Judge Rakoff & the SEC: What a difference a judge makes!

by Kurt Schulzke

The law is the law, right?  So how much impact can a judge have on a whistleblower case?  Way more than most people imagine.

Prospective whistleblowers — many of whom optimistically view “blind justice” in even-handed, rule-bound terms — tend to be unaware that judges can move a case as much as the law itself.  A recent Washington Post profile of U.S. District Judge Jed S. Rakoff (SDNY) sheds light on the human side of America’s sophisticated legal machinery.  In the video below, Judge Rakoff is seen lecturing at Dartmouth University in 2008.

Understanding judges is a priority for attorneys who represent whistleblowers.  In deciding whether and where to file a False Claims Act case, a multitude of factors should be considered including judicial temperament and philosophy. Judges in whistleblower cases typically make many close calls in which the law gives them plenty of wiggle room. Some of these calls can tip the scales decisively for or against the whistleblower.  How the judge feels about whistleblowers (or what the judge thinks about ambiguous points of whistleblower law) can drive the decision.

For example, a (newly) close question — newly thanks to Judge Rakoff — arises in the prosecution of SEC fraud claims.  Under the Dodd-Frank SEC whistleblower law passed in 2010, a case settled or litigated by the SEC can result in an award to a whistleblower.  However, the existence and amount of the award depends on the amount of “monetary sanctions” eventually collected by the SEC from the defendant.

In a given case, the SEC is required to award Dodd-Frank whistleblowers between 10 and 30 percent of the monetary sanctions the SEC collects but only if the total collected is greater than $1,000,000.  Whether the case settles out of court or is decided at trial is immaterial to the award.  Whether the magical $1 million threshold is reached (or by how much it is exceeded) depends in large part on how aggressively the SEC pursues the case.  The SEC’s enthusiasm turns on internal, probabilistic risk-return analysis of expected costs and benefits.  Settlement or trial?  In this analysis, the historical tendencies and personality of the assigned judge loom large.

Enter Judge Rakoff, now a species of judicial rock star thanks to his pithy deconstruction of the SEC in a fraud case against Citigroup Global Markets, Inc.  Rackoff has seriously upended an erstwhile boring, settled legal question:  whether courts can allow the SEC — as they have for decades — to quickly settle fraud claims by publishing only limited case facts and inserting “neither admit nor deny” language into the settlement.*  Until last November, the answer was a routine “yes” which, ironically in view of the SEC’s mission, has significantly reduced defendants’ exposure to investor lawsuits. Rakoff’s colleagues on the federal bench — most of whom apparently don’t see the irony — have more or less passively acquiesced in the SEC’s approach.

On October 19, 2011, the SEC announced to great fanfare a proposed consent judgment against Citigroup Global Markets, Inc. according to which the company agreed to a fine of $285 million.  Sounds like a big number unless, like Judge Rackoff, you compare it to the SEC’s $535 million 2010 settlement with Goldman Sachs.  Wasting no time, on November 28, 2011, Judge Rakoff firmly rebuffed the SEC’s proposal in a 15-page Opinion and Order.  His central objection?  Lack of facts.

In Judge Rackoff’s view, the SEC harbors an erroneous expectation that judges are obligated to rubber stamp SEC decisions heedless of the facts (or lack thereof).  Rakoff’s integrity (and, dare we say, pugnacious personality) brooks no such expectation.  Rackoff wanted more facts on which to base his judgment independent of that of the SEC:

[T]he Court has spent long hours trying to determine whether, in view of the substantial deference due the S.E.C. in matters of this kind, the Court can somehow approve this problematic Consent Judgment. In the end, the Court concludes that it cannot … because the Court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment (emphasis added).

For, as Rackoff continued:

[T]he D.C. Circuit, in United States v. Trucking Employers. Inc., 561 F.2d 313 (DC Cir. 1977), reaffirmed that “prior to approving a consent decree a court must satisfy itself of the settlement’s ‘overall fairness to beneficiaries and consistency with the public interest’” (citations omitted). As these and similar authorities make plain, a court, while giving substantial deference to the views of an administrative body vested with authority over a particular area, must still exercise a modicum of independent judgment in determining whether the requested deployment its injunctive powers will serve, or disserve the public interest. Anything less would not only violate the constitutional doctrine of separation of powers but would undermine the independence that is the indispensable attribute of the federal judiciary…

Without multiplying examples, it is clear that before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.

Applying these standards to the case in hand, the Court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, nor in the public interest. Most fundamentally, this is because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards… [W]hen a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance…

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. If its deployment does not rest on facts — cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.

Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances….

Hard to counter Rackoff’s logic.  But how will Rackoff’s decision affect the broader regulatory environment? Whether the decision is “good” or “bad” in terms of its general impact on whistleblowers, the SEC, other regulatory agencies and the market is an open question.   Strategically, if SEC defendants like Citigroup know that a “no facts, no admissions” settlement is off the table, their legal strategies will change.  Similarly, on the whistleblower side, setting a precedent that empowers other judges to scrutinize SEC settlements could lessen the attractiveness of SEC whistleblower cases to attorneys who rely on contingent fees to assist SEC whistleblowers. Size matters, but so does speed.

In the Citigroup case, if there is an award-eligible whistleblower (in theory, there could be), forcing the case to trial would considerably delay the payment of any award.  If a trial is actually held and it goes badly, the whistleblower — otherwise be entitled to at least 10% of the $285 million recovery under the rejected settlement — could get nothing.  Or trial could result in an even higher award.  With the public disapproval of big finance running so high, a jury having all the facts might deliver a verdict much higher than $285 million.

Whatever the eventual impact of Rackoff’s decision, the written law on which Rackoff based his decision was no different than the law under which scores of other judges have ruled in the opposite direction — in SEC and other administrative agency cases — for decades prior.  Rackoff decided the Citigroup case differently in large part because he sees the role of the SEC and the law differently than other judges.  At the same time, the facts of the case and its political setting allowed him to credibly voice a different view.

Case update: At this point, Rakoff’s November 28 order is on hold pending the SEC’s “emergency” (and, per Judge Rackoff’s decidedly miffed December 29 order, misleading) interlocutory appeal to the 2nd Circuit Court of Appeals.  A 2nd Circuit “motions panel” was to begin addressing the case on January 17.  No telling yet when the 2nd will rule.

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* For whistleblowers, another particularly (pun intended) nettlesome “close call” question arising in every federal civil claim alleging fraud (including SEC and False Claims Act or “FCA” cases) is whether the  complaint meets the pleading “particularity” requirements of Federal Rule of Civil Procedure 9(b).  A future post will explore Rule 9(b).

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