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SEC's Settlement With SAC Capital Draws Judicial Scrutiny

This article is more than 10 years old.

In another high-profile settlement, a federal judge again scrutinized the Securities and Exchange Commission's willingness to settle charges with defendants without requiring an admission of wrongdoing.

A federal judge must determine whether a settlement is "fair, reasonable and adequate within the limitations Congress has imposed on the SEC to recover investor losses," Federal District Court Judge Victor Marrero wrote on Tuesday.  "Courts should also weigh the effect of the proposed settlement in an SEC enforcement action on the public interest."  The judge found no fault with the $602 million settlement amount, which set a record for an insider trading case, between the SEC and SAC Capital Advisors, the hedge fund run by Steven Cohen.

Yet he found it troubling to approve a settlement in which SAC denied any culpability.

Judge Marrero joined a growing list of federal judges who have admonished the SEC - as well as other federal agencies - for entering into settlements of this nature.  Last year, Marrero's colleague on the court, Judge William H. Pauley III, echoed a similar sentiment in approving a settlement between Morgan Stanley and Wall Street's chief regulator involving the apparent use of derivatives to artificially inflate electricity rates.

The loudest criticism came from Judge Jed R. Rakoff, who also serves in the federal court in Manhattan, the most popular destination for cases involving the financial sector.  In 2011, he rejected a $285 million settlement between Citigroup and the SEC.  The lack of an admission of liability on Citigroup’s part, Judge Rakoff explained at the time, made the settlement “neither reasonable, nor fair, nor adequate, nor in the public interest.”   He also argued that the amount the bank agreed to pay represented “pocket change to an entity as large as Citigroup” and left the “defrauded investors substantially short-changed.”

“As for common experience,” he concluded, “a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business….”

The ruling earned Rakoff praise from Wall Street's critics and threatened a posture long-maintained by the SEC.  The agency’s Director of the Division of Enforcement at the time, Robert Khuzami, responded on appeal that Rakoff’s “new standard is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country.”

Eventually, Khuzami's department instituted minor modifications to the SEC's long-standing policy yet remained steadfast in defending the practice.  Khuzami's thinking was consistent with that of other securities experts who have argued that the SEC lacks the resources to take every case to trial and therefore relies upon "neither admit nor deny" arrangements as a reasonable and efficient enforcement strategy.

The agency received a boost last March when an appellate court rebuffed Rakoff's line of thinking.  The lower court, the federal appellate panel held in a preliminary ruling, “does not appear to have given deference to the SEC’s judgment on wholly discretionary matters of policy.”  The proper function of a federal court, it went on, does not “dictate policy to executive administrative agencies.”

With this preliminary ruling in mind, Judge Marrero weighed the "delicate balancing act... between various competing interests."  The court, he wrote, "must avoid undue meddling and second-guessing" of federal agencies and must accord enforcement bodies "the proper level of deference they are due."

"At the same time," Marrero continued, "the Court cannot conceive that Congress intended the judiciary's function in passing upon these settlements as illusory, as a predetermined rubber stamp any settlement put before it by an administrative agency."

Despite acknowledging past judicial deference in this arena, he pointed out that "we live in a different era" in which "the regulatory and judicial practices which have governed to date fail to reflect what new realities demand to adequately protect the public interest."

The scope and length of the judge's deliberation symbolized the difficult position confronting federal judges, particularly after the 2008 economic crisis intensified the scrutiny of the financial sector and its regulatory oversight.  On the one hand, judges are disinclined to second-guess federal agencies and interfere in settlements negotiated by two sophisticated parties.  On the other hand, these agencies are asking for a judicial imprimatur of their actions, making judges reluctant to blindly sign-off on settlements when their approval represents a key component of the enforcement process.

After weighing all of these competing factors, Judge Marrero tentatively approved the settlement but conditioned it upon receiving additional guidance from the federal appellate court that is in the process of issuing a definitive ruling in Rakoff's Citigroup case.