In an eagerly anticipated decision, the U.S. Court of Appeals for the Second Circuit vacated the 2011 decision of Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York, rejecting a proposed settlement between the Securities and Exchange Commission (SEC) and Citigroup Global Markets, Inc. (Citigroup). Judge Rakoff had ruled that, because the proposed Consent Judgment, in which the SEC requested injunctive relief, lacked any proven or acknowledged facts, he was unable to determine that it was fair, reasonable, adequate and in the public interest.1 For further information regarding the district court decision, please refer to DechertOnPointCourt Challenges SEC’s Policy of Allowing Settling Parties to “Neither Admit nor Deny” Agency Allegations.

On appeal, the Second Circuit made clear that “there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement …”2 The Second Circuit also reiterated that courts owe a substantial amount of deference to agencies seeking consent decrees. But, the court did go on to clarify the role of the court in reviewing and approving consent decrees. No longer will district courts in the Second Circuit review the decree under the “fair, reasonable, adequate and in the public interest” standard when the decree includes injunctive relief. Instead, the lower courts were directed to review such decrees under the standard that they be fair and reasonable and that the “public interest would not be disserved.”3 The Second Circuit’s decision upholds the SEC’s long-time practice of entering into settlements without requiring an admission of liability. Given the policy changes announced by the SEC in 2013 while the appeal of Judge Rakoff’s decision was still pending, however, the Second Circuit decision is not likely to have a significant impact on the SEC’s current settlement policy.

This DechertOnPoint summarizes and considers the potential impact of the Citigroup opinion.

Background and Judge Rakoff’s Ruling

On October 19, 2011, the SEC filed a complaint (Complaint) against Citigroup for violations of Sections 17(a)(2) and (3) of the Securities Act of 1933 (Securities Act). The SEC alleged that, in early 2007, Citigroup, realizing that the market for mortgage-backed securities was beginning to weaken, created a billion-dollar fund (Fund) that enabled Citigroup to sell dubious assets to misinformed investors. According to the Complaint, Citigroup misrepresented that the Fund’s assets were attractive investments rigorously selected by an independent investment adviser. The SEC alleged that Citigroup included in the portfolio a substantial percentage of negatively projected assets and then took a short position in those assets, which resulted in a net profit of approximately $160 million, while investors suffered a loss of more than $700 million.

Simultaneously with the filing of the Complaint, the SEC presented a Final Judgment (Consent Judgment) for the court’s approval together with the consent of Citigroup to the entry of the Consent Judgment, which consent made clear that Citigroup was agreeing to the entry of the Consent Judgment without admitting or denying the allegations of the Complaint. The Consent Judgment: (1) permanently restrained and enjoined Citigroup from future violations of Section 17(a)(2) and (3) of the Securities Act; (2) required Citigroup to disgorge to the SEC the $160 million Citigroup realized in profits, plus $30 million in interest, and to pay a civil penalty of $95 million; and (3) required Citigroup to undertake certain internal measures designed to prevent recurrences of securities fraud, subject to court enforcement.

In a November 9, 2011 opinion, Judge Rakoff ruled that the court could not determine whether the settlement was in the public interest as a result of, inter alia, the posture of the defendant in neither admitting nor denying wrongdoing. The implication of Judge Rakoff’s decision was that the SEC had to establish the truth of the allegations against the defendant in order for the court to approve the consent decree and that the SEC could not be “the sole determiner of what was in the public interest.”4 Judge Rakoff also commented on the fact that the Consent Judgment did not seem to take into account harmed investors.

Immediate Impact of Judge Rakoff’s Ruling

On the heels of Judge Rakoff’s decision, two courts outside of the Second Circuit quickly followed suit. InSEC v. Hohol, the U.S. District Court for the Eastern District of Wisconsin required the SEC to provide a “written factual predicate” delineating the reasons that the court should find the settlement at issue “fair, reasonable, adequate, and in the public interest.”5 In FTC v. Circa Direct, the U.S. District Court for the District of New Jersey conditioned the approval of the settlement at issue on the condition that the Federal Trade Commission (FTC) set up a publicly accessible website setting forth the factual predicate for the FTC’s claims, so that the public could “assess the truth of the FTC’s claims.”6 Neither court, however, went so far as to preclude the government from agreeing to a consent order with the defendants without an admission of liability.

