NEW YORK, NY - SEPTEMBER 03: Judge Jed Rakoff poses for a portrait in his office at the Daniel Patrick Moynihan court house in Manhattan, New York on September 3, 2013. (Photo by Yana Paskova/For The Washington Post via Getty Images)

By Jonathan Stempel and Sarah N. Lynch

NEW YORK/WASHINGTON (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, handing the regulator a victory as it drives to get tougher on enforcement.

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

Rakoff had faulted the SEC's longtime policy of letting some corporate defendants settle without admitting or denying its charges. Wednesday's decision may make it easier for the SEC to win settlements without having to worry about federal judges rejecting them because of an absence of proven facts, legal experts said.

"It is an abuse of discretion to require, as the district court did here, that the SEC establish the "truth" of the allegations against a settling party as a condition for approving the consent decree," Circuit Judge Rosemary Pooler wrote for a three-judge 2nd Circuit panel. "The district court's failure to make the proper inquiry constitutes legal error."

The 2nd Circuit returned the case to Rakoff, who must review the settlement again unless he pursues a further appeal. One judge on the panel, Raymond Lohier, said he would have ordered Rakoff to approve the accord.

Rakoff, in an email, said: "I don't think it's appropriate to comment."

Citigroup Spokeswoman Danielle Romero-Apsilos declined to comment. The SEC had no immediate comment.

Wednesday's decision is a rebuke to Rakoff, who in two decades on the bench has earned a reputation as a brilliant, iconoclastic judge and whose voiding of the Citigroup accord in November of 2011 prompted other judges to scrutinize similar settlements.

Rakoff has also been a thorn for the SEC, having in 2009 rejected as "a slap on the wrist" its original accord with Bank of America Corp over the bank's purchase of Merrill Lynch.

His decisions have spurred a debate over the proper SEC role in policing Wall Street and have been followed by big changes at the regulator. Last June, SEC Chair Mary Jo White said the regulator would begin requiring admissions of wrongdoing as a condition of settling particularly serious civil charges, citing the need for accountability to the public. White is a former federal prosecutor who joined the regulator last year.

PRAGMATISM

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 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.

Pooler, however, said such fact-finding should be left for a trial, while "consent decrees are primarily about pragmatism."

The SEC did go to trial against former Citigroup manager Brian Stoker, the only individual sued over the CDO, but a jury in July 2012 found him not liable. In Wednesday's decision, the 2nd Circuit also adopted a new standard for reviewing settlements with U.S. enforcement agencies that involve injunctive relief, saying judges must assess whether such accords are fair and reasonable and whether the public interest "would not be disserved."

It said an SEC settlement of this type must have a "basic legality," must be clear, must resolve the underlying claims and is not tainted by collusion or corruption.

Rakoff, it added, may if necessary ask the SEC and Citigroup to provide more evidence that there was no collusion.

Since White changed SEC policy, the regulator has extracted several admissions of wrongdoing, including from JPMorgan Chase & Co over its $6.2 billion trading loss in London, and from billionaire Philip Falcone over transactions involving his hedge fund firm. White's predecessor Mary Schapiro had defended the "neither admit nor deny" policy, saying that requiring admissions would discourage settlements, clog courts with lawsuits and delay returning money to harmed investors.

In early 2012, the SEC decided to stop allowing settling defendants to neither admit nor deny its charges when they admit guilt in related U.S. Department of Justice criminal cases.

Rakoff himself has criticized prosecutors for failing to prosecute high-level banking executives over the financial crisis, saying in a November speech it "speaks greatly to weaknesses in our prosecutorial system that need to be addressed."

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

(Reporting by Joseph Ax, Nate Raymond and Jonathan Stempel in New York and Sarah N. Lynch in Washington, D.C.; Editing by Karey Van Hall, Lisa Von Ahn, Chizu Nomiyama and Dan Grebler)