Law professors and Wall Street critics alike are applauding Judge Jed Rakoff's decision this week not to allow the Securities Exchange Commission to settle fraud charges against Citigroup. As a clear break from business as usual when it comes to negotiating settlements between the SEC and big banks that have done wrong, pundits are calling Rakoff's decision "an incredible judicial butt-kicking" for the banks. But it's not as simple as the headlines make it seem.
Rakoff doesn't reference the Occupy Wall Streets protests directly in his decision, but he sure does provide some protest-sign-friendly quotes in pushing back against the now commonplace practice of banks paying penalties to the SEC without actually admitting any wrong-doing. After the SEC sued it for fraud earlier this year, Citigroup hoped to pay a penalty of $285 million, though the strategy of selling toxic mortgage debt in the lead up to the financial crisis cost investors $700 million and earned the bank a $160 million profit. But it wasn't the size of the settlement that irked Rakoff; it was not actually knowing what happened. In The New York Times words, Rakoff's refusal to accept the settlement "undermined the S.E.C.’s longstanding policy of allowing companies to neither admit nor deny the commission’s charges in return for a multimillion-dollar fine and a promise not to do it again." In his decision -- embedded at the bottom of this post and totally worth reading -- Rakoff called the SEC's habit of letting banks pay their way out of trouble "neither reasonable, nor fair, nor adequate, nor in the public interest." It's not hard to understand why Rolling Stone reporter and Wall Street muckraker Matt Taibbi called the ruling "a manifesto," when you read the last few lines:
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.
The Citigroup case is far from over, though, and depending on the outcome, Rakoff's shot across the bow of both the SEC and Wall Street could backfire. Depending on the outcome of a possible appeal, Citigroup and its army of lawyers will face Rakoff once again on July 16, 2012. Regardless of how this particular case pans out, however, Rakoff's ruling sets a precedent that would make it harder not only for banks to weasel their way out of trouble by writing big checks to regulators but could also make it more difficult for the SEC to challenge the banks in the first place. In a staff editorial on Wednesday, The Wall Street Journal lauds Rakoff for taking a stand against "the cozy relationship between regulators and the regulated that too often leaves justice as an orphan" but adds a foreboding kicker: "A defeat might even cause the SEC to bring fewer of these grandstanding cases against the corporate villain of the moment -- for now, it's Wall Street -- and focus more on real financial criminals like Bernie Madoff."
The idea that the SEC will shy away from facing off against Wall Street is speculative at best. Nevertheless, the status quo has been broken. "[Judges have] been covering up these crimes by agreeing to these settlements without full disclosure," Matt Taibbi told Keith Olbermann after the ruling. "It's a cost of doing business for these companies. They recognize that every now and then they're gonna get dragged into court; they're gonna have to give a little money to somebody. And then they get to walk away and keep doing it." In a Politico op-ed also published Wednesday, Yale Law Professor Jonathan Macey argues that Rakoff's breaking from the ranks of federal judges before him that approved settlements between the SEC and law-breaking banks is an important symbolic turning point. Forcefully setting him up as the courtroom hero the Occupy movement has been waiting for Macey praises Rakoff:
He refused to allow the usual chummy settlement between a government agency -- the Securities and Exchange Commission -- and a major bank -- Citigroup. He instead created a new legal paradigm -- in which the big banks and their purported government watchdogs must give the rest of us a look at the backroom machinations that have ruined the U.S. economy.
We'll have to wait and see what happens with Citigroup, but as we continue to learn new details about how the government helped out the banks behind closed doors, this new judicial mission of requiring greater transparency seems like a step in the right direction. Nobody wants to allow more of the same dirty dealings that practically wrecked the American economy. And like Supreme Court Justice Louis Brandeis famously said, "Sunlight is the best disinfectant."