Class Discussion Slides - S.E.C. v. Citgroup Global Markets

SECv. Citigroup Global Markets - Remedies 1s 11

S.E.C. v. Citigroup Global Markets

George W. ConkAdjunct Professor of Law & Senior Fellow, Stein Center for Law &

EthicsRoom 409

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Updated March 3, 2015

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SECv. Citigroup Global Markets - Remedies 2

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STAYS

FRCP Rule 8 Notice Risk of error Bond

3Ch. 4 Injunctions

SEC v. Citigroup (2012 & 2014) Did Judge Rakoff’s rejection of the

proposed settlement and injunction exceed his powers under FRCP 65 to take into account the public interest?

Was his order to the SEC and Citigroup to proceed to trial properly stayed?

Is there any significant role remaining for a trial judge to review a settlement between prosecutor and regulated entity?

Should there be?Ch. 4 Injunctions 4

Rule 8 – Stay or Injunction Pending Appeal

(a) Motion for Stay.

(1) Initial Motion in the District Court. A party must ordinarily move first in the district court for the following relief:(A) a stay of the judgment or order of a district court pending appeal;(B) approval of a supersedeas bond; or(C) an order suspending, modifying, restoring, or granting an injunction while an appeal is pending.

5Ch. 4 Injunctions

Rule 8 – Stay or Injunction pending Appeal (2) Motion in the Court of Appeals;

Conditions on Relief. A motion for the relief mentioned in

Rule 8(a)(1) may be made to the court of appeals or to one of its judges.

(A) The motion must:(i) show that moving first in the district court would be impracticable; or(ii) state that, a motion having been made, the district court denied the motion or failed to afford the relief requested and state any reasons given by the district court for its action.

6Ch. 4 Injunctions

Rule 8 – Stay or Injunction pending Appeal

(B) The motion must also include:i) the reasons for granting the relief requested and the facts relied on;(ii) originals or copies of affidavits or other sworn statements supporting facts subject to dispute; and

(iii) relevant parts of the record.

7Ch. 4 Injunctions


(C) The moving party must give reasonable notice of the motion to all parties.

8Ch. 4 Injunctions


(D) A motion under this Rule 8(a)(2) must be filed with the circuit clerk and normally will be considered by a panel of the court.

But in an exceptional case in which time requirements make that procedure impracticable, the motion may be made to and considered by a single judge.

9Ch. 4 Injunctions


(E) The court may condition relief on a party's filing a bond or other appropriate security in the district court.

10Ch. 4 Injunctions

Citigroup and SEC consent order

(1) a permanent injunction barring Citigroup violations of SEC Act

(2) disgorge $160 million asserted net profits usable to compensate investors

(3) prejudgment interest - $30 million (4) a civil penalty of $95 million - no offset vs. civil claims by

investors - internal changes monitored for 3

years SECv. Citigroup Global Markets - Remedies 11

Fair, reasonable, and in the public interest? Rakoff 2011

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.


2d Circuit – remand – June 4, 2014A rubber stamp? Proof of adequacy is not required “determining whether the proposed

S.E.C. consent decree serves the public interest...rests squarely with the S.E.C.”

“the primary focus of the [District Court] should be ensuring the consent decree is procedurally proper..taking care not to infringe on the S.E.C.’s discretionary authority to settle…”


Judicial review – 2d Cir. 2014

A court should, at a minimum, assess (1) the basic legality of the decree, (2) are the terms of the decree clear (3) does the consent decree reflects

a resolution of the actual claims in the complaint

(4) is the consent decree tainted by improper collusion or corruption of some kind.


Fraudulent Interstate Transactions15 U.S.C. 77q

A material omission


Securities Act of 193315 USC 77q(a) Fraudulent Interstate Transactions

It shall be unlawful for any person in the offer or sale of any securities…(1) to employ any device, scheme, or artifice to defraud, or(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; orSECv. Citigroup Global Markets -

Remedies 16

Securities Act of 193315 USC 77q(a) Fraudulent Interstate Transactions

(3) to engage in any transaction,

practice, or course of business which

operates or would operate as a fraud

or deceit upon the purchaser.


The complaint15 USC 77q (a)(2) and (3)

Citigroup Global Markets violated

sections 17(a)(2) and (3) of the

Securities Act of 1933 by negligently

misrepresenting key deal terms,

namely the process by which the

investment portfolio was selected

and Citigroup’s financial interest in

the transaction.


The remedies sought

“The Commission seeks

injunctive relief

disgorgement of profits

prejudgment interest

civil penalties and

other appropriate and necessary

equitable relief from defendant.”SECv. Citigroup Global Markets -

Remedies 19

15 USC 77t Injunctions and prosecution of offenses

(d)(2) (2) Amount of penalty

(A) … (ii) the gross amount of

pecuniary gain to such

defendant as a result of the

violation.


