On June 4, 2014, the Second Circuit Court of Appeals vacated U.S. District Judge Jed Rakoff’s influential and controversial decision to reject a consent injunction between the SEC and Citigroup Global Markets Inc. (Citigroup) in November 2011. Judge Rakoff’s decision called into question the continued viability of the SEC’s long-standing use of “neither admit nor deny” settlements.[1] In its decision, the Second Circuit re-affirmed the SEC’s practice of routinely settling cases and obtaining consent judgments that do not require a defendant to admit nor permit the defendant to deny the factual allegations in the SEC’s Complaint or Order Instituting Proceedings.

The District Court’s Decision and 2012 Stay by the Second Circuit

In October 2011, the SEC filed a complaint alleging that Citigroup sold a $1 billion mortgage-linked collateralized debt obligation (CDO) without telling its investors that it had taken a $500 million “short” position against certain components that it selected for the CDO and did not short components that it had no role in choosing. The CDO eventually lost about $700 million, while Citigroup allegedly profited from its short position.

On the same day that it filed its complaint against Citigroup, the SEC presented to the court a proposed consent judgment that required Citigroup to disgorge $160 million in profits, plus $30 million in interest and to pay the SEC a $95 million civil penalty, along with certain other undertakings.

Judge Rakoff criticized the settlement because it was “neither reasonable, nor fair, nor adequate, nor in the public interest.”[2] Moreover, Judge Rakoff stated that because the SEC did not require that Citigroup admit to the SEC’s allegations, the court had not been provided with “any proven or admitted facts upon which to exercise even a modest degree of independent judgment.”[3] The court ordered that the parties prepare for trial.

Both the SEC and Citigroup appealed the court’s order and the SEC filed an application for an emergency stay and a petition for writ of mandamus with the Second Circuit Court of Appeals. On March 15, 2012, the Second Circuit issued an opinion which granted a stay of the district court proceedings and took issue with the district court's justifications for refusing to approve the settlement. The Second Circuit stated that it was “doubtful whether the court gave the obligatory deference” to the SEC’s judgment on wholly discretionary issues of policy.[4] While “[t]he district court believed it was a bad policy, which disserved the public interest, for the SEC to allow Citigroup to settle on terms that did not establish its liability,” the Second Circuit stated that ‘[i]t is not, however, the proper function of federal courts to dictate policy to executive administrative agencies.”[5] Moreover, the Second Circuit stated that the district court overlooked “the possibilities (i) that Citigroup might well not consent to settle on a basis that requires it to admit liability, (ii) that the SEC might fail to win a judgment at trial, and (iii) that Citigroup perhaps did not mislead investors.”[6]

The Second Circuit also questioned the district court’s view that “the public interest is disserved by an agency settlement that does not require” an admission of liability.[7] The Second Circuit expressed doubt as to “whether it lies within a court’s proper discretion to reject a settlement on the basis that liability has not been conclusively determined” and that it is “commonplace for settlements to include no binding admission of liability.”[8]

The Second Circuit Decision on the Merits and Standard for Review

In the Second Circuit’s decision last week, a three-judge panel ruled that the proper standard for a district court’s review of a proposed settlement involving a governmental agency is “whether the proposed consent decree is fair and reasonable, with the additional requirement that the public interest would not be disserved in the event that the decree includes injunctive relief.” The Court disagreed with Judge Rakoff in his review of the terms of the settlement to ensure its adequacy. The Second Circuit held that while an adequacy requirement makes perfect sense in the context of a class action settlement where a court is justifiably concerned about the preclusion of future claims, it “strikes us particularly inapt in the context of a proposed SEC consent decree” because potential plaintiffs with a private cause of action remain free to bring their own actions. Additionally, the Court found that “[a]bsent 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.”

In evaluating the settlement's fairness and reasonableness, the Court articulated a clear standard in evaluating SEC injunctive settlements. A district court's review is limited to a seemingly high-level review of the merits of the settlement including: (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. “The primary focus of the inquiry, however, should be on ensuring the consent decree is procedurally proper, using objective measures similar to the factors set out above, taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.”

Pragmatism over Finding the Truth

The Court found that it was an abuse of discretion for the district court to require that the SEC establish “cold, hard, solid facts established either by admission or by trials” as to the truth of its allegations as a condition for approving the consent decree. “Trials are primarily about the truth. Consent decrees are primarily about pragmatism.” The Court recognized that consent decrees are normally compromises that provide parties with a means to manage risk and the evaluation of those risks should be left to the litigants to make. “The SEC’s resources are limited, and that is why it often uses consent decrees as a means of enforcement.”

Understanding that district courts will need to establish a factual basis for the proposed decree, the Court explained that “[i]n many cases, setting out the colorable claims, supported by factual averments by the SEC, neither admitted nor denied by the wrongdoer, will suffice to allow the district court to conduct its review.”

The Court also reaffirmed the need for judicial deference to the SEC’s discretion in entering into settlements. It rejected the district court’s rationale that the proposed consent decree's monetary or other terms would disserve the public interest “in knowing the truth.” A district court may not find the public interest is disserved because it disagrees with the agency’s decision on discretionary matters of policy. The Second Circuit stated that the “job of determining whether the proposed SEC consent decree best serves the public interest, however, rests squarely with the SEC, and its decision merits deference.” District courts are not permitted to withhold approval of a consent decree on the grounds that they believe that the SEC failed to bring the proper charges or that the decree fails to provide collateral estoppel assistance to private litigants.


While this decision is a victory for the SEC, the effect of Judge Rakoff’s opinion will continue to be felt. The SEC announced in June 2013, in part in response to criticism to its no admission settlement policy, that it would seek to extract admissions of wrongdoing from defendants in cases involving egregious intentional misconduct, widespread harm to investors or efforts to obstruct an SEC investigation. Having secured notable admissions of guilt, starting with New York-based hedge fund adviser Phillip A. Falcone and his advisory firm Harbinger Capital Partners on August 19, 2013,[9] and including admissions of wrongdoing by JPMorgan and others, the SEC announced that it remains committed to this new policy. In response to the Second Circuit’s decision, Director of Enforcement Andrew Ceresney stated:

“While the SEC has and will continue to seek admissions in appropriate cases, settlements without admissions also enable regulatory agencies to serve the public interest by returning money to harmed investors more quickly, without the uncertainty and delay from litigation and without the need to expend additional agency resources.”

Thus, this decision removes the cloud of uncertainty hanging over any settlement that did not require an admission and provides a level of comfort that the courts will not second-guess those traditional settlements between the SEC and a defendant.