Two cases in recent months have peered into the SEC’s normally opaque charging and settlement processes and raised disturbing questions. Bank of America, resolved earlier this year took repeated hearings to secure approval of the SEC’s settlement with the Bank. The case was significant, charging that the bank defrauded its shareholders when soliciting approval for its acquisition of then failing Merrill Lynch. (here). The Commission and the Bank eventually secured court approval of the deal. It came only after repeated hearings and explanation. In the process, the court required that the procedures intended to prevent a reoccurrence be bolstered. The amount of the penalty which the SEC claimed would achieve this result was increased. Judge Rakoff also conducted an extensive review of the evidence about the participation by various individuals in the decision to withhold critical information from the shareholders. Reluctantly, the court finally agreed to sign the consent decree.

More recently, the Commission had the same difficulty obtaining court approval of its proposed settlement with Citigroup. That case is based on claims that the bank made false statements to investors about its exposure to the sub-prime market (here). As in the Bank of America, the SEC and the Bank proposed to settle with the payment of a fine and procedures implemented to prevent a future reoccurrence of the wrongful conduct. This time, however, the SEC named two bank officers as Respondents in related administrative proceedings.

Again, the court had piercing questions about the settlement. Additional briefing was ordered in which the parties discussed the procedures, the amount of the penalty and who was involved in the underlying conduct.

On Friday, Judge Huvelle reluctantly approved the Citigroup settlement. In doing so, the Court essentially deferred to the SEC’s judgment regarding the liability of bank officers for the false statements. Repeated language in the complaint raised questions since it at least suggests that individuals other than the two officers named in the administrative proceedings were involved. Judge Huvelle also made it clear that she did not view the $75 million penalty – or for that matter even a $100 million penalty – as any type of a deterrent to future violations by a company the size of Citi, despite claims to the contrary by the parties. This is, of course, consistent with Bank of America’s position in its case. There, the Bank made it clear it would pay a large fine to make peace with the SEC.

As in Bank of America, the court focused on the procedures being installed to prevent a replication of the wrongful conduct in the future. Before signing off on the deal, Judge Huvelle ordered the SEC to certify that Citigroup actually put in place the procedural remedies cited in the papers.

Bank of America and Citigroup should serve as a wake-up call to the SEC. In each case, the court raised significant questions about the terms of the settlements focusing on the remedies in the consent decrees to prevent a future reoccurrence of the claimed wrongful conduct as well as the exercise of prosecutorial discretion in the charging process. In each case, after reading the SEC’s complaint, the court raised questions about its decision on who to charge. This suggests that either the agency is over-stating the facts in the complaint or it is not properly exercising its charging discretion. The fact that the court ultimately deferred to the SEC’s decision in each instance after a more careful review of the case suggests that the former is true. If so, in the future the Commission should implement procedures to give more scrutiny to the facts inserted in complaints. This will help avoid not only the difficulties encountered with these settlements, but also cases such as the Rorech insider trading action where the proof failed at trial to match the allegations of the complaint (here).

Equally important, however, are the questions raised about the terms of the settlement in each case. As both Judge Rakoff and Judge Huvelle recognized, a key focus of any SEC settlement is the steps taken to prevent a reoccurrence of the wrongful conduct. It is axiomatic that the SEC’s mission is not just to halt conduct which violates the law, but also to bring a new ethics to the marketplace. This begins by ensuring that market participants move forward in a fashion which is fully consistent with the letter, as well as the spirit, of the federal securities laws. Thus, in Bank of America, Judge Rakoff directed the parties to add provisions to the procedural remedies to meet these goals. Judge Huvelle in Citigroup ordered the SEC to certify compliance with the procedures.

Large fines generate great headlines, sound good in congressional testimony and make great statistics, but have little real deterrent value for big corporations who are more than prepared to pay big dollars to end an SEC inquiry and move on. Properly crafted procedural provisions can have a lasting impact that implements the goals of the federal securities laws.

In the end, these cases suggest that the SEC conduct a critical evaluation of its settlement procedures. The SEC has broad charging discretion and a wide range of remedies which can be used to fashion effective remedies. For the Commission to be an effective regulator of the securities markets – the agency is not a prosecutor piling up convictions and big fines – it is essential that the enforcement program be effective at halting wrongful conduct and preventing it from reoccurring. Complaints which overstate the facts and remedies keyed to big dollar penalties will generate headlines, but are not necessarily effective enforcement. Rather, complaints charging violations based on carefully presented facts coupled with remedies that halt violations and make sure that they will not reoccur are the keys to a successful enforcement program and an agency fulfilling its statutory mandate.