The Securities and Exchange Commission’s policy of letting financial institutions settle enforcement actions without admitting liability was challenged by a judge who rejected its $285 million Citigroup Inc. (C) accord.
U.S. District Judge Jed Rakoff in Manhattan rejected the settlement in a decision yesterday, citing the public interest in learning the truth about SEC allegations that the bank defrauded investors in a $1 billion collateralized debt obligation linked to bad residential mortgages.
“It’s a frontal assault on the ‘neither admit nor deny’ approach,” said J. Robert Brown Jr., who teaches corporate governance at the University of Denver Sturm College of Law. “This puts the SEC in a very difficult spot.”
Rakoff said the Citigroup settlement, in which the bank agreed last month to resolve SEC claims that it misled investors in a fund called “Class V Funding III” gave him no basis to decide whether it was fair.
“The court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment,” Rakoff said in yesterday’s opinion.
The decision is the latest by Rakoff criticizing the SEC’s practice of allowing financial institutions to settle enforcement actions without admitting or denying the agency’s allegations. In 2009, Rakoff, a former federal prosecutor and civil litigator, rejected a $33 million agreement between the SEC and Bank of America Corp. (BAC)
The SEC and Citigroup may try to reach a revised settlement to address Rakoff’s objections and avoid a trial, which he scheduled for July 16. Any admissions by Citigroup in a revised settlement might be used by investors suing the bank to recover their losses.
“While we respect the court’s ruling, we believe that the proposed $285 million settlement was fair, adequate, reasonable, in the public interest, and reasonably reflects the scope of relief that would be obtained after a successful trial,” Robert Khuzami, director of the SEC’s Division of Enforcement, said yesterday in a statement. Khuzami didn’t say what action the agency would take in response to Rakoff’s decision.
Danielle Romero-Apsilos, a spokeswoman for New York-based Citigroup, said the bank disagreed with Rakoff’s ruling.
“The proposed settlement is a fair and reasonable resolution to the SEC’s allegation of negligence,” she said yesterday in an e-mailed statement. “The settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges.”
In his ruling, Rakoff consolidated the Citigroup case with an SEC lawsuit against former Citigroup employee Brian Stoker. Stoker, a former director in Citigroup’s CDO structuring group, was responsible for structuring and marketing the investment, according to an SEC complaint filed last month. Brook Dooley, a lawyer for Stoker, didn’t immediately return a voice-mail message yesterday seeking comment on the SEC allegations.
Rakoff noted that, in its complaint against Stoker, the SEC claimed Citigroup knowingly withheld information from investors that it intended the fund to include poorly rated assets, an allegation missing from the agency’s complaint against the bank.
He has criticized federal sentencing guidelines, ordering expert-network consultant Winifred Jiau in September to serve four years in prison for her insider-trading conviction and not at least 6 1/2 years, as recommended by the guidelines.
Also in September, Rakoff dismissed most of a billion- dollar claim by the trustee liquidating Bernard Madoff’s former firm against the owners of the New York Mets. In a separate case he directed the trustee, New York lawyer Irving Picard, to explain why investors who withdrew money from their Madoff accounts in good faith shouldn’t be allowed to keep it, challenging a position supported by the SEC, the Securities Investor Protection Corp. and the bankruptcy judge in the Madoff case.
This month, Rakoff imposed a record $92.8 million penalty against Raj Rajaratnam in the SEC’s insider trading suit against the Galleon Group LLC co-founder.
Rakoff is also presiding over the criminal prosecution of former Goldman Sachs Group Inc. (GS) Director Rajat Gupta on insider- trading charges and a related SEC civil case. He has been considering whether the parties in the SEC case may take witness depositions before completion of the criminal case, set for trial on April 9.
Rakoff has been a frequent critic of SEC settlements in which the defendant “neither admits nor denies” the allegations.
At a hearing this month, Rakoff asked if the public interest doesn’t require determining whether Citigroup did what the SEC claims.
