An appeals court on Wednesday voided a controversial decision in 2011 by New York Judge Jed S. Rakoff, saying he erred in scuttling a $325 million settlement between the Securities and Exchange Commission and Citigroup.

The Second Circuit Court of Appeals sent the high-profile case back to the lower court, arguing that it had "abused its discretion" by claiming the settlement was not reasonable, fair or "in the public interest."

The high-profile case, which was appealed by both parties, involves allegations that Citi defrauded investors in structuring a $1 billion fund of subprime securities tied to the faltering U.S. housing market.

Rakoff, a U.S. District Court Judge for the Southern District of New York who is often referred to as "Judge Dread," had refused to approve of the settlement agreement in part because Citi had neither denied nor admitted wrongdoing.

Citi told investors that the portfolio was chosen by an independent advisor. But the SEC found Citi itself had selected $500 million of the fund's assets in which the bank had also taken a short position. Citi realized profits of roughly $160 million from the poor performance of its chosen assets while fund investors suffered millions of dollars in losses.

A three-judge panel of the appeals court found that Rakoff based his ruling on "an erroneous view of the law," and had failed to give proper deference to the SEC.

"It is an abuse of discretion to require, as the district court did here, that the SEC establish the "truth" of allegations against a settling party as a condition for approving the consent decrees," the court found. It did, however, state that the district court may ask both the SEC and Citi to provide additional information to allay concerns of "improper collusion" between the two parties.

A Citi spokesperson declined to comment.

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