U.S. Sec. & Exch. Comm'n v. Citigroup Global Markets, Inc.

752 F.3d 285

UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff–Appellant–Cross–Appellee,

v.CITIGROUP GLOBAL MARKETS, INC., Defendant–Appellee–Cross–Appellant.

Docket Nos. 11–5227–cv (L), 11–5375–cv(con), 11–5242–cv(xap.).

United States Court of Appeals, Second Circuit.

Argued: Feb. 8, 2013.

Decided: June 4, 2014.

Michael A. Conley, Deputy General Counsel, Securities and Exchange Commission(Jacob H. Stillman, Solicitor, Mark Pennington, Assistant General Counsel, Jeffrey A. Berger, Senior Counsel, on the brief), Washington, D.C., for Plaintiff–Appellant–Cross–Appellee United States Securities and Exchange Commission.

Brad S. Karp, Paul, Weiss, Rifkind, Wharton & Garrison, LLP (Theodore V. Wells, Jr., Mark F. Pomerantz, Walter Rieman, Susanna M. Buergel, on the brief), New York, N.Y., for Defendant–Appellee–Cross–Appellant Citigroup Global Markets, Inc.

John R. Wing, Lankler Siffert & Wohl LLP (Patrick P. Garlinger, on the brief), New York, N.Y., Appointed Pro Bono Counsel for the United States District Court for the Southern District of New York (Jed S. Rakoff, J.).

Mark A. Perry, Gibson, Dunn & Crutcher, LLP, Washington, D.C., for Amicus Curiae Business Roundtable, in support of reversal.

William Michael Cunningham, Temple Hills, MD, Amicus Curiae pro se, in support of affirmance.

Dennis M. Kelleher (Stephen W. Hall, Katelynn O. Bradley, on the brief) Washington, D.C., for Amicus Curiae Better Markets, Inc., in support of the affirmance.

Matthew G. Yeager, PH.D., Department of Sociology, King's University College, London, Ontario (William Calathes, Department of Criminal Justice, New Jersey City University, Jersey City, N.J., on the brief), Amici Curiae pro se, in support of affirmance.

Barbara J. Black, Charles Hartsock Professor of Law & Director, Corporate Law Center, University of Cincinnati College of Law, Cincinnati, OH, for Amici Curiae Securities Law Scholars Jayne W. Barnard, Douglas M. Branson, Chris J. Brummer, Samuel W. Buell, John C. Coffee, Jr., James D. Cox, James Fanto, Jill E. Fisch, Tamar Frankel, Theresa Gabaldon, Joan MacLeod Heminway, Thomas W. Joo, Lawrence E. Mitchell, Jennifer O'Hare, Alan R. Palmiter, Margaret V. Sachs, Faith Stevelman, and Lynn A. Stout, in support of affirmance.

Akshat Tewary, Edison, N.J., for Amicus Curiae Occupy Wall Street–Alternative Banking Group, in support of affirmance.

Teresa Marie Goody, Kalorama Legal Services, PLLC, Washington, D.C., for Amicus Curiae Harvey L. Pitt, in support of affirmance.

Lori Alvino McGill, Latham & Watkins LLP, (Robin S. Conrad, Rachel Brand, National Chamber Litigation Center, Inc.; James M. Spears, Melissa B. Kimmel, Pharmaceutical Research and Manufacturers of America, on the brief), Washington, D.C., for Amici Curiae Chamber of Commerce of the United States and Pharmaceutical Research and Manufacturers of America, in support of reversal.

Annette L. Nazareth, Davis Polk & Wardwell LLP (Edmund Polubinski III, Gina Caruso, on the brief) New York, N.Y., for Amicus Curiae Securities Industry and Financial Markets Association, in support of reversal.

Daniel P. Chiplock, Lieff Cabraser Heimann & Bernstein, LLP, New York, N.Y., for Amicus Curiae National Association of Shareholder and Consumer Attorneys, in support of reversal.

Before: POOLER, LOHIER, and CARNEY, Circuit Judges.

POOLER, Circuit Judge:

The United States Securities and Exchange Commission (“S.E.C.”) in conjunction with Citigroup Global Markets, Inc. (“Citigroup”) appeals from the November 28, 2011 order of the United States District Court for the Southern District of New York (Rakoff, J.) refusing to approve a consent decree entered into by the parties and instead setting a trial date. Our Court stayed that order and referred the matter to a merits panel for consideration of the underlying questions. S.E.C. v. Citigroup Global Markets, Inc., 673 F.3d 158 (2d Cir.2012). We now hold that the district court abused its discretion by applying an incorrect legal standard in assessing the consent decree and setting a date for trial.

