the law does not permit the Commission to seek penalties based upon a defendant's wealth."

Bill Singer's Comment

Although a great deal of Khuzami's comments strike me as a simplistic rendering of the Court's concerns, they are helpful to the extent that they will crystallize one of the classic disputes involving modern-day regulation: the cost-benefits analysis of settlements with defendants who are afforded the considerable concession of not having to admit liability.

Among the less compelling aspects of Khuzami's position is the fairly hypocritical assertion that it is improper for the SEC to take into account a given defendant's size when determining sanctions - as if size doesn't matter in virtually every facet of the SEC's and other bureaucracies daily ministrations.  Frankly, I and other Wall Street reform advocates have long complained that not only does the inappropriate consideration of size routinely corruptregulatory organizations, but defendants of lesser "size" seem to receive far more scrutiny and disproportionate sanctions than their larger industry colleagues.

Similarly, as a spokesperson for the SEC and, hence, for those involved in regulation, there is a compulsion upon Khuzami to be balanced in his public remarks.  Missing - absolutely missing - from his critique of Judge Rakoff's rationale for rejecting the proposed Citigroup settlement is some commentary on the fact that the SEC's settlement protocol is, indeed, decades old, and that flowing from that longstanding approach is the inevitable and troubling conclusion that the manner in which the SEC has drafted and discharged settlements with the too-big-to-fail on Wall Street has, in part, contributed to the recent failures of due diligence, of compliance, of supervision, and of prudent risk practices.

The SEC's and even the Department of Justice's settlements do seem calculated largely for the reasons that Khuzami defends: to conserve staff resources.  Unfortunately, Khuzami fails to recognize that one can also conserve such resources by being more prudent in what one chooses to investigate and resorting to necessary triage of what one issues Complaints about.  Perhaps it may make more sense to file fewer charges and fewer cases, but to be prepared to go to trial and win the higher caliber of work that you put into the pipeline. A lot of what goes on at the SEC is make-work, politics, and public relations - all of which zaps resources.  When you make a meaningful effort to cut waste and better utilize existing resources, then start whining about the damages of rejected settlements.

Another flaw in Khuzami's logic is its failure to factor in the substantial benefit that would accrue if defendants were confronted with the choice between a settlement (in which they could enjoy some damage control and could negotiate the inclusion/exclusion of some language) versus the free-for-all that occurs in a public trial in which there is no clear cap on damages (if one takes into account the intangible damages of reputation and the public airing of dirty laundry).

Missing completely from Khuzami's defense of the SEC's settlement with Citigroup is one simple point. If the SEC took Citigroup to trial and won, and if Citigroup was sanctioned to the full extent of the law, and if the SEC and other regulators stopped the pernicious practice of waiving the imposition of Bad Boy provisions - such a dramatic victory would likely compel  future defendants to avoid trial at all costs and take the best deal available at settlement.

See this article for an in-depth analysis of post-settlement leniency by SEC: No Time-Out for UBS. SEC Says All Is Forgiven, For Now (Street Sweeper, June 9, 2011)

If Citigroup gets hammered after a federal trial, how quick would the likes of Goldman Sachs, JP Morgan, Merrill Lynch, Wells Fargo, Morgan Stanley, UBS, and other powerful financial services firms be to roll those same dice?  I suggest that Khuzami is not fully considering the cost of such defendants crapping out.  The SEC is not the only player with bets on this table.


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