Agency wants to preserve flexibility to settle cases without an admission of guilt, leading to savings if litigation is avoided.
The Securities and Exchange Commission on Thursday announced that it would appeal a U. S. district judge's ruling rejecting a proposed settlement of a fraud case with Citigroup, a move that could affect both the agency's legal strategies and its deployment of resources.
The independent regulator had charged Citigroup with fraud for having sold, in the years leading up to the 2007-2008 financial meltdown, mortgage-backed securities that were not favored in its internal investment plans. Following an investigation, SEC reached a settlement with the corporation that required it to pay $285 million and abide by an injunction against future violations, while staying silent on the issue of guilt.
In November, U.S. District Judge Jed Rakoff of New York rejected the proposed deal, saying the absence of an admission or denial of guilt meant he could not determine whether it was fair or in the public's interest.
SEC Enforcement Director Robert Khuzami on Dec. 15 announced that the agency would appeal the case to the 2nd Circuit Court of Appeals, because "we believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits."
He said the ruling ignores decades of precedents in which such cases have been settled without costly litigation even without clear declarations of guilt or innocence. "Based on a careful balancing of these risks and benefits, settling on favorable terms even without an admission serves investors, including investors victimized by other frauds," Khuzami wrote. "That is due to the fact that other frauds might never be investigated or be investigated more slowly because limited agency resources are tied up in litigating a case that could have been resolved."
He stressed that SEC is prepared to take the case to court, but has been able to reach out-of-court settlements in 70 percent of the cases it has brought related to the financial crisis. It participated in 19 trials last year. "The new standard adopted by the court could in practical terms press the SEC to trial in many more instances," Khuzami said, "likely resulting in fewer cases overall and less money being returned to investors."
The decision to appeal comes as SEC, having reorganized its enforcement division in 2009 and 2010, has reported filing a record high number of enforcement actions -- 735 in fiscal 2011, up from 677 in fiscal 2010 and 664 in fiscal 2009. It ordered more than $2.8 billion in penalties and disgorgement in 2011.
Among the cases related to the financial crisis filed by SEC in 2011 were 15 actions naming 17 individuals, including 16 chief executive officers, chief operating officers and other senior corporate officers, according to agency figures. The division employs about 900 enforcement investigative attorneys.
"We continue to build an unmatched record of holding wrongdoers accountable and returning money to harmed investors," SEC Chairman Mary Schapiro said in a November statement. "I am proud of our enforcement division's many talented professionals and their efforts that resulted in a broad array of significant enforcement actions, including those related to the financial crisis and its aftermath."
Republicans in Congress have sought to trim the agency's budget and oppose many of the regulations it is writing under the 2010 Dodd-Frank Financial Reform law. On Wednesday, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises approved a bill introduced by Rep. Michael Grimm, R-N.Y., that would limit some Dodd-Frank protections for corporate whistleblowers, requiring private sector employees seeking to expose misdeeds to go to their employers before going to SEC.
Michael Smallberg, an investigator for the nonprofit Project on Government Oversight, told Government Executive that SEC's ability to take risks in pursuing litigation "is one of many reasons it should get a boost in funding, so it can take this risk in routine investigations. But the bigger question is whether these settlements ultimately deter companies from committing similar misdeeds in the future," he said. "Our concern is that many settlements become a cost of doing business for companies."
If the agency is able to continue offering "strong protections to whistleblowers," he added, "higher quality tips would allow them build to build better cases."
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