As David notes, the Second Circuit reversal of Judge Rakoff in the SEC v. Citigroup litigation fails to surprise. But that doesn’t mean the Second Circuit was correct. Indeed, I believe the Second Circuit, in an attempt to be pragmatic, allowed the emperor to continue strolling naked. The fact that the walk has going on for a while doesn’t mean the clothes are there.
If asking for facts makes a judge a maverick …
For all the media talk of Judge Rakoff as a “hero” or “maverick,” he carefully crafted his original opinion. The essence of his ruling: a court cannot approve a settlement and agree to an injunction when the SEC and the defendant give the court no facts. According to Judge Rakoff’s reasoning, without “any proven or admitted facts” the court cannot “exercise even a modest degree of independent judgment.”
Note that Judge Rakoff did not ask for an admission of liability. The Second Circuit panel recognized this and disposed of this quickly in Part II of its opinion.
Without facts, Judge Rakoff asked, how can district courts judge whether a settlement that includes substantial injunctive relief is reasonable, fair, adequate, and in the public interest? (The Second Circuit ruled that courts should not inquire into the adequacy of settlements.) Judge Rakoff rightly found that the SEC’s complaint does not itself establish facts.
Second Circuit ignores absence of elephant in room
The Second Circuit, as did Judge Rakoff, underscores the deference that trial courts must afford to SEC settlements. But the Second Circuit opinion chose to focus on dicta in Judge Rakoff’s order rather than the simple problem: how can a judge determine whether a settlement meets the legal standard – that it is fair, reasonable, and in the public interest – absent any facts about the defendant’s conduct. The Second Circuit held:
“Absent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.”
But what if there isn’t any real factual record? In the absence of any facts, wouldn’t district courts automatically have to approve a settlement? The Second Circuit may have created a strong incentive for the SEC and defendants to avoid creating any factual record.
The Second Circuit said that in reviewing SEC consent decrees, courts should review at a minimum (1) the basic legality of the decree, (2) whether terms of the decree, including its enforcement mechanism are clear, (3) whether the consent decree reflects a resolution of the actual claims in the complaint, and (4) whether the decree is tainted by improper collusion or corruption.
That sets the bar incredibly low. Indeed, the Second Circuit limits Judge Rakoff to asking for “additional information sufficient to allay any concerns the district court may have regarding improper collusion between the parties.” Imagine the colloquial version of how this inquiry would proceed:
“Any colluders in there?”
“No – just us chickens.”
The potential absurdity of the Second Circuit’s position is underscored by its insistence that, of course, courts must develop a factual record.
“As part of its review, the district court will necessarily establish that a factual basis exists for the proposed decree. In many cases, setting out the colorable claims, supported by factual averments by the SEC, neither admitted nor denied by the wrongdoer, will suffice to allow the district court to conducts its review.”
Here is a fun exercise: find the facts in the preceding two sentences. “Factual averments by the SEC” are not facts (unless you want to get really cute: it is a fact that the SEC said A, B,and C were facts.)
Facts mean that judges can’t be mavericks
Perhaps this “just the facts” focus feels like wrestling with an epistemological dragnet. But Judge Rakoff’s insistence on a record of proven or admitted facts is crucial – not only to providing some check on the SEC, but, moreover, to restraining judicial powers.
Let’s focus on two pieces of the proposed consent decree between the SEC and Citi: the ongoing injunction not to violate federal securities laws and the injunction to enforce the internal compliance measures at Citigroup. A court cannot impose a broad and long-lasting injunction without having any factual basis to assess whether an injunction is appropriate and to guide the court in undertaking this responsibility.
In many ways, Judge Rakoff’s reasoning served to limit judicial power.
For the injunction on Citigroup’s internal behavior, the court needs some factual basis to grant this relief. The court needs admitted and proven facts for at least two related reasons. First, it needs to ascertain whether it can enforce this injunction. Second, it needs some factual basis to judge later requests by the agency to enforce the injunction. Injunctions are not computer codes, and courts require some factual basis to understand what it is that the parties are asking them to do.
For the injunction on violations of Section 17: an open-ended injunction invites courts to scrutinize all sorts of potential securities law behavior. A district court needs some factual basis in order to understand whether an injunction is an appropriate remedy, and if and how the court could prudently enforce the injunction. What types of conduct by the defendant should the court look to enjoin? The Second Circuit focuses on reviewing injunctions to make sure they are “legal” and “clear.” “I agree not to violate federal securities laws” is both legal and clear in one sense. But take a good read of Section 17 and see how less than specific this agreement is.
Open-ended injunctions sought by public agencies on the basis of no factual information run multiple risks. Among these risks, broad injunctions without a factual basis attempt to commandeer the judiciary in another branch’s responsibility to enforce the law. This creates real separation of powers problems.
Second, open-ended invite judges to take broad enforcement matters into their own hands. A factual basis helps to restrain judges from free-wheeling efforts to enforce injuctions.
Third, broad injunctions without facts run the risk of playing a running joke on the judiciary. If this injunction is a makeweight which the SEC will never seek to enforce (and there is quite a bit of evidence that the SEC does not follow-up on many injunctions), the agency should not be wasting the resources of the judicial branch. Nor should it be involving the judiciary in a charade in which it looks like the SEC is enforcing federal securities laws, but does little to follow through on injunctions it has already obtained.
As amicus briefs to the Second Circuit pointed out, the SEC was able to get admissions of facts in other consent decrees before the Citigroup case. And the SEC has other administrative remedies available to it: suing and then asking for a consent decree in the S.D.N.Y. was not the only game in town.
But the SEC chose to sue Citigroup in federal court and to ask a federal judge to approve a consent decree with a broad injunction. Judge Rakoff’s message to the SEC might have been paraphrased succinctly: “Don’t attempt to invoke the machinery of the judicial system, unless you are serious and you are willing to give a court the information necessary to perform its judicial role.”
The Second Circuit turns this on its head. Its message to trial judges seems to be: “unless the SEC hands you facts that this consent decree is illegal, unrelated to the complaint, or collusive/corrupt, you must approve.”
The only real hook for judges who are frustrated by settlement agreements without facts is the Second Circuit’s insistence that judges can review whether terms of a decree are “clear.”
How lasting a legacy?
Judge Rakoff’s opinion did leave an incredibly thorny question unanswered: what kinds of facts does a judge need to approve a settlement? His opinion simply said no facts cannot suffice. The Second Circuit answered the question in a very cramped way. The appellate court warns judges to take very limited role, which might be as little as comparing a consent decree to the SEC’s complaint.
Some commentators point out that Judge Rakoff’s now overturned opinion still prompted the SEC to change its enforcement policies with respect to “neither admit nor deny.” I agree. But there is nothing to say that the SEC’s policy cannot change. Certainly not this Second Circuit opinion.
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