The wisdom of Judge Rakoff’s tough and controversial decisions taking issue with the decades-long SEC practice of entering into settlements in which companies admit to no wrongdoing is becoming apparent. This is the essence of Rakoff’s beef, as represented in his latest ruling on this topic:
[T]he Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.
It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? It is not fair, because, despite Citigroup’s nominal consent, the potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged patent. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. And, most obviously, the proposed Consent Judgment does not serve the public interest, because it asks the Court to employ its power and assert its authority when it does not know the facts.
Now we’ll put aside the issue that the SEC could enter into settlements that merely provide for monetary damages (ie, the reason Rakoff reviewed the settlement was that it also included provisions that offered injunctive relief). We’ll assume the SEC deems this to be useful (presumably for the incremental PR generated by having a court approve the decision, and/or that injunctive relief can be used to fill the gap between how much the SEC would want in pure monetary terms versus what the presumed miscreant is willing to pay). Rakoff basically says that he can’t decide if any settlement makes any sense if he has no facts, and raises concerns of fairness and public purpose.
Alison Frankel at Reuters highlights a new New York appellate court decision where JP Morgan is being hoist on the Rakoff petard. Bear Stearns, which is now owned by JP Morgan, entered into a $250 million settlement in 2006 over allegations that it cheated customers by engaging in impermissible market timing. The agreement contained standard SEC “without admitting wrongdoing or denying” language. The payment broke down into $160 million of disgorgement and $90 million of penalties.
What may surprise many readers is that the $160 million disgorgment was covered by insurance, or at least JP Morgan thought it was. Per Frankel:
The insurance agreements said the bank was covered for damages awards and charges incurred by regulatory investigations, with one catch: The policies excluded claims “based upon or arising out of any deliberate, dishonest, fraudulent, or criminal act or omission,” if there were a final adjudication reflecting that wrongdoing.
The insurers said no dice, and JP Morgan took them to court to try to force them to pay. The lower court decided in favor of JP Morgan, but the appeals court reversed. And the logic is revealing:
But a ruling Tuesday by the New York state Appellate Division, First Department, suggests the boilerplate language that Ramos cited — and Rakoff has derided — may no longer offer defendants much benefit even without judges specifically rejecting it….
But the decision’s implications may be broader than that. In an opinion written by Justice Richard Andrias, the state judges simply didn’t pay much heed to the SEC “neither admit nor deny” boilerplate. “Read as a whole,” the decision said, “the offer of settlement, the SEC Order … and related documents are not reasonably susceptible to any interpretation other than that Bear Stearns knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity.” Moreover, in a footnote, the opinion referred explicitly to Rakoff’s criticism of SEC boilerplate in SEC v. Vitesse Semiconductor.
Putting on a public policy, rather than a legal hat, insurance that has the effect of letting companies and boards buy their way out of the economic consequences of bad conduct is a terrible idea. Even though it is widely accepted that no one would become a director of a public company ex directors and officers insurance, the consequences are detrimental. Why should, for instance, the directors of Lehman not be sued into penury? If we didn’t have D&O insurance, companies would have to pay directors a prince’s ransom to do the job, and a director would have to work really really hard at oversight. That would mean he could probably only sit on one board (ending the board as high level social club phenomenon, another plus) and would do a vastly better job. You’d also see an end to directors who serve as mere decoration (nice enough people, say college presidents or heads of heavyweight not for profits) but add bupkis in terms of monitoring management.
Now I’ll admit we have not seen all the implications of the Rakoff decision, but this first one seems entirely salutary. I suspect on balance, the effect will be to give companies fewer “get out of jail free” cards, which is something that everyone but the SEC and public company executive should welcome.
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I read this as, “WTF would we waste our time with that drivel the SEC keeps serving up?”
Very encouraging.
More, please.
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a fine example of the ‘enforcement’ system that our regulators (both federal as in this example, and at the state level as well) have arrived at, at the spoken and unspoken demands of the rich. Just like Pomeranians and Pugs, they know how to playfully nuzzle their masters for attention and squeak for treats.
Is there anyone who really believes that allowing companies (as is the case with the SEC ‘investigations’) to 1. be advised of the charges against them that are of interest to the regulator, 2. be allowed to hire the company’s own ‘investigator’ to research the allegations of wrongdoing, 3. be allowed to determine if there is anything actionable that was done, and (in the off chance that the alleged violator and his own hired investigator actually agree that some bad behavior occurred) 4. be allowed to suggest the penalty to be assessed & all the while knowing that this edifice of oligarchic malfeasance rests upon the demand that no violator will ever have to admit wrongdoing, is enforcement. Does anyone believe that this sham of a system of enforcement has the capacity to deter?
Is there anyone who does not believe that regular Americans can easily detect the unabashed unfairness of a justice system that holds them to account under our nation’s laws but allows rich ‘donors’ and other powerful people to never have to account for or atone for their illegal behaviors or provide restitution to those citizens who were harmed by their criminal behaviors?
those who hold these beliefs are sure to be still waiting for the tooth fairy to pay them for those teeth under their pillows – everyone else – follow the example of philosophers and patriots from Jefferson to Gandhi, from Christ to LaFollett – to the streets!
That all reminds me of a specific ‘f’ word – one that has more than four letters.
