Investors who wished for a helping hand in pursuing claims against banks that sold them exotic debt instruments instead got a kick in the pants from the Second Circuit today.

No no-admit deals

In 2011, U.S. District Judge Jed Rakoff famously refused to approve a consent decree between the Securities and Exchange Commission and Citigroup. The pact concerned the financial behemoth's possibly fraudulent role in marketing and selling interests in a risky "fund". The "Fund’s assets . . . were primarily collateralized by subprime securities tied to the already faltering U.S. housing market." Securities and Exchange Comm'n v. Citigroup Global Markets, Inc., No. 11-5227, slip op. at 4 (2d Cir. June 4, 2014).

Judge Rakoff rejected the deal largely on the ground that Citigroup did not admit to facts that would support the injunctive relief to which it had agreed. He wrote:

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

Id. at 9 (quoting Securities and Exchange Comm'n v. Citigroup Global Markets, Inc., 827 F. Supp. 2d 328, 335 (S.D.N.Y. 2011)).

Appeals court vacates and remands

The Second Circuit vacated the ruling. It held that the district court abused its discretion by requiring that the record establish the "truth' about the allegations underlying the SEC's charges against Citigroup.

Investors and their lawyers should note the panel's view about a major reason that Citigroup did not want to concede it did something wrong — the issue-preclusive (or, if you prefer old school, collateral estoppel) effect of the consent decree. " "Nor can the district court reject a consent decree on the ground that it fails to provide collateral estoppel assistance to private litigants—that simply is not the job of the courts." Id. at 27.

Winners and losers

With an admission of guilt by a Citigroup (or a Bank of America or a Credit Suisse or another financial institution), unhappy investors would not have to prove wrong-doing. They would mainly need to show that they bought a bad investment during the relevant time period and lost money on it.

The Second Circuit's decision paves the way for more no-admit settlements with the SEC. That is good news for banks, bad news for investors.