In Wake of Citigroup Ruling, SEC Seeks Statutory Changes
- As widely reported, Federal Judge Jed Rakoff has refused to approve a consent judgment sought by the Securities and Exchange Commission. SEC v. Citigroup Global Markets, No. 1:11-cv-07387 (S.D.N.Y. Nov. 28, 2011). Following the court's ruling, which if followed by other courts would make it more difficult for the SEC to obtain consent judgments, SEC Chairman Schapiro has sent a letter for key congressmen that urges statutory enhancements to the penalty provisions of the securities laws.
According to the SEC's allegations as summarized by Judge Rakoff, Citigroup created a billion-dollar fund of mortgage-backed securities and misrepresented to investors that the fund's assets were attractive investments rigorously selected by an independent investment adviser, whereas in fact Citigroup had arranged to include in the portfolio a substantial percentage of negatively projected assets and had then taken a short position in those very assets it had helped select. The proposed consent judgment would have provided for disgorgement of $160 million in profits, plus $30 million interest, and a civil penalty of $95 million, as well as internal measures to prevent recurrences and, significantly, a permanent injunction against future violations. Consistent with the usual SEC practice, Citigroup neither admitted nor denied the SEC allegations. In practical effect, this would leave Citigroup largely unable to contest the allegations against it in the media, but free to make whatever arguments it pleases in subsequent litigation brought by private parties.
Judge Rakoff ruled that before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest. This, he concluded, he could not do, because he could not rely on allegations that are not admitted by the defendant, and the court was left without a sufficient evidentiary basis to know whether the requested relief was justified under any of these standards. He therefore set the case for trial on July 16, 2012, to be consolidated with a companion SEC action against a Citigroup employee who is actively contesting the SEC's allegations. Robert Khuzami, Director of the SEC's Division of Enforcement, issued a statement arguing that the practice of settling cases without a defendant's admission of wrongful conduct has significant advantages and is widely accepted. He said that the SEC will continue to review the court's ruling and take those steps that best serve the interests of investors.
Khuzami is undoubtedly right that Judge Rakoff's opinion is an outlier. Thousands of consent judgments, in actions brought by the SEC and by other federal regulators, have been entered on the basis of facts that were neither admitted nor denied by the defendants. Judge Rakoff's opinion implies that all of those settlements were improperly approved. If there are any precedents supporting his view, he did not cite them in his opinion. Still, Judge Rakoff's opinion is eloquently written and gives close attention to an issue that other courts generally have ignored, so it could be influential. If so, that will give the SEC a strong incentive to bring enforcement actions as administrative proceedings, which do not require court approval. Under current law, however, while the SEC can obtain disgorgement and injunctive relief in an administrative proceeding, it is limited in the amount of monetary penalties it can obtain.
Chairman Schapiro on Monday sent a letter to two key Senators, arguing for several enhancements to the SEC's statutory authority to obtain civil monetary penalties for securities law violations. Schapiro's letter does not mention the Citigroup case and may have been written before Judge Rakoff's order was released, but it responds to several concerns raised by his order. Perhaps most significantly, the letter's approach would allow for the same monetary penalty relief in administrative proceedings as in court actions. Among other changes, the letter also argues for authorizing a monetary penalty based on investor losses (which can be much greater than the defendant's profit); allowing penalties equal to three times the gross amount of pecuniary gain for tier three violations (the most serious kind); and providing for civil penalties against recidivists. Schapiro said she has asked her staff to prepare draft legislative language.
Judge Rakoff's opinion is available online at
For Khuzami's statement in response, see
I have placed a copy of Chairman Schapiro's letter on the FundLaw website (free registration with Yahoo Groups may be required), and it is available at
John M. Baker <JMB@...>
Stradley Ronon Stevens & Young, LLP http://www.stradley.com
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
FundLaw Listowner http://groups.yahoo.com/group/fundlaw