The following editorial appeared on Bloomberg View on Thursday:
The U.S. Court of Appeals, in resolving a dispute between a federal judge and the Securities and Exchange Commission, has raised an important question: Should judges be allowed to second-guess the deals the SEC strikes with alleged lawbreakers?
The court asserts the law says no. In that case, the SEC should hold itself to a higher standard. At issue is Judge Jed Rakoff’s refusal of a 2011 settlement between SEC and Citi-group. The agency accused the bank of misleading investors in a $1 billion mortgage investment by concealing that the bank’s own traders designed the investment to fail and were betting against it. The bank would pay a $285 million fine without admitting or denying guilt and promise not to break the law.
Rakoff argued that unless he knew which of the SEC’s allegations were true, he couldn’t assess whether the settlement was adequate, fair or reasonable. He noted a similar case involving Goldman Sachs, in which the SEC had extracted a larger penalty and required the bank to admit to certain facts.
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With no admission, perpetrators can keep denying what happened, and victims are deprived of evidence they can use in their efforts to recoup losses — which, in the Citi-group case, the SEC estimated at more than $700 million.
The appeals court ruled Rakoff interpreted his remit too broadly — the judge’s role in approving settlements should be limited to making sure the parties have their papers in order and understand what they’re doing. Such deals, it said, are for managing risks, not necessarily establishing truth. That the SEC is “politically liable” to the people, the court said, should be enough to ensure it acts in their best interests.
Recent experience suggests political liability alone isn’t enough. The SEC also faces other pressures, such as large financial institutions’ immense lobbying power and a heavy workload. The agency allowed companies to settle without admitting guilt, then failed to hold them to the law. When the SEC cut its deal with Citigroup, for example, it already had two cease-and-desist orders in place barring the same unit of the bank from violating the same sections of the securities laws.
Even if Rakoff exceeded his authority, he was right about the SEC’s approach. If the agency believes it has enough evidence to press charges and impose punishment, it should get the defendant to confirm the facts, if not admit to breaking the law. If its actions are restricted to fines and unenforced promises, who can know whether it is letting the guilty off easy or shaking down the innocent?
Rakoff’s activism, and that of other judges who have also questioned SEC settlements, appears to have had some effect: Since 2012, the agency has been moving toward requiring more admissions from companies. It’s not too late to require the same in the Citi-group settlement. The appeals court decision is a perfect opportunity for the SEC to show that it can do the right thing.