Jed Rakoff and the Lonely Fight for Wall Street Justice
Long before he began crossing swords with the Securities and Exchange Commission over its tepid response to the 2008 financial collapse, US District Judge Jed Rakoff had already established a reputation for speaking his mind on the major issues of the day. But in his refusal to allow the SEC to rap a few knuckles and move on, the judge seemed to be speaking for everyone who shared his rage at the lack of accountability on Wall Street and the reluctance of the regulatory and legal systems to do much about it.
“Who was to blame?” Rakoff asked readers in a widely circulated article published in The New York Review of Books in January. “Was it simply a result of negligence, of the kind of inordinate risk-taking commonly called a ‘bubble,’ of an imprudent but innocent failure to maintain adequate reserves for a rainy day? Or was it the result, at least in part, of fraudulent practices, of dubious mortgages portrayed as sound risks and packaged into ever more esoteric financial instruments, the fundamental weaknesses of which were intentionally obscured?”
The more he researched and thought about the financial crisis, and the more cases he presided over involving its aftermath, the more Rakoff came to believe the latter. That stance has guided a series of landmark rulings in which he has challenged the SEC’s preference for consent decrees—agreements in which banks pay a token fine to settle complaints without admitting guilt—and placed the agency’s lax approach to regulatory oversight in the national spotlight.
In 2009, rejecting a settlement between the SEC and Bank of America that he described as “neither fair, nor reasonable, nor adequate,” Rakoff wrote that the deal “does not comport with the most elementary notions of justice and morality.”
Bank of America was in hot water over the way it had taken over Merrill Lynch in 2008. The takeover, which had come at the urging of the Treasury, prevented a tottering financial edifice from collapsing and setting off what could have been a catastrophic global domino effect. The problem was that, to sweeten the deal and smooth the process, Bank of America had allegedly secretly authorized Merrill to pay out up to $5.8 billion in year-end bonuses. According to the complaint, the bank had also hidden from its shareholders that Merrill was about to post enormous fourth-quarter losses, which would likely have provoked a shareholder revolt against the action.
The SEC had agreed to a settlement in which Bank of America would pay a token fine of $33 million as a consequence of the shady deal. The penalty would essentially be paid by the bank’s shareholders, even though they were the ones who had taken the hit. When Rakoff first read the settlement, he recalls, “it looked totally unreasonable on every level.”
By putting a kibosh on the deal, Rakoff embarrassed the SEC into taking another look at Bank of America’s actions. When the parties returned to Rakoff after a full discovery process that laid bare the facts of the case, the terms of the deal had changed. Now Bank of America was going to pay a $150 million penalty; the money would come from Merrill shareholders rather than the bank’s; and the merged institution agreed to implement a series of prophylactic measures to prevent such actions from occurring again.
Ideally, Rakoff felt, such settlement agreements should hold individual decision-makers responsible for their organization’s actions and should also involve admissions of wrongdoing. Nevertheless, what was on the table was, he felt, a whole lot better than the original settlement. So the judge held his nose and accepted the deal.
Two years later, in a blistering November 2011 ruling that was notable for its strong tone and moral judgment, Rakoff tossed out a settlement between the SEC and Citigroup that allowed the firm to pay a $285 million fine—without admitting guilt—for allegedly selling a billion-dollar fund it knew was filled with toxic mortgage debt, and then betting against its own customers to profit from the failure. Citigroup had made $160 million on the deal; its investors had lost more than $700 million.
The settlement might have been good enough for the regulators, but Rakoff felt that the penalty left “the defrauded investors substantially short-changed.” Besides, he added, he wouldn’t be able to determine whether the settlement was in the public interest until the SEC produced more information about Citigroup’s practices before 2008.
“The S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges,” Rakoff wrote, “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.”
Unfortunately, not all judges agreed with Rakoff’s analysis. On June 4, the Second Circuit Court of Appeals overturned his Citigroup ruling. Rakoff had “abused” his discretion, argued Judge Rosemary Pooler, author of the appellate court’s decision, “by applying an incorrect legal standard” in his review. “Consent decrees are primarily about pragmatism,” Pooler added, essentially holding that if both parties to the lawsuit agreed to settle, the judge really couldn’t stand in the way. In other words, Rakoff’s sense of moral unease simply didn’t have a place in the process. This was about getting deals done and moving on, about helping firms and regulatory agencies manage risk; it was not about seeking the truth.
That leaves Rakoff in an unusual position: standing on the side of full disclosure and the public interest even as the appeals court sides with the banks and their regulatory enablers.
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