To assist your ongoing regulatory efforts, you have inquired about the recent controversy regarding a consent decree entered into by the United States Securities and Exchange Commission ("SEC") and Citigroup Global Markets ("Citigroup") in Securities & Exchange Commission v. Citigroup Capital Markets (the "Citigroup case"). In response, this article presents a brief background on consent decrees; a description of their potential benefits; and an analysis of the Citigroup case controversy.

I. Background

As used in this article, a "consent decree" is an agreement between the SEC and an adverse party under which the party agrees to undertake or not undertake certain actions in order to avoid further prosecution by the SEC. As a consent decree is an agreement, by definition, its terms are negotiated and agreed to by the parties (the SEC and the regulated party). In other words, a consent decree is a settlement. Thus, a consent decree is distinguished from a sanction applied against a regulated party by the SEC or a court after an adjudication on the merits of a case, without the regulated party's consent. As part of the consent decree, the adverse party may agree to not engage in practices that the SEC does not want it to undertake; it may agree to undertake remedial or palliative measures, or to make disclosures to investors or customers, to avoid further problems (in the SEC's opinion); it may agree to a monetary payment to the SEC; or it may agree to some combination of all of these measures. In every case, the adverse party also agrees not to violate the securities laws in the future.

A consent decree usually is entered into at the start of an adjudication-that is, either at the start of an SEC administrative action, which is an internal proceeding the SEC may commence to enforce the U.S. securities laws; or at the start of a civil lawsuit filed by the SEC in a United States federal district court to enforce the U.S. securities laws. In this scenario, the SEC and the adverse party reach an agreement on terms prior to the filing of the administrative action or lawsuit. The SEC then files the administrative action or lawsuit, while simultaneously announcing that the matter has been settled by consent. The Citigroup case is an example of this: simultaneous with the SEC's filing of a complaint against Citigroup in the district court, the SEC presented to the Court for its approval a consent judgment, coupled with a consent by Citigroup that the judgment be entered. A major difference between a consent decree entered in an administrative action and a consent decree in a civil lawsuit is that, in the latter case, the federal district court must approve the terms of the consent decree so that it may be entered as a judgment of the court. See SEC v. Cioffi, No. 08-CV-2457 (FB) (VVP), ___ F. Supp. 2d ___, 2012 WL 2304274, *1 (E.D.N.Y. June 18, 2012) ("A consent decree (or consent judgment) is an agreement of the parties entered upon the record with the sanction and approval of the court." (citing Barcia v. Sitkin, 367 F.3d 87, 90 (2d Cir. 2004))).

According to an opinion in another consent decree case discussed below, by the same judge in the Citigroup case (Judge Jed Rakoff), consent decrees have been used for over forty years. SEC v. Vitesse Semiconductor Corp., 771 F. Supp. 2d 304, 308-309 (S.D.N.Y. 2011). In 1972, the SEC modified its policies in one respect, by enacting a regulation under which the settling adverse party must agree "not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis." Id. at 309 (citing 17 C.F.R. § 205.5). However, at all times, the SEC has allowed the adverse party to settle without either admitting or denying the SEC's allegations. As noted below, the neither-admit-nor-deny aspect of the Citigroup consent decree was one of the terms to which Judge Rakoff objected.

II. Benefits Of Consent Decrees

The controversy over the Citigroup consent decree tends to obscure the potential benefits of consent decrees. By our analysis, there are at least six benefits to a regulator such as SEBI or the SEC-as well as to the public interest served by the regulator.

1. Settlement. As explained above, a consent decree, by definition, constitutes a settlement. In any settlement, the parties obtain a benefit-here, for the regulator, the terms of the consent decree. In a consent decree, the regulator obtains these benefits without undertaking the costs of a full litigation on the merits, and without the risk of losing the litigation and obtaining nothing at all for its efforts. This also allows the regulator to devote its enforcement efforts to other matters. Traditionally, U.S. law favors settlements, which may be one reason why Judge Rakoff's decision was unexpected.

