U.S. District Judge Jed S. Rakoff’s frustration with the way the federal government has handled (or mishandled) the 2008-09 financial crisis has been well documented.1 The focus of this commentary, however, is his multi-year attempts to push back at the Securities and Exchange Commission’s historical practice of seeking to have Article III judges approve regulatory settlements. For over 40 years, the SEC has, as a matter of course, entered into settlements with corporations. These settlements have, at their core, two features: the corporations neither admit nor deny liability, and the SEC asks a federal district court judge to ink his or her signature on the settlement, thereby triggering the judge’s injunctive/contempt power vis-à-vis future violations of law. The first component has traditionally been justified on two grounds. First, it saves the SEC resources by not having to litigate and prove wrongdoing at trial. Second, it allows corporations the ability thereafter to litigate tag-along civil litigation brought by private plaintiffs (and the plaintiffs’ bar). The second component is more of a historical artifact; it dates back to a time when the SEC had very few weapons in its enforcement arsenal to penalize and deter corporate wrongdoing. THIRD TIME’S THE CHARM? In 2009 it looked like at least part of this settlement protocol was going to be Two years later, in March 2011, the SEC again found itself before Judge Rakoff with a settlement he found less than compelling. Judge Rakoff decided to approve the settlement, largely because two of the individuals involved had pleaded guilty to related criminal charges, and the company, despite being destitute, had paid a multimillion-dollar penalty. He said, however, that the “disservice to the public interest in such a [settlement] practice is palpable.”5 More generally, Judge Rakoff decried the SEC seeking a federal court’s imprimatur on such settlements, tracing the rationale for that approach back to the above-referenced era when the commission’s enforcement powers were limited. The SEC’s current enforcement powers are now both wide and deep, and they can be invoked without ever having to go to court. Later that same year, 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 2007.6 Simultaneously with the court filing, the SEC did the following: • Announced it was settling the matter with Citigroup for $285 million. • Filed a separate lawsuit against a former Citigroup employee it claimed was the principal individual responsible for the CDO fraud. • Instituted settled administrative proceedings against two Credit Suisse entities and a Credit Suisse employee for their roles in the CDO transaction. The judge who drew the task of overseeing and approving the SEC’s settlement with Citigroup was again Judge Rakoff. At the same time the SEC was going public with its spin on the resolution of this allegedly fraudulent securities transaction, Citigroup issued its own press release. In addition to the settlement tracking the traditional affected when Judge Rakoff rejected a $33 million settlement between the SEC and Bank of America. According to the SEC, Bank of America had “materially lied” to its shareholders. Prior to a Dec. 5, 2008, vote on Bank of America’s proposed acquisition of Merrill Lynch, Bank of America had failed to disclose that $5.8 billion in bonuses were to be paid to Merrill Lynch employees. In rejecting the settlement, Judge Rakoff said it did “not comport with the most elementary notions of justice and morality.”2 Judge Jed Rakoff said the “disservice to the public interest in such a [settlement] practice is palpable.” The judge was upset that Bank of America shareholders were both victimized and being made to bear the financial penalty for the alleged misconduct. Therefore, he ruled that the settlement was merely “a contrivance designed to provide the SEC with the façade of enforcement and the management of the bank with a quiet resolution of an embarrassing inquiry.”3 Ultimately, in 2010 — only after Bank of America had worked hard to meet all his demands — Judge Rakoff grudgingly approved a $150 million settlement; by then, it hardly seemed like an SEC triumph.4
mantra of neither admitting nor denying wrongdoing, Citigroup highlighted for the investing public the fact that the SEC had not charged the company with “intentional or reckless misconduct.” Perhaps in response to the foregoing (how can a securities fraud of this nature and magnitude be the result simply of negligence?), Judge Rakoff scheduled a settlement hearing. In advance, he asked the settling parties to answer nine questions relating to whether the settlement was “fair, adequate and reasonable.” Not satisfied with the answers he received, Judge Rakoff rejected the settlement,7 which was appealed by both the SEC and Citigroup. THE 2ND CIRCUIT’S ‘REBUKE’ On June 4 the 2nd U.S. Circuit Court of Appeals vacated Judge Rakoff’s order and sent the settlement back to him for “further proceedings in accordance” with the appellate court’s ruling.8 The publicity attendant to the ruling termed it as a frontal “rebuke” of Judge Rakoff. But was it really? On this last point, the district judge must first determine that it is “fair and reasonable.” The 2nd Circuit laid out four indicia to measure those concepts: • Whether the settlement has a basis in law. • Whether its terms are clear. • Whether it resolves the actual claims in dispute. • Whether it is tainted by some form of collusion or corruption. Finally, if the court’s injunctive/contempt powers are invoked, the judge is also to determine that the “public interest would not be disserved” by the settlement. The 2nd Circuit then concluded that “[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 Aug. 5 with a caustic Another fallout from Judge Rakoff’s settlement offensive is that the SEC seems to have figured out (finally) that it need not always go to federal court to mete out the regulatory justice it wants to impose. In many areas, including insider trading cases, it has now started to invoke its own administrative law process and procedures. While this trend may be troubling with respect to due process and other rights in certain types of cases (e.g., insider-trading cases), it certainly makes sense with respect to settlements. By going this route, all the SEC is giving up is something it never used anyway, the contempt “teeth” to punish corporate recidivism.12 Thus, perhaps because of Judge Rakoff’s tilting at the SEC’s settlement windmills, he will have achieved what he wanted in the first place: fewer regulatory settlements being brought before Article III judges for review and approval. WJ “approval” of the Citigroup–SEC settlement, the SEC granted Citigroup relief under the 1940 Investment Advisers Act from the effects of the settlement for purposes of its activities as an investment adviser. The SEC’s current enforcement powers are now both wide and deep, and they can be invoked without ever having to go to court. Clearly, on one front, the 2nd Circuit ruled that Judge Rakoff had 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. 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. It is not necessary, and the SEC never seems thereafter to invoke the court’s injunctive/contempt powers.9 The court also agreed with Judge Rakoff that if the SEC continues to come into federal court in such circumstances, the district judge is not to be a mere “potted plant,” but to play a role in assessing the settlement. Finally, the court articulated standards as to what the district judge is to employ in reviewing such settlements. statement: “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 2nd Circuit had “fixed the menu,” he was left “with nothing but sour grapes.”10 WHERE TO NOW? 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. In fact, judges in Washington, D.C., and Colorado — courts outside the jurisdictional/ precedential scope of the 2nd Circuit — have followed Judge Rakoff’s rationale in rejecting SEC settlements.11 Whether going forward the 2nd Circuit’s standards will be the guideposts for the federal judiciary throughout the country remains to be seen.