Global Policy Forum

Judge Blocks Citigroup Settlement with S.E.C.

On Monday November 18, New York federal judge Rakoff threw out a settlement of a mortgage derivatives case between the US Securities and Exchange Commission (SEC) and banking giant Citigroup because it “did not satisfy the law.” According to Rakoff, the SEC’s longstanding practice of offering defendants a deal that allows them to settle without admitting to any wrongdoing, forces the courts to rule without the necessary facts despite an “overriding public interest in knowing the truth.” The judge also halted the SEC’s familiar claim that settlements are prudent, noting that “recidivist” Citigroup had settled five times before. Citi would now merely have to pay $285 million, despite misleading investors in the amount of $700 million and receiving two multi-billion dollar public bailouts to remain afloat. By dismissing the settlement, the judge forcefully breaks with the tradition of perfunctorily “rubber stamping” deals made between the SEC and Wall Street.

By Edward Wyatt

November 28, 2011

A federal judge in New York on Monday threw out a settlement between the Securities and Exchange Commission and Citigroup over a 2007 mortgage derivatives deal, saying that the S.E.C.’s policy of settling cases by allowing a company to neither admit nor deny the agency’s allegations did not satisfy the law.

The judge, Jed S. Rakoff of United States District Court in Manhattan, ruled that the S.E.C.’s $285 million settlement, announced last month, is “neither fair, nor reasonable, nor adequate, nor in the public interest” because it does not provide the court with evidence on which to judge the settlement.

The ruling could throw the S.E.C.’s enforcement efforts into chaos, because a majority of the fraud cases and other actions that the agency brings against Wall Street firms are settled out of court, most often with a condition that the defendant does not admit that it violated the law while also promising not to deny it.

That condition gives a company or individual an advantage in subsequent civil litigation for damages, because cases in which no facts are established cannot be used in evidence in other cases, like shareholder lawsuits seeking recovery of losses or damages.

The S.E.C.’s policy — “hallowed by history, but not by reason,” Judge Rakoff wrote — creates substantial potential for abuse, the judge said, because “it asks the court to employ its power and assert its authority when it does not know the facts.”

Judge Rakoff also refers at one point to Citigroup as “a recidivist,” or repeat offender, which has violated the antifraud provisions of the nation’s securities laws many times. The company knew that the S.E.C.’s proposed judgment – that it cease and desist from violating the antifraud laws – had not been enforced in at least 10 years, the judge wrote. 

The S.E.C. did not respond immediately to a request for comment on the judge’s decision, which was released Monday morning. A Citigroup spokesman said the company was studying the decision and had no immediate comment.

Citigroup was charged with negligence in its selling to customers a billion-dollar mortgage securities fund, known as Class V Funding III. The S.E.C. alleged that Citigroup picked the securities to be included in the fund without telling investors, claiming that the securities were being chosen by an independent entity. Citigroup then bet against the investments because it believed that they would lose value, the S.E.C. said.

Investors lost $700 million in the fund, according to the S.E.C., while Citigroup gained about $160 million in profits.

The settlement established none of those allegations as fact, thereby making it impossible for the court to properly judge whether the settlement meets the required standard of being fair, adequate and in the public interest.

“An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous,” Judge Rakoff wrote in the case, S.E.C. v. Citigroup Global Markets. “In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth.”

The S.E.C. in particular, he added, “has a duty, inherent in its statutory mission, to see that the truth emerges.”

Click here to see the ruling.


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