Appeal Sets Stage For Showdown On SEC's 'Neither Admit Nor Deny' Settlement Policy

After U.S. District Judge Jed Rakoff's November 28, 2011 decision rejecting the proposed $285 million settlement between the SEC and Citigroup, observers wondered whether the SEC would present the judge a revised settlement that might cure what the judge saw as the proposed consent decree's deficiencies. An appeal was viewed widely as a dangerous proposition that could lead to even worse precedent for the SEC. On December 15, 2011, the SEC ended the speculation and appealed Judge Rakoff's decision. Thus, the United States Court of Appeals for the Second Circuit may soon decide whether the SEC's long-standing practice of entering into settlements with defendants that "neither admit nor deny" the SEC's allegations is appropriate.

The District Court Opinion

In early 2007, Citigroup created a $1 billion fund known as Class V Funding III (Fund) that allegedly sought to "dump" some toxic mortgage-backed securities on "misinformed investors." SEC v. Citigroup Global Markets, Inc., --- F. Supp. 2d ----, 2011 WL 5903733, *1 (S.D.N.Y., November 28, 2011). While promoting the Fund's assets as "attractive investments rigorously selected by an independent investment adviser," Citigroup allegedly selected a substantial amount of negatively performing assets for inclusion in the Fund and then took a short position in those assets. Investors in the Fund lost more than $700 million, while Citigroup reaped net profits of approximately $160 million. Id. at *2.

After a lengthy investigation, the SEC brought a civil enforcement action on October 19, 2011, seeking an injunction and alleging that Citigroup had violated Sections 17(a)(2) and (3) of the Securities Act of 1933 — violations that require a showing of negligence, not knowing or reckless misconduct. That same day (before knowing that the matter would be assigned to Judge Rakoff), the SEC submitted for court approval a proposed consent judgment that required Citigroup, while neither admitting nor denying the SEC's allegations, to (1) disgorge $160 million of ill-gotten gains along with $30 million in pre-judgment interest, (2) pay a civil penalty of $95 million, and (3) comply with certain remedial undertakings for a period of three years that would prevent control weaknesses. Asserting that the proposed settlement was "fair, adequate, reasonable, and in the public interest," the SEC and Citigroup asked the court to approve the proposed settlement.

To assess whether the settlement was "fair, reasonable, adequate, and in the public interest," Judge Rakoff posed several questions regarding the details of the allegations and the proposed consent judgment, and both parties submitted lengthy memoranda supporting the proposed consent judgment. Judge...