The legal battle between federal judge Jed S. Rakoff and the Securities and Exchange Commission escalated Tuesday, adding new tension to a struggle over how the government should police white-collar fraud in general and what it should do to hold Citigroup accountable in one of the biggest cases to emerge from the mortgage meltdown.

Rakoff last month challenged the SEC’s standard way of doing business when he rejected a settlement under which Citigroup would pay $285 million while neither admitting nor denying wrongdoing. The penalty amounted to “pocket change” for a company as large as Citigroup, the U.S. district judge in Manhattan ruled, and with no admission or denial of wrongdoing he said he was unable to determine whether the deal was appropriate. He told the two sides to prepare for trial.

The SEC argued that its enforcement efforts would be crippled if it had to hold out for admissions of wrongdoing and pursue cases all the way to verdicts instead of negotiating settlements.

On Tuesday, the SEC ratcheted up its counterattack with an “emergency” motion asking a higher court to put the Citigroup case on hold while the agency appeals Rakoff’s decision.

Acknowledging that its right to appeal at this stage might be subject to dispute, the SEC signaled that it was willing to take the extreme step of seeking a “writ of mandamus” — a special order overturning the judge on the grounds that he “clearly abused” his discretion.

Rakoff fired back Tuesday with an order saying that the SEC and Citigroup have no grounds to appeal. He said the harm the SEC claimed it would suffer if it had to prepare for trial was “largely illusory,” and he refused to put the case on hold.

By the end of the day, the U.S. Court of Appeals for the 2nd Circuit froze action until Jan. 17, when it said it will consider the SEC’s request to stay the case while the appeal is pending.

The developments underlined how much is at stake and how much impact a judge can have.

Last week, a federal judge in Wisconsin demanded more information from the SEC before approving settlements involving Koss Corp. and a Koss executive. Citing Rakoff’s November ruling in the Citigroup case, U.S. District Judge Rudolph T. Randa wanted to know why the Koss deals were “fair, reasonable, adequate, and in the public interest.”

Rakoff has criticized SEC settlements as contrivances that produce headlines but little else.

SEC officials have argued that Rakoff’s November decision would force the agency to devote much more time and money to each case and, therefore, pursue fewer cases, undermining efforts to combat financial fraud. The judge failed to give the SEC the deference it deserves, said the SEC, which has asked the higher court to expedite its appeal.

The clash comes as protesters are clamoring for Wall Street to be held accountable for the financial crisis.

Citigroup is accused of dumping assets tied to subprime mortgages on misinformed investors in 2007, when the housing market was deteriorating. Citigroup bet that the assets it was selling would lose value, according to the SEC complaint. The bet paid off for Citigroup, which reaped profits of about $160 million, and investors lost more than $700 million, the SEC said.

The SEC said the proposed settlement took into account “the litigation risk”— in other words, the possibility of losing at trial — and “the benefit of avoiding that risk.” The $285 million settlement also reflected the amount the SEC was likely to obtain if it won a trial, the agency said.

In a court filing Tuesday, the SEC said Rakoff had given Citigroup until Jan. 3 to answer the complaint or move for dismissal.

By forcing Citigroup’s hand, Rakoff could have won a symbolic victory. The requirement “threatens a central provision” of the proposed settlement, “namely that Citigroup would not deny the Commission’s allegations,” the SEC said in its Tuesday filing. As a result, the SEC said its position would be “irreparably harmed.”

The appeals court’s decision to freeze the trial court action averts that moment of truth, for now.