Matthew Martens, the SEC’s chief litigation counsel, told Rakoff that the agency adopted its policy of allowing settlements without admission or denial of liability in 1972 to avoid having defendants claim publicly they hadn’t done anything wrong after agreeing to settle.
In its complaint against Citigroup, the SEC said the bank misled investors in a $1 billion fund that included assets the bank had projected would lose money. At the same time it was selling the fund to investors, Citigroup took a short position in many of the underlying assets to benefit if they fell in value, according to the agency. The settlement was an attempt to resolve a four-year SEC investigation.
‘Very Good Deal’
“If the allegations of the complaint are true, this is a very good deal for Citigroup,” Rakoff wrote in yesterday’s ruling. “Even if they are untrue, it is a mild and modest cost of doing business.”
Rakoff, after rejecting Charlotte, North Carolina-based Bank of America’s settlement with the SEC over claims it misled investors about bonuses at Merrill Lynch & Co., approved a revised settlement in February 2010. In the revised settlement, Bank of America agreed to pay $150 million to resolve broader allegations about misstatements to investors, including those about bonuses at Merrill Lynch, which it had acquired in 2009.
This year, Rakoff criticized an SEC settlement with Vitesse Semiconductor Corp.
“Here an agency of the U.S. is saying, in effect, ‘although we claim that these defendants have done terrible things, they refuse to admit it and we do not propose to prove it, but will simply resort to gagging their right to deny it,’” he wrote in a decision approving the agreement.
Citigroup doesn’t want to formally admit liability because of the bad publicity that would follow and because an admission would give a powerful tool to investors suing the bank, said Mark Fickes, a former senior trial counsel at the SEC and now a partner at BraunHagey & Borden LLP in San Francisco.
A revised settlement would probably have to include “an agreement as to what the actual facts were,” said Darrin Robbins, who represents investors in securities fraud lawsuits. Robbins’s firm, San Diego-based Robbins Geller Rudman & Dowd LLP, was lead counsel in more settled securities class actions than any other firm in the past two years, according to Cornerstone Research, which tracks securities suits.
In his ruling yesterday, Rakoff said he can’t endorse the proposed settlement based only on the unproved allegations in the SEC’s complaint. He rejected the SEC argument that he should defer to the agency’s determination that the settlement is fair, particularly as it asked him to issue an order requiring Citigroup not to violate securities laws in the future.
Calling Citigroup “a recidivist,” Rakoff said the SEC hasn’t tried to enforce such an order against a financial institution in the past 10 years.
Khuzami, the SEC’s chief of enforcement, said Rakoff’s criticism “disregards the fact that obtaining disgorgement, monetary penalties, and mandatory business reforms may significantly outweigh the absence of an admission when that relief is obtained promptly and without the risks, delay, and resources required at trial.”
Rakoff’s position also ignores “decades of established practice” by federal agencies and threatens to drain resources that could otherwise be used to uncover other frauds, Khuzami said. The allegations against Citigroup are the “reasoned conclusions of the federal agency responsible for the enforcement of the securities laws after a thorough and careful investigation of the facts,” he said, not “mere allegations.”
Khuzami said the law generally limits the SEC to recovering twice Citigroup’s ill-gotten gains. Citigroup made $160 million to $190 million on the transaction, according to SEC estimates.
“Judge Rakoff’s opinion is a major blow to the SEC,” said Bradley J. Bondi, a Washington- and New York-based partner at Cadwalader, Wickersham & Taft LLP and former SEC lawyer.
“If defendants are forced to admit to allegations in an SEC complaint in order for a federal judge to approve a settlement involving injunctive relief, then defendants may opt to battle the SEC rather than settle and adversely affect civil litigation,” Bondi said.
Citigroup rose $1.42, or 6 percent, to $25.05 yesterday in trading in New York. The shares have declined 47 percent this year.
The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-cv-07387, U.S. District Court, Southern District of New York (Manhattan).
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