Judge Rakoff v. SEC: Does Ruling Close ‘Loophole’ for Wall Street?

11/30/11

According to the November 29^th wsj.com article, “Citi Ruling Could Chill SEC, Street Legal Pacts”, U.S. District Judge Jed S. Rakoff rejected a nearly $300 million deal made by Citigroup Inc. to settle civil fraud charges filed by the Securities and Exchange Commission, calling it “neither fair, nor reasonable, nor adequate, nor in the public interest.”


However, the deal was agreed upon earlier this year, following the SEC's accusations that Citi had sold investors part and parcel of a $1 billion mortgage bond deal termed Class V Funding III; Citi failed to disclose it was “betting against $500 million of those assets,” per the wsj.com article.

Judge Rakoff is known for speaking out against SEC settlements. In this case, he focused on, per the article, the standard language utilized by the SEC in settlements such as these for nearly fifty years; it could seemingly almost be deemed a ‘loophole' for Wall Street. Per the article, “this standard formula, in which the firm neither admits nor denies wrongdoing, was “hallowed by history, but not by reason,” Judge Rakoff was quoted as saying.

“If the allegations of the complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business,” Judge Rakoff said.

Judge Rakoff also went on to say the advantages were obvious for Wall Street firms, of being allowed to settle allegations of fraud without admitting to any wrongdoing – they could be used in private class action suits.

In addition, Rakoff was quoted as saying, that “other than a quick headline”, it was more difficult to understand how the SEC was benefiting from the deal.

A Citi spokeswoman said in the wsj.com article: “We respectfully disagree with the Court's ruling. We believe the proposed settlement is a fair and reasonable resolution to the SEC's allegation of negligence, which relates to a five-year-old transaction. We also believe the settlement fully complies with long-established legal standards.”

Robert Khuzami, director of enforcement at the SEC, was quoted as having said of Judge Rakoff's ruling that it “ignores decades of established practice throughout federal agencies and decisions of the federal courts.” He is against bringing a case to trial just because a firm refuses to admit to wrongdoing because it would tax the resources of the SEC, and ultimately cause other fraud investigations to suffer.

So, could Judge Rakoff's ruling be setting a major precedent, one that could lead to increased liability for Wall Street, as well as increased legal fees for companies, federal agencies, and an overall impediment to the resolution of securities cases? Some lawyers think so.

Joseph Grundfest, a law professor at Stanford University, and who served as an SEC commissioner for approximately five years, was quoted as saying: “Judge Rakoff's decision will likely be troubling to the entire federal government, and not just the SEC. By his logic, it's hard ever to support any settlement without a trial. So, will the federal courts be jammed with trials so that judges can know the ‘truth' because they are unwilling to accept allegations negotiated in the shadow of a trial?”

However, others, such as John Coffee, a law professor at Columbia University and admitted friend of Judge Rakoff, was quoted as saying: “Federal agencies learn, sometimes painfully, that you can't treat judges as though they're rubber stamps.”

Hear, hear. Judge Rakoff's ruling seems to have a nice ring to it, especially this holiday season. Perhaps it's time for more people to stand up against the nonsensical, Lewis Carol-esque logic to which Wall Street has become desensitized, and has crammed down the country's throats for far too many years. With Dodd-Frank and other reforms coloring the financial landscape, I say, in for a penny, in for a pound.

According to the article, legal experts feel that both the SEC and Citigroup face an immediate problem in response to Judge Rakoff's ruling. Erik Gerding, a law professor at the University of Colorado in Boulder, said: “The SEC is going to be very worried that, if they appeal this, there's the potential to set a precedent that would restrict their use of the ‘neither admit nor deny' formulation, which is their stock in trade for settlements.”

And about time too.