By Nate Raymond
NEW YORK (Reuters) - A federal appeals court signaled that a U.S. securities regulator's proposed $285 million civil fraud settlement with Citigroup Inc might end up back in the hands of the same judge who rejected it more than a year ago.
The settlement was intended to resolve U.S. Securities and Exchange Commission charges that Citigroup misled investors by selling a $1 billion collateralized debt obligation in 2007 as housing prices were falling, without revealing its bet against the underlying mortgages.
In rejecting the settlement in November 2011, U.S. District Judge Jed Rakoff in Manhattan challenged the long-standing practice of the SEC and other regulators of letting companies settle cases without acknowledging wrongdoing. He said he had no way to know if the accord was in the public interest.
At a hearing on Friday, a three-judge panel of the 2nd U.S. Circuit Court of Appeals weighed how to balance the deference given to the SEC to handle its own cases against the desire that judges have enough facts to decide if settlements are fair.
Two of the judges suggested that Rakoff reconsider the settlement, noting that he had presided over the trial and eventual acquittal of former Citigroup manager Brian Stoker, the only individual charged over the Class V Funding III CDO.
"We can remand to have him consider additional proof of evidence from the trial," Circuit Judge Raymond Lohier said.
DEFERENCE AT ISSUE
In rejecting the settlement, Rakoff chastised both the SEC and Citigroup for essentially hiding the facts.
"An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous," Rakoff wrote.
Because the SEC and Citigroup want the settlement approved, the 2nd Circuit took the rare step of appointing a lawyer to argue for Rakoff's position.
That lawyer, John "Rusty" Wing, called it a "clear misrepresentation and misreading" of Rakoff's decision to say that the judge required Citigroup to admit liability.
But he said there was no reason Rakoff could not ask for more evidence before approving a settlement.
"Although the SEC deserves deference, like the rest of us, it's not always right," Wing said.
Brad Karp, a lawyer for Citigroup, argued that more than 20 federal agencies do not always require settling defendants to admit liability.
He said imposing such a requirement would cause federal enforcement "to screech to a grinding halt."
In agreeing in March 2012 to hear the appeal, the 2nd Circuit put Rakoff's ruling on hold, saying the SEC and Citigroup had a "strong likelihood of success."
Circuit Judge Rosemary Pooler, one of the judges who issued that stay, said it was a "red herring" as to whether Rakoff could require an admission of wrongdoing by Citigroup.
"I don't think the district court asked for, or anyone thinks, he's entitled to that," she said.
Rakoff had noted that SEC had not for 10 years sought to enforce injunctions to prevent further backsliding, including against companies such as Citigroup that had faced prior enforcement actions.
But SEC lawyer Michael Conley told the court that such injunctions are still useful. "We do believe injunctions prove a good prophylactic remedy," he said.
Prior to rejecting the Citigroup settlement, Rakoff had also turned down the SEC's $33 million settlement with Bank of America Corp to resolve charges over the Merrill Lynch & Co takeover. He later approved a $150 million accord.
The case is SEC v. Citigroup Inc., 2nd U.S. Circuit Court of Appeals, 11-5227.
(Reporting By Nate Raymond in New York; Editing by Kenneth Barry)