2. Money. As explained above, the terms of a consent decree may include monetary payments. This can be substantial: in the Citigroup case, Citigroup Global Markets agreed to pay $285 million in disgorged profits, civil penalties, and interest. Monies collected by the SEC in a consent decree may be distributed to investors under the Fair Fund provisions enacted in 2002 under the Sarbanes-Oxley Act. See, e.g., SEC v. Vitesse Semiconductor, 771 F. Supp. 2d at 307 n.3 (SEC averred that it may deposit $3 million fine proposed in consent decree into Fair Fund account). Alternatively, the SEC may keep the funds and so benefit the U.S. Treasury.

3. Cooperation against other defendants. The SEC may reach a consent decree with some of the principals to alleged wrongdoing while continuing to pursue its administrative action or lawsuit against non-settling other parties. For example, in the Citigroup case, the SEC agreed to a consent judgment to be applied to Citigroup Global Markets; at the same time, the SEC filed a separate lawsuit making parallel allegations against a former Citigroup employee, Brian Stoker, who supposedly masterminded the alleged fraud. Likewise, the consent decree entered in Vitesse Semiconductor left out the two alleged masterminds of the stock option backdating alleged in the case. By settling with some potential defendants and not others via a consent decree, a regulatory agency can obtain the cooperation (or at least acquiescence) of the settling party as it continues to pursue other alleged wrongdoers, and focus its litigation expenditures on those non-settling parties.

4. Disclosures to investors or customers. As explained above, the terms of a consent decree may include the adverse party's agreement to make disclosures to investors or customers. This more often occurs in consent decrees entered in SEC administrative proceedings, as part of a dialogue between the SEC and the regulated entities, but it is nevertheless an important factor in all respects. For example, disclosures made pursuant to an administrative consent decree have played a major role in litigation following the collapse of the auction rate securities market (in February 2008). The largest brokers and issuers of auction rate securities had made additional disclosures of the risks of that market after entering into a major consent decree with the SEC in May 2006. In the opinion of many (but not all) courts, these disclosures informed customers and investors of the risks, sufficient to bar private claims based on purchases after the disclosures. See, e.g., In re Merrill Lynch Auction Rate Sec. Litig., 758 F. Supp. 2d 264, 273-74 (S.D.N.Y. 2010) (following consent decree, defendant firm had posted 23 page description of its practices on its Internet site, which included disclosures that it provided bids in the auctions and gave no assurance this would suffice to save auctions if they were failing).

5. Secondary disclosure benefits. As explained above, the terms of a consent decree always include an agreement not to violate the securities laws in the future. This gives rise to further duties to disclose. Specifically, under Regulation S-K Item 401(f)(3), an issuer must disclose if any officer, executive director, or candidate for those positions was the subject of an order, judgment, or decree regarding a violation of the securities laws in the prior ten years (a period extended from the prior five years). Hence, by agreeing to a consent decree with an individual a regulator believes violated the securities laws, the regulator assures that if that person seeks a high position at a reporting company, investors will know of his or her alleged past. In addition, if an issuer is the subject of a consent decree under an antifraud provision of the U.S. securities laws (which is a subset of the securities laws as a whole), the issuer cannot obtain the benefits of the safe harbor for forward-looking statements for a period of three years. 15 U.S.C. §78u-5(b)(1)(a)(ii). Thus, the regulator can target issuers that it believes have engaged in fraud in the past, and discourage them from providing investors with forward-looking statements (essentially, forecasts) that might prove to be inaccurate by removing the safe harbor protections for such statements.

6. Enforcement. Finally-but by no means least in importance-a consent decree entered in a civil action in a federal court is an injunction: an order of the court. If the regulator believes that the adverse party is violating the terms of the consent decree, it may enforce the injunction by expedited means in federal court. As Judge Rakoff himself explained, the SEC "can move summarily to have the Court hold the defendant in contempt, following an expedited hearing, rather than having to go through the laborious process of filing a civil complaint, undergoing full discovery and motion practice, and trying the case to a jury." Vitesse Semiconductor, 771 F. Supp. 2d at 308 n.5. In addition, the existence of a consent decree entered as an injunction in a prior case renders it easier for the SEC to obtain an administrative order barring a broker or dealer from participation in the securities business. SEC v. Cioffi, 2012 WL 2304274 at **4, 8 (citing this factor as reason to approve consent decree).