Synthetic CDO


Proposed settlement and complaint filed simultaneously October 19, 2011

SEC v. Citigroup Global Markets, Inc.


A negligence action

Citigroup “negligently

misrepresent(ed) key deal

terms“


SEC ¶ 43-45: Pitchbook described Citigroup as Initial CDS Asset Counterparty

Citibank – not Credit Suisse -

selected the assets to be sold as long

positions

Citigroup structured it as a “prop

trade”

Citigroup had a $500 million short

position of which $490 million was

“naked short”


SEC: negligent material omissions Citigroup play a substantial role in

asset selection Citigroup had taken a $500 million

short position of which $490 M was naked short

Citigroup shorted only the names it selected


SEC: Citigroup misleading disclosures were relied upon

Investors believed Citigroup was in

“traditional role of an arranging

bank”

But did not know Citigroup had

structured the deal and its interests

were adverse to those of the

investorsSECv. Citigroup Global Markets -

Remedies 26

The Deal“without admitting or denying

the allegations of the complaint”

SEC v. Citigroup


Citigroup consents to a final judgment: Permanently restraining violation of

Sections 17(a)(2) and (3) of the Securities Act

Pay disgorgement of $160 million Pre-judgment interest of $30 million Civil penalty - $95 million No offset in any related investor

action Preventive measures: In future -

closer internal controls and audit; advice of outside counselSECv. Citigroup Global Markets -

Remedies 28

The Court’s pre-hearing questions 1) Why should the Court impose a

judgment where serious securities fraud is alleged but the defendant neither admits nor denies wrongdoing?

2) Is there an overriding public interest in determining if the charges are true? Particularly where there is no parallel criminal case?

3) What was the total loss at most?


The Court’s pre-hearing questions 4) How was the amount set? Why is

the penalty here less than that in SEC v. Goldman Sachs?

5) State particularly how you applied the nine factors you say you consider in setting penalty amount.

6) How does SEC maintain compliance with the injunctions? Does it use contempt proceedings/

7) Why aren’t the culpable individuals paying the penalty?


The Court’s pre-hearing questions

8) What “control weaknesses”

led to the acts alleged? How will

the remedial measures prevent

recurrence?

9) How can a securities fraud of

this magnitude be the result

simply of negligence?


F.R.C.P. 65 – Injunctionsfair – reasonable - adequate - in the public interest

Plaintiffs must show:

(1) unless the restraining order issues, they will suffer irreparable harm;

(2) the hardship they will suffer absent the order outweighs any hardship the defendants would suffer if the order were to issue;

(3) they are likely to succeed on the merits of their claims;

(4) the issuance of the order will cause no substantial harm to the public; and

(5) they have no adequate remedy at law.

32Ch. 4 Injunctions

FRCP 65 - d) CONTENTS AND SCOPE OF EVERY INJUNCTION AND RESTRAINING ORDER.( (1) Contents. Every order granting an

injunction and every restraining order must:

(A) state the reasons why it issued; (B) state its terms specifically; and (C) describe in reasonable detail—

and not by referring to the complaint or other document—the act or acts restrained or required.


“a very good deal for Citigroup” (Rakoff)

Charged only with negligence

Very modest penalty

Injunctive relief of a kind rarely

if ever enforced

Inexpensive prophylactic

measures for 3 years


What does the settlement lack (Rakoff) No admission or finding of liability –

no collateral estoppel effect for investors

No Compensation for victims -who cannot recover for negligence under 10(b)(5)

Penalty low compared to Goldman Sachs and mere “pocket change” for Citibank

SEC contradicts itself by filing simultaneously against Stoker for intentional fraud


SEC – due deference is due The court’s fairness determination is

“within carefully prescribed limits” The court owes SEC “substantial

deference as the primary regulatory authority policing securities markets especially with respect to matters of transparency”


SEC – due deference is due Unless a consent decree is unfair,

inadequate, or unreasonable, it ought to be approved.

Also, the courts should pay deference to the judgment of the government agency which has negotiated and submitted the proposed judgment.SEC v. Randolph, 736 F.2d 525, 529 (9th Cir. Cal. 1984)


SEC v. Brian Stoker

Stoker intentionally structured

the deal as “a tailored

proprietary bet against the

assets in class V III”


Stoker’s “untrue statements of material facts or omissions of material facts” operated as a fraud or deceit upon purchasers of securities in violation of 17 (a) (2) and (3) of the Securities Act

SEC v. Brian Stoker


SEC: in assessing penalties we consider: Corporate benefits from the violation Impact on injured investors Need for deterrence Pervasiveness of the conduct Degree of scienter Harm to investors Difficulty of detection Voluntary remedial measures Extent of cooperation with

investigationSECv. Citigroup Global Markets -

Remedies 40

McConnell: judges must be neutral Judge Rakoff has effectively taken on

the role of a prosecutor, second-guessing the SEC’s law enforcement decisions. He may think his intervention will lead to more effective enforcement of the securities laws. But the more likely result of preventing settlements is to force companies to defend themselves in each case with all the resources at their command, rendering it impossibly costly for the SEC to pursue many enforcement actions.


