Judge Rakoff, friendly-looking scourge of the SEC. Photographer: Yana Paskova/For The Washington Post via Getty Images
Judge Rakoff, friendly-looking scourge of the SEC. Photographer: Yana Paskova/For The Washington Post via Getty Images

Back in 2011 the Securities and Exchange Commission had a vogue of entering into nine-digit settlements with major banks who sold collateralized debt obligations of mortgage-backed securities with not-so-hot disclosure. It would take those settlements to judges, to show off what it had done, and the judges would then approve the settlements. But then one day, one judge, Jed Rakoff, decided that the SEC was not allowed to settle these cases. These cases had to go to trial -- or, at least, end with a full confession from the banks -- so that The Truth Could Come Out.

He didn't say that, but he meant that.1

This got a lot of people excited but was sort of obviously wrong. I mean, of course the SEC can settle cases. And so a few months after Rakoff's decision, the U.S. Court of Appeals for the Second Circuit sort of said that it was obviously wrong, and then, the justice system being what it is, the appeals court sat around and pondered for two years just to see if it was in fact obviously wrong, and today it decided, yep, obviously wrong:

A federal appeals court on Wednesday overturned a judge’s decision to reject a federal settlement deal with Citigroup, undercutting the judge’s concerns that the bank got off with little more than a slap on the wrist.

In a long-awaited 28-page opinion, a three-judge panel of the United States Court of Appeals for the Second Circuit concluded that the trial judge “abused its discretion by applying an incorrect legal standard in its review” of the case. The harsh rebuke of the judge, Jed S. Rakoff, will now set in motion additional proceedings that will most likely lead him to approve the settlement deal.

Here is the Second Circuit's opinion. Here is the SEC's relatively restrained gloating. Here is what it means for future settlements:

The appeals court, in effect, told judges reviewing settlements by the S.E.C. to stand down from reviewing the terms of the agreement, writing: “Trials are primarily about the truth. Consent decrees are primarily about pragmatism.”

As a result of the decision, the role of the district judge is largely consigned to ensuring the parties have not pulled a fast one by reaching a corrupt bargain.

But, at the same time, the SEC's current vogue is to be slightly less willing to do neither-admit-nor-deny settlements, so in some sense Judge Rakoff lost the battle but won the war. The SEC's settlements will be a little more about truth, and a little less about pragmatism, than they were in 2011.

What's next?2 Well, the case will go back to Judge Rakoff to sign off on the settlement. Which he'll have to do unless -- hmm:

On remand, if the district court finds it necessary, it may ask the S.E.C. and Citigroup to provide additional information sufficient to allay any concerns the district court may have regarding improper collusion between the parties.

Of course it would be absurd to think that there was any "improper collusion" between the SEC and the banks in these CDO cases. I mean, wait. You were supposed to read that sentence in a sarcastic voice, even though I actually meant it literally. It would be absurd to think that the SEC and the banks struck settlements that were "tainted by improper collusion or corruption of some kind." But lots of people do think that! Here are headlines:

Yes, the SEC was colluding with banks on CDO prosecutions
The SEC's just been caught colluding with the banks it's supposed to regulate

Umm. So. The claim is basically that, because the SEC settled only one CDO case with each bank, but reached an informal understanding not to bring any other CDO cases against those banks, it "was not being fully honest with the public about the deals it was cutting." The SEC "worked out an arrangement whereby both sides would publicly act as if only one case had been settled while agreeing under the table that all claims were now resolved."

Sounds like collusion!

We've discussed this claim before, and I am unimpressed by it. My view is that, well, "settlements are primarily about pragmatism": The SEC isn't required to bring every case that it could possibly bring, and it was perfectly entitled to bring its best case, settle that case, and leave the others unsettled and vaguely-but-not-really hanging over the banks' heads. The SEC has to have some ability to make tactical decisions about how to pursue cases and how to settle them.

But if Judge Rakoff really believes that the SEC shouldn't be allowed to settle cases, then the appeals court has left him a little bit of an out. Does he have concerns about improper collusion? He certainly could. I mean, a lot of other people have those concerns. And if he does, then he can demand "additional information sufficient to allay" those concerns. If he's interested in dredging up the whole truth about these settlements, that might be a fun way to do it.

1 Here's what I wrote about it at the time. Here's his opinion. Here's the key passage:

Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint. But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, 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, while the public is deprived of ever knowing the truth in a matter of obvious public importance.

Here, the S.E.C.’s long-standing policy – hallowed by history, but not by reason – of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relieve it is being asked to impose has any basis in fact.

Like he says: Purely private parties pretty much always settle lawsuits without agreeing on the facts. All a settlement is is, you make a case go away by compromising, without agreeing on who's right.

2 I want to flag one random aside here that doesn't fit in the text and is maybe only interesting to me. When Judge Rakoff issued his decision, I argued that the SEC could have avoided this whole problem by just entering into an administrative settlement with Citi, which would have gotten it the same results but without requiring court approval. (In fact, the SEC did just that with Credit Suisse in the same case: Credit Suisse had a minor involvement with Citi's CDO, and settled out of court with the SEC for $2.5 million in fines and disgorgement.)

I was pleased to see that the Second Circuit agreed with me, and seems equally puzzled about why the SEC was so keen on bothering with Judge Rakoff:

Finally, we note that to the extent that the S.E.C. does not wish to engage with the courts, it is free to eschew the involvement of the courts and employ its own arsenal of remedies instead. See, e.g., Exchange Act § 21C(a), 15 U.S.C. § 78u‐3(a); Securities Act § 8A(a), 15 U.S.C. § 77h‐1(a). The S.E.C. can also order the disgorgement of profits. Exchange Act § 21B(e), 15 U.S.C. § 78u‐2(e); Securities Act § 8A(e), 15 U.S.C. § 77h‐1(e). Admittedly, these remedies may not be on par with the relief afforded by a so‐ordered consent decree and federal court injunctions. But if the S.E.C. prefers to call upon the power of the courts in ordering a consent decree and issuing an injunction, then the S.E.C. must be willing to assure the court that the settlement proposed is fair and reasonable.

Is the court scolding the SEC here, or just giving it some friendly advice?

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.