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The impact of Judge Rakoff’s settlement odyssey

Cohen & Gresser LLP

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USA September 10 2014

Law360, New York (September 05, 2014,  10:15 AM ET) -- Judge Jed S. Rakoff has  become pretty well-known of late. For  many, it has been his very public  questioning of the U.S. Department of  Justice’s “failure(s)” to prosecute financial  executives for the near apocalypse of  2008 (see “The Financial Crisis: Why  Have No High-Level Executives Been  Prosecuted?” The New York Review of  Books (Jan. 9, 2014); “Why Have Top  Executives Escaped Prosecution?” The  New York Review of Books (April 3,  2014)).

For most lawyers, especially those in the  securities bar, his recent prominence has  been highlighted more by the public  “rebuke” delivered on June 4, 2014, by  the Second Circuit Court of Appeals to his  rejection of Citigroup’s settlement with the  U.S. Securities and Exchange  Commission, and his subsequent  approval (albeit reluctantly) of that same  settlement on Aug. 5, 2014. Beyond the  sound bites, what really happened?

How It Started

In October of 2011, the SEC filed a  complaint in federal court in New York,  charging Citigroup with securities fraud in  connection with a synthetic collateralized  debt obligation sold to investors in 2007.  Simultaneously, the SEC announced,  inter alia, that it was settling the matter  with Citigroup for $285 million. Judge  Rakoff drew the assignment of overseeing  and approving the lawsuit’s resolution. Perhaps in response to Citigroup’s press  release about the settlement (in which the  bank highlighted that it had not been  charged with “intentional or reckless  misconduct”), Judge Rakoff wondered  aloud how “a securities fraud of this  nature and magnitude [could] be the result  simply of negligence?” After a hearing  before him to test whether the settlement  was “fair, adequate, and reasonable,” the  judge answered each question in the  negative. Both the SEC and Citigroup  appealed to the Second Circuit.

The Second Circuit Speaks

The Second Circuit vacated Judge  Rakoff’s order and remanded the  settlement back to court for “further  proceedings in accordance” with the  court’s ruling. On its face, that sounds like a “rebuke”; but was it really? Clearly, on one front, the Second Circuit  ruled that Judge Rakoff had in fact  overstepped his authority in criticizing and  rejecting the SEC’s policy of not requiring  the settling party to admit to legal  wrongdoing; in other words, it was an  abuse of discretion for Judge Rakoff to  require the SEC to prove the “truth” of its  claims against Citigroup.

But on three other fronts, the court of  appeals pretty much lined up with Judge  Rakoff: (1) the court cautioned the SEC  that it might want to rethink its reflexive  approach of always going into federal  court to seek judicial approval of  settlements (since it is not necessary, and  the SEC never seems thereafter to invoke  the court’s injunctive/contempt powers);  (2) the court agreed that, if the SEC is  going to come into federal court in such  circumstances, the district judge is not to  be a mere “potted plant,” but in fact does  have a role to play in assessing the  settlement; and (3) the court articulated  standards as to what the district judge is  to employ in reviewing such settlements.

On this last point, the district judge must  first determine that it is “fair and  reasonable.” The Second Circuit laid out  four indicia to measure those concepts:  (1) whether the settlement has a basis in  law; (2) whether its terms are clear; (3)  whether it resolves the actual claims in  dispute; and (4) whether it is tainted by  some form of collusion or corruption. Finally, if the court’s injunctive/contempt  powers are invoked, the district court  judge is also to determine that the “public  interest would not be disserved” by the settlement. The Second Circuit then  concluded: “[a]bsent a substantial basis in  the record” that the settlement fails to  meet these requirements, a district judge  “is required to enter the order.”

Back to Judge Rakoff

Obviously not thrilled with the vacatur and  remand, Judge Rakoff started off his  three-page opinion on Aug. 5 with the  caustic: “They who must be obeyed have  spoken.” Applying the “modest standard[s]  imposed” by the higher court, Judge  Rakoff then approved the settlement. He  concluded by wondering whether courts  going forward would entertain “no  meaningful oversight whatsoever” on such  matters; but given that the Second Circuit  had “fixed the menu,” he was left “with  nothing but sour grapes.”

Judge Rakoff’s original shot across the  SEC’s bow in 2011 emboldened a number  of other Article III judges to take on a  more active oversight role in evaluating  SEC settlements. Notwithstanding Judge  Rakoff’s “sour grapes,” the Second Circuit’s opinion does not vitiate that  oversight role; rather, it should provide a  clearer road map on how to navigate the  process without adverse appellate review.

Cohen & Gresser LLP - C Evan Stewart
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