MANHATTAN (CN) - The 2nd Circuit ruled that the SEC has "a strong likelihood of success" in overturning a federal judge's bid to stop a $285 million settlement with Citigroup over massive mortgage fraud, a deal the judge rejected as "pocket change."
The SEC in October 2011 accused Citigroup Global Markets of hyping and selling roughly $1 billion in residential mortgage-backed collateralized debt obligations, while secretly selling the CDOs short.
Citigroup Global Markets is Citigroup's principal U.S. broker-dealer subsidiary.
According to the SEC complaint: "One experienced CDO trader characterized the portfolio as 'a collection of dogsh!t' and 'possibly the best short EVER!' An experienced CDO collateral manager commented, 'the portfolio is horrible.'" (Punctuation as in complaint.)
The SEC offered to settle with Citigroup for $285 million, with $95 million going as restitution to victims.
But U.S. District Judge Jed Rakoff rejected the settlement as "pocket change" in November 2011.
In a scathing opinion, Rakoff blasted the SEC for its "long-standing policy - hallowed by history, but not by reason - of allowing defendants to enter into consent judgments without admitting or denying the underlying allegations."
Rakoff's blast set off a national conversation about the SEC's practice of allowing defendants to buy their way out of trouble without admitting they had done anything wrong.
The SEC defended its practice and immediately appealed Rakoff's ruling.
Though the 2nd Circuit did not overturn Rakoff's his decision, the three-judge panel's unanimous grant of a stay indicates that the court believes Rakoff overstepped his bounds.
"The district court believed it was a bad policy, which disserved the public interest, for the S.E.C. to allow Citigroup to settle on terms that did not establish its liability," according to the 17-page ruling. "It is not, however, the proper function of federal courts to dictate policy to executive administrative agencies."
Second Circuit Judges John M. Walker Jr., Pierre Leval and Rosemary Pooler said that the judiciary should defer to the executive branch for public-interest decisions.
"This does not mean that a court must necessarily rubber stamp all arguments made by such an agency," the judges wrote. "It does mean at least that a court should not reject the agency's assessment without substantial reason for doing so.
"We have no reason to doubt the S.E.C.'s representation that the settlement it reached is in the public interest. We see no bases for any contention that the S.E.C.'s decision to enter into the settlement was 'arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. Nor do we find reason to doubt that the stay the S.E.C. seeks, so as to prosecute its challenge to the district court's disallowance of the settlement, is also in the public interest." (Citation omitted.)
SEC Director Robert Khuzami applauded the ruling in a statement.
"As we have said consistently, we agree to settlements when the terms reflect what we reasonably believe we could obtain if we prevailed at trial, without the risk of delay and uncertainty that comes with litigation," Khuzami wrote. "Equally important, this settlement approach preserves resources that we can use to stop other frauds and protect other victims."
The 2nd Circuit stayed the trial on the case, which Rakoff set for July, and ruled that a merits panel will review whether the order blocking the settlement will be overturned.
"In conclusion, we are satisfied (1) that the S.E.C. and Citigroup have made a strong showing of likelihood of success in setting aside the district court's rejection of their settlement, either by appeal or petition for mandamus; (2) the petitioning parties have shown serious, perhaps irreparable, harm sufficient to justify grant of a stay; (3) the stay will not substantially injure any other persons interested in the proceeding; and (4) giving due deference to the S.E.C.'s assessment of the importance of its settlement to the public interest, that interest is not disserved by our grant of a stay," the panel wrote.
"It is hereby ORDERED that the motion to stay the proceedings in the district court is GRANTED pending the outcome of these consolidated appeals, and the motion to expedite the appeal is DENIED. The Clerk of the Court is directed to appoint counsel, who will advocate for upholding the district court's order, and to set a briefing schedule. Counsel will submit briefs addressing the issues discussed above, as well as any other matters they consider pertinent. These appeals shall be heard by a panel in due course."
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