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In the Courts

By ALM Staff | Law Journal Newsletters |
December 28, 2011

Judge Calls into Question SEC's Long-Standing Policy Of Allowing Consent
Judgments in Which Defendants Neither Admit Nor Deny the Allegations

On Nov. 28, 2011, Judge Jed S. Rakoff of the Southern District of New York issued an opinion in which he refused to approve a settlement between the U.S. Securities and Exchange Commission (“SEC”) and Citigroup Global Markets, Inc. (“Citigroup”) wherein Citigroup would not be required to admit or deny the underlying allegations. The opinion, U.S. SEC v. Citigroup Global Markets Inc., 11 Civ. 738, 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011), has received much attention as it may herald a sea change in SEC settlements, which historically have not required such admissions.

The case is one of several that are working their way through to SEC settlements in which large banks are charged with fraud in connection with the marketing and sale of complex financial products referencing residential mortgage-backed securities. These types of securities are frequently cited as at least a partial cause of the global financial crisis that began in 2007. In the matter before Judge Rakoff, the SEC alleges that Citigroup created a billion-dollar collateralized debt obligation (“CDO”) ' a fund consisting of asset-backed securities such as mortgages and auto loans ' that it marketed to investors without disclosing that the fund included assets which the bank believed were unlikely to be profitable. Id. at *1. Citigroup allegedly misrepresented to investors that the fund's assets had been selected by an independent investment advisor despite the fact that Citigroup had exercised substantial influence over the selection process and had arranged to include a large number of assets that the bank had actually bet against by taking a short position in a transaction know as “credit default swap.” Id. According to the SEC, Citigroup made approximately $160 million as a result of this transaction, while investors lost over $700 million. Id.

In a separate complaint filed against a Citigroup employee charged in relation to this scheme, the SEC alleges that the bank knew it would be difficult to find investors willing to purchase shares of the fund if it disclosed that Citigroup intended to take a short position with respect to assets it included in the fund's portfolio. Id. However, despite the allegation in the complaint against this Citigroup employee that the bank acted with knowledge, the SEC charged Citigroup only with negligence. Furthermore, as is typical in such settlements, the SEC proposed allowing Citigroup to consent to judgment “[w]ithout admitting or denying the allegations of the complaint.” The judgment would also “permanently restrain[] and enjoin[]” Citigroup from future similar violations and require the bank to disgorge $160 million in profits plus $30 million in interest and pay a civil penalty of $95 million to the SEC. In addition, Citigroup agreed to a three-year period of enhanced internal compliance measures. Id.

In refusing to approve the judgment, Judge Rakoff expressed his disapproval of several aspects of the proposed settlement. First, and most notably, he explained that the court could not approve a judgment without “proven or admitted facts upon which to exercise even a modest degree of independent judgment.” Id. at 2. The court reviewed the proposed judgment to determine whether its terms were “fair, reasonable, adequate, and in the public interest,” notwithstanding the SEC's assertion that the public interest should not be part of the analysis. Id. In response to the SEC's arguments regarding the public interest analysis, Judge Rakoff cited several recent Supreme Court opinions holding that injunctive relief, such as the permanent injunction against future securities violations sought by the SEC in this matter, cannot be granted without considering the public interest. Id. (citing, e.g., eBay, Inc. v MercExchange, 547 U.S. 388, 391 (2006)).

The SEC also contended that consideration of the public interest should be left to the sole discretion of the Commission. Id. at 3. However, while acknowledging that substantial deference is afforded to administrative agencies such as the SEC in such matters, Judge Rakoff dismissed the Commissions argument on this point as well, citing appellate precedent as well as the constitutional doctrines of separation of powers and independence of the judiciary in holding that the court must satisfy itself that any judgment meets the necessary legal standards.

