Rakoff Seeking Truth of Wall Street Wrongdoing Labeled Rogue
U.S. District Judge Jed Rakoff doesn’t shy away from high-profile fights.
In 2005, he challenged the Department of Defense for holding suspected terrorists at Guantanamo Bay in Cuba without identifying them. The Pentagon protested his order to release their names, saying it would undermine their privacy rights and in a few cases threaten national security. The judge rejected most of the arguments from the military and forced it to reveal the names, Bloomberg Markets magazine reports in its May issue.
“I’m not by nature reticent,” Rakoff, 68, says from behind his glass-topped desk in his chambers in lower Manhattan. “I wonder if Rush Limbaugh is ever going to come after me.”
Rakoff sits on the court for the Southern District of New York, which covers Wall Street. He has presided over a number of heavyweight financial lawsuits and currently is overseeing the case of former McKinsey & Co. head Rajat Gupta, who’s charged with insider trading. The judge is also embroiled in a battle with the Securities and Exchange Commission over what he considers its tepid enforcement of the law.
On Nov. 28, Rakoff threw out the SEC’s $285 million settlement of a lawsuit with Citigroup (C) Inc. for selling $1 billion of toxic mortgage securities in a collateralized debt obligation that defaulted in 2007. As part of the agreement, New York-based Citigroup neither admitted nor denied the agency’s allegations, a clause that has been standard in such settlements for at least four decades. Rakoff said he wanted the SEC to reveal more facts about Citigroup’s wrongdoing so he could judge whether the settlement is fair.
“In much of the world, propaganda reigns, and truth is confined to secretive fearful whispers,” Rakoff wrote in the Citigroup case. “But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges.”
An appeals court may soon block Rakoff from getting the truth. The SEC, stung from the judge’s criticism, appealed his Citigroup ruling -- the first time the agency has challenged a judge’s decision in an enforcement action since 1984. In a blunt rebuke to Rakoff on March 15, the U.S. Court of Appeals in Manhattan said judges like Rakoff have only minimal authority to second-guess the SEC, which is better equipped to protect investors.
The appeals court won’t make a final ruling until at least September, when a court-appointed lawyer, Lankler Siffert & Wohl Partner John Wing, presents Rakoff’s argument.
“The court says Rakoff’s a rogue judge,” says Adam Pritchard, a professor of law at the University of Michigan. “It is not the district court’s business to determine what’s in the public interest.”
Rakoff’s bold decisions have been shot down before. In 2002, he ruled the death penalty unconstitutional in a case before him -- a decision that was later reversed.
“He’s not a madman off on a power trip,” says David Schulz, the attorney who represented the Associated Press, which was seeking the names in the Guantanamo case. “He is a very principled guy who wants the government to do the right thing and gets very impatient when it doesn’t.”
Rakoff’s rulings helped spur the $162 million settlement on March 16 of a lawsuit threatening the owners of the New York Mets. The trustee of Bernard Madoff’s investment firm claimed co-owners Fred Wilpon and Saul Katz ignored warnings of fraud in order to pocket hundreds of millions of dollars in profits. Rakoff had earlier rejected much of the trustee’s $1 billion claim while also putting the Mets at risk of paying as much as $386 million.
Rakoff is also presiding over the criminal trial of Gupta -- one of the highest-profile insider-trading cases -- which begins in May. Gupta, also a former Goldman Sachs Group Inc. (GS) director, is accused of leaking inside tips to hedge-fund founder Raj Rajaratnam, who was sentenced to prison for 11 years. As part of an SEC lawsuit, Rakoff ordered Rajaratnam to pay $92.8 million, the largest such penalty ever. Gupta denies wrongdoing, his lawyer says. Rajaratnam is appealing.
Rakoff’s decision in the Citigroup case has added fuel to criticism from investor advocates that the SEC is too cozy with Wall Street. Since 2001, the commission has settled five fraud cases with Citigroup, the world’s third-largest lender. None of them involved an admission of wrongdoing, and all of them included a promise not to commit fraud.
