Skip To Content

U.S. Appellate Court Overturns Decision Rejecting SEC’s No-Contest Settlement

Author(s): Shawn Irving, Raphael T. Eghan

June 6, 2014

The United States Court of Appeals for the Second Circuit held on June 4, 2014 that the U.S. Southern District Court of New York “abused its discretion” when it refused to approve a “no-contest” settlement agreement between the U.S. Securities and Exchange Commission (SEC) and Citigroup Global Markets Inc. (Citigroup). The Court held that the judge who had refused to approve the settlement at first instance applied an incorrect legal standard by requiring the SEC to establish the truth of the allegations made against Citigroup as a condition for approving the settlement. The Court also noted that an admission of liability is not a precondition that the court is required to consider before approving a settlement.

While this decision is not binding in Ontario, the Citigroup saga had been closely watched by securities market participants and regulators on both sides of the border. This decision will likely be studied and debated closely in Ontario, given that OSC (Ontario Securities Commission) Staff recently announced that it will permit no-contest settlement agreements in certain circumstances. The proposal to permit no-contest settlements in OSC proceedings has attracted considerable attention and controversy. The Citigroup decision will likely be cited by those who support the initiative because it strongly reaffirms that no-contest settlements have a place in regulatory proceedings, and it supports deference to the discretion of regulators to enter into such settlements.

Background of SEC Complaint Against Citigroup and Proposed No-Contest Settlement

The SEC filed a complaint against Citigroup in October 2011 alleging that it negligently misrepresented its role and economic interest in structuring and marketing a fund that held certain mortgage-backed assets (Fund). It alleged that Citigroup had taken a short position in the Fund, thereby earning $160 million while investors, to whom Citigroup had promoted the Fund, lost millions.

The SEC and Citigroup agreed to a settlement shortly after the complaint was commenced. The settlement terms included an agreement to a permanent injunction barring Citigroup from future violations of the U.S. Securities Act of 1933, disgorgement of $160 million, prejudgment interest of $30 million and a civil penalty of $95 million. Citigroup also agreed to make internal changes to prevent similar conduct from occurring in the future. Notably, there was no admission of guilt or liability by Citigroup.

Decision of the N.Y. Southern District Court

The proposed settlement was brought before Judge Rakoff of the District Court for approval in November 2011. Judge Rakoff refused to approve the settlement, stating in his decision that the settlement “is neither fair, nor reasonable, nor adequate, nor in the public interest ... because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards.” Judge Rakoff went on to state that “the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts.” The matter was ordered to be set down for trial. The SEC and Citigroup both appealed.

Decision of the Second Circuit Appeals Court

The Second Circuit Appeals Court overturned Judge Rakoff’s decision. It held that “there is no basis in law for the district court to require an admission of liability between the parties. The decision to require an admission of liability before entering into a consent decree rests squarely with the SEC.”The Court went on to clarify that the proper standard for reviewing a proposed settlement agreement involving an enforcement agency required the court to assess whether the proposed agreement is “fair and reasonable,” and that “the public interest would not be disserved.” The focus of the court’s analysis should be on ensuring that the proposed settlement is “procedurally proper,” and care should be taken “not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.” The Court further held that it is an abuse of process to require the SEC to establish the “truth” of the allegations against a settling party as a condition for the court’s approval of a settlement agreement. Instructively, the Court commented that “[t]rials are primarily about the truth,” while “[c]onsent decrees are “primarily about pragmatism.”

Significance of the Appellate Court Decision for Canadian Securities Regulation

On March 11, 2014, the OSC issued a press release announcing that the Commission had advised Staff that it would be prepared to consider the approval of settlements that did not contain formal admissions of misconduct. Staff also announced that it had amended the Credit for Cooperation Program to permit, in “limited circumstances,” alleged wrongdoers to settle cases launched against them without admitting to any “facts or liability.” The OSC reasoned that no-contest settlements are needed to speed up Staff’s heavy load of investigations and prosecutions, and to allow it to concentrate on the most serious securities infractions. Such settlements will need to be approved by a panel of the OSC on the basis that they are in the public interest.

Prior to the recent announcement, respondents settling with the OSC were required to formally admit a set of facts that were included as part of a settlement agreement. That settlement agreement was then brought before a panel of the OSC and the terms of the settlement, including the admitted facts, were reflected in an order of the Commission. The proposal to admit no-contest settlements was strenuously debated since it was first introduced in 2011.

The Citigroup case has been closely watched by both proponents and opponents of no-contest settlements in Ontario and by the OSC. For example, a year to the day before the Second Circuit Appeals Court issued its decision, the OSC published a paper commenting on the possible implications of the Citigroup matter for OSC proceedings. Proponents of no-contest settlements will no doubt be pleased with the Court’s decision, which strongly supports such settlements in appropriate circumstances.The OSC may also look to the Court’s decision to help it define the deference to afford to OSC Staff, and to identify the factors it may consider when deciding whether to approve settlements between OSC Staff and parties accused of wrongdoing in circumstances in which the proposed settlement contains no admission of liability or agreement about the facts.

The Court’s full decision can be found here


Authored by:  Shawn Irving, Raphael T. Eghan