Judge’s Ruling Complicates Enforcement for S.E.C.

Judge Jed S. Rakoff of the Federal District Court in Manhattan added another dimension to that quandary on Monday when he told the Securities and Exchange Commission that he could not determine whether a proposed $285 million penalty against Citigroup was adequate if he did not know what had really happened.

His opinion has undermined the S.E.C.’s longstanding policy of allowing companies to neither admit nor deny the commission’s charges in return for a multimillion-dollar fine and a promise not to do it again.

The commission has “been benefitting for a long time from this huge hammer that allows them to get settlements without having to prove their case,” said Adam C. Pritchard, a University of Michigan law professor. Judge Rakoff’s decision “eliminates that possibility for them.”

Securities law experts say there are ways that the S.E.C. might be able to strengthen its enforcement efforts and make Wall Street fearful of penalties that sting. Jill Gross, a law professor and director of the Investor Rights Clinic at Pace University, said that as a result of the judge’s decision, companies were now likely to have to admit some kind of fault in their settlements.

“It doesn’t need to be a full admission of all culpability,” Ms. Gross said, “but they are going to need some type of admission that something went awry.”

Goldman Sachs did so last year when it settled S.E.C. charges similar to the case against Citigroup that Judge Rakoff rejected. Both firms were charged with selling a mortgage bond investment without telling investors that the people assembling the portfolio were betting that it would drop in value.

In its S.E.C. settlement, Goldman acknowledged that its marketing materials “contained incomplete information,” and that it committed “a mistake” in leaving the full disclosures out of its marketing documents.

“We agree to settlements because they achieve for us largely everything that we could hope to get should we take the case to trial,” Robert Khuzami, the S.E.C.’s enforcement director, said in an interview this month. “I think the message is pretty clear. And the investors get their money much faster, because, as you know, lawsuits can take years.”

Mr. Khuzami said that the “neither admit nor deny” policy was used by the S.E.C. against companies other than Wall Street firms. In addition, he said, other governmental agencies often use the same formulation, and the courts had upheld its application.

The S.E.C. fashioned its “neither admit nor deny” policy in the 1970s, when Wall Street was far different. Most Wall Street firms were relatively small partnerships, meaning that any penalties essentially came out of the pockets of the people who ran them.

Now, however, most Wall Street brokerage houses and investment banks have been joined with publicly traded commercial banks, forming companies so large that penalties of hundreds of millions of dollars are merely “the cost of doing business,” in Judge Rakoff’s words.

The S.E.C. has said that stiffer penalties will provide a greater deterrent. This week, the agency asked Congress to raise the amounts that it can fine companies for securities law violations.

The agency says that it does not have the resources to take many cases to court. The commission said recently that it filed a record 735 enforcement cases in the year ended Sept. 30, producing $2.8 billion in penalties.

Some members of Congress do not buy that argument. “Government resources always will be limited,” said Senator Charles E. Grassley, an Iowa Republican. “That shouldn’t be an excuse.”

S.E.C. officials remain fearful of changing their longstanding policy, however. High-ranking officials at the agency monitored online public commentary after Judge Rakoff’s decision, one agency official said.

“We understand there is a greater public clamoring for accountability for those responsible for the credit crisis,” said the official, who spoke on the condition of anonymity because the Citigroup case was still before the court. “But there are costs with doing away with the policy, and we think they would be pretty significant.”

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