During the housing market collapse, various companies took to finding inventive ways to profit off the decline. One of these companies was Citigroup Global Inc., whose subsidiaries include Citibank and Morgan Stanley. Without over-analyzing the convoluted and complicated world of financial shenanigans, Citigroup is essentially expected of stuffing portfolios with risky mortgage-related investments, selling said portfolios to investors, and then “betting” against them. On October 19, 2011 the Securities and Exchange Commission (SEC) filed a complaint against Citigroup, detailing their alleged infractions, and proposing a settlement of $285 million, which included a $95 million civil penalty. To put that number into perspective, Goldman Sachs recently paid a $535 million civil penalty for similar tactics. The ratification of this settlement was left up to Southern District of New York Judge Jed Rakoff.
Shortly after being handed the settlement, Judge Rakoff issued an order to prepare Citigroup and the SEC of his planned questions for a November 9th hearing. Rakoff’s order included nine questions in which nearly every aspect of the settlement is questioned. From the part of the agreement allowing Citigroup to walk away without acknowledging any wrongdoing, to wondering how this type of securities fraud could be a result of negligence, Rakoff left no stone unturned, and rightfully so. Especially in light of the fact that Citigroup’s 3rd Quarter profits were in excess of $3.8 billion (that’s right, billion), meaning the entire settlement isn’t even a tenth of their profits earned over the course of four months.
Recently, a few authors on the LexBlog Network have taken it upon themselves to discuss this case and Judge Rakoff’s pointed questioning of the SEC and Citigroup. We’ll kick things off with a few words from Steve Berk on his blog, The Corporate Observer, where he offers a spot-on sports analogy for the suggested settlement:
“The outrageousness of this plan can be illustrated with an analogy to our favorite sport, baseball. Consider Cardinals skipper Tony La Russa convincing thousands of fans to bet on his team in the World Series, not too difficult. Once he’s holding the cash, he benches sluggers Albert Pujols and Matt Holliday and sneaks to Vegas, placing millions on the Rangers. Got it so far? Here’s the rub. When Major League Baseball finds out, he’s fined a mere $75,000. It’s that blatant folks.
Banks like Citigroup have proven time and again that a slap on the wrist like this won’t change the trend towards greed and unimpeded profit-mongering above sound banking principles and just plain ethical conduct. The SEC’s recent settlement with Citigroup wouldn’t even brush back Alex Rodriguez, so it’s certainly not scaring the world’s fourth-biggest bank into compliance.”
Next up, William McGrath of Porter Wright has been following the proceedings of the settlement since the SEC first filed its complaint, and has two posts of merit on the firm’s Federal Securities Law Blog. The first provides an overview of the settlement, the rules allegedly violated by Citigroup, and a foreshadowing of Judge Rakoff’s response:
“The Commission filed its Complaint against Citigroup Global Markets on October 19, 2011 in federal court in New York, where it alleged that “[t]he marketing materials Citigroup prepared and distributed to investors did not disclose Citigroup’s role in selecting assets for [the CDO] and did not accurately disclose to investors Citigroup’s short position on those assets.” The Commission further alleged that the materials were misleading in that they “suggested that Citigroup was acting in the traditional role of an arranging bank,” instead of disclosing its actual role and short position. The SEC claimed that after the CDO defaulted within months, investors were saddled with losses, but Citigroup Global Markets made $160 million in fees and trading profits. The company was charged with violations of Sections 17(a)(2) and (3) of the Securities Act.
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In the Citigroup Global Markets case, while the parties have agreed to a settlement it has not yet been approved by the Court. The Commission has submitted a Memorandum in Support of the Proposed Settlement (which is not yet available on PACER). It is important to note that the case has been assigned to Judge Jed Rakoff, who, in recent years has rejected a proposed settlement submitted by the SEC (briefly described here) and rejected arguments by the Commission in another case (here).”
McGrath followed up with a discussion on Judge Rakoff’s order the day after it was issued, which addressed the specific questions Rakoff included, below are the first four:
“”Why should the Court impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?”
“Given the SEC’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the SEC’s charges are true? Is the interest even stronger when there is no parallel criminal case?”
“What was the total loss to the victims as a result of Citigroup’s actions? How was this determined? If, as the SEC’s submission states, the loss was “at least” $160 million … what was it at most?”
“How was the amount of the proposed judgment determined?” Judge Rakoff pointed out that the $95 million penalty portion of the settlement was considerably less than the $535 million penalty paid by Goldman Sachs in 2010 and questioned whether there would be “a meaningful deterrent effect.” He also asked which factors were used to assess the amount of the penalty (citing an earlier SEC statement regarding nine factors that are used).”
This attention this story is recieving is most definitely not confined to the LexBlog Network. DealBook (which, interestingly enough, is partially supported by Goldman Sachs) has been covering this story, and is not surprised by Rakoff’s stance, as you can see from this article by Peter Lattman:
““This is classic behavior for Judge Rakoff,” said Andrew Stoltman, a securities lawyer in Chicago. “He has been a thorn in the side for the S.E.C. for years, and I can promise you these questions” make the agency nervous. The judge is perhaps best known for scuttling a proposed $33 million settlement in September 2009 between the S.E.C. and Bank of America over the bank’s acquisition of Merrill Lynch. He called it a sweetheart deal that had been done “at the expense, not only of the shareholders, but also of the truth.” The judge later approved a $150 million deal.
Judge Rakoff has also expressed aversion to the agency’s custom of settling cases without forcing the defendant to admit wrongdoing. In an opinion earlier this year, he threatened to reject the next S.E.C. settlement that included the “neither confirming nor denying wrongdoing” language. In Wednesday’s order, Judge Rakoff reiterated his displeasure with the boilerplate wording.“Given the S.E.C.’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.’s charges are true?” the judge asked.”
Bringing it full circle is Kevin LaCroix, the author of The D&O Diary. In his post, Kevin touches on why the SEC routinely allows companies to avoid admitting fault, and why it may be for the best:
“There will be those who believe that it is about time that somebody started asking these kinds of questions. But at the same time, it is worth noting that if companies must admit to wrongdoing in order to settle SEC enforcement actions, or if senior executives’ complicity must be alleged or even established in order for a settlement to be approved, it will be far more difficult for SEC enforcement actions to be resolved. Indeed, one clear implication if more courts start asking these kinds of questions about proposed SEC enforcement action settlements is that fewer cases will settle and more will have to go to trial. Even if more trials would advance the truth-telling function of SEC enforcement, it would also add enormous costs both for the SEC and for the corporate defendants. Whether the SEC could sustain the same level of enforcement activity if it had to absorb the added burdens and expense involved with more trials is one question. The added burden and expense for the corporate defendants presents other questions.
With the settlement still in limbo and a judge known for his previous rejections of such agreements, it’s unlikely that we’ve heard the last of this. How will Citigroup respond? How will the SEC frame it’s answers to Rakoff’s order? At the very least, the hearing scheduled for November 9, 2011 should prove interesting.
