Citigroup Inc. (C)’s $285 million mortgage-securities pact with the U.S. Securities and Exchange Commission was revived as an appeals court assailed a judge’s demand for more evidence backing up the regulator’s claims.
The bank challenged U.S. District Judge Jed Rakoff’s refusal in 2011 to approve the accord, which would resolve SEC claims the bank misled investors in a $1 billion financial product linked to risky mortgages, costing investors more than $600 million.
Rakoff, who has also criticized the agency practice of not requiring an admission of wrongdoing in settlements, said the parties didn’t give him “any proven or admitted facts” he could use to gauge the deal’s fairness. The court today cited the SEC’s purview to tailor settlements as it sees fit, saying Rakoff abused his discretion by requiring it first establish the “truth” of the allegations against the bank.
Rakoff’s ruling “was the shot heard ’round the world,” said Cornelius Hurley, director of Boston University’s Center for Finance, Law & Policy. The judge can be credited with changing SEC policy, he said, citing the regulator’s statement last year that it would seek more admissions of wrongdoing.
Despite being reversed by the U.S. Court of Appeals, Hurley said “Rakoff can take some solace by the fact that he’s moved the needle seismically on the issue.”
While the appellate court said there were probably enough facts to allow approval of the Citigroup accord, they sent the case back to Rakoff, 70, to review and said he may request additional information from the parties.
The settlement stems from SEC allegations that Citigroup structured and sold collateralized debt obligations in 2007 without telling investors that it helped pick about half the underlying assets, and that it was betting they would decline in value by taking a short position.
Though the case didn’t turn on it, today’s ruling casts doubt on whether judges can require an admission of wrongdoing in an SEC accord.
Provisions allowing defendants to neither admit nor deny SEC allegations have been a sticking point for Rakoff on more than one occasion. The regulator has defended the practice, saying it encourages settlements and allows defendants to avoid public admissions that could be used in private litigation.
In a 2012 policy change, the SEC limited the “neither admit nor deny” language to deals with defendants who have not already been convicted in related criminal cases.
SEC Enforcement Director Andrew Ceresney said in an e-mailed statement today that “while the SEC has and will continue to seek admissions in appropriate cases, settlements without admissions also enable regulatory agencies to serve the public interest by returning money to harmed investors more quickly, without the uncertainty and delay from litigation and without the need to expend additional agency resources.”
Danielle Romero-Apsilos, a spokeswoman for New York-based Citigroup, declined to comment on the ruling “pending a review of the decision.”
While the court today didn’t directly address the controversy over such clauses, the ruling may add finality to another SEC settlement.
In April of last year, a New York federal judge approved the regulator’s pact with hedge fund SAC Capital Advisors LP. The record $602 million insider trading accord was conditioned on today’s U.S. Court of Appeals decision.
U.S. District Judge Victor Marrero had expressed concern at the time about the “neither admit nor deny” provision in the SAC Capital deal.
“It is both counterintuitive and incongruous for defendants in this SEC enforcement action to agree to settle a case for over $600 million that would cost a fraction of that amount, say $1 million, to litigate, while simultaneously declining to admit the allegations,” Marrero said at a court hearing in March 2013.
SAC Capital later pleaded guilty to insider trading in a separate case, and agreed to pay an additional $1.2 billion to end Justice Department criminal and civil money-laundering probes.
In the Citigroup ruling, the appeals court held that judges should take “care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.”
Settlements “provide parties with a means to manage risk,” the court said. Even if the SEC’s case was strong, going to trial is costly and the SEC’s resources are limited, the court said in its 28-page ruling.
“It is not within the district court’s purview to demand cold, hard, solid facts, established either by admissions or by trials as to the truth of the allegations in the complaint as a condition for approving” the accord, the court wrote.
Federal regulatory enforcement would “screech to a grinding halt,” if companies were forced to admit liability or go to trial when they’re sued by the government, Brad Karp, a lawyer for Citigroup, told the three-judge panel during oral arguments in February 2013.
SEC lawyer Michael Conley argued at the time that courts should give deference to the agency’s judgment that a particular settlement is in the public interest.
John Wing, a lawyer appointed by the court to defend Rakoff’s ruling, said at the time that the parties didn’t give Rakoff sufficient facts for him to determine whether the settlement was fair.
Better Markets, a Wall Street watchdog group founded by Atlanta-based hedge fund manager Michael Masters, called today’s ruling “a victory for investors, our markets and the public interest” saying the panel had properly endorsed the principal that a federal judge must ensure that a proposed SEC settlement “is not the product of collusion.”
In 2009 Rakoff rejected a $33 million deal between the SEC and Bank of America Corp. He said the settlement suggested “a rather cynical relationship between the parties.”
“The SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger,” Rakoff wrote at the time. “The bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense not only of the shareholders, but also of the truth.”
Rakoff later approved a $150 million settlement in which the parties provided an agreed “statement of facts.”
The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-05227, U.S. Court of Appeals for the Second Circuit (New York).
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