Published in the Maryland Daily Record December 5, 2011
U.S. District Judge Jed Rakoff would probably be happier with some of the state agencies I regularly deal with than he was last week with the Securities and Exchange Commission. He refused to endorse a settlement of an enforcement action by the SEC, in part because the defendant, Citigroup Global Markets Inc., wasn’t required to admit the allegations against it. In my own practice, I tend to encounter the opposite problem. My state regulator adversaries seldom agree to a disposition of an enforcement action without an admission of guilt by my client. Rakoff thus attacked a kind of administrative prosecutorial discretion I’d like to see more of.
Why The Judge Was Mad
The allegations against Citigroup are pretty bad. It’s said that when in 2007 Citigroup held a load of mortgage-backed securities it well knew to be dubious, Citigroup arranged for some allegedly independent but secretly paid-off expert to tout the vitality of these stinkeroos, tricking investors into taking them off Citigroup’s hands. Citigroup then sold short against the very securities it was about to dump. After the securities did what Citigroup knew they would do, i.e. tanked, the final score (allegedly) was Citigroup: $160 million profits, Investors: $700 million losses.
Rakoff was annoyed with the settlement because Citigroup was charged only with negligence, not fraud (only its employee was charged with fraud). Investors can’t sue for mere negligence. Moreover, the settlement would have forced the disgorgement of Citigroup’s profits plus interest, but would not have necessarily landed a single penny back in the pockets of the investors. Third, and most upsetting to the judge, the settlement would have had zero collateral estoppel effect. The settlement would have given investors suing Citigroup no established factual basis for their own fraud actions. They would have had to have proved their cases from scratch.
Of course, Citigroup also promised never to do in future what it neither admitted nor denied having done in the past, and agreed to be enjoined. That agreed injunction was Judge Rakoff’s way in; as every litigator knows, an injunction can only be granted after the court takes the public interest into account. And Rakoff found that the public interest would not be served if Citigroup admitted nothing, particularly if the investors were not made whole.
Why The Judge Was Wrong
I wish Rakoff had stayed with his first two gripes, which I think were legitimate. The timidity of SEC in undercharging Citigroup and in not trying to build restitution to defrauded investors into the settlement seems unfortunate. But saying that there was a public interest in admissions went too far.
For one thing, the whole point of a settlement is to leave something on the table for each side. For a person or company at the receiving end of an administrative enforcement action, that something can take the form of facts not admitted. It is a natural quid pro quo. Usually, the agency will get the sanction it seeks. And usually, not admitting facts protects against grave practical consequences.
Nothing Collateral About Collateral Damage
Typically, the consequences when facts are admitted are collateral. The statutory sanction the agency seeks and will typically receive in a settlement (delicensure of a professional, fines and disgorgement for a corporation, and the like) will be direct. But if facts are admitted, the damage to the regulatee will go on in ways not contemplated by the agency’s own organic statute.
For example, even if the professional is re-licensed someday, he or she may be unable to obtain, directly or indirectly, federal reimbursement – which in many practices, including medicine, is a death sentence. A government contractor may be debarred, another kind of death sentence. Admitted facts may lay a company like Citigroup open to huge claims through collateral estoppel. Risks may become uninsurable. Financing may become unavailable. Individuals may be deported. And above and beyond these consequences, there is the damage to reputation and to pride.
Typically, as noted, the agency’s founding statute charters it to pursue none of these consequences. Yet administrative prosecutors and/or regulators who insist on found facts are knowingly inflicting them.
This unnecessary roughness, I maintain, is not in the public interest. That interest, established by thousands of disciplinary statutes, should begin and end with the linkage articulated in those statutes between specified misbehavior and specified sanctions. Those sanctions are the only consequences in which the law establishes a public interest. With those sanctions achieved, the establishment of the facts of the misbehavior – at least by the prosecutor or agency in question – is not important.
Why then is it pursued? Often, I believe, from the conscious desire to inflict those collateral consequences, a blood-lust to stigmatize. I’ve seen prosecutors self-righteously bent on taking errant professionals “off the road” to greater extents than the laws they are supposed to enforce warrant. And I’ve definitely seen regulators afraid of being tagged as the ones on whose watch some malefactor got off insufficiently stigmatized.
Am I saying then that the public has no interest in finding out what really happened? For instance, is there no public interest in getting to the bottom of Citigroup’s alleged mammoth pump-and-dump? No, I think the public does have an interest, and a Congressional hearing or a journalistic investigation would be an appropriate way of vindicating it – not to mention what comes out of private lawsuits. But prosecutions, administrative or otherwise, serve a different aspect of the public interest, namely in protecting the public by sanctioning certain kinds of misbehavior. The fact-finding function is purely incidental to that service.
No Incentive To Settle
Practically speaking, if the incidental fact-finding is not allowed to be dispensed with in settlement, it leaves most regulatees very little reason to settle. If the administrative prosecutor or the regulatory board insists on the statutory sanction plus admissions of all facts, the settlement is nothing more than a surrender. And why should the regulatee who can afford a legal defense just surrender – at least when there remains the faintest chance of a successful defense? The inefficiency of the resulting trial in terms of the time and cost to both sides (one financed by taxpayers, let’s not forget) is considerable.
In fact, even the word surrender may not always capture the essence of the prosecutorial overkill. Many professionals, once charged with misconduct, cannot merely unconditionally surrender their licenses; boards will not even accept the surrender without admissions being made. It becomes a strange conditional surrender, in which, contrary to the usages in warfare, the victor sets the conditions. Unless the professional gives the demanded admissions, the professional must withstand an administrative trial he or she does not even wish to contest. This is show-trial time; this is madness.
Enough With The Mea Culpas
One can applaud Judge Rakoff for trying to make SEC get a backbone. If the SEC had insisted on restitution, one can guess Rakoff would not have harped on admissions. But the SEC didn’t do that, drawing the judge off-base. It would be unfortunate if this high profile case further increased the respectability of the practice of shaking down regulatees for admissions when the regulators are already getting, practically speaking, everything they wanted.
They should be encouraged to take yes for an answer, without a particularized mea culpa attached.
Copyright (c) Jack L. B. Gohn