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I know that word – and, all it takes is one look at the stormtrooper shock & awe po-leece that have been sent to disperse peaceful protestors to see in our country and our lifetime analouges to the first fascisti.
The sad fact is, when deception fails, they will choose force. its time to choose to stand down or stand up. – – “History will have to record that the greatest tragedy of this period of social transition was not the strident clamor of the bad people, but the appalling silence of the good people.” MLKing
Following herewith are the extraordinary closing paragraphs from Judge Rakoff’s decision. They bear reading and rereading. I find myself feeling– however fleetingly– as if a fog has lifted and there is still some hope for saving the country I love from the rapacious parasites who would gladly see it sacrificed on the altar of their own financial self-interest:
“The point, however, is not that certain narrow interests of the parties might not be served by the Consent Judgment, but rather that the parties successful resolution of their competing interests cannot be automatically equated with the public interest, especially in the absence of a factual base on which to assess whether the resolution was fair, adequate, and reasonable. Even after giving the fullest deference to the S.E.C.’s views – which have more than once persuaded this Court to approve an S.E.C. Consent Judgment it found dubious on the merits, see, e.g., Bank of America II, supra — the Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.
“It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? It is not fair, because, despite Citigroup’s nominal consent, the potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged is patent. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. And, most obviously, the proposed Consent Judgment does not serve the public interest, because it asks the Court to employ its power and assert its authority when it does not know the facts.
“An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. 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 it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”
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both righteous and right
Yves,
Thanks for the posting. I need a wake up call tomorrow morning early here on the West Coast so I guess I can repeat my shout out to the SEC employee that persists in engaging in telephone harassment of me to DO YOUR JOB for the American public and not the global inherited rich!
Gawd that feels good.
If nothing else maybe what is left of decent members of our judiciary can choke up the Supremes with cases like this for them to overturn.
Slightly besides the point, but can someone provide a fact pattern that the policy would indisputably cover? The exclusion seems wide enough to drive a truck through – won’t the insurer always be able to claim that any error or negligence was actually deliberate/dishonest? Somehow I get the impression that it’s the size of the settlement and not necessarily the facts of the case that’s causing the insurer to contest the payment.
The insurance covers errors, i.e. human mistakes or negligence, i.e. sloppiness. What it won’t cover is intentional acts, typically criminal or fraudulent acts. So, if a client requests a trade and the broker forgets to make some default swaps trades, or executes them inaccurately, he/she would be covered. If the trader intentionally never books the trades counting on the defaults never being called, insurance doesn’t pay. The burden is on the insurer to demonstrate that there was criminal or fraudulent misconduct, most likely based on a pattern of behavior I’d think. They can’t make baseless claims (who will buy from them if they don’t pay legitimate claims?). And yes, the larger the losses, the more scrutiny the insurer will give the claim.
It’s similar to malpractice insurance in the medical field. More often than not, if a patient in a nursing facility dies due to a condition going untreated, it’s an error/omission, not intentional. Mistakes happen. If several patients are dying due to lack of treatment, then there may be criminal negligence involved.
Another excellent illustration of Emil Brunner’s remark about Capitalism:
“Capitalism is irresponsibility organized into a system.”
The particular aspects of our Capitalist society–the corporate liability shield for investors, an electoral system owned by the Capitalists, and non-functional corporate governance–and you have Late Stage Capitalism’s extractive and corrupt characteristics brought to to their fullness of expression, all without anyone being held accountable or responsible.
The securities industry in general has bad habits formed from decades of making their own rules and deciding what those rules mean.
When Joe and Jane Martini lose their nest egg to a pump and dump or other fraud, or more likely, to unrestrained churning, they discover they’ve signed a binding arbitration clause. Bottom line on that, they’re going to ask three people chosen, hired, and paid by the NASD or the NYSE to give them back their losses. Not surprisingly, it’s currently a percentage of the rip off going to a percentage of the ripped off.
The SEC world is nearly the arbitration world; it’s got the same slant, just different name on the paychecks.
Good ‘un for the insurance co…must not be run by the friends of the Morgan board.
Given the state of business as conducted by US capitalists, the end could surpass anything we dared to envisage in our darkest thoughts.
I had to look up who exactly were some of the insurers balking at paying for this and lo and behold, it appears that AIG (Nat’l Union Fire) is one of the plaintiff insurers. Ha ha.
Very encouraging. Surprising even. Got to wonder what history will make of this entire episode in 50 years.
I wish I had 50 years left to be able to witness this. Just who might the victor be? Everyone knows that the victory is the one who writes the history.
Wanker of the Day: Robert Khuzami. From the NYT: “…the Citigroup settlement ‘reasonably reflects the scope of relief that would be obtained after a successful trial,’ and…the judge’s decision ‘ignores decades of established practice throughout federal agencies and decisions of the federal courts.'”
.. ignores decades of established graft…”.
Once they have to admit criminal wrongdoing, what fiduciary would ever be able to do business with these habitual criminals?
“The Venetian Court” by Charles L. Harness is an interesting take on personally responsible corporate officers (in the context of patent law, no less).
D&O insurance to cover legal fees is one thing (and I certainly would demand that — you may be the target for a lot of meritless lawsuits as a director), but to cover actual fines, civil penalties, and payments for wrongdoing… that’s just wrong. Why is that even legal?