Citigroup Tries a Fast One on SEC

Citigroup and the SEC

Hallowed by history, but not by reason

Nov 29th 2011, 8:20 by T.E.| NEW YORK

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IT WOULD be hard to imagine a more thorough rebuke of how America’s Securities and Exchange Commission (SEC) tries to discipline financial firms. In a ruling issued on November 28^th, New York District Judge Jed Rakoff rejected a deal between Citigroup and the SEC settling charges over garbage mortgage securities. He called the settlement not just a betrayal of the public interest, but the product of an approach “hallowed by history but not by reason”. It allowed firms to settle allegations without ever acknowledging guilt. This not only failed investors, but—by obscuring the truth—society.
Otherwise, too, the opinion was scathing. Mr Rakoff faulted the SEC for prosecuting Citigroup for negligence when a fraud prosecution was warranted; for failing to provide the court with “any proven or admitted facts upon which to exercise even a modest degree of independent judgment”; for erroneously contending that “public interest…is not part of [the] applicable standard of judicial review”; and for wrongly arguing that “if the public interest must be taken into account, the SEC is the sole determiner”.
“The court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, nor in the public interest,” Mr Rakoff wrote.
Citigroup had agreed to pay a fine of $285m for having issued a mortgage bond that quickly exploded—but provided the bank with $160m in fees. Mr Rakoff called the settlement ludicrous when compared to investor losses of more than $700m. The penalty, he wrote, would likely be regarded by Citigroup as merely a cost of doing business and to “maintain a working relationship with a regulatory agency”.
It is hard to discern, wrote Mr Rakoff, “what the SEC is getting for this settlement other than a quick headline.” Victims of Citigroup’s actions, he added, had their legal prospects wacked multiple times. Above all, private litigation was made difficult by the lack of an admission of guilt. The only transgression mentioned was negligence, which cannot be the basis for a private claim.
Mr Rakoff also attacked a second condition of the settlement. Citigroup had agreed to operate under a court injunction if it ever violated the deal, which could lead to contempt charges. Whatever threat this carried, Mr Rackoff wrote, it was mitigated because Citigroup, as other financial firms, had been cited similarly over the past decade—and never faced any consequences. The threat of a court injunction should rest on “cold, hard, solid fact, established either by admissions or by trials.” Merely establishing the authority of the court without firm cause, “serves no lawful or moral purpose and is simply an engine of oppression.”
By not pushing to link the settlement with a possible crime, Mr Rakoff concluded, the transparency of the financial markets has been compromised. “The SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges,” he wrote.
In the absence of an agreement, Mr Rakoff ordered a trial to begin on July 16^th. Citigroup and the SEC have the option of striking a new deal or appealing to a higher court. Citigroup put out a brief statement saying it disagreed with the court’s ruling on the fairness of the settlement and noted its divergence from “long-established legal standards”. It added that it was prepared to present “substantial factual and legal defenses” in a trial.
The SEC also issued a statement, but it was far longer and much more testy. It claimed the settlement was in the public interest, fair and in line with decades of precedent. If there was a difference in tone, the reason was that the court’s decision had little to do with Citigroup—and everything with how the SEC understands its mission. Collectively, the statements read as the first step of an appeal—not only to a higher judicial court, but to public opinion.
 Schumpeter, Economist