Susan Beck's Summary Judgment: Second Circuit Redeems Itself in SEC-Citi Oral Arguments

It’s not often that a court transcript makes me cheer out loud.

But that was my reaction when I read the proceedings of Friday’s oral arguments in Securities and Exchange Commission v. Citigroup Global Markets, the much-watched case in which Manhattan U.S. District Judge Jed Rakoff in 2011 upended convention and refused to approve the SEC’s proposed $285 million settlement with Citigroup. The SEC and Citi had challenged Rakoff’s ruling to the U.S. Court of Appeals for the Second Circuit, asserting that he improperly blocked the deal because Citi wouldn’t admit to wrongdoing. (You can read the transcript here.)

First of all, I was thrilled to see that the three judges hearing the appeal didn’t adopt the harshly dismissive tone that a different Second Circuit panel directed at Rakoff when it stayed the underlying case last March. Lots of people assumed that the appellate court’s ruling, in which it held that the SEC and Citi had a "strong likelihood" of winning their appeal, proved that Rakoff would get slapped down when the court ruled on the merits. At the time I admonished the Second Circuit for showing so little respect for Rakoff’s concerns about the SEC’s settlement decisions, writing that the court all but told Rakoff to shut up with his complaining and just approve the damn things.

Instead, on Friday Second Circuit Judges Susan Carney, Raymond Lohier Jr., and Rosemary Pooler treated Rakoff’s concerns as legitimate. They pressed the lawyers for the SEC and Citi to explain why Rakoff shouldn’t be given more information before he decides if the settlement is in the public interest. In this case, as you might remember, the agency accused Citi of misleading large investors in a $1 billion collateralized debt obligation. Pooler’s open-minded approach was especially welcome, given that she was on the earlier hostile panel.

Even more surprising, the panel flat-out rejected the oft-repeated claim that Rakoff nixed the settlement because Citi wouldn’t admit to wrongdoing. I’d always thought that Citi and the SEC were twisting Rakoff’s words when they made that assertion. As Rakoff’s court-appointed counsel John ("Rusty") Wing argued, Rakoff instead rejected the deal because the parties hadn’t presented him with sufficient information to decide if the settlement was in the public interest. In an appellate brief, Wing accused the SEC and Citi of engaging in "a flat mischaracterization and distortion of the district court’s ruling" when they claimed that Rakoff demanded an admission of wrongdoing.

I’m betting that Citi lawyer Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison had one of those "oh shoot" moments when he attempted to raise this argument and was quickly shut down by Pooler. "I think the question of admissions is a red herring, with all due respect," Pooler told Karp. "I don’t think the district court asked for it and I don’t think anyone supports the idea that he’s entitled to that."

Midway through the arguments, Carney posed a question that I believe is the most essential: "Is transparency part of the Commission’s mandate?" Bingo! What this case is really about–or should be about–is whether the public has any right to understand what’s behind these SEC settlements. What evidence did the SEC have, or not have, that led it to settle on the terms it presented to Rakoff? SEC lawyer Michael Conley repeatedly told the judges that as long as a settlement is reached at arms’ length by capable counsel, then it should be presumed to be fair, adequate, and reasonable. In other words, trust us and don’t ask too many questions. Even if the SEC is deserving of that trust, which is a big if, the public needs to know more. The legitimacy of our public markets requires transparency, and the enforcement of our securities laws must be more transparent, too.

By the end of the hearing, the panel had signaled that it was inclined to remand the case to Rakoff to allow him to consider more information before ruling on the settlement. Wing suggested that Rakoff needed only to review the evidence that emerged during last summer’s trial of former Citi employee Brian Stoker, who was sued by the SEC along with Citi for the same underlying CDO transaction. Rakoff presided over that trial, in which a jury found Stoker not liable. But that result shouldn’t be seen as a victory for the bank. The jury foreman, Beau Brendler, told me after the verdict that the jurors found Citi’s behavior "appalling." He stressed: "This was not a verdict about Citi being absolved of any wrongdoing. I think we as a jury felt there was probably wrongdoing going on, but it was the collective wrongdoing of Citigroup."

Regardless of how the Second Circuit rules, it’s off to a good start. By taking Rakoff’s concerns seriously–and by refusing to accept Citi’s spin on the case–it redeemed itself from its shoddy treatment of Rakoff last March.