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Unintended Consequences? Possible Fallout of District Courts' Scrutiny of SEC Settlements, Contributed by Joan McKown, Jones Day

Thursday, March 8, 2012

In what seems to be turning into an annual event, the Securities and Exchange Commission (SEC) has run afoul of Judge Jed Rakoff of the U.S. District Court for the Southern District of New York, and now, more recently Judge Rudolph Randa of the U.S. District Court for the Eastern District of Wisconsin and Judge Frederic Block of the Eastern District of New York. Both judges have questioned the SEC regarding the strength of the facts supporting its requests for consented-to injunctions and whether the settlements are in the public interest.

Judge Rakoff

With increasing frequency, Judge Rakoff seems to call into question whether a settlement that the SEC has negotiated is adequate. Judge Rakoff's issue typically lies with the amount of the financial sanction. However, and most significantly, he also quarrels with the SEC—and presumably other civil federal agencies—for agreeing to settle a matter but not requiring the defendant to admit the factual allegations underpinning the final order. In response to one matter before Judge Rakoff, the SEC significantly renegotiated the monetary sanctions and modified the language of the final settlement, in order to work around Judge Rakoff's concerns. In an unusual response to Judge Rakoff’s recent decision, Robert Khuzami, the SEC's Director of Enforcement, publically responded to the issues raised by defending the SEC’s proposed settlement and, in particular, the "neither admit nor deny" language that so concerned Judge Rakoff. At the same time, the SEC seems to be making certain it does not have any weak links in its “neither admit nor deny policy.” While effecting only a small number of cases in which there are parallel SEC and criminal cases (and therefore not effecting the matter currently pending before Judge Rakoff), on January 6, 2012, the SEC announced that it would no longer allow defendants to settle civil fraud or insider trading charges without admitting the facts underlying those charges when, at the same time, they admit to or have been convicted of criminal violations in parallel proceedings.

Judge Randa

In late December, in a case pending before him, Judge Randa cited Judge Rakoff in a letter to the SEC directing the agency to explain the factual basis on which he could determine that the requested sanctions are “fair, reasonable, adequate and in the public interest.” The SEC has responded to Judge Randa’s request in a lengthy memorandum. Judge Randa has since explained that his concerns have been satisfied and that he would approve the settlement if the SEC added some of the information set forth in its response to the proposed order.

Judge Block

On February 13, 2012, the day that trial was supposed to begin, Judge Block questioned the parties that proposed to settle an SEC civil enforcement action against Ralph Cioffi and Matthew Tannin, the former Bear Stearns fund managers accused (and acquitted after a criminal trial) of securities fraud. Judge Block questioned why the SEC's action, which alleged that Cioffi's and Tannin's activities cost $1.8 billion in investor losses, was being settled for a total of approximately $1.05 million, or, as Judge Block called it, "relatively speaking—chump change." Citing Judge Rakoff, Judge Block noted that "no Judge likes to feel that he or she is a rubber stamp." Judge Block continued: When you have an injunctive aspect in the consent agreement that simply says: Don't violate the law. I mean, obviously, you're not allowed to violate the law. But that consent denotes—that permission seems to be giving ice in the wintertime. Although Judge Block advised that "I'm not so sure I necessarily agree with everything Judge Rakoff wrote," he questioned the court's role when being asked "to consent to one of these types of [settlements]." Judge Block noted that he was inclined to approve the settlement, but asked the parties to write letter memoranda in light of Judge Rakoff's standards. He concluded by explaining that he wanted an opportunity to reflect on the court's proper role.

Administrative Proceedings?

Leaving aside the issue of whether the district courts are correct in giving the proposed settlements such rigorous scrutiny, as well as the question of how the courts will resolve these specific issues going forward, it seems that the SEC could, and may choose to, avoid completely courts that might question its settlements by filing consented-to administrative actions. In fact, at a certain level it is perplexing why they do not do so more often. Such an action would not even require asking an administrative law judge to rubber stamp the settlements, because settled administrative proceedings need go no further than the SEC with respondents agreeing to the terms of the consent order which is filed directly with, and issued by, the Secretary of the Commission.


There are numerous benefits to settling an enforcement matter administratively. First, of course, is the benefit that there would be no review and questioning by a district court judge. While Judge Rakoff, Judge Randa, and Judge Block are the most recent judges to raise an issue with SEC settlements, there certainly have been other judges who have questioned the "neither admit nor deny" policy, and the concept of an injunction for conduct that, in some instances, ended long ago.1 Although at one time in the past judges may have been more likely to issue these injunctions against future misconduct when that was the SEC’s only available enforcement option, more recently courts have begun to question the need for these injunctions,2 most emphatically with Judge Block's recent question to the SEC about the court's proper role and whether it acts merely as a "rubber stamp." Prior to 1990, the SEC’s only alternative for responding to a violation of the securities laws by someone who is not a regulated entity or person, such as a broker or dealer, was to bring an action in federal district court. However, with the advent of the Remedies Act of 1990, cease and desist orders became an available remedy in administrative proceedings as a means of precluding future violations against any person. With this development, the need for exclusive federal court jurisdiction over such actions lessened. Notwithstanding this, the SEC continued to seek injunctive actions in federal courts, because in addition to injunctive relief, the agency often wanted other sanctions—such as penalties or officer and director bars—that it could obtain only from a court, particularly in higher-profile actions The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) has changed all that, and now the differences between injunctive actions and administrative actions involving non-regulated entities and people have eroded completely, especially in settled actions. Because the agency now is able to seek what it needs in administrative proceedings, federal judges increasingly have started to raise questions as to why the SEC needs courts to “rubber stamp” injunctive actions, especially where the underlying misconduct has long ended. While administrative proceedings still may be settled on a neither admit nor deny basis, administrative orders typically are comprehensive in their description of the facts underlying the misconduct. These orders are “speaking orders” and are at least as descriptive as complaints filed in district court in describing what activity the defendant allegedly engaged in and that forms the basis of the complaint. These administrative orders are also an opportunity for the SEC to articulate what they see as problematic conduct, and inform the public as to the conduct it views as violations of the securities laws. Resolving more matters administratively was likely not what Judge Rakoff, Judge Randa, and Judge Block intended, but it would be a logical response by the SEC and defendants who want to settle and move on without the delay from judicial review.

 And possibly, at a certain level, with so many administrative options now available to the SEC and defendants, it is unfair to ask a district court judge to sign off on a deal that the SEC and the defendant could have done themselves. 

Joan McKown is a partner in Jones Day's Washington, D.C office. She specializes in securities litigation and SEC enforcement defense. Prior to joining Jones Day in October 2010 she was the long time chief counsel in the SEC's Division of Enforcement where she played a key role in establishing enforcement policies and in reviewing all enforcement actions before they were recommended to the Commission.The views set forth herein are the personal views of the author and do not necessarily reflect those of the law firm with which she is associated.

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