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Second
Circuit Grants SEC's Motion for Stay and Sharply Criticizes District
Court's Rejection of Settlement in Case Against Citigroup
By James
A. Meyers, Lori
Lynn Phillips and Alison
K. Roffi
On Thursday, March 15, the United States Court of Appeals
for the Second Circuit issued a per
curiam stay order
strongly criticizing Judge Jed S. Rakoff's order
rejecting a proposed consent judgment between the Securities and
Exchange Commission and Citigroup Global Markets Inc. The Second
Circuit granted the Commission's motion for a stay of the district court
proceedings in SEC v. Citigroup Global
Markets Inc., No. 11 Civ. 7387 (S.D.N.Y.), pending resolution
of the appeals. While the Second Circuit has yet to rule on the
merits whether the district court's opinion should be overturned, it was
highly critical of that decision, finding that the SEC and Citigroup had
"made a strong showing of likelihood of success in setting aside the
district court's rejection of their settlement" and that they had
"shown serious, perhaps irreparable, harm sufficient to justify
grant of a stay." Op. at 17. The order appears to call
for practically complete deference to an agency's decision to settle.
The court acknowledged that, because the parties were united in seeking
the stay, it had not received the benefit of adversarial briefing and
stated that it would appoint counsel to argue in support of the views
expressed in the district court's opinion.
By way of background, the SEC sued Citigroup in October
2011, alleging that Citigroup had made various misrepresentations in
connection with its role in structuring and marketing a largely synthetic
billion-dollar collateralized debt obligation fund. The SEC alleged
that Citigroup had informed investors that the Fund's assets, which
consisted primarily of subprime residential mortgage-backed securities,
were selected by an independent investment adviser. According to
the SEC, however, Citigroup in reality had arranged to include a
substantial percentage of poorly performing subprime RMBS in the Fund and
established short positions on those very assets. Citigroup
allegedly realized net profits of around $160 million from this
arrangement while investors in the Fund claimed that they lost more than
$700 million. The SEC brought non-scienter based charges under
Sections 17(a)(2) and (3) of the Securities Act of 1933, and Citigroup
agreed to settle the case for $285 million in disgorgement and civil
penalties. The SEC submitted a consent judgment to the court in
which, consistent with the SEC's regular practice, Citigroup did not
admit or deny any of the SEC's allegations.
Judge Rakoff rejected the settlement, criticizing the fact
that it did not require an admission of liability from Citigroup.
The district court concluded that the proposed consent judgment was not
fair, reasonable, adequate, or in the public interest.
The Second Circuit took a much more deferential approach,
expressing its view that the judiciary should not second-guess the
decision of an agency as to what is in the public interest. It held
that: "While we are not certain we would go so far as to hold
that under no circumstances may courts review an agency decision to
settle, the scope of a court's authority to second-guess an agency's
discretionary and policy-based decision to settle is at best
minimal." Op. at 8. The only circumstance suggested in
the order in which a court should reject a proposed settlement is where
the injunctive relief provisions affirmatively harm the public interest in some way. See Op. at 7 n.1 & 12 n.5.
With respect to the deference to be given to the agency's
judgment to settle, the Second Circuit concluded that Judge Rakoff did
"not appear to have considered the agency's discretionary assessment
of its prospects of doing better or worse, or of the optimal allocation
of its limited resources." Op. at 9. Regarding Judge
Rakoff's stated position that the settlement was unfair to Citigroup because
it imposed substantial relief without a finding of liability, the Second
Circuit found that the "more important concern is whether it is a
proper part of the court's legitimate concern to protect a private,
sophisticated, counseled litigant from a settlement to which it freely
consents. We doubt that a court's discretion extends to refusing to
allow such a litigant to reach a voluntary settlement in which it gives
up things of value without admitting liability." Op. at 10.
More fundamentally, this decision, while preliminary and not
a final ruling on the merits, shows that the Second Circuit is inclined
to affirm the Commission's current practice of not requiring defendants
to admit liability when settling cases (though the Commission's standard
practice is also to prohibit defendants from denying the Commission's
allegations). The Second Circuit "question[ed] the district
court's apparent view that the public interest is disserved by an agency
settlement that does not require the defendant's admission of liability.
Requiring such an admission would in most cases undermine any
chance for compromise." Op. at 10. According to the
Court of Appeals, Judge Rakoff's order was "tantamount to ruling
that . . . a court will not approve a settlement that
represents a compromise. It is commonplace for settlements to
include no binding admission of liability. A settlement is by
definition a compromise. We know of no precedent that supports the
proposition that a settlement will not be found to be fair, adequate,
reasonable, or in the public interest unless liability has been conceded
or proved and is embodied in the judgment." Op. at 12.
With the district court proceedings now stayed, the next
step in the process is the Second Circuit's decision on the merits
regarding the SEC's and Citigroup's interlocutory appeals and mandamus
petition.
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