Second Circuit Vacates Judge Rakoff’s Order Refusing to Approve Citigroup “Neither Admit Nor Deny” Settlement

Today, the Second Circuit Court of Appeals vacated Judge Rakoff’s order refusing to approve a settlement between the SEC and Citigroup in which Citigroup neither admitted nor denied the agency’s allegations. See SEC v. Citigroup Global Mkts., Inc., Docket Nos. 11-5227-cv; 11‑5375-cv; 11-5242-cv (2d Cir. June 4, 2014). Judge Rakoff took issue with the consent decree, finding that it was not fair, reasonable, adequate, or in the public interest because the public was denied the opportunity to know the truth underlying the allegations of securities fraud. The Circuit Court disagreed, reasoning that the district court abused its discretion by requiring the SEC to “establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decrees.” Id., slip op. at 21. The court said, “Trials are primarily about the truth. Consent decrees are primarily about pragmatism.” Id.

The court clarified that the proper standard for reviewing a consent decree requires determinations of whether the decree is fair and reasonable and whether the public interest would be disserved. According to the court, district courts assessing consent decrees for fairness and reasonableness should consider (1) the basic legality of the decree; (2) whether the terms of the decree, including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind. The court jettisoned the “adequacy” requirement, finding it incompatible with the use of consent decrees. In addition, the court made clear that “[t]he job of determining whether the proposed S.E.C. consent decree best serves the public interest . . . rests squarely with the S.E.C., and its decision merits significant deference . . . .” Id., slip op. at 24-25.

The court remanded the case to the district court for consideration of the factual basis for the consent decree under these standards, noting that “[a]bsent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.” Id., slip op. at 19.

The court cautioned that the SEC must be “willing to assure the court that the settlement proposed is fair and reasonable” when it seeks the court’s imprimatur of consent decrees. Id., slip op. at 27. The court pointed out, however, that the SEC has the ability to employ its own remedies—like administrative proceedings—that do not require court involvement. It remains to be seen whether the SEC will make more use of administrative proceedings in an effort to avoid judicial scrutiny in settled cases. During the pendency of the Citibank ruling, the SEC did not shy away from filing significant settled cases such as the JP Morgan internal controls matter in federal court. Moreover, in light of the standard articulated by the Second Circuit, it would seem that both the SEC and settling defendants should have less concern about courts second-guessing or questioning whether proposed settlements serve the public interest.

SEC Gives Insider Trader a $30,000 Slap On The Wrist

On April 23, 2014, the SEC agreed to settle insider trading charges against Chris Choi, a former accounting manager at Nvidia Corporation who allegedly set into motion a trading scheme that reaped nearly $16.5 million in illicit profits and avoided losses. Given the amount of the purported loss, the fact that Choi was the original “tipper,” and the fact that nearly every other member of the scheme has been indicted, the Choi settlement seems like nothing more than a slap on the wrist: a $30,000 penalty without admitting to the insider trading allegations. The Choi settlement also represents a notable departure from the SEC’s recent insider trading fines and penalties against “tippers.”

According to the SEC’s complaint, on at least three occasions during 2009 and 2010, Choi tipped material nonpublic information about Nvidia’s quarterly earnings to his friend Hyung Lim. SEC v. Choi, No. 14-cv-2879 (S.D.N.Y. Apr. 23, 2014). Lim passed the information along to Danny Kuo, a hedge fund manager at Whittier Trust Company, who passed the information to his boss and to a group of managers at three other hedge funds.

Kuo and the other tippee-hedge fund managers used Choi’s information to trade in advance of Nvidia earnings announcements and reaped trading gains and/or avoided losses of approximately $16.5 million.

The SEC alleged that Choi was liable for this trading because he “indirectly caused trades in Nvidia securities that were executed” by the hedge funds and “did so with the expectation of receiving a benefit and/or to confer a financial benefit on Lim.” The SEC charged him with violations of Section 10(b) of the Exchange Act (and Rule 10b-5) and Section 17(a) of the Securities Act.

Choi, without admitting or denying the SEC’s allegations, agreed to settle the matter and to the entry of an order: (1) permanently enjoining him from violations of Section 10(b), Rule 10b-5, and Section 17(a); (2) barring him from serving as an officer or director of certain issuers of securities for five years; and (3) ordering him to pay a $30,000 penalty.

Not only is Choi’s settlement a significant departure from the resolutions obtained by his “downstream” tippees, a number of whom were convicted on criminal charges of insider trading, it is a departure from recent SEC “tipper” settlements. For example:

•   A former executive at a Silicon Valley technology company, who allegedly tipped convicted hedge fund manager Raj Rajaratnam with nonpublic information that allowed the Galleon hedge fund to make nearly $1 million profit, agreed to pay more than $1.75m to settle the SEC’s insider trading charges. See SEC Charges Silicon Valley Executive for Role in Galleon Insider Trading Scheme.

•   A physician who served as the chairman of the safety monitoring committee overseeing a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies, who allegedly tipped a hedge fund manager with safety data and eventually data about negative results in the trial approximately two weeks before they became public, which allowed the hedge fund to make nearly $276 million in gains, agreed to pay more than $234,000 in disgorgement and prejudgment interest to settle the SEC’s insider trading charges. The physician’s penalty may have been mitigated by the fact that he cooperated with and received a non-prosecution agreement from the U.S. Attorney’s Office in a parallel criminal action. See SEC Charges Hedge Fund Firm CR Intrinsic and Two Others in $276 Million Insider Trading Scheme Involving Alzheimer’s Drug.

•   A former executive director of business development at a pharmaceutical company located in New Jersey, who allegedly tipped a hedge fund manager (a friend and former business school classmate) with material nonpublic information regarding the company’s anticipated acquisition that allowed the manager to make nearly $14 million in gains, escaped criminal prosecution and agreed to pay a $50,000 penalty to settle the SEC’s insider trading charges. See SEC Charges Pharmaceutical Company Insider and Former Hedge Fund Manager for Insider Trading, Resulting in Approximately $14 Million in Profits.

There are a few reasons the SEC may have settled with Choi for such a small civil penalty. First, the SEC recently settled with Lim, the second chain in the insider trading scheme. Lim tentatively agreed to disgorgement or to pay a penalty once he has completed his cooperation with the U.S. Attorney’s Office for the Southern District of New York and has been sentenced in its pending, parallel criminal action¾i.e., United States v. Lim, 12-cr-121 (S.D.N.Y.). It also could be Choi’s limited financial means. We likely will never know the reason for the SEC’s agreed-upon resolution, but the fact of the resolution may have some value to other defendants.