Could Interest in Truth be Returning to Courts?

Judge Spurns SEC-Citigroup Deal as Contrary to Interest in Truth
The New York Law Journal by Mark Hamblett  -  November 29, 2011

Southern District Judge Jed S. Rakoff yesterday [November 29, 2011] rejected a proposed $285 million settlement between the Securities and Exchange Commission and Citigroup over the marketing of collateralized debt obligations the bank was also selling short.  Judge Rakoff said Citigroup created a billion-dollar fund "that allowed it to dump some dubious assets on misinformed investors" but was allowed to settle the case with no admission of wrongdoing. There was "an overriding public interest in knowing the truth," he said, and he would not approve the settlement without some "cold, hard, solid facts."  The decision in U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11 Civ. 7387, comes just weeks after Judge Rakoff grilled Matthew T. Martens, the SEC's chief litigation counsel, at a hearing on the consent judgment, which was filed simultaneously with the lawsuit on Oct. 19.  Specifically, the judge wanted Mr. Martens to explain why the court should be compelled to approve the settlement as against the public interest even if he found the settlement to be otherwise fair, reasonable and adequate and after he gave due deference to the SEC's judgment (NYLJ, Nov. 10).  The consent judgment requires Citigroup to disgorge $160 million in profits, with $30 million in interest, and pay a civil penalty of $95 million. It also requires Citigroup to adopt internal controls and measures to hold individuals accountable for signing off on public statements about the worthiness of the investments pitched by Citigroup, measures that counsel Brad S. Karp of Paul, Weiss, Rifkind, Wharton & Garrison said at the hearing had already been undertaken.  Mr. Martens had submitted papers saying the public interest was not part of the judge's analysis.  "This is erroneous," Judge Rakoff said in his 15-page opinion and order. "A large part of what the S.E.C. requests, in this and most other consent judgments, is injunctive relief, both broadly, in the request for an injunction forbidding future violations, and more narrowly, in the request that the court enforce future prophylactic measures."

"The Supreme Court has repeatedly made clear, however, that a court cannot grant the extraordinary remedy of injunctive relief without considering the public interest," he said, citing eBay, Inc. v. MercExchange, 547 U.S. 388 (2006).  In the end, Judge Rakoff concluded "regretfully" that "the proposed consent judgment is neither fair, nor reasonable, nor adequate, nor in the public interest."  The reason, he said, was that he had not been given enough evidence to make an informed judgment, for when a public agency asks a court "to become its partner in enforcement" both the public and the court need to know what the underlying facts are.  Otherwise, he said, "the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance."  He said the SEC "of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances."  Judge Rakoff criticized a settlement with no admission of wrongdoing, where Citigroup is charged only with negligence, and where the deal involves a civil penalty that is "pocket change" to Citigroup and imposes injunctive relief that Citigroup knew the "SEC had not sought to enforce against any financial institution for at least the last 10 years."  "It is harder to discern from the limited information before the court what the SEC is getting from this settlement other than a quick headline," he said, adding that Citigroup might just see the money paid as the cost of doing business.  Spokeswoman Danielle Romero-Apsilos said in a statement that Citigroup "respectfully disagrees" with the ruling.  "We believe the proposed settlement is a fair and reasonable resolution to the SEC's allegation of negligence, which relates to a five-year-old transaction," she said. "We also believe the settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges."  Robert Khuzami, director of the SEC's division of enforcement, said in a statement that the judge's criticism "disregards the fact that obtaining disgorgement, monetary penalties, and mandatory penalties and mandatory business reforms may significantly outweigh the absence of an admission when that relief is obtained promptly and without the risks, delay, and resources required at trial." These kind of settlements have been "repeatedly approved for good reason" by other federal courts, Mr. Khuzami said, including by Judge Rakoff's colleagues.  In June, Southern District Judge Richard Berman approved the SEC's $153.6 million settlement with J.P. Morgan Securities in a case that contained nearly identical provisions to the Citigroup settlement and also dealt with an ill-fated CDO.  And in July 2010, Judge Barbara Jones approved the SEC's $550 million deal with Goldman Sachs over its ABACUS CDO.  Judge Rakoff had faulted the $285 million settlement, an amount he said the consent judgment "only suggests that the SEC 'may'" return to defrauded investors. It was an amount, he said, that "still leaves investors shortchanged."  But in his statement, Mr. Khuzami said the securities laws generally limit the SEC to pursuing disgorgement for Citigroup's ill-gotten gains plus a penalty in an amount up to its gain, and he insisted the SEC had intended to deliver the entire $285 million to investors.  "We will continue to review the court's ruling and take those steps that best serve the interests of investors," he said.  Mark Hamblett can be contacted at mhamblett@alm.com. David Bario, a reporter at The American Lawyer, an affiliate publication, contributed to this report.