The SEC and the Courts: Challenging the Citigroup Decision

The Commission has not had a pleasant time in the courts recently.  The difficult decisions fall into two broad camps.  There are those that adopt legal interpretations that make the SEC's ability to enforce the securities laws more difficult. 

Janus is an example of that.  By limiting liability to those with "ultimate authority," the Court restricted the category of persons subject to the antifraud provisions.  While the meaning of this phrase is yet to be played out, the SEC has already had to deal with attempts to dismiss actions against corporate officers on the grounds that they did not have "ultimate authority" over the allegedly misleading disclosure.  See SEC v. Carter, 2011 U.S. Dist. LEXIS 136599 (ND Ill. Nov. 28, 2011).

The other category of decisions are those where the courts excessively intrude into the duties and responsibilities of the SEC.  The decision to strike down the shareholder access rule was one example.  The court in Business Roundtable v. SEC found that the cost-benefit analysis was deficient.  Had the decision been narrowly drawn, it might have been defensible.  It was not.  The decision was extraordinarily broad.  Moreover, whatever one thinks of the merits, the decision effectively imposed substantial additional costs on the rulemaking process (discouraging the SEC from engaging in this process) and provided plenty of support for future legal challenges (adding uncertainty to any regulatory steps taken by the agency).  

Similarly, in Gupta v. SEC, the court allowed a decision to go forward involving a challenge to the forum selected by the SEC.  The case was not narrowly written and provided a basis for future law suits by defendants who sought to contest the forum selected by the staff.  The case has the potential to influence enforcement decisions within the SEC.  There may now be instances where the staff chooses to bring an injunctive rather than an administrative proceeding solely to avoid the possibility of a legal challenge.  

The SEC did not appeal the Business Roundtable decision.  In Gupta, the SEC agreed to dismiss the administrative proceeding.  An injunctive proceeding has since been filed. 

Citigroup is another case that has the potential to interfere with the SEC's internal process.  The order is here.  Courts have a role in the settlement process.  They must ensure that the terms are reasonable.  Sometimes they are not.  The same judge rejected a settlement against Bank of America with the result that the parties returned with a better settlement.

The decision in Citigroup, however, did not reject the settlement on the merits.  Instead, the settlement was rejected because the judge disagreed with the decision to allow Citigroup to neither admit nor deny the allegations in the complaint.  This was not a narrowly written opinion.  Indeed, the court suggested that his reasoning had universal application.  As the opinion stated:  "It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations?" 

In both Business Roundtable and Gupta, the Commission did not appeal the decisions, leaving the law as articulated by the respective courts unchallenged.  There are plenty of strategic reasons why appeals ought not to be taken.  They can make matters worse.  Challenging Business Roundtable would almost certainly have resulted in a loss given the current makeup of the DC Circuit. 

But to some degree, the Citigroup decision is the natural consequence of this approach.  The decision is an attempt to rewrite the process used by the SEC in reaching settlements.  To the extent that the reasoning stands, the SEC will either have to litigate more cases (perhaps substantially more cases) or bring settlements as administrative proceedings, thereby avoiding the need for judicial approval.  In the latter circumstance, that will mean more settlements not subject to enforcement through contempt.

Moreover, it is not at all clear that private parties will benefit from abandonment of the "neither admit nor deny" language.  The absence of the language does not guarantee a trial.  Instead, the defendants will have an incentive to make some factual admissions.  But in general they will be less willing to do so in actions that can also be brought by private parties, such as fraud actions under Rule 10b-5.  Instead, defendants will put pressure on the SEC to bring actions for negligence or aiding and abetting.  As a result, there is no guarantee that the "overriding public interest in knowing the truth" will be advanced.  Quite the contrary.  The approach taken by the court in Citigroup may result in the truth becoming even more obscure.  

The reasoning of this decision cannot be left unchallenged.  Unlike Gupta and Business Roundtable, the SEC needs to take steps to clarify the law in this area.  So what might the SEC do?  It could seek voluntary dismissal and refile (and settle) the case as an administrative proceeding.  That, however, would leave the legal analysis in Citigroup unchallenged. 

The Commission could seek reconsideration of the decision and, in the alternative, an interlocutory appeal.  The trial court will not reverse his decision but with a spirited challenge he may at least narrow the holding. The same is true with respect to an appeal.  Moreover, it would seem likely that the Justice Department and other federal agencies that rely on a similar approach (and similar language) would support the challenge.  Certainly, such a united approach would, at a minimum, send a message to other judges that the SEC does not intend to accept this sort of reasoning.