The penalties have been too small -- totaling $765 million -- to serve as a deterrent, says Dennis Kelleher, chief executive officer of Better Markets Inc., a nonprofit group that promotes transparency in markets.
“The SEC penalties are not even a slap on the wrist,” he says.
If Rakoff’s position prevails, it will change the way the SEC enforces the law. The agency would have to make deals in which defendants admit some fault, and this would lead to many more trials. That’s because most businesses would be unwilling to make such admissions, which could be used against them in court by other litigants including shareholders. So companies will opt for litigation, says Maria Ghazal, counsel for the Washington-based Business Roundtable, which represents U.S. chief executives.
Robert Khuzami, director of the SEC’s Division of Enforcement, said in December that forcing cases to trial will hurt shareholders in the end.
“The result would be longer delays before victims get compensated, the expenditure of SEC resources that could be spent stopping the next fraud and -- quite possibly -- less money in the pockets of wronged investors,” he said in a speech to the Consumer Federation of America.
To avoid judges like Rakoff, the SEC might bypass district courts and bring cases as administrative actions, where it would have more leeway in making deals, says Peter Henning, a professor at Wayne State University Law School.
“The outcome of the appeals case could have a significant impact on our practice,” says George Canellos, who heads the SEC’s New York office.
Some legal scholars say Rakoff is close to overstepping his authority by acting as if he’s a regulator.
“You get a picture of a judge who sees himself as an active player in the political process,” says David Skeel, a University of Pennsylvania law professor. “That he enjoys having his picture in the New York Times is something that makes other judges grimace.”
Shylock v. Antonio
For all of his combativeness, Rakoff possesses a playfulness off the bench. A New York Yankees fan, he beams when showing off a baseball signed by Mariano Rivera, the best relief pitcher in history, in his chambers. He and his wife, Ann, take ballroom dancing lessons.
Rakoff also writes musical sketches for the courthouse’s satirical revue each Christmas. His sense of humor comes out in photographs on his wall of him clowning in a skit with Sonia Sotomayor, who was once a fellow judge in the Southern District and is now a U.S. Supreme Court justice.
Soon after the 2008 collapse of Lehman Brothers Holdings Inc., Rakoff led a panel of judges, lawyers and a Shakespeare scholar at a New York law school’s mock appeal of the case of money lender Shylock, a character in The Merchant of Venice, against Antonio. The panel ruled in favor of Shylock. Rakoff delivered the opinion -- in iambic pentameter:
“The point is taken, and worthy of note: Venice, like Citibank, must be kept afloat. If Venice, like Lehman, was fated to sink, gondoliers, like brokers, would sure make a stink.”
Rakoff, a Philadelphia native, has been challenging the power of institutions since college. As student council president at Swarthmore College in suburban Philadelphia, he assailed a faculty committee as biased and secretive for ignoring a student recommendation that students sit on a faculty curriculum committee. He also called for a campuswide protest to overturn a rule requiring dormitory doors to be open 6 inches when men and women were inside together.
“He was incredibly active, politically and sort of idealistically,” says Daniel Menaker, who graduated a year before Rakoff and later became executive editor-in-chief of Random House Publishing.
After Rakoff graduated with an honors degree in English in 1964, he earned a Master of Philosophy degree from Balliol College at the University of Oxford and completed law school at Harvard University in 1969. Two years later, he became an assistant U.S. attorney in Manhattan, eventually taking over as chief of the securities fraud unit.
He left government service in 1980 to head the criminal defense and civil racketeering sections of Mudge Rose Guthrie Alexander & Ferdon in New York. In private practice, Rakoff negotiated the same kind of settlements he rails against today.
One of his clients, Martin Siegel, a Kidder, Peabody & Co. banker who pleaded guilty to insider trading in 1987 and cooperated with prosecutors, settled an SEC case without admitting wrongdoing.