III. The Citigroup case

A. Vitesse Semiconductor Preview

Judge Rakoff's November 2011 rejection of the proposed consent decree in Citigroup was prefigured by his decision in SEC v. Vitesse Semiconductor Corporation earlier that year. In Vitesse Semiconductor, Judge Rakoff was asked to approve a consent decree with a high technology company and three of its former officers, where the company was accused of backdating stock options and thereby issuing false financial statements for a ten-year period. The proposed judgments called for the company to pay a $3 million civil penalty and submit to an injunction against violating the securities laws, including the antifraud provisions thereof; two of the individual defendants also agreed to pay civil penalties, and one of those persons consented to a permanent bar from serving as an officer or director of a public company.

Judge Rakoff asserted that the SEC had been "confident that the courts in this judicial district were no more than rubber stamps" when it submitted the proposed judgments without any reasons why they should be approved. 771 F. Supp. 2d at 305. Upon being informed that such justification was required, the parties submitted additional information sufficient to allow the court to assess whether the proposed settlement was fair, reasonable, and in the public interest, which was the legal standard advocated at the time by the SEC. Judge Rakoff found that the settlement satisfied these standards. Among the reasons why were that two settling individuals had pleaded guilty to parallel criminal charges and were cooperating in the ongoing action against the alleged principal wrongdoers; and that the company already had paid $10 million to settle a parallel private class action lawsuit, despite being short of cash. 771 F. Supp. 2d at 307-308.

Still, the court was troubled by the provision that the defendants neither admitted nor denied the allegations of the complaint. When coupled with the additional, seemingly contradictory provision that a defendant cannot make "any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis," the result was " a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C." under which "the public will never know whether the S.E.C.'s charges are true, at least not in a way that they can take as established by these proceedings." 771 F. Supp. 2d at 309. Judge Rakoff claimed that he "is ultimately obliged to determine whether such a practice renders any given proposed Consent Judgment so unreasonable or contrary to the public interest as to warrant its disapproval," as the public interest was implicated. 771 F. Supp. 2d at 310. In the present case, however, the criminal pleas and the company's large cash contribution in the settlement(s) made it clear that the defendants had admitted the merits of the complaints, and hence there was no need to upset the SEC's standard practice in settlements. Judge Rakoff, though, warned that this case was not the last word: he "reserv[ed] for the future substantial questions of whether the Court can approve other settlements that involve the practice of 'neither admitting nor denying'." 711 F. Supp. 2d at 310.

B. Judge Rakoff's Citigroup Decision Rejecting a Consent Decree

SEC v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011), provided the vehicle by which Judge Rakoff revisited his concerns expressed in Vitesse Semiconductor. In that case, the SEC and Citigroup Global Markets proffered a settlement of a negligence-only complaint alleging that Citigroup had selected mortgage-backed securities to be packaged and sold in a billion-dollar collateralized debt obligation (CDO) fund, when it knew that the securities had negative performance projections and had even taken a short position in those assets. 827 F. Supp. 2d at 329. Under the proposed consent decree, Citigroup agreed to undertake unspecified remedial measures designed to prevent the reoccurrence of the alleged misconduct, and to pay $285 million in disgorged profits, civil penalties, and interest. Simultaneously, the SEC filed a separate case alleging that a Citigroup employee, Brian Stoker, knew that it would be difficult to sell the poorly-rated securities without falsely representing that they had been selected by a third party adviser. 827 F. Supp. 2d at 329-30.