In January of 2012, Robert Khuzami, then the Director of the SEC’s Division of Enforcement, announced that the SEC would, in cases involving parallel criminal convictions or Non-Prosecution Agreements or Deferred Prosecution Agreements that include admissions or acknowledgments of criminal conduct, delete the “neither admit nor deny” language from the settlement documents.7 Then, shortly after her confirmation, SEC Chair Mary Jo White surprised many in the legal community when she announced, in June 2013 before the Second Circuit had issued its ruling on appeal, that the SEC would seek admissions of liability more frequently in certain cases.8 Later, in a September 26, 2013 speech, she provided more color as to the “cases” that may warrant admissions, including:

  • cases where a large number of investors have been harmed or the conduct was otherwise egregious;
  • cases where the conduct posed a significant risk to the market or investors;
  • cases where admissions would aid investors deciding whether to deal with a particular party in the future; and
  • cases where reciting unambiguous facts would send an important message to the market.9  

Chair White went on to note that the SEC would continue not to require admissions of liability in many cases, but the decision as to whether or not to require such an admission should rest with the SEC and not with the courts. Since the announcement of the policy change, the SEC has entered into several settlements where it has required admissions of liability.10 In April 2014, Chair White, testifying before the House Committee on Financial Services, noted that in the prior year, the SEC has aggressively enforced the securities laws, “requiring for the first time admissions to hold certain wrongdoers more publicly accountable…”11 Chair White explained that the SEC has “taken steps to enhance the SEC’s already strong enforcement program, including by modifying the longstanding ‘no admit/no deny’ settlement protocol to require admissions in certain cases,” and that “[w]hile no admit/no deny settlements still make a great deal of sense in many situations, because admissions can achieve a greater measure of public accountability, they can bolster the public’s confidence in the strength and credibility of law enforcement and in the integrity of our markets.” Chair White commented that SEC has resolved a number of cases with admissions, and “[her] expectation is that there will be more such cases during 2014 and going forward as the new protocol continues to evolve and be applied.”

The Second Circuit Decision

The Second Circuit rejected Judge Rakoff’s reasoning, instead holding that courts owe substantial deference to a governmental agency seeking a consent decree. In doing so, the Second Circuit clarified that courts reviewing such decrees must find them to be “fair and reasonable” and that the “public interest would not be disserved” if the decree were approved.

The Second Circuit held that, to determine fairness and reasonableness, a court must assess “(1) the basic legality of the decree …; (2) whether the terms of the decree, including the 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 court noted that “the primary focus of the inquiry … should be ensuring the consent decree is procedurally proper,” but that it was improper for courts to require that the SEC establish the “truth” of the allegations for the purposes of settlement because “[t]rials are primarily about the truth. Consent decrees are primarily about pragmatism.”12 The Second Circuit indicated that it is usually sufficient for the SEC to set out colorful claims with supporting “factual averments” to satisfy this standard, and that further inquiry would only be necessary in certain cases – for example, if there was some evidence of collusion between the SEC and the defendant.

As to the determination of whether or not the public interest is “disserved” by the settlement, the court held that the SEC was the party best suited to determine whether a consent decree was in the public’s best interest. The Second Circuit indicated that a court can overrule the SEC and find that a consent decree disserves the public interest if, for example, the consent decree “barred private litigants from pursuing their own claims independent of the relief obtained under the consent decree.” Courts, however, cannot overrule the SEC because of “decisions over discretionary matters of policy, such as deciding to settle without requiring an admission of liability,” or because the court believes the SEC failed to “bring the proper charges” against the defendant.

Based on this reasoning, the Second Circuit vacated Judge Rakoff’s ruling and remanded the case to the district court to consider the Consent Judgment under the standard set forth in its decision.

Potential Lasting Impact of Judge Rakoff’s Decision Despite Second Circuit Ruling

While the Second Circuit’s decision was not unexpected given the substantial deference the courts have historically accorded to the SEC when considering consent decrees, the genie cannot be put back in the bottle. Indeed, Andrew Ceresney, the Director of the SEC’s Division of Enforcement, in a statement immediately following the decision, made clear that the SEC “will continue to seek admissions in appropriate cases.”13 Requiring admissions of liability in selected cases will likely remain a powerful tool in the SEC’s enforcement arsenal.