Second Circuit Mixes Clarity with Opacity in Ruling on Trial Courts’ Review of SEC Settlement

MatskoGuest Commentary

by Gary S. Matsko, Davis Malm & D’Agostine P.C.

It is curious how an appellate court can resolve cases before it in a manner and spirit that are vastly at odds with the driving philosophy behind the lower court’s decision. The U.S. Court of Appeals for the Second Circuit’s decision in United States Securities and Exchange Commission v. CitiGroup Global Markets, Inc.is such a case. Judge Jed Rakoff’s decision below, S.E.C. v. CitiGroup Global Markets, Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011), in which he declined to enter a consent decree that resulted from settlement negotiations, was driven by the judge’s intense displeasure that the settlement presented to him failed to include an admission of guilty. The decision emboldened advocates who believed that the SEC should require admissions, and likely played a role in the agency announcing that it would so require them in certain matters.

The counsel appointed to represent Judge Rakoff’s view in the Second Circuit did not forcefully argue that a trial court could require admission as a predicate to approving settlement. The Second Circuit thus curtly brushed that perspective aside. Instead, the appellate court clipped the wings of trial judges who embrace an expansive substantive role for courts in reviewing consent decrees, underscoring the deference owed to a prosecuting agency. Despite that distinct conclusion, CitiGroup Global Markets did not offer clear guidance on the trial court’s role in assessing facts, and, surprisingly, invited the SEC to turn to its administrative forum if it is unhappy with the remaining limited intervention reserved to the trial judge.

The Second Circuit imposed substantial limitations on court review of proposed consent decrees. The decision eliminates “adequacy” of the settlement as a factor to be considered. Whether the settlement terms are sufficiently exacting is left solely to the agency. The decision permits trial judges to determine whether a proposed settlement is “fair and reasonable” but sharply limits that inquiry to whether the consent decree is “procedurally proper.” That is to say, the trial judge must determine if the relief is within the court’s jurisdiction to issue, within the allegations of the complaint, and within the purpose of the implicated law. To the extent a consent decree involves the entry of an injunction, there is a public interest consideration, but it is limited to determining that the “public interest would not be disserved.” The prosecuting agency should determine whether the consent decree best serves the public interest. The trial judge may find the public interest disserved, by way of example, if the decree were to prevent private litigants from asserting their own claims against the defendant. The public interest evaluation is clearly a limited one, and it is unlikely to be a valid obstacle to successfully entering a consent decree.

In contrast to the Second Circuit’s clarity on trial judges’ assessment of settlement terms, the court was far more opaque regarding that judge’s role in evaluating a settlement’s underlying facts. The Second Circuit ruled that a district court will have to determine that a factual basis exists for the proposed decree. It suggested that when the defendant consents without admitting or denying, that consent along with the allegations of the complaint may serve to satisfy the factual inquiry. CitiGroup Global Markets, however, applies to review of decrees entered into by agencies other than the SEC. Some of those agencies permit settling defendants to deny the allegations while agreeing to the decree. Will the agency’s allegations in that setting be adequate to satisfy the factual review? If not, what other process will fill the gap? Moreover, while suggesting, as an example, that further factual inquiry may be required where the court suspects the proposed decree is the product of improper collusion between the defendant and the government, the Second Circuit declined to offer guidance as to what might be a sufficient factual record to permit approval of a consent decree. It is likely that this opening will result in road blocks to the approval of settlement acceptable to the parties.

The closing paragraph of CitiGroup Global Markets is surprising and a little troubling. After the court rendered a decision that appeared to be a complete win for the SEC, it invited the agency to resort to its administrative forum instead of the federal courts if it is unhappy with the remaining role reserved to the trial judge. The agency should decline this invitation in the future. By bringing enforcement actions administratively, the SEC eliminates a defendant’s right to a jury, affords it less robust discovery, and sends it to a forum where the SEC is judge, prosecutor and executioner.

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