Legal Developments in Securities Law

Federal Judge Critiques SEC’s Proposed Settlement with Citigroup

Could Force SEC to be More Aggressive in the Future

This blog post references Peter Latman’s NY Times article, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement,” found here.

Yesterday, the Securities and Exchange Commission (“SEC”) was asked by Judge Rakoff to defend its proposed settlement with Citigroup Global Markets, Inc. (“Citigroup”) based on its structuring and marketing of a largely synthetic collateralized debt obligation. Specifically, the SEC alleged that Citigroup negligently misrepresented key deal terms, such as its own financial interest in the transaction and that Citigroup had exercised significant influence over the selection of assets.

Judge Rakoff questioned the SEC’s decision to accept a settlement of $285 million, while indicating that the SEC estimated that investors lost close to a total of $700 million in the investments. Judge Rakoff was equally inquisitive about the SEC’s injunction, to bar Citigroup from violating securities laws in the future. Notably, the Judge asked, “Why do you ask for an injunction when you never use it?”  The SEC can file civil contempt proceedings if an organization or individual under an injunction not to violate securities laws in fact violates securities laws again in the future.  Notably, no such charges have been brought in the last ten years.  Such injunctive relief has been the subject of ridicule in the past – it is axiomatic that an organization or an individual is prohibited by law from violating securities laws. As is standard with settlements with the SEC, the entity or individual involved does not admit or deny any wrongdoing with regard to the allegations.  Judge Rakoff likewise questioned Citigroup’s unwillingness to admit liability in this matter.

Some may remember that Judge Rakoff likewise questioned the SEC’s proposed settlement with Bank of America concerning whether Bank of America misled investors about its acquisition of Merrill Lynch.  There, Judge Rakoff initially rejected a $33 million settlement proposal, and later reluctantly accepted a revised settlement for $150 million.

Judge Rakoff’s refusal to “rubber stamp” the SEC’s proposed settlements with large financial institutions could have potential ramifications on the settlements the SEC negotiates in the future. Judge Rakoff’s comment, “I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me,” indicates that this type of scrutiny is perhaps reserved for larger financial institutions, rather than their smaller counterparts or even individuals. Seemingly, given the alleged violations involved and the impact on the shareholders involved, the settlement amount was not proportionate to the harm based on Judge Rakoff’s observation.  Although the SEC may adjust its disgorgement figures or civil penalties based upon a respondent’s showing of its/his/her financial inability to pay, an entity like Citigroup clearly does not face such a burden.  As a result of Judge Rakoff’s refusal to acquiesce to whatever settlement proposal the SEC sets forth, the SEC may play hardball with large financial institutions to avoid future judicial scrutiny. Further, it is conceivable that the SEC may file a civil contempt proceeding the next time that an institution that has been barred from violating securities laws, violates securities laws. Although the SEC has not done so in at least ten years, pressure from the public may mount if an entity like Citigroup or Bank of America is accused of violating securities laws again.  It seems unlikely, however, that respondents would be forced to admit liability as a condition of settlements – the practice of neither admitting nor denying liability is not only standard among settlements with the SEC, but in the general practice of law.

So-called smaller actors, such as smaller entities or individuals, may nonetheless find the SEC requesting large settlement amounts, especially given the impact, severity or frequency of their alleged securities law violations. The SEC takes into account a number of factors when determining an appropriate civil penalty, such as the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations.  Think of an individual like Raj Rajaratnam, who was recently ordered to pay a total of $156.6 million in fines and disgorgement, an amount that Judge Rakoff again questioned given Rajaratnam’s net worth and the fact that the civil penalty was designed, in Judge Rakoff’s words, “to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.”

Further, although the SEC may request injunctive relief that an individual be barred from violating securities laws in the future, that individual may also be barred from serving as a director of a public company, from working in the securities industry, or from participating in the issuance of certain kinds of securities offerings, to name but a few examples.  Judge Rakoff’s remarks should serve as a wake-up call for large financial institutions, but others are by no means less vulnerable to the range of consequences the SEC could request.

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