It's not denial. I'm just selective about the reality I accept.
Calvin and Hobbes, Cartoonist Bill Watterson
Since at least 1972, the Securities and Exchange Commission (SEC) has expected federal courts to think like the famous cartoonist, Bill Watterson, by approving and enforcing settlements with injunctive relief where the defendant, often a public company, curiously neither admits nor denies the SEC's allegations. To make matters more confusing, the SEC's traditional injunctive relief merely instructs the defendant not to engage in the conduct that violated the law. Until recently, courts rarely questioned settlements or this corresponding injunctive relief.
The SEC's nearly 40-year period of tranquility with its settlements came to an abrupt end in a courtroom in the US District Court for the Southern District of New York. Judge Jed Rakoff tossed the proverbial rubber stamp in the trash when he refused to approve a "neither admit nor deny" settlement between the SEC and Citigroup Global Markets, Inc. In the court's order, Judge Rakoff stated that "an application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated." This ruling, rejecting the settlement between the SEC and Citigroup, could have serious implications for SEC enforcement practices.
The critical issue in the Citigroup case, which is now on appeal to the US Court of Appeals for the Second Circuit, is the validity of the SEC's standard "neither admit nor deny" settlements that is, settlements where the defendant does not admit to the SEC's allegations but also is prohibited from denying the SEC's allegations (but can deny identical allegations made by private plaintiffs). The SEC argues that these settlements are critical to its ability to protect investors and enforce securities laws because they allow the SEC to obtain disgorgement of ill-gotten gains and impose penalties in a settlement without being forced to prove the allegations in a resource-intensive trial. Defendants, on the other hand, resolve their exposure to the SEC without making any admissions that could be used against them by private plaintiffs.
Seizing on the "neither admit nor deny" language, Judge Rakoff set forth several reasons why the Citigroup settlement might not be in the public interest. He posited that a scienter-based charge and a larger penalty might be more appropriate given the severity of the SEC's allegations against Citigroup and a related enforcement in which the SEC charged an individual Citigroup employee [PDF] with fraud for his role in the conduct. Judge Rakoff questioned the adequacy of investor protection when the SEC neither had proven that Citigroup violated securities laws nor had required Citigroup to admit so in the settlement. Without an admission by Citigroup or any evidence in the record, the court was unable to impose substantial relief on the basis of mere allegations. According to Judge Rakoff, "[T]he proposed Consent Judgment does not serve the public interest, because it asks the court to employ its power and assert its authority when it does not know the facts." Finally, in perhaps a preview for a future ruling, Judge Rakoff questioned whether the First Amendment allows the SEC, a government agency, to prohibit private parties from publicly denying the allegations following a settlement.
Impact on Future Enforcement Cases?
Judge Rakoff's ruling is on appeal [PDF] to the Second Circuit. An adverse ruling by the Second Circuit will have a major impact on the SEC's enforcement program with so many cases filed in that circuit. While awaiting a determination by the Second Circuit, the SEC may be reluctant to bring enforcement actions in federal district court. If the SEC is unable to impose penalties and obtain injunctions in federal court without an admission of wrongdoing by the defendant, the SEC will be forced either to enter into settlements outside of the judiciary's purview, to obtain admissions of wrongdoing from defendants, or to prove its allegations at trial.
The SEC's troubles may extend beyond the Second Circuit, as other judges are beginning to question SEC settlements. In a case pending in the US District Court for the Eastern District of Wisconsin, Chief Judge Rudolph Randa recently requested the SEC and defendant Koss Corporation to demonstrate why the court should approve a "neither admit nor deny" settlement.
The Dodd-Frank Wall Street Reform and Consumer Protection Act expanded the SEC's authority at the SEC's request to bring administrative proceedings against any violator of the federal securities laws, where previously the SEC's administrative proceedings were limited to certain registered entities and persons. It remains to be seen whether the SEC will utilize this new power to avoid federal court scrutiny, which it had requested from Congress. Although administrative proceedings provide an alternative course, federal court remains the SEC's preferred venue for enforcement actions. In the SEC's view, an injunction by an Article III federal court judge carries a greater stigma than a cease-and-desist order by a SEC administrative law judge. Does it really? As Judge Rakoff pointed out during one of the hearings in the Citigroup case, the SEC had not sought to enforce a court injunction in over ten years.
The SEC sought from Congress the power to bring more administrative actions, so the SEC's decision to forgo such a proceeding against Citigroup is puzzling, particularly where the SEC knew from prior experience in the Southern District of New York that at least one judge (coincidentally, Judge Rakoff) scrutinizes SEC settlements. Under the current "neither admit nor deny" formulation, defendants can treat settlements as a cost of doing business, as Judge Rakoff described. However, the price of poker goes up if a defendant must admit to violating securities laws in order for the SEC to obtain a federal court injunction, because the defendant will be exposing itself to private party lawsuits. In many cases, a defendant might choose to roll the dice by litigating with the SEC rather than settling and admitting wrongdoing. If defendants force the SEC to prove its allegations at trial, the SEC may become more selective in bringing enforcement actions. After all, the SEC has limited resources and is generally adverse to bringing cases it might lose (see, as evidence, the SEC's claimed 96 percent success rate in administrative trials).
It is ironic that, after arguing that a court needs only to look at the SEC's allegations before using its powers to enforce a settlement, the SEC may be forced to apply its own form of selectivity in deciding which enforcement actions it pursues.
Bradley Bondi is an experienced trial attorney and litigation partner with Cadwalader, Wickersham & Taft LLP in Washington, DC and New York. He focuses on representing companies, financial institutions, boards of directors, and audit committees and individuals in internal investigations and enforcement actions initiated by the Securities and Exchange Commission and the Department of Justice. He also represents companies in private securities litigation. Prior to joining Cadwalader, Wickersham & Taft LLP, he served as enforcement counsel to two SEC commissioners and as assistant director and deputy general counsel of the Financial Crisis Inquiry Commission.
Douglas Fischer is an associate with Cadwalader, Wickersham & Taft LLP in Washington, DC. He represents companies and individuals in SEC and Department of Justice actions and in internal investigations.
Suggested citation: Bradley Bondi & Douglas Fischer, Citigroup Ruling Has Serious Implications for SEC Settlements, JURIST - Sidebar, Jan. 16, 2012, http://jurist.org/sidebar/2012/01/bondi-fischer-sec-citigroup.php.
This article was prepared for publication by Stephen Krug, an assistant editor for JURIST's professional commentary service. Please direct any questions or comments to him at firstname.lastname@example.org