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SEC Back to Business As Usual?

The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.
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The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.

In November 2011, US District Judge Jed Rakoff threw out a settlement between Citigroup and the US Securities and Exchange Commission over alleged financial misdeeds. According to the SEC, Citi misled investors about a financial product backed by high-risk mortgages. Judge Rakoff rejected the $285 million settlement, calling it "pocket change," and excoriated the SEC for not getting an admission of wrongdoing. A trial was scheduled for July 16. Both parties appealed.

In a unanimous decision, a federal appeals court has now agreed to delay the trial. It's not a final decision on Judge Rakoff's rejection of the settlement; a different set of judges will decide that later this year.

But in the current ruling, the court seemed to suggest that Judge Rakoff had overstepped his bounds with regard to the SEC.

C. Evan Stewart is a securities litigator and partner at Zuckerman Spaeder LLP. Among other significant cases, in 2005 Mr. Stewart won an acquittal for Ted Sihpol, criminally charged in a scandal that triggered a far reaching investigation of the mutual fund industry. He spoke with CNBC.

LRS: What do you think of this ruling?

Stewart: As a matter of law, it's hard to take issue with the Second Circuit. They're skeptical about Judge Rakoff's premises. At the same time, you have to be careful not to over-read it.

LRS: Has the court given Judge Rakoff his comeuppance?

Stewart: The court rules based on the likelihood of success on the merits.

What the court is saying is that the role of a judge in determining if a settlement is reasonable is not to pre-judge if one party did something wrong. That's not the role of a judge.

The more fundamental point is it's really not the proper role of the judiciary to tell the executive branch, the SEC, what their policy should be with regard to settlements. It's a dangerous or slippery slope for the courts to weigh in on, or try to control, or reject what a federal agency is doing.

The court wants to have a more thorough airing but they're indicating where it'll come out. I certainly wouldn't go to Las Vegas and put down all my extra cash on Judge Rakoff's ruling.

LRS: Judge Rakoff called the original settlement "pocket change." Is the appeals court saying that $285 million is enough?

Stewart: I don't agree that it is pocket change. That sort of settlement impacts management, profitability, shareholders and relationships with regulators.

That these are trivial settlements is a criticism made by people who've never been the target of an SEC enforcement matter. Whether it's an individual or a corporation, resolving these matters without a trial is much preferred. Corporations having to go to trial find that it's very difficult, even if it's not criminal.

The idea that these settlements are chump change, or buying a get-out-of-jail-free card — is just not true. It's not how the companies view it, or the lawyers advising the companies.

LRS: So what is the takeaway here, for bank shareholders, or anyone?

Stewart: Judge Rakoff has been saying that these things shouldn't be in the federal court to begin with. They should be resolved between the parties. They should be administrative settlements, between the parties. But, in Rakoff's view, if you come to court, then I as the judge have to make a judgement if the settlement is fair and reasonable. And to do that, I need criteria.

The appeals court is saying to Judge Rakoff: you may have gone a little too far, and you can't be telling the executive branch what to do.

More and more judges have been questioning these settlements. But if Judge Rakoff is reversed, other judges will back off.

And the SEC will continue its time-honored tradition of going to federal court to approve these settlements, which usually includes an injunction to stop doing whatever it is that's in question.

LRS: Some might say that the banks, which are under fire for their role in the housing mess, and which were bailed out by taxpayers, should be facing more serious consequences than a return to business as usual. Your view?

Stewart: People who have that view don't realize how heavily regulated the financial institutions are. It's simply not true that there are no consequences for certain actions. This is about how large financial institutions resolve alleged problems with regulators. It's not like there are no consequences. The fines paid are significant.

And there's no criminal behavior here that's going unpunished. You've seen a flurry of criminal prosecutions here in the Southern District of New York. It's not like they're letting anyone do whatever they want.

LRS: What do you think Citi is saying right now?

Stewart: I'm sure they're pleased. And it doesn't have anything to do with passing the stress tests or their business model or anything like that.

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