SEC And Regulatory Settlements: A New Era?

In late 2011, the Securities and Exchange Commission (SEC) sued Citigroup Global Markets (Citigroup) in connection with its 2007 structuring and marketing of a $1 billion CDO. That same day it announced a proposed agreement to settle the matter for $285 million and other relief. Neither event was particularly remarkable. Ninety percent of SEC cases are resolved by settlement, and nine-figure SEC settlements are no longer out of the ordinary. Nor was it unusual for the SEC to announce the lawsuit and settlement simultaneously. Corporations frequently cooperate with the SEC during the agency's pre-filing investigations, and part of that process often involves a negotiated resolution prior to the formal filing of a claim.

What was noteworthy is what did — or didn't — happen next. Calling it unfair, unreasonable, inadequate, and not in the public's interest, United States District Court Judge Jed Rakoff rejected the settlement in an opinion that has generated widespread attention and concern in the legal and business communities. See Opinion and Order, SEC v. Citigroup Global Mkts. Inc., 2011 U.S. Dist. LEXIS 135914 (S.D.N.Y., Nov. 28, 2011) (Citigroup). Does this provocative decision signal a new, more stringent, and more disconcerting standard in settling regulatory enforcement actions?

The Role of the Court

In most civil actions, a court is not required to approve a settlement. In general, the federal rules require the court to enter judgment when parties agree on settlement terms before trial. Fed.R.Civ.P. 68. However, settlements in certain cases — frequently those involving shareholders and regulators — do require court approval. For example, settlements in representative class and derivative actions are conditioned on court approval "only after a hearing and on finding that [they are] fair, reasonable, and adequate." Fed.R.Civ.P. 23(e), 23.1(c). Because of inherent conflicts of interest and the possibility of collusive settlements, the law has long required court approval in similar cases involving trustees and guardians in order to protect incompetent or absent parties. See Hon. Jed S. Rakoff, Are Settlements Sacrosanct? 37 ABA Litigation J. no. 4 at 16 (Summer 2011) (Are Settlements Sacrosanct?).

The requirement of court approval for settlements in cases involving regulators such as the SEC, however, rests on a different footing. There is little need for a court to be concerned that sophisticated and well-represented parties such the SEC or large corporations are unable to determine whether a settlement is in their best interests. Instead, court approval in these cases is required because the settlement terms invoke the court's continuing jurisdiction. These terms typically include injunctive relief, which subjects the parties to the court's power to enforce the settlement's non-monetary provisions, such as a defendant's promise to implement certain corporate governance measures or not to violate the securities laws in the future. Thus the court itself essentially becomes a party to the settlement. See Citigroup, 2011 U.S. Dist. LEXIS 135914 at *10 ("a public agency asks a court to become its partner in enforcement" when it seeks injunctive remedies). The court order approving the settlement is generally embodied in a consent judgment or decree, which allows the agreement to be enforced by judicial oversight and sanctions. Injunctive relief, and thus consent judgments, have long been favored by administrative agencies like the SEC. See 15 U.S.C. §78u(d); SEC v. Vitesse Semicondutor Corp., 771 F. Supp. 2d 304, 308 (S.D.N.Y. 2011) (prior to 1972, SEC's enforcement powers largely limited to injunctive relief).

In evaluating a proposed SEC settlement, the court examines the agreement not only for its fairness, reasonableness, and adequacy but also for whether its terms are in the public's interest. See, e.g., S.E.C. v. Bank of America, 653 F. Supp. 2d 507, 508 (S.D.N.Y. 2009). To a large extent, these factors all merger together. See Citigroup, 2011 U.S. Dist. LEXIS 135914 at * 9 (consideration of the public interest is not "meaningfully severable from the requirements ... that the consent judgment be fair, reasonable, and adequate; for all these requirements inform each other"). This "public interest" aspect traces its roots at least to the 1970s and has been used in courts' analyses of proposed settlements in a variety of cases, including antitrust, environmental, civil rights, and trade regulation suits. See, e.g., United States v. Miami, 614 F.2d 1322, 1333 (5th Cir. 1980) (Title VII); FTC v. Onkyo U.S.A. Corp., 1995 U.S. Dist. LEXIS 21222 (D.D.C. 1998);United States v. Hooker Chemicals & Plastics Corp., 540 F. Supp. 1067, 1072 (W.D.N.Y. 1982) (environmental); 15 U.S.C. § 16(b)-(d) (antitrust); see also Citigroup, 2011 U.S. Dist. LEXIS 135914 at *7 ("The Supreme Court has repeatedly made clear . . . that a court cannot grant the extraordinary remedy of injunctive relief without considering the public interest.") (citation omitted).

In evaluating a proposed settlement, it is not the court's role to resolve the merits of the dispute or to drive the parties to what it thinks is the best bargain. See United States v. Cannons Engineering Corp., 899 F.2d 79, 84 (1st Cir. 1990) ("The relevant standard . . . is not whether the settlement is one which the court itself might have fashioned, or considers as ideal...."); SEC v. Randolph, 736 F.2d 525, 529 (9th Cir. 1984) (approval should not be conditioned on what the court considers "to be the public's best interest") (emphasis in original); Citizens for a Better Env't v. Gorsuch, 718...