Judge Rakoff decided that he could not approve the consent decree because he lacked "any proven or admitted facts upon which to exercise even a modest degree of independent judgment." 827 F. Supp. 2d at 330. The SEC had modified its position from Vitesse Semiconductor, arguing that consideration of the public interest was not part of the court's standard of review. Judge Rakoff disagreed, reasoning that the court was being asked to issue an injunction, which implicated the public interest. He also opined that the SEC did not have the unilateral, unquestionable authority to determine what was in the public interest, as that position purportedly would violate the Constitutional doctrine of separation of powers by removing any role for an independent judiciary. 827 F. Supp. 2d at 331.

Judge Rakoff then concluded that the proposed settlement was not fair, reasonable, adequate, nor in the public interest-substantially because he purportedly lacked a sufficient evidentiary basis to make such a determination. He reasoned that he could not rely on the mere allegations of a complaint, as in a private lawsuit, but rather required more when the government sought to enlist a court in enforcing the public interest. Here, while Citigroup had agreed to settle, it had affirmed that it contested the allegations and hinted that it would do so in the parallel case against Stoker. Moreover, it had suggested that the penalty was modest, and characterized it as merely a cost of doing business. 827 F. Supp. 2d at 333. While this position helped Citibank (including in any parallel civil litigation), it meant that there were no admitted facts that could serve as evidence in any separate proceeding, or to support an injunction. Moreover, according to Judge Rakoff, the SEC did not commit to using the payment to compensate investors under the Fair Fund provision. 827 F. Supp. 2d at 334. Hence, the proposed settlement did not serve the public interest, including the interests of civil litigants suing under the same circumstances.

In the end, Judge Rakoff asked whether "it could ever be reasonable to impose substantial relief on the basis of mere allegations?" 827 F. Supp. 2d at 335. A settlement on that basis would offer obvious potential for abuse and would enlist the courts in applying judicial power without a factual basis, which supposedly is "inherently dangerous." Id. Any injunction that "does not rest on facts - cold, hard, solid facts, established either by admissions or by trials," would serve no purpose and would be "simply an engine of repression." Id. This was especially true given that the Citigroup case purportedly "touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives," creating "an overriding public interest in knowing the truth." Id. The court thus rejected the settlement and set the case for trial in less than eight months.

C. The Second Circuit Decision Staying the Case

Both settling parties sought immediate appellate review of Judge Rakoff's decision. Judge Rakoff himself denied a motion to stay the case pending an appeal. SEC v. Citigroup Global Markets Inc., 827 F. Supp. 2d 336 (S.D.N.Y. Dec. 27, 2011). On March 15, 2012, however, a panel of the Second Circuit issued an order staying the case so that a full appeal of the decision could be considered. SEC v. Citigroup Global Markets Inc., 673 F.3d 158 (2d Cir. 2012) (per curiam). Hence, at present, the order denying approval of the consent decree is on appeal; the Second Circuit denied a companion motion to expedite that appeal. While this decision is not a final resolution of the matter, the Second Circuit panel raised strong challenges to Judge Rakoff's opinion, in finding that the appellants had a strong likelihood of success on the merits. Indeed, the court identified several problems with Judge Rakoff's reasoning.

First, the Second Circuit panel reasoned that Judge Rakoff had erred in finding that the settlement did not serve the public interest because its no-admissions language did not aid parallel civil litigants. For one thing, the judge, in apparently assuming that the SEC had breached an obligation to take the case to trial, had failed to consider that the claims may not have merit and would not be proven at trial. 673 F.3d at 163. Indeed, the panel noted, Judge Rakoff had not given any reason to believe that the SEC would prevail on the merits; rather, he had said that he did not know the facts. 673 F.3d at 163 n.2. In addition, the judge had not given deference to the SEC's views on these "wholly discretionary matters of policy," when in fact "[i]t is not, however, the proper function of federal courts to dictate policy to executive administrative agencies." 673 F.3d at 163. The importance of the SEC's policy discretion to enter into this settlement was especially important in light of the substantial monetary benefits it stood to gain by the consent decree, as compared to the risk and expenses of going to trial. 673 F.3d at 164. Furthermore, Judge Rakoff had engaged in questionable reasoning in opining that no settlement served the public interest without an admission of liability on the part of the defendant, which "would in most cases undermine any chance for compromise." 673 F.3d at 165.

