January 13, 2012
Practice Groups:
Securities Litigation
Securities
Enforcement
Government
Enforcement
Securities Litigation Changes In A
New York Minute
By Andrew L. Morrison and Richard A. Kirby
The end of 2011 saw a flurry of cases decided in New York which have the potential to effect
fundamental changes regarding how securities fraud and related claims are litigated in New York. In
rapid-fire succession, federal and state judges in New York have issued opinions that, among other
things, (1) refuse to accept SEC consent judgments at face value; and (2) make it easier for plaintiffs
to assert traditional common law claims arising from securities transactions. These decisions reverse
and/or call into question several longstanding legal principles, and practitioners and parties should
thoroughly review the decisions before prosecuting, defending or settling securities fraud and related
claims in New York.
S.E.C. v. Citigroup Global Markets Inc.
On November 28, 2011, Judge Rakoff of the Southern District of New York rejected a consent
judgment negotiated between the SEC and Citigroup Global Markets Inc. (“CGMI”). The SEC had
filed a lawsuit against CGMI accusing it of fraudulently misrepresenting the value of assets in an
investment fund and then taking a short position in those assets. Although CGMI agreed to disgorge
$160 million in profits and to pay a $95 million civil penalty, it neither admitted nor denied the factual
allegations set forth in the SEC’s complaint. Notwithstanding the historical use of such disclaimers in
consent judgments, Judge Rakoff held that absent further development of the facts, the Court lacked a
sufficient evidentiary basis to enable it to determine whether the injunctive relief contained in the
proposed consent judgment met the standards for granting such relief. Key to the decision was the
Court’s view that the judiciary has an independent responsibility to determine the fairness and
adequacy of a settlement and “whether the requested deployment of its injunctive powers will serve,
or disserve, the public interest.” While the Court acknowledged that the views of an agency vested
with authority in a particular area are entitled to “substantial deference,” it rejected the contention that
the SEC is the “sole determiner of what is in the public interest in regard to Consent Judgments
settling S.E.C. cases.” CGMI’s failure to admit or deny the allegations in the complaint was one of
the principal reasons given by the Court for its conclusion that it lacked sufficient facts on which to
exercise its independent judgment, and so the Court refused to approve the proffered consent
judgment.
Significantly for securities fraud defendants, Judge Rakoff’s ruling marks an abrupt departure from
longstanding precedent approving the use of consent judgments that do not admit to any wrongdoing.
The policy considerations that weigh in favor of approving consent judgments are obvious and well
known. For decades, courts have entered consent judgments providing for injunctive relief without
the adjudication or admission of facts. Federal policy favors the use of consent judgments to preserve
the resources of the courts and of the parties, and typically the decisions of federal agencies such as
the SEC as to how best to allocate agency resources receive strong deference. However, Judge Rakoff
was not moved by these policy considerations. Instead, Judge Rakoff held:
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
Securities Litigation Changes In A New York Minute
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.
Both the SEC and CGMI have appealed Judge Rakoff’s decision.1 In its press release announcing the
appeal, the SEC framed the issue as whether the agency is required to support a proposed consent
judgment “with proven or acknowledged facts.” Press Release from Robert Khuzami, Dir. of Div. of
Enforcement, S.E.C., S.E.C. Enforcement Director's Statement on Citigroup Case (Dec. 15, 2011),
available at http://www.sec.gov/news/press/2011/2011-265.htm.
Judge Rakoff’s decision has sparked renewed scrutiny of SEC settlements by the judiciary. See Letter
from Hon. Rudolph T. Randa, U.S. Dist. Judge, E. Dist. of Wis., to S.E.C. (Dec. 20, 2011) (asking the
agency for additional factual support in support of its request for injunctive and ancillary relief in the
case of S.E.C. v. Koss Corp., No. 2:11-cv-00991-RTR (E.D. Wis. filed Oct. 24, 2011)) (on file with
the court). Pending a decision by the Second Circuit on the issues raised by Judge Rakoff, there will
remain considerable uncertainty as to what type of proof will be required to support the entry of a
consent judgment providing for injunctive relief.