BACKGROUND

I. Complaint and proposed consent judgment.

In October 2011, the S.E.C. filed a complaint against Citigroup, alleging that Citigroup negligently misrepresented its role and economic interest in structuring and marketing a billion-dollar fund, known as the Class V Funding III (“the Fund”), and violated Sections 17(a)(2) and (3) of the Securities Act of 1933 (the “Act”). The complaint alleges that Citigroup “exercised significant influence” over the selection of $500 million worth of the Fund's assets, which were primarily collateralized by subprime securities tied to the already faltering U.S. housing market. Citigroup told Fund investors that the Fund's investment portfolio was chosen by an independent investment advisor, but, the S.E.C. alleged, Citigroup itself selected a substantial amount of negatively projected mortgage-backed assets in which Citigroup had taken a short position. By assuming a short position, Citigroup realized profits of roughly $160 million from the poor performance of its chosen assets, while Fund investors suffered millions of dollars in losses.

Shortly after filing of the complaint, the S.E.C. filed a proposed consent judgment. In the proposed consent judgment, Citigroup agreed to: (1) a permanent injunction barring Citigroup from violating Act Sections 17(a)(2) and (3); (2) disgorgement of $160 million, which the S.E.C. asserted were Citigroup's net profits gained as a result of the conduct alleged in the complaint; (3) prejudgment interest in the amount of $30 million; and (4) a civil penalty of $95 million. Citigroup also agreed not to seek an offset against any compensatory damages awarded in any related investor action. Citigroup consented to make internal changes, for a period of three years, to prevent similar acts from happening in the future. Absent from the consent decree was any admission of guilt or liability.

The S.E.C. also filed a parallel complaint against Citigroup employee Brian Stoker. See S.E.C. v. Brian H. Stoker, 11 Civ. 7388(JSR). The Stoker complaint alleged that Stoker negligently violated Sections 17(a)(2) and (3) of the Act in connection with his role in structuring and marketing the collateralized debt obligations in the Fund.

II. Proceedings before the district court.

The district court scheduled a hearing in the matter, and presented the S.E.C. and Citigroup with a list of questions to answer. The questions included:

• Why should the Court impose a judgment in a case in which the S.E.C. alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?

• Given the S.E.C.'s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.'s charges are true? Is the interest even stronger when there is no parallel criminal case?

• How was the amount of the proposed judgment determined? In particular, what calculations went into the determination of the $95 million penalty? Why, for example, is the penalty in this case less than one-fifth of the $535 million penalty assessed in S.E.C. v. Goldman Sachs & Co ....? What reason is there to believe this proposed penalty will have a meaningful deterrent effect?

• The proposed judgment imposes injunctive relief against future violations. What does the S.E.C. do to maintain compliance? How many contempt proceedings against large financial entities has the S.E.C. brought in the past decade as a result of violations of prior consent judgments?

• Why is the penalty in this case to be paid in large part by Citigroup and its shareholders rather than by the “culpable individual offenders acting for the corporation?” [ ] If the S.E.C. was for the most part unable to identify such alleged offenders, why was this?

• How can a securities fraud of this nature and magnitude be the result simply of negligence?

Both the S.E.C. and Citigroup submitted written responses to the district court's questions. On November 9, 2011, the district court conducted a hearing to explore the questions presented. A few weeks later, the district court issued a written opinion declining to approve the consent judgment. S.E.C. v. Citigroup Global Markets Inc., 827 F.Supp.2d 328 (S.D.N.Y.2011) ( “Citigroup I ”). The district court stated that

before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.

Id. at 332. It found that the proposed consent decree

is neither fair, nor reasonable, nor adequate, nor in the public interest ... because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards. 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.

Id. (footnotes omitted).

The district court criticized the relief obtained by the S.E.C. in the consent decree, comparing it unfavorably with settlements entered in S.E.C. v. Bank of America Corp., No. 09 Civ. 6829(JSR), 2010 WL 624581 (S.D.N.Y. Feb. 22, 2010), and in S.E.C. v. Goldman Sachs & Co. et al., No. 10 Civ. 3229(BSJ), Docket No. 25 (S.D.N.Y. July 20,...