Larson: need for congressional oversight

I certainly understand the frustration

of the court over what it apparently

perceives as persistent and systemic

problems at the SEC, as well as the

extent to which the SEC is effectively

(or ineffectively) fulfilling its mandate

through settlements such as the one

at issue in this case.SECv. Citigroup Global Markets - Remedies 42

Larson: need for congressional oversight

Those same concerns, however, are

most certainly a proper subject for

congressional oversight, and I would

not be surprised to see this case

serve as a springboard for additional

funding of the SEC by Congress,

perhaps precisely the objective Judge

Rakoff was seeking.SECv. Citigroup Global Markets - Remedies 43

Wanger: tough call I side with no one, as the law defines

the standards for approval of a class action settlement and vests the assigned judge with discretion to determine whether the overall settlement is fair, adequate, and reasonable. A myriad of factors unique to making this determination are to be considered by the trial judge.

What record should SEC have to develop to satisfy a judge a settlement is fair?


NJ LJ: judges are not rubber stamps Rakoff recognized that substantial

deference was due the SEC but correctly observed that he had to exercise independent judgment to determine the settlement to be fair, reasonable, adequate and in the public interest.

The government took the extraordinary position that the SEC is the sole determiner of the public interest regarding consent judgments in its cases. But as Rakoff pointed out, that is not the law.


2d Circuit: D.J.’s Refusal to Approve Settlement Probably Unwarranted

3/15/2012

SEC/Citigroup Motion for a Stay or Mandamus


Stay – factors to consider (1) strong showing of likelihood

of success on merits (2) applicant will suffer

irreparable harm

(3) other parties will be injured by a stay

(4) a stay is in the public interest


Rakoff’s reasons for refusal to approve settlement as `fair reasonable, adequate, and in the public interest’

1) Failure of settlement to serve

the public interest

2) Unfairness to Citigroup

3)Absence of basis to assess

fairness


Rakoff – settlement fails public interest S.E.C. policy of allowing defendants

to enter consent orders without admitting or denying the underlying allegations is “hallowed by history but not by reason”

- investors shortchanged w/o collateral estoppel

Penalties too low - “a cost of doing business”


Rakoff – settlement fails public interest

Unfair to Citigroup because penalties

“on the basis of facts neither proven

nor acknowledged” carries risks of

abuse Injunction sought has inadequate

basis in facts established by trial or admissions


2d Circuit critique on merits Rakoff prejudged the facts

Assumed SEC would win at trial

Rakoff did not defer to SEC’s

judgment “on wholly discretionary

matters of policy”

Court review of policy-based

settlement decision is “minimal”SECv. Citigroup Global Markets -

Remedies 51

2d Circuit critique on merits Requiring an admission of liability

would “undermine any chance for compromise”

What is the harm in that? In school integration cases proof of

past discrimination is a required element for injunctive relief. [Grant v. Miami distinguished]

Shouldn’t payments of penalties and damages and injunctive relief have similar factual support?SECv. Citigroup Global Markets -

Remedies 52

SEC asserts its settlement is in the public interest Deference is owed to an executive

branch decision - - Agency expertise - Resolving competing views of the

public interest belongs to the political branches

- Judicial role not a rubber stamp – but limited to findings of arbitrariness, capriciousness, etc.


Will issuance of the stay substantially injure other persons in the Proceeding

The stay does nothing more than maintain the status quo existing prior to the district court's order.

We see no appreciable harm to anyone from issuing a stay [of the trial pending appeal].


Harvey Pitt as amicus in support of Judge Rakoff

A district court may consider

scienter or lack of it as one of

the aggravating or mitigating

factors to be taken into account

in exercising its equitable

discretion in deciding whether or

not to grant injunctive relief.SECv. Citigroup Global Markets - Remedies 55

Harvey Pitt as amicus in support of Rakoff

SEC internal processes address each factor in its prosecutorial decisions:

fair, reasonable, adequate, in public interest

SEC is able to answer Rakoff’s questions

Judge must exercise “a modicum of independent judgment”


Class Discussion Slides - S.E.C. v. Citgroup Global Markets

Documents

district court

appeal2 motion

appeala motion

initial motion

district clerk

court of appeals conditions

following relief

citigroup global marketsgeorge