After the October 19, 2011 news that Citigroup  had reached an agreement to pay $285 million settle SEC charges that it had misled investors in a $1 billion collateralized debt obligation linked to risky mortgages, a number of commentators raised questions about the settlement.


Among other concerns noted was that neither the SEC’s action nor settlement targeted or even identified the senior level executives who were responsible for the alleged misconduct. The proposed settlement was also compared unfavorably with the much larger settlement amount to which Goldman Sachs had agreed to pay to settle similar allegations. Commentators also noted that though upper level executives were not charged in the action, like the Goldman case a lower level operative was targeted, seemingly for having had the misfortune of having sent an indiscrete email. A particularly good critique of the settlement appears in Jesse Eisenger’s October 26, 2011 post on the New York Times Dealbook blog (here).


As luck would have it, the settlement (supposedly as a result of a random lottery) landed on the desk of Southern District of New York Judge Jed Rakoff, who famously refused to accept a prior settlement of the SEC”s action against BofA (about which refer here). In March 2011, Rakoff also challenged the SEC’s settlement with Vitesse Semiconductor (about which refer here).


As it turns out, Judge Rakoff has some questions about this settlement, too – nine of them, to be precise.


In a very pointed October 27, 2011 order (here), Judge Rakoff scheduled a November 9, 2011 hearing at which the parties were directed to be prepared to answer nine specific questions about the settlement. He also said that the parties were “permitted, but not required” to file written answers to his questions in advance of the hearing.


Among other things, Rakoff has asked why he should enter judgment in a case “In which the S.E.C. alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?” He also asked whether the SEC’s mandate to ensure transparency in the financial markets might provide “an overriding public interest in determining whether the S.E.C.’s charges are true,” particularly “when there is no parallel criminal case?”


Like many of the commentators, Judge Rakoff also viewed this proposed settlement in contrast to the $535 million Goldman Sachs settlement. He asked specifically how the $95 million penalty portion of the proposed $285 million settlement was calculated, given that it is “less than one-fifth” of the penalty assessed in the Goldman Sachs case.  


Judge Rakoff also questioned why the penalty is to be “paid in large part by Citgroup and its shareholders rather than by the ‘culpable individual offenders acting for the corporation.’”


The most challenging question Rakoff posed was his final query: “How can a securities fraud of this nature and magnitude be the result simply of negligence?”


Many of Judge Rakoff’s questions might well be asked in connection with many SEC enforcement action settlements, in which corporate parties routinely settle the action pay paying specified sums out of corporate resources without admitting or denying wrongdoing. However, the parties to these settlements are rarely challenged as Judge Rakoff has challenged the parties here to justify the settlement. However it is worth noting that Judge Rakoff asked several similarly challenging questions when he rejected the BofA settlement in 2009, but he ultimately (“reluctantly”) approved a revised settlement that arguably presented many of the same features of the original settlement. (Judge Rakoff discussed the BofA settlement in a speech at the Stanford Directors’ College in June 2010, as noted here.)


There will be those who believe that it is about time that somebody started asking these kinds of questions. But at the same time, it is worth noting that if companies must admit to wrongdoing in order to settle SEC enforcement actions, or if senior executives’ complicity must be alleged or even established in order for a settlement to be approved, it will be far more difficult for SEC enforcement actions to be resolved. Indeed, one clear implication if more courts start asking these kinds of questions about proposed SEC enforcement action settlements is that fewer cases will settle and more will have to go to trial. Even if more trials would advance the truth-telling function of SEC enforcement, it would also add enormous costs both for the SEC and for the corporate defendants. Whether the SEC could sustain the same level of enforcement activity if it had to absorb the added burdens and expense involved with more trials is one question. The added burden and expense for the corporate defendants presents other questions.


As noted in a guest post on this blog by Maurice Pesso of the White & Williams firm (here), the potential barriers to settlement posed by the kinds of questions Judge Rakoff has asked here may also present some significant challenges for D&O insurers, who often are paying the costs of defense associated with SEC enforcement actions.


An October 27, 2011 Bloomberg article discussing Judge Rakoff’s questions about the Citigroup settlement can be found here. Peter Lattman’s October 27, 2011 post on the New York Times Dealbook blog about Rakoff’s questions can be found here.