Yesterday's decision in SEC v. Citigroup weakens the much needed judicial check on the Securities and Exchange Commission's enforcement program. The U.S. Court of Appeals for the Second Circuit told District Court Judge Jed Rakoff to stop being so skeptical when the SEC presents him with settled enforcement actions.
As he had done before with respect to the SEC's Bank of America settlement, Judge Rakoff raised questions about the proposed settlement with Citigroup for its alleged nefarious dealings in mortgage-backed securities. In handing out judicial injunctive relief, he wanted to be more than "a mere handmaiden to a settlement privately negotiated on the basis of unknown facts." Judge Rakoff was uneasy about blessing a settlement based on a contested set of facts:
An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts--cold, hard, solid facts, established either by admissions or by trials--it serves no lawful or moral purpose and is simply an engine of oppression.
The appellate court scoffed at the notion that truth is relevant to settlement agreements: "Trials are primarily about truth. Consent decrees are primarily about pragmatism." Unless the record contains "a substantial basis" for concluding that a proposed settlement is unfair, unreasonable, or disserves the public interest, "the district court is required to enter the order." The court must give "significant deference" to the SEC's public interest determination.
The appellate court's pragmatism falls neatly in line with the incentives faced by companies and the SEC. Regulated entities cannot afford to fight for the truth, even when the SEC is alleging something very far from it. The SEC is not rewarded for ferreting out the truth and bringing cases based squarely upon it. The SEC earns praise for bringing lots of cases, especially ones involving big names, regardless of the strength of those cases. The answer is not to force companies to admit to facts they know not to be true, but neither should judges be forced to sign off on settlements they suspect are not just.