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Are Settlements Sacrosanct?

By Jed S. Rakoff

When should a judge turn down a settlement that is presented for approval? Some would say never. After all, doesn’t the judge have better things to do than muck up an agreement that the parties have labored to reach?

As with so much in the law, the answer is, “it depends.” Even in the case of a purely monetary settlement between private parties, where there is no request for court involvement, a court is required to scrutinize the settlement if it involves an infant or incompetent, and may get involved if the settlement smacks of collusion. The reason for the court’s involvement in such cases is the risk that the façade of a legally binding settlement will conceal over-reaching by one or more parties or will compromise rights of third parties.

One might go further and argue that, where parties invoke the power of the court to enforce a settlement, the court is obligated to ensure it passes minimal fairness standards. My own experience, however, is that unsolicited court involvement is as likely to cause mischief as promote fairness. For example, while judges may be useful in promoting settlements in suits that are the product of emotion rather than rational disagreement, it may be suggested that judges are sometimes too quick to push settlement when they have little understanding of the basic facts at issue. Too often, the judge’s motivation for pressing settlement is to ease an overcrowded docket; but the effect of heavy-handed judicial pressure may be to coerce a settlement that does not reflect the merits of the case. In such circumstances, it is the unequal bargaining power of the court, rather than the parties, that leads to unfairness.

Prudence therefore suggests judicial restraint in pushing private parties to settle, for they and their lawyers are often in a much better position than the court to make the cost-benefit analysis that underlies any agreement. My own suggestion is to push forward, instead, with the case itself: There is nothing that promotes settlement like the imminence of trial.

At the other end of the spectrum from purely private settlements between parties fully represented are those settlements a court is required by law to assess for their fairness, reasonableness, and adequacy. Typically, these involve situations where the settlement affects the rights of absentees. A common example is a class action. Pursuant to Rule 23(e) of the Federal Rules of Civil Procedure, a federal class action may be settled “only with the court’s approval,” which may be given only when, following notice to all class members and a full hearing, the court determines that the settlement “is fair, reasonable, and adequate.” These requirements, both procedural and substantive, are prompted by a recognition that, without such safeguards, there is a genuine danger that the absentee members of the class will not be accorded due process. Congress has recognized that these cases tend to be “lawyer-driven,” and for that reason, the court also has a significant role in the appointment of class counsel and the determination of counsel’s fees.    

In reality, however, courts find themselves handicapped in undertaking the considerable scrutiny mandated by these rules, chiefly because the adversarial system does not operate in this context. Once the parties have settled, they have no incentive to apprise the court of how the settlement might be unfair, unreasonable, or inadequate. Defendants’ counsel, for example, having agreed to pay a fixed total of dollars in settlement, could not care less how the sum is divided between class members and class counsel; and, indeed, the settlement agreement often contains an express term that defendants will not object to the plaintiffs’ lawyers’ fee application. While absentee class members are given the opportunity to appear and make objections, they rarely have a sufficient individual stake to warrant such an appearance, let alone to hire counsel to make their objections legally forceful.

Court as Inquiring Magistrate
The result is that, if the court is really to make the kind of factual inquiry necessary to make the findings required by Rule 23(e), it will have to play the role of inquiring magistrate that is far removed from what Chief Justice Roberts has described as the American model of the “umpire” judge calling “balls and strikes” between contending parties. Few judges are ready to undertake this unfamiliar, sometimes unpleasant, and always time-consuming role except in exceptional circumstances.

Some have appointing special masters, or even court-appointed experts, to aid judges in such evaluations. But, quite aside from the added costs and delays that this would engender, special masters and court-appointed experts have their own biases, often shaped by their “day jobs” as private practitioners, law professors, and the like. While no one is without biases, federal district judges are about as free of external influences as possible, and it is that comparative objectivity that should be exercised in evaluating a class action settlement. But, of course, such objectivity cannot be exercised unless the judge has immersed herself in the underlying facts. There is just no substitute for hard work in such cases—and for judges handling overloaded dockets, that is frequently the rub.

In fairness, however, able counsel in large class actions will often supply to the court, both at the time of the pre-notice “preliminary hearing” on approval of the settlement and again at the time of the ultimate “fairness hearing” on such approval, substantial written submissions detailing the bases on which the parties ask the court to find that the settlement is fair, adequate, and reasonable. This is in stark contrast to the typical submissions from the parties in the third kind of situation to which we now turn: administrative settlements.

