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Federal Judge Describes SEC Enforcement as Opaque, Inequitable

Since 1995, Judge Jed Rakoff has been hearing cases brought before the U.S. District Court for the Southern District of New York, which includes Manhattan and Wall Street. He has had a front-row seat in countless cases -- both criminal prosecutions and Securities and Exchange Commission civil enforcement actions -- concerning toxic mortgage securities, the foreclosure crisis, insider trading and other allegations against banking giants and financial industry insiders.

He has not been pleased. According to an article in the ABA Journal, Rakoff has grown notorious for refusing to sign off on sweetheart settlements the SEC has negotiated with banks and corporations. He has also publicly accused the agency of failing to prosecute high-level insiders while bringing the hammer down on mid-level scapegoats.

In 2011, for example, the SEC offered to settle, for $285 million, a civil enforcement action alleging that Citigroup Global Markets Inc. had made material misrepresentations in both structuring and marketing what are now called toxic mortgage-based securities. As has been customary in recent years, Citigroup was not required to admit any wrongdoing, and only limited details of the SEC's lengthy investigation would be publicly revealed.

Rakoff balked at declaring the settlement "fair, adequate, reasonable, and in the public interest," the standard judges use when signing off on such agreements. A federal court, he said, "cannot be a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of knowing the truth in a matter of obvious public importance."

The SEC and Citigroup together appealed Rakoff's decision to the 2nd Circuit, requesting an injunction to allow the SEC not to proceed to trial -- and seeking a writ of mandamus forcing Rakoff to approve the settlement. Citigroup said requiring an admission of wrongdoing and a public release of the details would make it a sitting duck for private lawsuits. Both the agency and the bank contend that those requirements would devastate the SEC's ability to negotiate future settlements.

The case is on hold, and the 2nd Circuit's final ruling has been long delayed. Other federal judges, however, have begun challenging the SEC's lack of transparency and apparently favorable treatment of financial industry insiders. Moreover, upon the swearing in of new SEC chairman Mary Jo White, the SEC has announced it will now require admissions of wrongdoing in cases of "egregious, intentional misconduct" or the potential of serious harm to financial markets.

For both the accused and for the public, civil and criminal enforcement must be based on clear legal standards and predictable policy. Hopefully, this high-profile battle will force the federal government to some critical self-assessment.

It has been my observation that the SEC takes a harder stand with those individuals and companies who lack the resources available to major companies and individuals.

Sources:

  • ABA Journal, "Judge Jed Rakoff's stance on the SEC deals draws fire, praise--and change," Terry Carter, Oct. 1, 2013
  • Bloomberg Law, "Second Circuit Stays District Court Proceedings that Rejected Settlement between SEC and Citigroup," Tatiana Rodriguez, March 2012
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