Recent headlines about the Securities and Exchange Commission have focused on Judge Jed S. Rakoff’s recent rejection of the agency’s proposed settlement of fraud charges with Citigroup Global Markets. In that case in the U.S. District Court for the Southern District of New York, Judge Rakoff rejected the Citigroup settlement because, in his view, there were no established facts on which to base a decision whether the settlement was “fair, reasonable, adequate and in the public interest.” The SEC and Citigroup have appealed Judge Rakoff’s decision, which is on hold as the U.S. Court of Appeals for the Second Circuit decides whether to grant an expedited hearing in the case.
Judge Rakoff’s decision is already having significant ramifications. In a December 20, 2011, letter to the SEC, Judge Rudolph T. Randa of the U.S. District Court for the Eastern District of Wisconsin cited Judge Rakoff’s Citigroup decision and requested that the commission provide a factual predicate showing the fairness and appropriateness of its proposed settlement of fraud charges against Koss Corporation, a Milwaukee-based maker and seller of stereo headphones. Like Judge Rakoff, Judge Randa would like the SEC to provide to the Court a factual predicate showing “the proposed final judgments are fair, reasonable, adequate and in the public interest.”
Koss and its chief executive, Michael J. Koss, were accused of maintaining materially inaccurate financial statements, books and records from 2005 through 2009 – a period during which the company’s chief accountant embezzled more than $30 million from the company. Koss and the company were also charged with failing to maintain adequate financial controls.
In addition to asking for a more detailed factual presentation, in his December 20 letter, Judge Randa also questioned whether he should – or even could – grant the relief that is specified in the proposed SEC-Koss settlement. The agreement would settle the case without any admission or denial of the charges (as is customary in SEC civil settlements). But the agreement also proposes the entry of an injunction restraining Koss from violating the same securities laws it was accused of violating, and would require the company to maintain adequate records and a system of internal accounting controls.
“If enforcement becomes necessary,” Judge Randa noted in his letter, “the terms of such a vague injunction would make it difficult for the court.”
The SEC has until January 24, 2012, to respond to Judge Randa’s letter, and an SEC spokesman has indicated that the agency intends to “provide the court with the information as requested.”
Citigroup and Koss are not the first companies to have judges call into question the adequacy of their proposed settlements with the SEC. In 2009, Judge Rakoff questioned the adequacy of a proposed settlement with the Bank or America, and settlements with Barclays and in an unrelated case with Citigroup were also questioned by federal district judges in Washington, D.C.
Going forward, the SEC may have to reconsider the way in which it settles civil enforcement matters with companies or, at a minimum, the way in which it presents those settlements to the courts for approval. The interesting question will be whether the need to present a factual predicate for the fairness of a settlement will still permit the SEC to settle cases with companies allowing the companies to avoid any admission of liability.
For those defendants – particularly companies – that seek to settle cases without admissions of liability, increased judicial scrutiny of SEC settlements may make it harder for them to resolve civil enforcement matters easily. In addition, if that scrutiny leads to more settlements in which companies admit liability, it may become more difficult for individual targets of investigations to defend themselves against legal claims and in the court of public opinion. The resolution of the Citigroup and Koss cases may give some hint of where things may be headed for those seeking to settle SEC cases in the future.