It turns out investors might have a voice after all when it comes to matters of fraud and punishment at the Securities and Exchange Commission. All they have to do, it seems, is ask.
That’s what lawyers for a Citigroup Inc. shareholder named Stanley Lerner soon found out after they filed a court brief complaining about the SEC’s sweetheart settlement agreement last month with the bank and two executives. The terms of the July 29 deal made no sense and let Citigroup’s officers and directors off too easy, Lerner’s attorneys told the federal judge presiding over the case.
The judge, Ellen S. Huvelle of the District of Columbia, proved to be a sympathetic ear. This week, Huvelle ordered the SEC to file a memo by Sept. 8 providing detailed answers to a litany of questions challenging the SEC’s handling of the case, many of which echoed Lerner’s objections.
The SEC accused Citigroup of committing negligent -- not intentional -- fraud when it told investors in 2007 that its risk of losses on subprime mortgages was $43 billion less than it actually was. (Negligent fraud: Now there’s an oxymoron.) The SEC proposed a $75 million fine, which would be borne by Citigroup shareholders. Those include the U.S. Treasury, which still owns an 18 percent stake in the twice-bailed-out bank.
The SEC didn’t file fraud allegations against anyone who worked at Citigroup, though. Instead the SEC claimed the two executives, former Chief Financial Officer Gary Crittenden and former investor-relations head Arthur Tildesley, had engaged in mere disclosure violations. Crittenden agreed to pay $100,000 in a separate SEC proceeding. Tildesley, who still works for Citigroup in a different job, was fined $80,000.
Naturally, the defendants didn’t admit or deny the allegations. It’s as if it would be possible to have fraud without living, breathing fraudsters.
Among Judge Huvelle’s queries: How did the SEC come up with the $75 million figure? Why didn’t the SEC accuse Citigroup of intentional fraud? What was the SEC’s evidence in the case? And why did it bring claims against only two individuals? She also asked the SEC for its thoughts on a three-page list of non-monetary sanctions proposed by Lerner, including the selection of a court-appointed auditor to assess Citigroup’s accounting practices; no Big Four accounting firms would be eligible.
U.S. District Judge Jed Rakoff of New York paved the way for this kind of activism last year when he rejected a $33 million settlement between the SEC and Bank of America Corp. over alleged disclosure violations. Rakoff reluctantly approved a later deal that included greater penalties.
What makes the events in the Citigroup case unique is Lerner’s role. In 13 years of covering such cases, I had never heard of a shareholder filing a friend-of-the-court brief asking a judge to reject an SEC settlement as inappropriate, though it seems like a perfectly reasonable thing for a ticked-off investor to do. Don’t be surprised if this starts a trend.
“To our knowledge it’s never been done before,” said Richard Greenfield, one of Lerner’s attorneys at the New York law firm Greenfield & Goodman, who’s been practicing securities law for almost 40 years. “I’m surprised I hadn’t thought of it many years earlier. I’m embarrassed I hadn’t.”
Tom Newkirk, a 19-year veteran of the SEC’s enforcement division who’s now a partner at Jenner & Block in Washington, said he hadn’t seen the tactic before, either. “Who’s to say it hasn’t happened before? But I can’t recall it ever happening,” said Newkirk, the SEC enforcement division’s associate director from 1993 to 2004. Neither Newkirk nor his firm is involved in the Citigroup case.
Lerner, a resident of Boca Raton, Florida, also is the plaintiff in a shareholder derivative lawsuit filed in a New York state court by the same lawyers, seeking damages on Citigroup’s behalf from 24 current and former executives and directors. The defendants in that case include Robert Rubin, the former Treasury secretary who once led Citigroup’s executive committee, and former Chief Executive Officer Charles Prince.
Were Huvelle to approve the SEC settlement in current form, the defendants in the other suit probably would use that to argue there was no serious wrongdoing at Citigroup, because otherwise the SEC would have imposed more severe penalties and identified the individuals responsible for the alleged fraud. Lerner has asked Huvelle for permission to make an appearance in the SEC case, on the grounds his lawyers can advance arguments about the settlement’s substance that neither Citigroup’s attorneys nor the SEC’s are willing to make.
More power to him. For all the SEC’s talk about getting tough on crooks, the cozy arrangement with Citigroup smacks of a whitewash. This shouldn’t come as a shock. As former SEC Chairman Christopher Cox warned in a December 2008 speech, the government undermines its ability to enforce the law when it takes stakes in companies it’s supposed to be regulating.
“Rules that might be rigorously applied to private-sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules,” Cox said, less than two weeks after Citigroup landed the second installment in its $45 billion government bailout.
Here’s hoping Judge Huvelle puts the SEC and Citigroup through the wringer.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
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