In the wake of these developments, the SEC has revisited some of its settlement policies and
announced on January 6, 2012, that it will no longer allow defendants to neither admit nor deny civil
fraud or insider trading charges to settle civil claims when, at the same time, they admit or have been
convicted of criminal violations. See Edward Wyatt, S.E.C. Changes Policy on Firms’ Admissions of
Guilt, N.Y. TIMES, Jan. 7, 2012, at B1. The SEC’s new policy, however, is not likely to have material
effect in most cases, because as a practical matter the admission of liability associated with a criminal
case operates as collateral estoppel in related civil litigation.
J.P. Morgan Securities Inc. v. Vigilant Insurance Co.
Two weeks after Judge Rakoff’s rejection of the CGMI consent judgment, a New York appellate court
further undermined the longstanding use of consent judgments that neither admit nor deny any
wrongdoing. Specifically, the New York State Supreme Court, Appellate Division, First Department,
held that a defendant was not entitled to insurance coverage for disgorged profits paid pursuant to a
consent judgment, inferring from the circumstances that the defendant had knowingly and
intentionally engaged in unlawful activity. Previous to J.P. Morgan Securities Inc. v. Vigilant
Insurance Co., the SEC and New York Stock Exchange had accused Bear Stearns and its successor
J.P. Morgan Securities Inc. of knowingly helping customers to engage in improper market timing.
Without admitting or denying the allegations, Bear Stearns agreed to a consent judgment with the SEC
disgorging $160 million and paying a $90 million civil penalty.
When Bear Stearns’ successor in interest sought coverage for the disgorgement payment, the
Appellate Division, First Department, held that an insurance carrier is not obligated to indemnify a
policyholder for profits disgorged pursuant to a consent judgment if the consent judgment indicates
that the policyholder engaged in illegal activity. Ignoring the plain language of Bear Stearns’
stipulation in which it neither admitted nor denied the allegations in the SEC’s complaint, the First
Department stated that, as a matter of law, the only reasonable interpretation of the consent judgment
and accompanying evidence was that Bear Stearns knowingly and intentionally engaged in illegal
1
S.E.C. v. Citigroup Global Mkts, Inc., No. 11 Civ. 07387 (JSR), 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011), appeal
docketed, No. 11-5227 (2d Cir. Dec. 20, 2011); S.E.C. v. Citigroup Global Mkts. Inc., No. 11 Civ. 07387 (JSR), 2011 WL.
5903733 (S.D.N.Y. Nov. 28, 2011), appeal docketed, No. 11-5242 (2d Cir. Dec. 21, 2011). Judge Rakoff denied the
parties’ application for a stay pending appeal, holding that the parties did not meet the statutory criteria for an interlocutory
appeal. S.E.C. v. Citigroup Global Mkts. Inc., No. 11 Civ. 7387 (JSR), 2011 WL 6762964 (S.D.N.Y. Dec. 27, 2011).
2
Securities Litigation Changes In A New York Minute
trading activity. Accordingly, the Court deemed the disgorgement payment to be an uninsurable loss
and granted the insurers’ motion to dismiss the coverage claims even though any alleged wrongdoing
had never been admitted. The Appellate Division, First Department explicitly referred to Judge
Rakoff’s November 28, 2011, decision to support its refusal to accept the agreed-upon terms of the
consent judgment at face value.
Assured Guaranty Ltd. v. J.P. Morgan Investment
Management Inc.
Only a week later, on December 20, 2011, the New York Court of Appeals clarified the right of
securities plaintiffs to assert non-scienter based New York common law claims premised on breach of
fiduciary duty or negligent misrepresentation. The Court halted a trend in the federal courts that had
interpreted New York’s Martin Act to preempt such claims. The Martin Act, which allows the New
York Attorney General to pursue securities fraud through civil or criminal actions without the
typically required showing of intent to defraud, does not create a private cause of action. Many
federal courts and some state courts had interpreted the Martin Act to preempt private, non-scienter
based common law claims related to securities transactions because to allow them would effectively—
and impermissibly—create a private cause of action under the Martin Act.
