Why Populist Hero Judge Rakoff Could Help Wall Street Win

Judge Jeb Rakoff has become a hero for standing up to Wall Street and its regulators at the SEC. But his good intentions could end up backfiring, to the benefit of the banks.



In the age of Occupy Wall Street, U.S. District Judge Jed Rakoff has the makings of a perfect hero. From his perch in Manhattan's federal courthouse, he has emerged as one of the financial industry's chief antagonists. He's a furiously articulate critic of the banks. But he's even more unsparing with their regulators at Securities and Exchange Commission, whom he has accused, in so many words, of being utter failures.

Unfortunately, heroes aren't always great policymakers. And that's the problem with Rakoff's latest headline grabbing decision.

This week, Rakoff rejected a $285-million dollar settlement between the SEC and Citigroup over allegations that the bank had misled clients into buying a mortgage-related security that its own traders were betting against. In doing so, the judge challenged the commission's 40-year-old practice of letting companies enter into settlements without admitting or denying the accusations against them, which helps the banks avoid private lawsuits form investors down the road. According to Rakoff, Citigroup was getting a sweetheart deal. The SEC was getting a quick headline, and the public was getting screwed out of learning the facts.

"In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers," he wrote. "But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances."

If Howard Beal were a judge, this is what he'd sound like. This decision was a big, cathartic swipe at a whole system that many have come to regard as corrupt. And progressives have celebrated it. Rolling Stone writer Matt Taibbi called the opinion "an incredible judicial buttkicking" during an interview with Keith Olberman.

But just because something feels good doesn't make it good for you. Already, some are wondering whether Rakoff's stand will inspire other judges to follow suit. If they do, the results will be tragic, because Wall Street might end up even more immune to punishment than it is today.


As Rakoff's opinion points out, defendants enter into deals with the SEC largely because they know their aggrieved investors will have a hard time suing them later on. If the bank never admits to any of the underlying facts in a settlement, a plaintiffs' lawyer can't use them later on as evidence in another case. That protects the banks from a lot of financial liability. If you take away that protection, as Reuters wrote, banks are more likely to fight a case all the way to trial. In a perfect world, that wouldn't be a problem. The SEC would just get ready for a knock-down, drag-out fight.

But we don't live in a perfect world. We live in a world where the SEC is horribly under-funded and often legally outgunned by the banks they're supposed to regulate. The commission's total budget in 2011 was $1.185 billion. That's how much revenue a single large Wall Street law firm earns during a year. Just one firm. With that budget, the SEC is charged with overseeing 35,000 public companies

Because it can't afford competitive salaries compared to private firms, the SEC suffers from enormous turnover among its attorneys. Staffers leave, taking years of know-how and experience with them. The most experienced ones usually end up leaving to represent the banks their old colleagues are tasked with monitoring.

But keeping talent is just one problem among many. The SEC's budget woes also make it hard to fund the basic ingredients that go into putting together a big securities enforcement case--elements like sophisticated data analysis and travel to take depositions. As The New York Times pointed out, there are already concerns that the commission may be avoiding certain kinds of suits because of cost.

So if the SEC has to go to court to prove its case every time, there's a good chance you'll simply see fewer cases overall. We'd have even more lax enforcement than we do now.

It's a bit of a paradox in the end. As Stanley Sporkin, a former federal judge and head of the SEC's enforcement division, put it to me, both Rakoff and the SEC are right. The judge can't sign a settlement he doesn't believe is in the public interest. But the commission also needs the ability to pursue cases in a way that fits within its budget.

Of course, all of this could be fixed. Congress could double the SEC's budget with half of what it spends each week in Afghanistan, alone. But don't hold your breath. Not as long as anti-spending, anti-regulation Republicans control one third of the government. For the foreseeable future, we're stuck with what we have.

Rakoff might be a hero. But maybe we should hope he doesn't inspire any more.