Second, the Second Circuit panel rejected Judge Rakoff's ostensible position that the settlement should be rejected on the basis that it was unfair and oppressive to Citigroup, the defendant, based as it was on mere allegations that were neither proven nor admitted. The court properly questioned the sincerity of this position, given the judge's characterization of the settlement as mild and as a mere cost of doing business. More fundamentally, the Second Circuit panel questioned whether it was legitimate for a court to "protect a private, sophisticated, counseled litigant from a settlement to which it freely consents." 673 F.3d at 165.

Third, the Second Circuit panel expressed doubt in the soundness of Judge Rakoff's proposition that the absence of proven or admitted liability could justify a refusal of a settlement. For one thing, there was a record for the judge to consider, based on the extensive pre-filing investigation conducted by the SEC. 673 F.3d at 165-66. More fundamentally, "[a] settlement is by definition a compromise," reached before trial. Id. at 166.

Having determined that the appellants had a strong likelihood of success on the merits to their challenge to Judge Rakoff's order, the Second Circuit panel considered the other factors justifying a stay. Of particular interest here is its analysis of whether a stay was in the public interest. Consistent with its expressed position that Judge Rakoff should have deferred to the SEC's discretion on the appropriateness of the settlement, the Second Circuit panel held that it, too, was bound to defer to the SEC's position on whether a stay was in the public interest. 673 F.3d at 168.

IV. Conclusion and Additional Assessment

The final status of Judge Rakoff's rejection of the Citigroup consent decree is yet to be determined. The Second Circuit's granting of a stay does not bode well for the rejection, and hence signals that courts will be directed to approve consent decrees and thereby provide the benefits thereof described in Section II, supra. Indeed, Judge Frederic Block recently cited the history of the Citigroup case in considering a consent decree between the SEC and two managers of a hedge fund - a settlement in which the defendants had agreed to pay what the court characterized as "chump change" ($1,050,000) in light of investors' alleged losses ($1.6 billion). SEC v. Cioffi, 2012 WL 2304274 at *1. Judge Block, like Judge Rakoff, was troubled by the alleged connection between the circumstances of the case and the financial crisis. 2012 WL 2304274 at **2-3. In the end, the court reluctantly approved the consent decree in recognition of what it considered to be the SEC's limited authority to recover investor losses and the risks that it would end up with nothing at trial. 2012 WL 2304274 at **6-7, *9. In so doing, Judge Block concluded that while courts are not required to "rubber stamp every settlement between the SEC and a defendant," their review is restricted to assessing whether the settlement was fair, reasonable, and adequate "within the limitations Congress has imposed on the SEC to recover investor losses." 2012 WL 2304274 at *9. Significantly, the judge did not cite the public interest as a relevant factor in assessing the consent decree.

To be certain, no party has yet appeared in the Second Circuit, and perhaps effective arguments in defense of Judge Rakoff's decision may yet be presented (although both parties seek to overturn Judge Rakoff's decision). Indeed, even after the Second Circuit panel decision, a separate federal district court judge claimed that she had not been provided with sufficient information to approve a settlement between a government agency (the Federal Trade Commission) and an adverse party alleged to have engaged in deceptive advertising, under the reasoning enunciated by Judge Rakoff, where the agency had not obtained an admission of liability. FTC v. Circa Direct LLC, No. 11-2172 RMB/AMD, 2012 WL 2178705, **5-6 (D. N.J. June 13, 2012). On the other hand, there are additional reasons to question Judge Rakoff's decision that have not yet been cited by the Second Circuit, which provide further support for the continued use of consent decrees notwithstanding the Citigroup case.

