In his famous White House Correspondents Dinner speech in 2006, Stephen Colbert offered this advice to journalists: “Here's how it works: the president makes decisions … The press secretary announces those decisions, and you people of the press type those decisions down. Make, announce, type. Just put 'em through a spell check and go home.”

The second circuit court of appeals gave similar advice to Judge Jed Rakoff today.

In effect, they said the Securities and Exchange Commission (SEC) makes decisions, then announces them, and you judges should just approve them. Make, announce, approve. Just put 'em through a spell check and go home.



In other words, even though judges have to rule on some SEC settlement agreements, that ruling should be less of an opinion and more of a rubber stamp.

Smelling a rat



At issue was a 2011 consent decree – a settlement agreement – between the SEC and Citigroup over one of the bank's toxic mortgage-backed securities. The bank agreed to pay $285m, without admitting guilt, on allegations that they pushed investors into purchasing securities without disclosing their poor quality.



The SEC made a cottage industry of settling these securities fraud cases, and only one case at each bank, leaving on the table dozens of other similarly constructed deals.



Dogged journalism from The American Lawyer recently confirmed that the SEC was indeed working closely with banks to limit their securities fraud exposure – sweeping dozens of deals into settlements that looked like they were covering only one or two. That usually meant the banks could pay less in fines.



Rakoff, the district court judge assigned to approve the SEC-Citi consent decree, apparently smelled a rat.



He denied the Citigroup settlement, arguing that the fine was “pocket change” for a bank of Citi's size and saying that he had not been provided with the relevant facts to “exercise even a modest degree of independent judgment”.



Mary Jo White, the relatively new head of the SEC. benefits from a victory for the agency's powers in a case that started years before her tenure. Photograph: Brendan McDermid/Reuters Photograph: BRENDAN MCDERMID/REUTERS

Using a standard that enables judges to reject consent decrees if they are not “fair, reasonable, adequate and in the public interest”, Rakoff rebelled against rubber-stamping the deal. He refused to, in his words, “become a mere handmaiden to a settlement privately negotiated on the basis of unknown facts”.

Get off our turf



While Judge Rakoff became something of a folk hero for demanding stronger accountability for Wall Street crimes, the SEC and Citigroup teamed up to appeal his ruling, in another troubling example of the close cooperation of entities that should be adversaries.



The SEC argued that Rakoff did not accord their agency “adequate deference” in handling the settlement. Translation: "get off our turf." Today, after years of anticipation, a three-judge panel of the second circuit agreed with the SEC and Citi.

In so doing, the appeals court panel, all of whom were appointed by Presidents Bill Clinton and Barack Obama, effectively neutered future efforts by judges to play a role in determining the standards of financial fraud settlements like this.



The court ruled that, as long as the SEC’s deal with Citi was “fair and reasonable” (striking the word “adequate”) and that “the public interest would not be disserved,” Judge Rakoff would have to approve it.



According to the second circuit, while judges could check for the legality of the complaint and whether any collusion was involved, the second circuit considered it “an abuse of discretion” for Judge Rakoff to try to get at the truth of the claims.



Citigroup has been cooperating with the SEC, presumably to pay smaller fees and avoid criminal penalties. Photograph: Brendan Mcdermid/Reuters Photograph: Brendan Mcdermid/REUTERS

They literally write in the order that “trials are primarily about the truth; consent decrees are primarily about pragmatism.”

The message to future judges on these settlements is clear: get out of the way and don't make any waves.

This ought to shock people, as it completely undermines judicial oversight. Rakoff insisted that he was given no facts to determine the fairness and reasonableness of the settlement.



Judges must mainly check for grammatical errors



But while the second circuit allows for additional scrutiny at court if there’s suspicion of collusion, they also say a number of other troubling things: that facts are irrelevant, that a settlement represents a contract between only two parties, and that judges should accept that without any questions.



As for the public interest, that is a matter for regulators. The second circuit specifically says the decision on whether the settlement serves that purpose “rests squarely with the SEC".

Under these standards, it’s hard to argue that district courts like Rakoff’s have much of a role to play in potential settlements, beyond agreeing to them.

The courts could not expect much cooperation from regulators or banks; they would have to effectively operate a private detective service to ferret out collusion, in order to have any impact on the final ruling.



The court ruled settlements' suitability are to be judged by the SEC. Photograph: Emmanuel Dunand/AFP/Getty Images Photograph: EMMANUEL DUNAND/AFP/Getty Images

The second circuit wrote, correctly, “For the courts to simply accept a proposed SEC consent decree without any review would be a dereliction of the court’s duty to ensure the orders it enters are proper.”



But given the logic of the rest of their ruling, that mostly extends to checking for grammatical errors.

The next steps: Rakoff's redemption?



In this specific instance, Rakoff, with an assist from the financial press, actually has a small window to keep up the questioning on the SEC. The second circuit remanded the case back to Rakoff to make another judgment, and said that he could “ask the SEC and Citigroup to provide additional information” to allay concerns about improper collusion.

And because of the previously mentioned revelations of collusion in a separate but similar securities fraud case with Goldman Sachs, Rakoff has explicit leeway to ask whether the SEC and Citigroup agreed to settle on just this one securities deal, ignoring all the other ones Citi made. He should take the opportunity.

It’s also a small comfort that, partially because of Rakoff’s criticism of the SEC failing to require Citi to admit wrongdoing in the case, the agency has changed their policy, and has forced admissions of guilt in some selected cases. The legacy of Rakoff’s initial ruling, even while extinguished, still lives on.

The death of a judicial rebellion



But make no mistake – this was a smackdown by the second circuit against a judge who they decided searched a little too hard for the truth.



And it will have wide impact in future consent decree cases. This is the death of a movement. Judges who had followed Rakoff’s reasoning will now have substantial incentive not to run afoul of the appeals courts.



While the SEC’s transparently close cooperation with Citigroup may trip them up in this particular case, in the future they’ve grabbed a lot of authority to tailor settlements as they see fit.

It’s bad enough when the Congress or the executive branch steals power for themselves at the expense of the courts. But when a higher court basically does the job for them, the result is a self-inflicted wound that damages checks and balances.

