In a statement accompanying a filing in Federal District Court in New York, the agency cited “legal error” in the decision in late November and said it would ask the United States Court of Appeals for the Second Circuit to overturn the opinion of Judge Jed S. Rakoff. In the ruling, the judge rejected an agreement for Citigroup to pay $285 million and accept an injunction against future violations of an antifraud provision of federal securities laws.
Judge Rakoff’s ruling shook a central pillar of federal securities law, potentially upending a practice that allows the S.E.C. to settle hundreds of enforcement cases each year. The commission usually settles charges with companies by getting them to pay a fine and agreeing to reimburse investors without making them admit or deny the charges.
Citigroup was charged by the S.E.C. with fraud for selling a $1 billion fund in 2006 and 2007 that invested in mortgage-related securities without telling investors that the bank was betting against many of the securities. Citigroup, which has said it disagrees with Judge Rakoff’s decision, is expected to support the appeal.
Judge Rakoff dismissed the proposed settlement as “neither fair, nor reasonable, nor adequate, nor in the public interest,” in part because Citigroup did not have to admit or deny the charges. Judge Rakoff said that without an admission or evidence that Citigroup violated the law, he had no way to determine whether the settlement was adequate.
The S.E.C., in a statement issued Thursday, sharply criticized the judge’s decision.
“We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits,” Robert Khuzami, the S.E.C.’s director of enforcement, said in the statement.
“The court’s new standard is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country,” Mr. Khuzami said. “Courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.”
Appealing the judgment carries risk for the S.E.C., because if the ruling is upheld by the circuit court, it would set a precedent that is likely to influence judges hearing similar S.E.C. cases.
The Second Circuit court, located in New York, hears many cases involving financial issues and securities laws; though its decisions are not binding on other circuits, they often influence judges around the country because of the court’s familiarity with securities law, experts say.
Judge Rakoff’s decision also could affect many other types of civil settlements forged by government regulators. Several other agencies, including the Environmental Protection Agency and the Federal Trade Commission, have settled civil cases by letting a defendant avoid having to admit or deny the charges.
Securities law experts say they know of only one previous instance where the S.E.C. appealed a federal judge’s rejection of a commission settlement — and the S.E.C. won that appeal. In 1983, a federal district court judge in San Francisco rejected an insider trading settlement because he thought the penalty was inadequate and did “not appear to be in the public’s best interest.”
The next year, in S.E.C. v. Randolph, the Court of Appeals for the Ninth Circuit reversed the decision, saying “the courts should pay deference to the judgment of the government agency which has negotiated and submitted the proposed settlement.”
While it was correct to consider the public interest, the appeals court said, that does not mean the “best interest” possible. “Compromise is the essence of a settlement,” the court said.
In the Citigroup case, Judge Rakoff said in his decision that investors lost more than $700 million in the transaction, and he criticized the proposed penalty as “pocket change to any entity as large as Citigroup.”
The S.E.C. batted away the importance of Citigroup’s size. “The law does not permit the commission to seek penalties based upon a defendant’s wealth,” Mr. Khuzami said.
There are limits to the size of penalties that the S.E.C. is allowed to assess in such a case. The $285 million settlement, all of which would be returned to investors, includes a $95 million penalty, a $160 million disgorgement of profits and fees earned on the securities offering, and $30 million in prejudgment interest. The S.E.C. recently asked Congress to amend the law to allow it to seek bigger penalties.
Whether the S.E.C. could be hampered in its efforts to settle other fraud cases while the appeal is outstanding is uncertain. Two former S.E.C. enforcement officials, who spoke on the condition of anonymity because they now represent clients facing S.E.C. charges in separate cases, said the commission seemed to have slowed its settlement efforts since Judge Rakoff’s ruling.
A person involved in another S.E.C. settlement matter said there had been no slowdown, in part because commission officials have made clear that they expected Judge Rakoff’s decision to be overturned.
The S.E.C. has long contended that it must settle most cases rather than take them to trial because, with limited resources, it cannot afford much litigation. The commission says it frequently achieves in its settlements much the same result that it could hope to obtain in court, without the expense of a trial.
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