First, Judge Rakoff placed an inordinate weight on trials as the sole means by which facts are determined. Significantly, after rejecting the consent decree, he did not order the parties to develop a pre-trial schedule, which normally includes a provision allowing for motions for summary judgment before trial. Rather, the court assumed that if there was no settlement, the only alternative (perhaps other than an additional attempt at settlement) was trial. See Section III(B), supra. That is not the way U.S. federal courts usually function in civil cases. Rather, as noted, summary judgment is allowed under Federal Rule of Civil Procedure 56. Moreover, courts make important decisions all the time without the benefit of a trial-including, significantly, decisions on injunctions requested by the SEC (such as in asset freeze motions or motions for the appointment of a receiver). See, e.g., SEC v. Fife, 311 F.3d 1 (1st Cir. 2002) (affirming issuance of asset freeze injunction); SEC v. Gen-See Capital Corp., No. 09-CIV-14S, 2009 WL 57589 (S.D.N.Y. Jan. 8, 2009) (ex parte restraining order \ asset freeze granted in regulatory lawsuit alleging Ponzi scheme targeted to church members and senior citizens). If it really is the case that nothing short of an admission or trial may justify the use of a federal court's injunctive powers, then federal court practice would have to change dramatically-and it would become more difficult for a regulator to obtain an injunction enforceable by a court.

Second, Judge Rakoff suggested a higher standard for approving settlements than is used in an analogous context: private securities class action lawsuits. In private class actions, district court approval of a settlement is required (the source of the requirement is Federal Rule of Civil Procedure 23(e)), and here, too, the standard is whether the proposed settlement is fair, reasonable, and adequate. Moreover, the district court has a particularly strong role in carefully scrutinizing class action settlements: it acts as a fiduciary watchdog to ensure that the settlement protects the interest of absent class members, who are bound by the judgment even though they do not separately appear in court. In re Cendant Corp. Sec. Litig., 264 F.3d 201, 231 (3d Cir. 2001). Yet courts do not often reject settlements, and when they do it is under a theory that the settling parties colluded to reach a settlement that would pay off the named plaintiffs who sued without fully supporting the interests of absent class members. Judge Rakoff, however, did not suggest that the SEC had colluded with Citigroup to sell out the public interest.

Third, one may argue that Judge Rakoff's references to the financial crisis and the purported need to know the facts misapprehends the limited role of federal courts and their judges. Under Article III of the U.S. Constitution, the federal courts adjudicate cases and controversies-meaning actual disputes between adverse parties interested and able to argue for their respective sides of the dispute. Where both parties to a dispute have reached a settlement, fully informed and represented by counsel, there is no longer an actual dispute between adverse parties. At that point, one may question whether the "dispute" should continue to remain in a federal court. Put in other terms, federal courts are designed to adjudicate live controversies-not serve as tribunals of historical fact-finding, no matter how interested the public may be in that history. Moreover, even assuming that a federal court trial can be the means by which a judge may pursue historically interesting factfinding, one may question whether it should serve as the means to this end. The alternative view is that civil trials assess narrow factual disputes on the basis of legal rules of evidence-not sweeping historical propositions based on principles of historical proof.

As against all of these criticisms, Judge Rakoff's decision can be regarded as support for the proposition that whenever litigants seek to persuade a court to issue an injunction - either all of the litigants, in the case of a consent decree; or only one side of the dispute, in the case of a contested injunction - courts should demand a strong factual record in support of the request, lest judicial power be abused. While the Second Circuit ultimately may conclude that Judge Rakoff went too far in demanding a factual record and second-guessing the SEC's assessment of the public interest and litigation dynamics in Citigroup, his opinion surely serves a salutary purpose by reminding litigants (and the public) that court decisions with real-world consequences should be based on as strong a record as it practical.

In conclusion, Judge Rakoff's criticism of the process in the Citigroup case may or may not succeed in overturning the consent decree agreed upon in that case, pending the final determination from the Second Circuit. If the appellate court vindicates Judge Rakoff's rejection of the consent decree, its decision undoubtedly would require major changes in enforcement practice on the part of the SEC (and potential adverse parties). Until and unless that occurs, however, consent decrees remain a valid and valued enforcement tool of U.S. securities regulators.