Administrative Settlements
When a federal administrative agency reaches a settlement of an action brought by the agency in federal court—as opposed to an internal administrative action, which is subject to judicial review (under the Administrative Procedure Act) only if a party seeks review—the agency typically requests injunctive relief to prevent recurrence of the defendant’s alleged misconduct. This invocation of the court’s injunctive and contempt powers requires the court to make a determination that such relief, and more generally the settlement as a whole, is fair, reasonable, adequate, and, according to some authorities, “in the public interest.”

Indeed, in the case of an antitrust settlement, the terms of the Tunney Act expressly require the court to make the determination that the settlement is in the public interest. Although there is no similar statute in the case of settlements with the Securities and Exchange Commission (SEC), the SEC has itself repeatedly acknowledged to the courts that it is required to make such a showing.

In making such fairness findings, a court is expected to give substantial weight to the views of the government agency that has approved the settlement, although the days of blind deference to administrative agencies are long past—at least in theory. But, as in the case of class actions, actual practice is something else. So confident are some administrative agencies in the automatic approval of their proposed settlements that they rarely undertake to make any showing why the settlement is fair, reasonable, or adequate; rather, they simply submit to the court, without any accompanying explanation whatsoever, the proposed consent judgment settling the case and ordering injunctive relief. Such agency confidence is, again, the result of the failure of the adversary system to operate in the context of such settlements. Based on past practice, the agency assumes that, if no party is objecting, a court will not undertake the arduous and unfamiliar task of determining whether the settlement is fair, reasonable, adequate, and in the public interest, when there are a hundred other cases crying for immediate attention. Rather, the agency assumes that the court will be content to rely on the agency’s own determination that the settlement met these standards, without even requiring a word of explanation.

Bare-Bones Consent Judgments
This, for example, is the situation that I confronted when, in late August 2009, the SEC submitted to me a bare-bones complaint alleging that Bank of America had defrauded its shareholders in connection with its multi-billion-dollar acquisition of Merrill Lynch, together with an equally bare-bones consent judgment stating that the bank, without admitting or denying the allegations, had agreed to pay the SEC $33 million to settle the case. Not one word was offered as to why this settlement was fair, reasonable, adequate, or in the public interest; but so confident was the SEC that it publicly announced that same day that it had settled with the bank “subject to court approval,” which it clearly expected would be automatic.

I confess that I had signed off on such bare-bone settlements before. But I gagged on this one. In violation of what I later learned was the SEC’s own written policy, the commission was allowing the bank’s management to use shareholder money to buy their way out of what the SEC alleged was their fraud on those same shareholders. The clear implication was that the parties had cut a cynical deal, whereby the SEC got to proclaim publicly that it had taken action in a high-visibility situation, while the bank got to claim it had cheaply bought peace. For these and at least a half-dozen other reasons detailed in my opinion rejecting the settlement, I found it neither fair, nor reasonable, nor adequate, nor in the public interest.

Perhaps what bothered me most, is that, in a situation that had occasioned considerable public scrutiny, the bare-bones documents guaranteed the truth would never be known. And when, months later, after very substantial discovery, I finally, albeit reluctantly, approved a substantially different settlement submitted by the parties, it was contingent on their having provided me, and the public, with a 50-page statement of what the underlying facts were.

There is great danger in not undertaking the required meaningful inquiry of administrative settlements. The effect is to cede one of the judiciary’s most precious powers—its power of contempt—to an arm of the executive. More generally, the effect is to free from even the most modest scrutiny the sometimes too-cozy relationship between administrators and those they supervise, and to deprive the public of any judicial oversight, however modest, of the regulatory state. Such supine deference may give fodder to a Kafka novel, but it does not inure to the benefit of a free people.

Keywords: Rule 23(e), administrative settlement, SEC, bare-bone settlement

Jed Rakoff is a U.S. district judge for the Southern District of New York. In 2010, he presided over and rejected the first settlement reached between the Securities and Exchange Commission and Bank of America.

This article was adapted from a longer one that was published in the Summer 2011 issue of Litigation.


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