Judge questions SEC settlement with Citigroup over possible fraud

October 27, 2011

A federal judge is trying to determine whether the Securities and Exchange Commission is letting Citigroup off the hook too easily for allegedly misleading investors about a $1 billion investment it sold in 2007 tied to the collapsing housing market.

Judge Jed S. Rakoff issued an order Thursday calling for the SEC and Citigroup to defend the settlement they recently negotiated, and he posed a series of questions. Among them:

●“How can a securities fraud of this nature and magnitude be the result simply of negligence?”

●“What reason is there to believe this proposed penalty will have a meaningful deterrent effect?”

●“What was the total loss to the victims as a result of Citigroup’s actions?”

●And, if the SEC was generally unable to identify the people culpable for the fraud, “why was this?”

The SEC’s complaint against Citigroup Global Markets, a wholly owned subsidiary of the bank, says the firm reaped at least $160 million in profits from a complex investment known as a collateralized debt obligation while investors lost “several hundred million dollars.”

The firm failed to disclose it was using the CDO to bet against investors, the SEC alleged.

Under the proposed settlement, the Citigroup unit was charged with negligence-based fraud rather than reckless or intentional fraud. Without admitting wrongdoing, it agreed to pay $285 million. One former employee was also charged and is fighting the SEC action.

The fine pales in comparison with the $3.8 billion profit that Citigroup reported for the third quarter of this year.

The same questions have surrounded other SEC enforcement actions. In a similar case filed in June, the SEC charged J.P. Morgan Securities with fraud and negotiated a $153.6 million settlement, but no executive or employee of the firm was charged.

Rakoff has repeatedly accused the SEC of negotiating weak settlements. He forced it to renegotiate what was originally a $33 million settlement with Bank of America. The fine was too small, and the penalty was shouldered by shareholders instead of the individuals responsible, he said.

Rakoff accepted a revised version of that deal, citing an obligation to defer to the SEC. But he denounced the final $150 million Bank of America settlement as “inadequate” and “half-baked justice at best.”

In a March opinion involving a semiconductor firm, Rakoff ridiculed the SEC’s standard practice of letting defendants settle without admitting or denying that they did anything wrong.

“The result is a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C.,” he wrote. “Only one thing is left certain: the public will never know whether the S.E.C.’s charges are true, at least not in a way that they can take as established by these proceedings.”

Rakoff raised the same issue Thursday in the Citigroup case.

“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?” he wrote.

The judge scheduled a Nov. 9 court hearing on the Citigroup matter.

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