In a sharply worded March 15, 2012  per curiam opinion (here), a three-judge panel of the Second Circuit granted the motions of Citigroup and the SEC to stay district court proceedings in the SEC’s enforcement action against the company, so that the appellate court could consider the merits of the question of whether or not Judge Rakoff had properly rejected the parties’ $285 million settlement agreement.


While the Second Circuit did not rule that Judge Rakoff’s rejection of the settlement was improper, in concluding that that there was a substantial likelihood the parties would prevail on the merits on that question, the three-judge panel expressly rejected the reasoning on which Judge Rakoff had declined to approve the settlement.


In its enforcement action, the SEC alleged that Citgroup had made misrepresentations in its marketing of collateralized debt obligations. At the same time the SEC filed its complaint, the parties filed a consent judgment for court approval. Among other things, Citigroup agreed to pay $285 million into a fund to be distributed to CDO investors.


In a November 28, 2011 order (about which refer here), Judge Rakoff rejected the proposed settlement, holding that it was not fair, adequate, reasonable, or in the public interest because Citigroup had not admitted or denied the SEC’s allegations. Among other things, Judge Rakoff contended that without the admission of liability he was not in a position to assess the settlement. He also characterized the $285 million settlement as “pocket change” for Citigroup. Judge Rakoff put the action on track for trial on the merits. The parties jointly filed motions with the Second Circuit seeking to stay the District Court proceedings and for an interlocutory appeal of Judge Rakoff’s rejection of the settlement.


The three judge panel granted the motions to stay and for interlocutory appeal, finding that the parties had carried their burden of showing a substantial likelihood of success on the merits on appeal. In concluding that the parties had carried their burden, the three judge panel considered and rejected each of the three bases on which Judge Rakoff had based his decision to reject the settlement.


First, the three-judge panel rejected Judge Rakoff’s conclusion that the settlement without an admission of liability represented bad policy and failed to serve the public interest because defrauded investors could not use the settlement  against Citigroup in separate shareholder lawsuits. The three-judge panel said that this reasoning “prejudges the fact that Citigroup had in fact misled investors, and assumes that the SEC would succeed at trial in proving Citigroup’s liability.”


The three-judge panel was even more concerned that in rejecting the settlement on this basis, Judge Rakoff failed to give deference to the SEC on what the three-judge panel called a “wholly discretionary matter of policy.” It is not, the three-judge panel said, “the proper function of federal courts to dictate policy to executive agencies.” Nevertheless, the three-judge panel concluded, “the district court imposed what it considered to be the best policy to enforce the securities laws.”


The three-judge panel added that it questioned “the district court’s apparent view that the public interest is disserved by an agency settlement that does not require the defendant’s admission of liability. Requiring such an admission would in most cases undermine any chance of compromise.”


Second, the three-judge panel considered and rejected Judge Rakoff’s reasoning that he must decline to accept the settlement because it is unfair to Citigroup. The three-judge panel questioned “whether it is a proper part of a court’s legitimate concern to protect a private, sophisticated, counseled litigant from a settlement to which it freely consents.” The panel added that “we doubt that a court’s discretion extend to refusing to allow such a litigant to reach a voluntary settlement in which it gives up things of value without admitting liability.”


Third, the three-judge panel rejected Judge Rakoff’s reasoning that without an admission he lacked a basis on which to assess the fairness of the settlement. The panel said that this reasoning disregarded the substantial record the SEC had amassed over its investigation. The panel added that “the court was free to assess the available evidence and to ask the parties for guidance as to how the evidence supported the proposed consent judgment.”


The panel went on to reject Judge Rakoff’s suggestion that without an admission of liability that the settlement was somehow inherently unfair. The pane said that this is “tantamount” to a ruling that without an admission of liability “a court will not approve a settlement that represents a compromise,” adding that:


It is commonplace for settlements to include no binding admission of liability. A settlement is by definition a compromise. We know of no precedent that supports the proposition that a settlement will not be found to be fair, adequate, reasonable, or in the public interest unless liability has been conceded or proved ….We doubt whether it lies within a court’s proper discretion to reject a settlement on the basis that liability has not been conclusively determined.