In the end, Judge Rakoff held that the proposed judgment was “neither fair, nor reasonable, nor adequate, nor in the public interest.” Id. at 4. Memorably, Judge Rakoff held that, without requiring an evidentiary basis for approval, the court would become “a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.” Judge Rakoff seemed particularly troubled by the fact that, without admissions, the judgment would have no collateral estopple effect upon which private litigations might rely in suits against the bank to reclaim substantial losses allegedly resulting from the fraudulent marketing of the fund. Furthermore, the judgment did not commit the SEC to return any of the proceeds of the settlement to the defrauded investors, noting only that the Commission “may” do so. Id. at 5.

Finally, Judge Rakoff described the roughly $285 million in disgorgement and penalties agreed to by the Commission as “pocket change” and indicated that such penalties are frequently viewed merely “as a cost of doing business ' rather than as any indication of where the real truth lies.” Id. at 5. Judge Rakoff seemed particularly bothered by the fact that Citigroup, a recidivist offender of federal securities laws, would receive “a very good deal” under the proposed judgment if the allegations of the complaint were true, while he could not discern how the Commission would benefit from the settlement “other than a quick headline.”

The Citigroup opinion calls into question a long-standing SEC settlement policy described by Judge Rakoff as “hallowed by history, but not by reason.” Id. at 4. As such, the decision has caused considerable concern in the legal community, hampering settlement negotiations with the agency. The Commission plans to appeal Judge Rakoff's denial of the settlement to the Second Circuit, but, regardless of the outcome in this matter, further judicial scrutiny of the decision should certainly be expected.

Fifth Circuit Emphasizes Need for Evidence Tying Losses to Fraudulent Conduct

In United States v. Bernegger, No. 09-60932, 2011 WL 4990719, *8 (5th Cir. Oct. 20, 2011), the Fifth Circuit reemphasized the requirement that, for the purposes of sentencing and restitution determinations, there must be evidence that any losses attributed to a fraudulent scheme resulted from the criminal conduct alleged. In this case, the court held that losses related to certain local government grants to Bernegger's fraudulently operated business ventures could not be included as “relevant conduct” in sentencing and restitution calculations, absent evidence that the grants in question had been obtained through fraudulent means. Id.

Peter Bernegger was convicted of mail and bank fraud in connection with the fraudulent operation of two start-up business ventures purporting to make gelatins and extracts. Id. at *1. These ventures were supported through funding obtained from individual investors and private banks as well as two grants from local government authorities. Id. In the end, neither business ever succeeded in manufacturing or selling a viable product, despite solicitations to investors touting the success of the ventures. Bernegger received a sentence of seventy months imprisonment and was ordered to pay $2.1 million in restitution.

On appeal, the Fifth Circuit addressed several arguments related to Bernegger's convictions, including a challenge to the district court's calculation of losses properly attributable to the scheme. Mr. Bernegger argued that the two local government grants should not be included in loss calculations for the purposes of determining sentencing offense level and restitution because prosecutors did not offer evidence that these grants themselves were fraudulently obtained. Id. at *8. Despite the extensive fraud allegedly perpetrated by Bernegger with respect to these business ventures, the court agreed with this argument.

The Fifth Circuit held that losses with respect to the grants could not be included in sentencing and restitution calculations because no evidence was introduced demonstrating that the grants had been obtained in a fraudulent or otherwise criminal manner. Id. (citing U.S.S.G. ' 1B1.3(a)(2); United States v. Anderson, 174 F.3d 515, 526 (5th Cir.1999) (internal citations omitted); United States v. Randall, 157 F.3d 328, 331 (5th Cir.1998).)

The court modified the amount of restitution ordered to reflect this decision, deducting the $471,296 attributable to the two government grants at issue. Id. at *8-9. This change was not, however, great enough to alter the offense level under the sentencing guidelines; thus, Bernegger's ultimate sentence was not affected by the court's decision.


In the Courts was written by Associate Editors Jamie Schafer and Matthew J. Alexander, respectively. Both are associates at Kirkland & Ellis LLP, Washington, DC.

