The cautious federal bureaucracy responsible for policing Wall Street faces several options as it tries to salvage a high-profile case against Citigroup, and all of them amount to high-stakes gambles.
A federal judge put the Securities and Exchange Commission on the spot Monday by rejecting the $285 million settlement the agency had proposed to resolve charges that Citigroup misled investors about an investment product tied to subprime mortgages.
The judge complained that the $285 million was mere pocket change for a firm of Citigroup’s size, and he protested that the deal would leave the truth of the government’s allegations in question by allowing the bank to neither admit nor deny wrongdoing.
The ruling by U.S. District Judge Jed S. Rakoff threatens more than just the SEC’s case against Citigroup. It challenges the SEC’s decades-old practice of settling most of its cases instead of taking them to trial.
If defendants were forced to admit wrongdoing, many would refuse to settle because the admissions could be used against them in private lawsuits or other law enforcement actions, lawyers say.
Rakoff challenged the SEC to put up and prove its case.
The agency could take Citigroup to trial. That would risk a potentially embarrassing defeat that would expose the SEC to criticism that it was incompetent or overreaching.
In a legal brief, Citigroup telegraphed that it has defenses — “a number of substantial factual and legal issues that would need to be litigated in the absence of a settlement.”
The SEC essentially accused Citigroup of making $160 million by unloading deteriorating assets on unsuspecting buyers. One of the SEC’s main allegations is that Citigroup failed to adequately inform investors that even as it was selling them the investment, it was betting that the investment would decline in value.
Whether investors were given sufficient information would be a point of contention.
Citigroup says its marketing materials included this disclosure: The firm “may be expected to have interests that are adverse to those of the Noteholders.”
If the SEC won the trial, Rakoff’s ruling would stand unchallenged, threatening future settlements and leaving the state of the law unclear. From his bench in Manhattan, Rakoff presides over many Wall Street cases.
The agency could try to renegotiate its deal with Citigroup. In a previous case involving Bank of America, Rakoff rejected the $33 million settlement the SEC initially proposed but later accepted a revised $150 million deal, even though he said it was deeply flawed.
Whether or not it was intended as a hint, a footnote in Rakoff’s ruling Monday highlighted what could be part of a winning settlement. The judge said the Citigroup pact compared unfavorably to the deal Goldman Sachs struck in a similar case. Unlike Citigroup, Goldman made what Rakoff called an “express admission” — “Goldman acknowledges that the marketing materials for the . . . transaction contained incomplete information.”
Rakoff’s ruling Monday focused largely on the SEC’s request that he enter an injunction against Citigroup; it isn’t clear what would happen if the two sides dropped that piece of the settlement.
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