In a rebuke to the SEC, on Monday, November 29, 2011, U.S. District Court Judge Jed Rakoff (SDNY) refused to sign a consent judgment approving a $285 million settlement between the Agency and Citigroup.  At issue is a lawsuit filed in October 2011 by the SEC alleging that Citigroup created and sold mortgage bond investments without disclosing to investors that the people assembling the deal were betting against the performance of the securities.  As a result, Citigroup allegedly reaped a $160 million profit from the sale while investors lost more than $700 billion.  On the same day the Agency filed suit, the SEC filed a consent agreement whereby Citigroup agreed to disgorge the $160 million plus $30 million in interest, pay a civil penalty of $95 million, and undertake internal measures designed to prevent recurrences of the securities fraud alleged.  Under the agreement, Citigroup neither admits nor denies the SEC’s allegations, a longstanding practice by the SEC. 

Judge Rakoff’s opinion is significant because the SEC has routinely sought settlements similar to this one, whereby the defendant neither admits nor denies the SEC’s allegations of wrongdoing in exchange for a fine and/or injunctive relief.  Judges have generally signed off on such agreements as a matter of course.  However, it is precisely this practice that Judge Rakoff now finds offensive.  His 15-page opinion calls the entering into such an agreement, whereby a defendant neither admits nor denies allegations, “hallowed by history, but not by reason,” and ruled that he could not sign off on such an agreement because a judge must have some facts upon which to exercise “even a modest degree of independent judgment.”  Without such independent judgment, he refused to sign the consent agreement.

Traditionally, the SEC has arranged settlements such as the agreement with Citigroup because doing so allows the Agency to declare victory without having to devote the considerable time and money it would take to take the same matter to trial.  Requiring an admission of wrongdoing, which Defendants are reluctant to do, would decrease settlements and increase the number of trials.  Thus, if Judge Rakoff’s opinion gains traction, the SEC will have to dramatically shift how it uses its resources, with broad implications for the Agency and Defendants alike. 

In the meantime, as Kevin LaCroix at the D&O Diary notes, the SEC and Citigroup will likely have to work out a deal omitting the “admits or denies” language, and Citigroup will probably have to make a greater monetary contribution before a proposed settlement passes Judge Rakoff’s scrutiny.  Meanwhile, the clock is ticking; trial is scheduled for July 16, 2012.