The United States Court of Appeals for the Second Circuit has found that Judge Jed S. Rakoff of the District Court for the Southern District of New York abused his discretion in refusing to approve a settlement between the Securities and Exchange Commission and Citigroup Global Markets, Inc.i 

In its decision, issued June 4, the appellate court endorsed broad SEC discretionary powers to make charging decisions and reach settlements with those whom it sues. The decision also includes language supportive of SEC authority to avoid resort to the courts and to use its internal administrative processes.

As outlined in this Alert, those who are regulated by the SEC (or any other government agency) should consider carefully the potential consequences of the Second Circuit’s broad endorsement of SEC power.

The decision

In SEC v. Citigroup Global Markets, Inc.,ii the lower court rejected a proposed settlement to which the parties had agreed because the parties had not provided sufficient evidence for the court to determine whether the settlement was fair, reasonable or in the public interest. The Second Circuit reversed, finding that the district court had applied the wrong standard in reviewing the settlement.

The Second Circuit ruled that while a district court must review a proposed SEC consent decree, the scope of that review is limited. In reaching its decision, the Second Circuit emphasized a number of  key points:

  1. A consent decree is about pragmatism, compromise and risk management; it does not require the SEC to establish the truth of the allegations against the defendant.
  2. There is a “strong federal policy. . .favoring the approval and enforcement of consent decrees.”
  3. A district court may not condition approval of a consent decree on an admission of liability. Rather, “[t]he decision to require an admission of liability before entering into a consent decree rests squarely with the S.E.C.”
  4. The correct standard for reviewing a proposed consent judgment involving an enforcement agency is for the district court to determine “whether the proposed consent decree is fair and reasonable” and that the “public interest [will] not be disserved.”  The standard does not require a district court to consider whether the settlement is “adequate.”  A district court is required to enter the order “[a]bsent a substantial basis in the record” for concluding that these requirements are not met.
  5. In applying this review standard, a court’s focus is whether the decree is procedurally proper focusing on factors such as: the basic legality of the consent decree; whether the terms of the decree are fair; whether the terms of the decree resolve the claims in the complaint; and whether the decree is tainted by collusion.
  6. The allegations of the SEC’s complaint, even if neither admitted nor denied, can establish a factual basis for the consent decree.
  7. It is the SEC that has the “job” of “determining whether the proposed SEC consent decree serves the public interest.”  Courts must afford the SEC’s judgment “significant deference.”  A district court may not conclude that the public interest is disserved based on its “disagreement with the S.E.C.’s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability.”
  8. The SEC has the exclusive right to decide which charges to bring against a defendant.
  9. The SEC is free to avoid the courts and to pursue its remedies through its own administrative processes. 

Potential impact of the decision: three key points

At first read, the Second Circuit’s decision seems helpful to potential defendants – the risk that a court might reject a proposed settlement reached with the SEC is minimized. There is a real benefit to increased certainty in the settlement process. And it is helpful that the SEC need not prove the truth of its allegations as a condition of approval of a settlement. That preserves the benefits of settlements reached on a neither admit nor deny basis.

For several reasons, however, the Second Circuit’s endorsement of broad SEC discretion may have the impact of making it harder to resolve SEC matters or challenge the agency.

First, the court left the decision of whether to insist on an admission of liability in the hands of the SEC. While the ability to challenge the SEC’s recent policy of selectively seeking such admissions is likely limited and perhaps may not exist, the Second Circuit’s pronouncement provides the SEC with strong ammunition to defeat any such challenges going forward. The court’s support of the SEC’s discretion in this area may also lead the agency to seek admissions in more settlements, something the SEC is already signaling that it intends to do.

Second, the court’s statement that the SEC has the exclusive right to decide which charges to bring against a defendant will add to the heavy burden already faced by defendants seeking to assert claims of selective prosecution against the agency.

Third, after the enactment of Dodd-Frank, the SEC is able to obtain in an administrative proceeding almost any remedy that it might obtain through a court proceeding. The court’s support for the SEC’s ability to rely on its own internal processes may further encourage a shift from court actions to administrative proceedings in which defendants receive different protections than exist in federal court actions.

In sum, the Second Circuit’s endorsement of virtually unrestrained SEC discretion may have the broader effect of encouraging the agency to follow an even more aggressive enforcement approach than is currently the case. At the same time, the decision may have the consequence of undercutting the ability of potential defendants to challenge the agency’s actions.