by By Billy Corriher
The Second Circuit Court of Appeals has resurrected a deal between the Securities and Exchange Commission (SEC) and Citigroup to settle fraud charges based on the bank’s sale of certain mortgage-backed securities. District Court Judge Jed Rakoff rejected the settlement deal last fall, ruling that it was contrary to the public interest. The Second Circuit stayed Rakoff’s order and ruled that the parties are likely to prevail in arguing that the judge exceeded his authority. The court characterized Rakoff’s position as requiring an admission of liability to approve the settlement, suggesting he would not “approve a settlement that represents a compromise.” While judges are permitted to disagree with an agency’s decision, the Second Circuit said they need a “substantial reason” to do so.
Rakoff’s battle with the SEC and Citigroup comes amid continuing outrage over banks’ role in the financial crisis and the government’s failure to hold them accountable. Citigroup faces serious allegations: just before the crisis, the bank realized it owned risky mortgage-backed securities, so it set up investment vehicles for them and lied to purchasers about the risk. Citigroup made a $160 million profit by shorting the investments, while investors lost $700 million. Rakoff criticized the SEC’s $95 million penalty as “pocket change” and “a very good deal” for Citigroup. Rakoff previously rejected the SEC’s settlement with Bank of America, only approving it after the penalty went from $33 million to $150 million.
The Second Circuit’s decision delayed the trial, pending a ruling by a three-judge panel on whether Rakoff actually exceeded his authority in rejecting the settlement. Rakoff said the law requires him to determine whether such settlements are in the public interest, and that he could not rule that it was. If Rakoff indeed went too far, it is hard to see what is left of the legal standard that such settlements must be in the public interest.
Unlike most appeals, both parties to this lawsuit were in agreement. They argued Rakoff was wrong to require a tougher settlement. The SEC and Wall Street want these investigations to end. Yet, as Rakoff said, “[I]n any case . . . that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth.” Other judges have followed Rakoff’s lead. The SEC has faced criticism for its response to the financial crisis.
The circuit courts, possibly the Supreme Court, will determine the appropriate role for trial judges in SEC cases. While courts struggle with this question, the public must demand results from the SEC. Congress and the President must ensure the SEC has a clear mission and enough resources for tough enforcement. We should consider making the agency more accountable to political leaders. The public is still angry that Wall Street wrecked the economy, and Rakoff is right that these settlements constitute “half-baked justice.”