On 15 March, the 2^nd Circuit Court of Appeals in New York derailed a judicial attempt in SEC v. Citigroup Global Markets Inc. to force the SEC to explain how the public interest was protected by entering into a ‘neither admit nor deny’ settlement agreement. The appeal was allowed on the basis that Judge Jed Rakoff, of the Southern District of New York, overstepped his judicial authority by placing a limit on the administrative discretion of an agency of the executive branch, the appeals court stating: “…we have no reason to doubt the SEC’s representation that the settlement it reached is in the public interest.” This case is a pertinent example of how the SEC would rather fight to protect 40 years of tepid enforcement policy than provide the judiciary with ‘proven or admitted facts’ which evidence thorough public interest considerations.

The well established standard of review for judicial approval of settlement agreements is whether they are “fair, reasonable, adequate and in the public interest.” Although the law requires the federal judge to give substantial deference to the SEC, case law provides that when considering whether an administrative sanction serves the public interest, the SEC, in exercising its discretion, is to consider the six elements identified in Steadman v. SEC: (i) the egregiousness of a respondent’s conduct; (ii) the isolated or recurrent nature of the violation; (iii) the degree of scienter; (iv) the sincerity of the respondent’s assurances against future violations; (v) the respondent’s recognition that the conduct was wrongful; and (vi) the likelihood of recurring violations. When viewed against this criteria, the facts of the case strongly suggest that the SEC may not have exercised its discretion appropriately and Judge Rakoff was correct in refusing the settlement agreement.

First, the settlement agreement related to an SEC charge that in 2007 Citigroup negligently sold a $1 billion mortgage securities fund to investors and then bet against the investments because it believed that they were junk and would lose value. The parallel complaint against Citigroup employee Brian Stoker alleged that Citigroup “…knew it would be difficult to place the liabilities of [the Fund] if it disclosed to investors its intention to use the vehicle to short a hand-picked set of [poorly rated assets].” Judge Rakoff notes that this is tantamount to an allegation of ‘knowing and fraudulent intent’, aka. scienter. He further found “…little real doubt that Citigroup contests the factual allegations of the Complaint.” Citigroup made $160 million from the deal. Investors lost $700 million. While the injunctive relief requested in settlement agreements is a deterrence strategy,  Judge Rakoff notes that Citigroup is already a repeat offender and that the SEC has not sought to enforce such injunctive relief against any financial institution for the past 10 years.

Although the appeals court has signaled that Judge Rakoff’s decision will eventually be set aside, when viewed against the Steadman v. SEC criteria of a ‘public interest’ determination, the facts show that the SEC’s exercise of its discretion to settle with Citigroup in this case was misguided at best. Further, it is difficult to accept how the public interest is being served when the terms of the settlement agreement do not commit the SEC to return any of the $285 million settlement to defrauded investors and the charges brought by the SEC effectively act as a bar to private enforcement actions. Further, as Judge Rakoff notes, by charging Citigroup with negligence and permitting settlement without admitting or denying the charges prevents private litigation since private investors cannot bring securities claims based on negligence nor can they use the terms of settlement agreements as the basis of any actions. As guardian of the US securities markets, has the SEC protected investors and the public interest? You be the judge.