Judge Calls into Question SEC's Long-Standing Policy Of Allowing Consent
Judgments in Which Defendants Neither Admit Nor Deny the Allegations

On Nov. 28, 2011, Judge Jed S. Rakoff of the Southern District of New York issued an opinion in which he refused to approve a settlement between the U.S. Securities and Exchange Commission (“SEC”) and Citigroup Global Markets, Inc. (“Citigroup”) wherein Citigroup would not be required to admit or deny the underlying allegations. The opinion, U.S. SEC v. Citigroup Global Markets Inc., 11 Civ. 738, 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011), has received much attention as it may herald a sea change in SEC settlements, which historically have not required such admissions.

The case is one of several that are working their way through to SEC settlements in which large banks are charged with fraud in connection with the marketing and sale of complex financial products referencing residential mortgage-backed securities. These types of securities are frequently cited as at least a partial cause of the global financial crisis that began in 2007. In the matter before Judge Rakoff, the SEC alleges that Citigroup created a billion-dollar collateralized debt obligation (“CDO”) ' a fund consisting of asset-backed securities such as mortgages and auto loans ' that it marketed to investors without disclosing that the fund included assets which the bank believed were unlikely to be profitable. Id. at *1. Citigroup allegedly misrepresented to investors that the fund's assets had been selected by an independent investment advisor despite the fact that Citigroup had exercised substantial influence over the selection process and had arranged to include a large number of assets that the bank had actually bet against by taking a short position in a transaction know as “credit default swap.” Id. According to the SEC, Citigroup made approximately $160 million as a result of this transaction, while investors lost over $700 million. Id.

In a separate complaint filed against a Citigroup employee charged in relation to this scheme, the SEC alleges that the bank knew it would be difficult to find investors willing to purchase shares of the fund if it disclosed that Citigroup intended to take a short position with respect to assets it included in the fund's portfolio. Id. However, despite the allegation in the complaint against this Citigroup employee that the bank acted with knowledge, the SEC charged Citigroup only with negligence. Furthermore, as is typical in such settlements, the SEC proposed allowing Citigroup to consent to judgment “[w]ithout admitting or denying the allegations of the complaint.” The judgment would also “permanently restrain[] and enjoin[]” Citigroup from future similar violations and require the bank to disgorge $160 million in profits plus $30 million in interest and pay a civil penalty of $95 million to the SEC. In addition, Citigroup agreed to a three-year period of enhanced internal compliance measures. Id.

In refusing to approve the judgment, Judge Rakoff expressed his disapproval of several aspects of the proposed settlement. First, and most notably, he explained that the court could not approve a judgment without “proven or admitted facts upon which to exercise even a modest degree of independent judgment.” Id. at 2. The court reviewed the proposed judgment to determine whether its terms were “fair, reasonable, adequate, and in the public interest,” notwithstanding the SEC's assertion that the public interest should not be part of the analysis. Id. In response to the SEC's arguments regarding the public interest analysis, Judge Rakoff cited several recent Supreme Court opinions holding that injunctive relief, such as the permanent injunction against future securities violations sought by the SEC in this matter, cannot be granted without considering the public interest. Id. (citing, e.g., eBay, Inc. v MercExchange, 547 U.S. 388, 391 (2006)).

The SEC also contended that consideration of the public interest should be left to the sole discretion of the Commission. Id. at 3. However, while acknowledging that substantial deference is afforded to administrative agencies such as the SEC in such matters, Judge Rakoff dismissed the Commissions argument on this point as well, citing appellate precedent as well as the constitutional doctrines of separation of powers and independence of the judiciary in holding that the court must satisfy itself that any judgment meets the necessary legal standards.

