In a recent interview, former President Bill Clinton was asked: if he had to do it over again, would he sign the deregulatory Gramm-Leach-Bliley Act in 1999 and not regulate derivatives? Mr. Clinton responded “And again, if I had known that the S.E.C. would have taken a rain check, would I have done it? Probably not . . . In other words, I would have tried to reverse everything if I had known we were going to have eight years where we would not have an S.E.C. for most of the time.” Peter Baker, “The Mellowing of William Jefferson Clinton,” New York Times Magazine, May 31, 2009. Now, there is a new SEC Chairman and a new Enforcement Director. Both have promised to revitalize SEC enforcement. Yet one might ask, paraphrasing Mr. Clinton, “Has the SEC taken a rain check?”

Yesterday Judge Rakoff issued an order in SEC v. Bank of America, discussed here, rejecting the settlement of the SEC and the Bank. It is unusual for a judge to reject a settlement proposed by the parties in an SEC enforcement action. Proposed settlements are routinely accepted and executed. As the judge noted in his order, the parties are entitled to significant deference. The rejection of the settlement here however, is beyond unusual. It raises fundamental questions about the Commission, the Enforcement program and the repeated promises of the Chairman and her new Enforcement Director that the program is being rejuvenated.

The story of the case and the events leading to the rejection of the settlement is by now well known and is discussed here. In brief, the SEC brought an action claiming shareholders were defrauded when they voted to have the Bank acquire Merrill Lynch. The proxy materials suggested that bonuses would not be paid to Merrill executives absent consent from the Bank, according to the SEC. In fact, an omitted schedule to the merger agreement stated that the boards of both companies had approved the payment of up to $5.8 billion in bonuses for executives at the brokerage firm.

The SEC’s enforcement action alleges violations of the Exchange Act proxy provisions and rules. The Bank agreed to settle by consenting to an injunction and the payment of a $33 million fine. No action would be brought against any individuals.

The court initially ordered the parties to explain the proposed settlement, particularly the fine since it would ultimately be paid by the shareholders. Through two rounds of briefs the SEC essentially claimed that the Bank lied to the shareholders and it could not determine which individuals were involved because of privilege assertions, but the settlement should be accepted by the Court. The Bank maintained that it had done nothing wrong and settled only to avoid a dispute with a regulator.

In rejecting the settlement the Court concluded that since it does not “comport with the most elementary notions of justice and morality . . .,” it is not entitled to the usual deference. The court also rejected the SEC’s claim that the corporate penalty would send a strong signal to shareholders that unsatisfactory corporate conduct had occurred so they could better assess management as making “no sense.” In fact, the fine would be paid by the very shareholders who were defrauded.

The court went on to conclude that the settlement represented little more than a subterfuge cobbled together by the SEC and the Bank for their own interests: “Overall, indeed the parties’ submissions, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the S.E.C. with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry – all at the expense of the sole alleged victims, the shareholders. Even under the most deferential review, this proposed Consent Judgment cannot remotely be called fair.”

The Court went on to reject the SEC’s claim that its efforts to determine which individuals were responsible were stymied by privilege assertions. Rather, it appears that the SEC never “seriously pursued whether this [the privilege assertions] constituted a waiver of the privilege . . .” The Court also found inadequate the Bank’s explanations for the settlement with the payment of shareholder funds, concluding essentially that it failed to answer the questions posed by its orders.

The order concludes by returning to the theme that a cozy relationship between the SEC and the Bank generated a failed enforcement action noting: “The proposed Consent Judgment in this case suggests a rather cynical relationship between the parties: the S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense, not only of the shareholders, but of the truth.” To ensure that the truth comes out the Court is moving the case to trial.

To say that the Court’s order raises fundamental questions about the SEC and its Enforcement program is a gross understatement. This is particularly true here since the proposed deal in this case was approved by the current Commission in the wake of its repeated promises of a rejuvenated and renewed SEC enforcement program. While the SEC’s Inspector General is now investigating; the resolution of this matter should not wait. Bank of America calls for a swift and complete evaluation not just of the Enforcement Division and its program, but of the Commissioners who are the SEC, the predicate for their decision and the direction in which they are taking the agency. As Mr. Clinton’s comments make clear, it is essential that the SEC not take a rain check. We all need an effective SEC – now.