Having concluded that the parties had established a substantial likelihood of success on the merits, the three-judge panel went on to consider the likelihood of harm to the parties of the stay is not granted. In reaching a conclusion of the likelihood of harm, the panel noted that the “the district court’s rejection of the settlement cannot be cured by the parties returning to the bargaining table to make relatively minor adjustments to the terms of the settlement to address the court’s concerns,” a circumstance that “substantially reduces the possibilities of the parties reaching settlement.”


Finally, in concluding that the public interest would be served by granting the stay, the three-judge panel noted the SEC asserts that both the settlement and the stay would serve the public interest, about which the panel said “we are bound in such matters to give deference to an executive agency’s assessment of the public interest.” This does not mean, the panel said, that a court “must necessarily rubber stamp” an agency’s positions, but it does mean that “a court should not reject the agency’s assessment without substantial reason.” The panel added that “we have no reason to doubt the SEC’s representation that the settlement it reached is in the public interest.”


The three judge panel did note the rather anomalous circumstance that because Citigroup and SEC had both filed motions to stay and for interlocutory appeal, the adversarial position had not been presented. In order to ensure that the adversarial position would be represented on appeal, the three-judge panel directed the Court’s clerk to appoint counsel for the consideration of the merits.



The three-judge panel was careful to note that it did not rule on the question of whether or not Judge Rakoff had improperly rejected the settlement. It noted that its reasoning was not preclusive on the merits panel. It is in fact possible, at least as a theoretical matter, that on further proceedings and with skilled counsel engaged to argue the “adversarial position,” that a different panel might reach a different conclusion about Judge Rakoff’s rejection of the settlement.


The strong likelihood is that the merits panel will reach the same conclusion as the three-judge panel. The conclusion in the panel’s opinion that Judge Rakoff had failed to allow appropriate deference to the SEC (by contrast to the panel’s own exceptional deference to the agency) seems likely to be taken up by the merits panel. In addition, that there is “no precedent” for the conclusion that a court should reject a settlement because it lacked an admission of liability also seems to suggest the likeliest path that the merits panel would take.


Finally, and more importantly, there is a pervasive sense throughout the three judge panel’s opinion that if parties can’t settle without requiring an admission of liability, then parties are unlikely to try to compromise. This practical and common sense observation suggests that the three judge panel saw nothing wrong at any level with a settlement in which there has been no admission of liability. This reasoning may prove to be the most important to the merits panel.


Judge Rakoff’s opinion was emotional, reflected a high moral tone, and bespoke a theoretical consideration of the issues. The three-judge panel’s opinion more practical than theoretical, and reflected a more restrained and deferential conception of the appropriate role of the court in these circumstances. The difference behind these two approaches may be explained by the fact that Judge Rakoff may, as the three-judge panel observed, have “prejudged” the fact that Citigroup had misled investors.


The ultimate outcome of this appeal remains to be seen. However, if the three-judge panel’s view of this case prevails, the demise of the “neither admit nor deny” settlement will be avoided. Some commentators might decry this outcome, but many of the outrage voiced by many of these observers will be based on atheir own presumption that Citigroup had acted improperly. While compromises of disputed claims may be less emotionally satisfying than a determination of fault, the practical reality is that the system might well grind to a halt if parties cannot compromise. Perhaps the most valuable observation of the three-judge panel is that if parties are not free to reach settlements without an admission of liability, then parties will be unlikely to compromise, an outcome that would impose enormous costs on litigants and burdens on courts.


Allison Frankel has a good analysis of the three-judge panel’s opinion on Thimson Reuters News & Insight (here)


Many thanks to the several loyal readers who sent me copies of the three-judge panel’s opinion.