Rejecting the rationale of the federal courts within the Second Circuit, the New York Court of Appeals
determined that the Martin Act does not preempt traditional non-scienter based common law causes of
action related to the sale of securities. Although the Martin Act does not create a private cause of
action and cannot be the premise for a private cause of action, the Court stated that the statute does not
expressly repeal common law claims. The Court of Appeals held that traditional common law claims
that overlap but are not “entirely dependent” on the Martin Act are viable, and that private plaintiffs
may assert New York common law claims such as negligent misrepresentation and breach of fiduciary
duty as well as federal securities law claims.2
In re Optimal U.S. Litigation
In a decision issued the same day as Assured Guaranty, Judge Scheindlin of the Southern District of
New York held that a recent United States Supreme Court decision that limited group pleading for
federal securities law claims does not preclude the use of group pleading for New York common law
fraud claims. Under the group pleading doctrine, a pleading may impute misrepresentations or
omissions in published documents to a group of defendants without connecting the misrepresentations
or omissions to each individual defendant. In Janus Capital Group v. First Derivative Traders, the
Supreme Court severely curtailed the use of group pleading for Rule 10b-5 claims by holding that a
defendant who did not have ultimate authority for a prospectus could not be held liable for alleged
misstatements contained within the prospectus.
In In re Optimal U.S. Litigation, Judge Scheindlin rejected any such limitation on the group pleading
doctrine for causes of action based on New York common law fraud. Noting that the Janus decision
was based in part on the limited scope given to implied rights of action such as Rule 10b-5 claims, she
2
Although not the subject of this alert, defendants should expect plaintiffs to argue that the Assured Guaranty decision
should be applied retroactively to revive previously dismissed common law claims in actions that are active or on appeal.
See Gager v. White, 53 N.Y.2d 475, 483-84 (1981) (stating that “consonant with the common law’s policy-laden
assumptions, a change in decisional law usually will be applied retrospectively to all cases still in the normal litigating
process[,]” unless “adherence to the traditional course is strongly contradicted by powerful factors, including strong
elements of reliance on law superseded by the new pronouncement”); see also Signature Health Ctr., LLC v. State of
N.Y., 42 A.D.3d 678, 679, 840 N.Y.S.2d 191, 192-93 (3d Dep’t 2007); Trifaro III v. Town of Colonie, 31 A.D.3d 821, 822,
819 N.Y.S.2d 147, 149 (3d Dep’t 2006).
3
Securities Litigation Changes In A New York Minute
determined that such reasoning should not be used to limit the common law. Additionally, Judge
Scheindlin observed that a decision of a federal court (albeit the Supreme Court) interpreting federal
statutory law does not impact the scope of New York common law fraud claims. Accordingly, while
the group pleading doctrine may no longer be applicable to federal securities claims under Rule 10b-5,
Judge Scheindlin concluded that the group pleading doctrine remains available to a private plaintiff
seeking to assert traditional common law fraud claims in New York.
Conclusion
A “New York minute” has been described as the time between when a traffic light turns green and
when the car behind you starts to honk its horn. With analogous speed in the context of jurisprudence,
various courts in New York have issued separate decisions which impact how a securities case is pled,
defended and settled. The implications of these decisions will be felt throughout the new year and
beyond.
The authors would also like to acknowledge Elise Gabriel’s contributions to this alert.
Authors:
Andrew L. Morrison
andrew.morrison@klgates.com
+1.212.536.3941
Richard A. Kirby
richard.kirby@klgates.com
+1.202.661.3730
Additional Contact:
John W. Rotunno
john.rotunno@klgates.com
+1.312.807.4213
4