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UPDATE 1-U.S. appeals court says judge wrongly rejected SEC-Citigroup accord

(Adds details from decision, comments, case citation, WASHINGTON dateline, bylines)

NEW YORK/WASHINGTON, June 4 (Reuters) - A U.S. appeals court on Wednesday said a federal judge abused his discretion by rejecting a $285 million fraud settlement between Citigroup Inc and the U.S. Securities and Exchange Commission over securities sold before the financial crisis.

The 2nd U.S. Circuit Court of Appeals in New York said U.S. District Judge Jed Rakoff failed to give "significant deference" to the SEC's decision to settle, and was wrong to require the regulator to establish the "truth" of its allegations.

"The district court made no findings that the injunctive relief proposed in the consent decree would disserve the public interest, in part because it defined the public interest as 'an overriding interest in knowing the truth,"' Circuit Judge Rosemary Pooler wrote for a three-judge panel. "The district court's failure to make the proper inquiry constitutes legal error."

The 2nd Circuit returned the case to Rakoff's court for further proceedings.

Rakoff declined to comment. The SEC and Citigroup had no immediate comment. John Wing, a lawyer who argued Rakoff's case to the appeals court, could not immediately be reached for comment.

The decision came in a case that became a flashpoint in a debate over the SEC's longtime policy of letting some corporate defendants settle without admitting or denying its charges.

Citigroup's settlement was meant to resolve claims that the bank misled investors in 2007 about a $1 billion collateralized debt obligation, Class V Funding III, and simultaneously bet against the debt as the U.S. housing market began to falter.

Rakoff in November 2011 rejected the accord as neither fair, nor adequate nor in the public interest, saying the "neither admit nor deny" policy left him no facts on which to judge the settlement.

Wednesday's decision also follows SEC Chair Mary Jo White's decision last June to begin requiring admissions of wrongdoing as a condition of settling particularly serious civil charges, citing the need for accountability to the public.

The case is SEC v. Citigroup Global Markets Inc, 2nd U.S. Circuit Court of Appeals, No. 11-5227.

(Reporting by Nate Raymond and Jonathan Stempel in New York and Sarah N. Lynch in Washington, D.C.; Editing by Lisa Von Ahn and Chizu Nomiyama)