In the end, Judge Rakoff held that the proposed judgment was “neither fair, nor reasonable, nor adequate, nor in the public interest.” Id. at 4. Memorably, Judge Rakoff held that, without requiring an evidentiary basis for approval, the court would become “a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.” Judge Rakoff seemed particularly troubled by the fact that, without admissions, the judgment would have no collateral estopple effect upon which private litigations might rely in suits against the bank to reclaim substantial losses allegedly resulting from the fraudulent marketing of the fund. Furthermore, the judgment did not commit the SEC to return any of the proceeds of the settlement to the defrauded investors, noting only that the Commission “may” do so. Id. at 5.

Finally, Judge Rakoff described the roughly $285 million in disgorgement and penalties agreed to by the Commission as “pocket change” and indicated that such penalties are frequently viewed merely “as a cost of doing business ' rather than as any indication of where the real truth lies.” Id. at 5. Judge Rakoff seemed particularly bothered by the fact that Citigroup, a recidivist offender of federal securities laws, would receive “a very good deal” under the proposed judgment if the allegations of the complaint were true, while he could not discern how the Commission would benefit from the settlement “other than a quick headline.”

The Citigroup opinion calls into question a long-standing SEC settlement policy described by Judge Rakoff as “hallowed by history, but not by reason.” Id. at 4. As such, the decision has caused considerable concern in the legal community, hampering settlement negotiations with the agency. The Commission plans to appeal Judge Rakoff's denial of the settlement to the Second Circuit, but, regardless of the outcome in this matter, further judicial scrutiny of the decision should certainly be expected.

Fifth Circuit Emphasizes Need for Evidence Tying Losses to Fraudulent Conduct

In United States v. Bernegger, No. 09-60932, 2011 WL 4990719, *8 (5th Cir. Oct. 20, 2011), the Fifth Circuit reemphasized the requirement that, for the purposes of sentencing and restitution determinations, there must be evidence that any losses attributed to a fraudulent scheme resulted from the criminal conduct alleged. In this case, the court held that losses related to certain local government grants to Bernegger's fraudulently operated business ventures could not be included as “relevant conduct” in sentencing and restitution calculations, absent evidence that the grants in question had been obtained through fraudulent means. Id.

Peter Bernegger was convicted of mail and bank fraud in connection with the fraudulent operation of two start-up business ventures purporting to make gelatins and extracts. Id. at *1. These ventures were supported through funding obtained from individual investors and private banks as well as two grants from local government authorities. Id. In the end, neither business ever succeeded in manufacturing or selling a viable product, despite solicitations to investors touting the success of the ventures. Bernegger received a sentence of seventy months imprisonment and was ordered to pay $2.1 million in restitution.

On appeal, the Fifth Circuit addressed several arguments related to Bernegger's convictions, including a challenge to the district court's calculation of losses properly attributable to the scheme. Mr. Bernegger argued that the two local government grants should not be included in loss calculations for the purposes of determining sentencing offense level and restitution because prosecutors did not offer evidence that these grants themselves were fraudulently obtained. Id. at *8. Despite the extensive fraud allegedly perpetrated by Bernegger with respect to these business ventures, the court agreed with this argument.

The Fifth Circuit held that losses with respect to the grants could not be included in sentencing and restitution calculations because no evidence was introduced demonstrating that the grants had been obtained in a fraudulent or otherwise criminal manner. Id. (citing U.S.S.G. ' 1B1.3(a)(2); United States v. Anderson , 174 F.3d 515, 526 (5th Cir.1999) (internal citations omitted); United States v. Randall , 157 F.3d 328, 331 (5th Cir.1998).)

The court modified the amount of restitution ordered to reflect this decision, deducting the $471,296 attributable to the two government grants at issue. Id. at *8-9. This change was not, however, great enough to alter the offense level under the sentencing guidelines; thus, Bernegger's ultimate sentence was not affected by the court's decision.


In the Courts was written by Associate Editors Jamie Schafer and Matthew J. Alexander, respectively. Both are associates at Kirkland & Ellis LLP, Washington, DC.

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