SEC Inspector General Probes Khuzami's Role in Citi Settlement

The U.S. Securities and Exchange Commission’s internal watchdog is reviewing an allegation that Robert Khuzami, the agency’s top enforcement official, gave preferential treatment to Citigroup Inc. executives in the agency’s $75 million settlement with the firm in July.

Inspector General H. David Kotz opened the probe after a request from U.S. Senator Charles Grassley, an Iowa Republican, who forwarded an unsigned letter making the allegation. Khuzami told his staff to soften claims against two executives after conferring with a lawyer representing the bank, according to the letter. Jon Diat, a Citigroup spokesman, declined to comment.

Citigroup agreed in July to pay $75 million to resolve SEC claims that the bank understated investments linked to subprime mortgages as the housing crisis unfolded. Gary Crittenden, who stepped down as chief financial officer in 2009, and Arthur Tildesley, the New York-based bank’s former head of investor relations, agreed to pay $100,000 and $80,000, respectively, to resolve related claims. The two men settled without admitting or denying the SEC’s allegations.

“The settlement appropriately held the company and individuals accountable,” John Nester, an SEC spokesman, said yesterday in a statement issued after Khuzami was asked to comment. “It was the product of a thorough investigation and a careful evaluation of the evidence and the applicable law. We stand ready to assist and cooperate with the IG’s review.”

The agency’s settlement was questioned in August by U.S. District Judge Ellen Huvelle, who eventually approved it. She asked SEC lawyers why the agency hadn’t pursued executives more aggressively. “There has been nothing here that is being done to assure anyone that senior management who’s responsible, whatever level of culpability you’re talking about, is going to have any pain here,” Huvelle said.

Fraud Claims

According to the letter, the SEC’s staff was prepared to file fraud claims against both individuals. Khuzami ordered his staff to drop the claims after holding a “secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend” of his and “who was counsel for the company, not the individuals affected,” according to a copy of the letter reviewed by Bloomberg News.

Citigroup’s lawyers in the matter, Lawrence Pedowitz, a partner at Wachtell Lipton Rosen & Katz, and Brad Karp, chairman of Paul Weiss Rifkin Wharton & Garrison, didn’t return calls seeking comment. John Carroll, a partner at Skadden Arps Slate Meagher & Flom who represented Crittenden, declined to comment. Mark Stein, a partner at Simpson Thacher & Bartlett who represented Tildesley, didn’t return a call for comment.

Prince and Rubin

The SEC told Huvelle it only pursued claims against Crittenden and Tildesley because “no other individuals were tied to the misleading disclosures more closely” than they were. The agency also said in a filing that former Chief Executive Officer Charles O. “Chuck” Prince and former chairman Robert Rubin were among executives who knew 2007 losses were mounting on mortgage assets that Citigroup was faulted for not disclosing.

Citigroup executives repeatedly stated in 2007 that the bank had reduced exposure to subprime mortgage securities by 45 percent to $13 billion, as investors and analysts clamored for information about the deteriorating market, SEC attorneys said in court filings.

On an Oct. 15, 2007, conference call with analysts and investors, Crittenden said Citigroup’s “subprime exposure” was $13 billion at the end of second quarter and had declined during the third quarter.

The figure he cited omitted “super-senior” tranches of collateralized debt obligations and financial guarantees known as liquidity puts that allowed customers to sell debt securities back to Citigroup if credit markets froze, the SEC said. Those products added more than $40 billion of subprime risk that the bank didn’t disclose to investors, the SEC said.

To contact the reporter on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.

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