Is a financial giant being called to account — rather than slipping any real punishment — or is federal Judge Jed Rakoff simply putting his foot down amid public disillusionment and disgust over banking misdeeds?

The Securities and Exchange Commission, Judge Rakoff said Monday, must do more than just ink a $285 million deal with Citigroup (C) to settle accusations that the bank misled investors into buying subprime loan packages.

Predictably, both sides are complaining that failing to okay the long-standing practice of allowing financial institutions to settle without admitting or denying wrongdoing would create havoc. Some argue the government would be embroiled in a costly trial, pitted against battalions of corporate lawyers, and could lose the entire battle — and the nearly $300 million settlement.

Financial entities are “not going to admit to wrongdoing because then they would have no defense against other suits, and be opened up to massive liability,” contends Donald Langevoort, a securities law expert at Georgetown University Law School.

“Settling is a tradeoff,” agrees Hillary Sale, a professor at Washington University’s School of Law in St. Louis, “but if there is actual wrongdoing and individuals are held accountable, that would be preferable to today’s shareholders having to bail out companies for past misdeeds.”

“This is Judge Rakoff’s attempt to hold the SEC’s feet to the fire,” she says. adding that “he is looking for individual accountability.”

The judge who slapped Citi

Sale, who is writing a law review article on judges as legal gatekeepers, argues that judges are not paying enough attention to “defense collusion, where lawyers for individuals are working with company counsel to put the blame elsewhere.”

When “a settlement is this big, you have to wonder why,” she adds. By rejecting it, “the judge is saying, ‘Make it [the settlement] bigger or make it personal.”

For decades, financial wrongdoers have been able to skip public accountability for any illegal deeds, and slide out from under consequences by paying out a sometimes substantial sum and moving along to the next deal. Major financial players like Goldman Sachs, Morgan Stanley, and Bank of America have routinely pledged not to violate securities laws but have been accused of breaking their promises.

The rise of no-wrongdoing settlements between the banks and the SEC are a by-product of the rise of private civil lawsuits against big companies, says Jill Fisch, a law professor at University of Pennsylvania Law School. “If a company admits anything, it can be used against it in a civil case.”

Starting in the 1970s, legal historians say class-action lawsuits, with their big-dollar verdicts, malpractice, and other cases made companies more sensitive to their legal vulnerabilities. But no-wrongdoing-admitted settlements likely date back even further than that, experts say.

When called on the legal mat, companies have argued successfully that “this was an isolated incidence, and we shouldn’t penalize the whole firm,” notes Fisch.

Some 90% of all cases are settled, and trials are rare, notes Langevoort. “The SEC does an informal cost analysis,” he says, adding that pre-trial costs alone could exceed the settlement amount.

Allan Horwich, who teaches securities law and regulation at Northwestern School of Law, agrees that “we should defer to the SEC whether to litigate or fight for more.” But, he says, the regulator has failed to take repeat corporate wrongdoers to task for their lapses.

SEC-Citi settlement rejection: Public interest wake-up call

Settlements have been rolled into the cost of doing business, says University of Pennsylvania’s Jill Fisch, and “bad boy” provisions that exempt financial entities from penalties for the same actions wind up encouraging serial offenders. For example, a 2006 SEC settlement with J.P. Morgan Chase (JPM) over municipal bond securities did not disqualify it from engaging in such business, she notes.

Even so, the regulator’s staff “is limited by political concerns in a way that it wasn’t 10 or 15 years ago,” she says, adding that currently there is “a lack of political will” to pursue contempt charges.

“So, should we change our standards, and trade off resources … for transparency?”

Judge Rakoff gave a nod to transparency when he said Monday that he could not decide whether the settlement was “fair, reasonable, adequate and in the public interest,” because there was no evidence presented that Citigroup committed fraud.

Unlike a similar mortgage case against Goldman Sachs (GS) that was settled last year, where the SEC extracted an admission that Goldman’s marketing materials were incomplete, the settlement with Citigroup contained no admission of any wrongdoing.

If judges raise the bar for approving settlements, Horwich says the SEC could start to rely on authority granted in the recent financial system overhaul bill passed by Congress, which expanded the agency’s power to pursue securities fraud through administrative fines.

“The agency would not be able to recover amounts as large as the Citigroup settlement,” he adds, since the maximum penalty per charge is $500,000 under the new law, and it would not apply to Citigroup since its actions predated the new law.

“But if they get pushback, they could decide to pursue these cases administratively and not have to get judicial approval,” he notes.

Even so, the entire burden of fighting for the investor should not rest only on the SEC, notes Paul Hodgson, a spokesman for GMI, a corporate governance research group. “Institutional investors who lost so much money should be suing to find out what happened. But, so far, no one has, even though every bank so far has been let off. They pay massively in order to bury the evidence.

Rakoff’s ruling, he says, shows that he “wants to see the evidence, and there are acres of it. If it comes to light, and wrongdoing surfaces, people will be held to account” – something has yet to take place, to public consternation, in the three-year aftermath of the 2008 meltdown..

“The CEOs who swore to Congress that nothing happened would be in a lot of trouble,” he says.