The SEC will appeal a federal court’s (SDNY) rejection of a proposed settlement of an enforcement action against a global financial institution to the US Court of Appeals for the Second Circuit. The court ruled that the consent judgment was neither fair, nor reasonable, nor adequate, nor in the public interest. It is not reasonable, said Judge Rakoff, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations. It is not fair, because, despite Citigroup's nominal consent, there is a potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged patent. It is not adequate, because, in the absence of any facts, the court lacked a framework for determining adequacy. And, the proposed consent judgment does not serve the public interest because it asks the court to employ judicial power and assert judicial authority when it does not know the facts. SEC v. Citigroup Global Markets, Inc., SD NY, 11 Civ. 7387, Nov. 28, 2011.
In the enforcement action, the SEC alleged that the principal U.S. broker-dealer subsidiary of the financial institution mislead investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market in which the entity bet against investors as the housing market showed signs of distress. The CDO defaulted within months, leaving investors with losses while Citigroup made $160 million in fees and trading profits. Without admitting or denying the allegations, the financial institution agreed to settle the SEC’s charges by paying a total of $285 million, which will be returned to investors.
SEC Enforcement Director Robert Kuazami said that the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits. The court announced a new standard that is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. In fact, noted the Director, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.
A settlement puts money back in the pockets of harmed investors without years of courtroom delay and without the twin risks of losing at trial or winning but recovering less than the settlement amount, he continued, risks that always exist no matter how strong the evidence is in a particular case. Based on a careful balancing of these risks and benefits, settling on favorable terms even without an admission serves investors, including investors victimized by other frauds. This is due to the fact that other frauds might never be investigated or be investigated more slowly because limited agency resources are tied up in litigating a case that could have been resolved.
He emphasized that the $285 million obtained from Citigroup under the proposed settlement, while less than investor losses, represents most of the total monetary recovery that the SEC could have sought at trial. An SEC settlement does not limit the ability of injured investors to pursue claims for additional relief, he said. Moreover, while the court alluded to Citigroup’s size, the law does not permit the Commission to seek penalties based upon a defendant’s wealth.
The court was incorrect in requiring an admission of facts as a condition of approving a proposed consent judgment, observed the Director, particularly when the SEC provided the court with information laying out the reasoned basis for its conclusions.
In its reasoned memorandum to the court, the SEC answered questions posed by the judge before issuing an opinion on the proposed consent judgment. The SEC noted that use and entry of consent judgments has long been endorsed by the US Supreme Court. Lower federal courts have recognized the importance of consent judgments to the SEC’s effective and efficient enforcement of the federal securities laws. In its 1983ruling in SEC v. Clifton, the DC Circuit noted that, because of its limited resources, the SEC has traditionally entered into consent decrees to settle most of its injunctive actions.
The SEC said that there is nothing unusual or untoward about a consent decree entered into without an admission of wrongdoing by the defendant, and that criticism of consent decrees for not including such an admission is unjustified. Consistent with this standard practice, the SEC has long used consent decrees in which defendants admit no wrongdoing.
Courts have repeatedly recognized the balance of advantages and disadvantages in settlements entered in no admit/deny enforcement actions and have been reluctant to upset that balance, said the SEC. While the defendant is not subject to collateral estoppel with regard to the claims asserted, acknowledged the SEC, investors are able to pursue any available private remedies, in addition to the relief obtained by the SEC. Moreover, the SEC was able to bring the matter to a speedy conclusion, obtain compensation for victims in a timely manner, and allocate limited resources to bring additional enforcement actions for the protection of more investors.