“As a lawyer, your job is to get the best deal for your client,” Rakoff says.
In 1995, then-President Bill Clinton named him to the Southern District bench. As a judge, Rakoff says, he sees himself as more than an umpire overseeing a legal contest. The judge says he’s sometimes obligated to delve into the facts of cases, particularly when the stakes for the public are high or when the government seeks an injunction barring a party from violating the law, as in the Citigroup case.
“In those cases, I do feel that a judge should get very much involved,” Rakoff says. “Not every judge agrees with that.”
Rakoff’s fingerprints were all over the restructuring of WorldCom Inc., which the SEC sued in 2002 in what was then the biggest fraud case in U.S. history. The commission asked Rakoff to appoint a monitor who would later oversee major changes at the telecommunications giant. The judge tapped former SEC Chairman Richard Breeden to help save the company and its 60,000 jobs.
Rakoff spoke almost daily with Breeden, held frequent hearings to resolve disputes on pay and business strategy and authorized him to craft sweeping governance reforms. Their success allowed WorldCom, renamed MCI Inc., to sell itself in 2006 to Verizon Communications Inc. (VZ) for $8.4 billion.
“I am, frankly, very proud of how that turned out,” Rakoff says. “Hands-on is the way I do think of myself.”
Rakoff first admonished the SEC in 2009, tearing up its initial $33 million deal with Bank of America Corp. The bank had failed to disclose bonus payments that soon-to-be-acquired Merrill Lynch & Co. would pay out, the SEC said.
The commission pushed the penalty up to $150 million in a settlement Rakoff approved because it was accompanied by 35 pages of facts about the $5.8 billion in bonus payments and other issues.
In two other major SEC accords, Goldman Sachs paid $550 million in 2010 after it allowed fund manager John Paulson to select mortgage securities underpinning a CDO while he planned to short them. Goldman Sachs admitted its actions were a mistake. JPMorgan Chase & Co. (JPM) settled a CDO case last year for $153.6 million without admitting wrongdoing. Rakoff wasn’t involved in these two cases.
“The hard facts of what’s really going on in any given situation too rarely emerge,” Rakoff says. “The two enemies of truth are hypocrisy and secrecy.”
In the Citigroup case, which Rakoff won’t discuss, the SEC said the bank misled investors with its CDO. Citigroup launched the CDO in February 2007, 10 months before Vikram Pandit took over as CEO.
“One experienced CDO trader characterized the asset group in internal communications as ‘a collection of dogsh!t’ and ‘possibly the best short EVER!’” the SEC said. Yet in marketing materials, the bank described the assets as “attractive investments.”
Citigroup took short positions against them, and in November 2007, the security defaulted. Investors lost $700 million.
In the settlement, Rakoff called the deal pocket change for a bank with $78.4 billion in 2011 revenue. He ordered the case to trial in July. Citigroup, which is backing the appeal, is preparing for a trial.
“We would present substantial factual and legal defenses,” the bank said in a statement in November.
Rakoff’s rulings have swayed three fellow judges, who have cited him or his cases in challenging deals by the SEC or the Federal Trade Commission. A U.S. District Court judge in Milwaukee in December questioned an SEC settlement with headphone maker Koss Corp. (KOSS) for issuing inaccurate financial statements. Only after officials provided details about the accord did the judge approve it.
The SEC has begun to shift strategy amid the controversy of the Citigroup case. The commission said in January that it would require defendants to admit wrongdoing when they’ve done so in parallel criminal proceedings, a move that an official said wasn’t related to Rakoff’s decisions.
Even though some of the judge’s rulings have been reversed in the past, the irrepressible Rakoff remains confident in his opinions.
“I’m not shy about saying that I think in some of my cases that were reversed on appeal, it’s just a matter of time before the law comes my way,” he says.
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