“Trials are primarily about the truth. Consent decrees are primarily about pragmatism.” Appellate Panel Opinion, Second Circuit Court of Appeals in United States Securities and Exchange Commission vs. Citigroup Global Markets, Inc.
As the Big Bank settlements and stipulated decrees have continued to fill the financial pages over the last few years, most Americans have grown ambivalent about their habit of leaving federal courthouses after paying huge fines, but declining to admit they had broken any laws. The rationale for permitting them to do so is a concession by prosecutors in deference to Wall Street’s fear that such admissions would open the floodgates to litigation from shareholder groups. Apparently, it’s one thing to admit you were caught with your hand in the cookie jar, but quite another to admit that cookie theft is wrong.
However, recently, we have been reminded of a particular federal judge who, like Howard Beale, the fictional newsman in Network, was “Mad as hell” and “Not going to take this anymore!” Here’s the back story:
In 2011, the SEC filed a 21-page complaint against banking behemoth, Citigroup, accusing it of fraudulently telling investors that the CDO[1] fund it was selling them consisted of assets that had been selected by independent investment advisors. However, according to its Consent Decree, it turns out that Citi had not only participated in the selection process – but, adding insult to injury, had also bet against the investment by taking short positions in the fund. In other words, after cherry picking the losers, Citi bet it would fail, and stood to make a profit if it did. As it turns out, Citi pocketed $160 million by shorting the faux “independently selected” assets it had induced its investors to take long positions in [meaning the investors would profit only if the fund increased in value]. At the time of entry of plea, the SEC, following it’s standard practice, agreed that Citi could stipulate that it neither admitted nor denied any wrongdoing.
Enter Federal Judge Jed S. Rakoff, a former federal prosecutor, and, by all reports, a bit of an iconoclast. In October 2011, when the SEC and Citi attorneys appeared before him stipulating to $285 million in fees and fines for civil fraud, they sought to “neither admit nor deny” any violation of the law. In calling the $285 million “pocket change,” Judge Rakoff rejected the deal.
According to a recent article about Citi’s October 2011 court appearance in JDSupra® Business Advisor, attorney David Smyth said: “Judge Rakoff had a fit, and a lot of questions. Among them”:
- Why should the Court impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?
- How was the amount of the proposed judgment determined?
- How does the SEC ensure compliance with the proposed injunctive relief?
- Why would the penalty be paid by Citi and its shareholders rather than the culpable individuals involved?
- How could a securities fraud of this nature and magnitude be the result of mere negligence?
The SEC took the position that the Judge exceeded his authority by insisting on such information as a condition to accepting the plea. The case was immediately appealed to the U.S. Court of Appeals for the Second Circuit, keeping Wall Street lawyers and lenders waiting for an opinion over the next 2 ½ years.
On Wednesday, June 4, 2014, we learned that the appellate court overturned Judge Rakoff. According to a recent New York Times article about the decision, the Court:
…concluded that Judge Rakoff ‘abused’ his discretion ‘by applying an incorrect legal standard’ to the case. The court sent the case back to Judge Rakoff, who is expected to eventually approve the deal.
However, the appellate court, in an apparent tip of the hat to Judge Rakoff’s chutzpah, the Times noted that:
On remand, if the district court finds it necessary, it may ask the S.E.C. and Citigroup to provide additional information sufficient to allay any concerns the district court may have regarding improper collusion” between Citigroup and the S.E.C., the appellate court said in its ruling, written by Judge Pooler.
The Rakoff Effect. According to the Times article:
No judge likes a higher court rebuke. But Judge Rakoff’s effort was not in vain.
His standoff with the S.E.C. inspired other judges to question a handful of securities cases. And to critics of Wall Street, the judge became something of a celebrity, a representative of the effort to crack down on Wall Street misdeeds. Rolling Stone declared him “a sort of legal hero of our time.”
The S.E.C., under its chairwoman, Mary Jo White, has pursued a course change of its own after Judge Rakoff’s decisions. Last year, the agency reversed its longstanding yet unofficial policy of allowing companies to neither “admit nor deny wrongdoing,” signaling that it would force admissions in particularly egregious cases.
While conceding that Judge Rakoff had found an “overriding public interest in knowing the truth,” the Second Circuit concluded in a pithy observation that:
Trials are primarily about the truth. Consent decrees are primarily about pragmatism.
However, in an interesting and frequently echoed observation about Judge Rakoff’s refusal to blindly accept the plea deal without knowing more details, attorney Benjamin Coulter noted in his JDSupra article:
The SEC was probably right to give itself some flexibility on its settlement policy. It can be a hidebound institution when left to its own devices. And I suspect its leaders are happy tonight knowing that district courts have a bit less flexibility in assessing those settlements going forward. But make no mistake. By letting this final opinion sit for as long as it did, the Second Circuit gave the win to Judge Rakoff. It’s a different world now thanks to his overreaching approach to the Citi case. Funny how things work out.
For a closer look at Judge Rakoff’s thinking about why the top brass at the Big Banks don’t go to jail, see his article in the New York Review of Books here. ~PCQ
[1] Collateralized Debt Obligations – A generic term used to describe any security that collateralizes the cash flows generated by an aggregated pool of debt obligations. If the securitized pool consists of mortgages, it is generically called a “Collateralized Mortgage Obligation” or “CMO.” If the mortgages are commercial in nature, it’s a “Commercial Mortgage-Backed Security” or “CMBS.” If the mortgages are residential in nature, it’s a “Residential Mortgage-Backed Security” or “RMBS.” See, Q-Law Glossary.
