SEC Cases Bypass Top Execs to Target Employees for Negligence

SEC’s Third-Biggest Crisis-Related Settlement Fails to Impre
“Let’s keep in mind that obviously not all losses in the financial crisis resulted from fraud and misconduct,” SEC Enforcement Director Robert Khuzami said yesterday in an interview with Bloomberg Television. Photo:Joshua Roberts/Bloomberg

Oct. 20 (Bloomberg) -- A central piece of evidence against Citigroup Inc. that led to a $285 million settlement with the Securities and Exchange Commission is an e-mail message from a former employee to his supervisor.

“Don’t tell” a counterparty that Citigroup is shorting the security, former employee Brian Stoker wrote in 2006 to his unnamed supervisor. The agency sued Stoker, saying he was responsible for structuring the deal in which Citigroup failed to disclose that it had chosen about half the assets and was betting they would decline in value. No charges were announced against the supervisor.

That detail highlights a pattern in SEC enforcement cases that is drawing criticism from lawyers and lawmakers: Even as the agency has collected $2 billion in penalties from financial firms for wrongdoing related to the 2008 financial crisis, few top executives have been sanctioned, particularly in connection with complex instruments like collateralized-debt obligations.

“It’s very good to hold a corporation responsible, but these corporations are run by people,” Representative Michael Capuano, a Massachusetts Democrat and senior member of the House Financial Services subcommittee on investigations, said in an interview. “It’s impossible for me to believe” a firm would allow an individual to make deals without supervision that later “are found to be so beyond the pale that someone has to pay hundreds of millions of dollars in punishment.”

Stoker’s attorney, Fraser Hunter, said his client will “defend this lawsuit vigorously.”

The settlement with Citigroup announced yesterday was the third-largest to come from conduct related to the 2008 financial crisis. The biggest was a $550 million settlement with Goldman Sachs Group Inc. announced in July 2010, and the second-largest was a $300 million settlement with State Street Corp. announced in February 2010.

‘Don’t Tell’

In its complaint, the SEC said Citigroup failed to tell investors in a $1 billion collateralized-debt obligation about its role in picking the assets. In an e-mail describing the transaction, in which Credit Suisse Alternative Capital acted as collateral manager, Stoker called it the Citigroup trading desk’s “prop trade (don’t tell CSAC).” He added, “CSAC agreed to terms even though they don’t get to pick the assets.”

In another e-mail cited by the SEC, an unnamed CDO trader characterized the deal as “possibly the best short EVER.”

The SEC has faced growing criticism from investors, lawmakers and judges who have claimed the agency has been more concerned about reaching expedient settlements with companies than rooting out wrongdoing by individuals that may have contributed to the 2008 financial crisis.

SEC officials have countered that many of the causes of the financial crisis involved poor decision-making that might not qualify as illegal.

Not Fraud

“Let’s keep in mind that obviously not all losses in the financial crisis resulted from fraud and misconduct,” SEC Enforcement Director Robert Khuzami said yesterday in an interview with Bloomberg Television. “We can’t sue people based on poor judgment or poor risk-management policies or procedures or investments that perform badly.”

Because of that, the SEC has considered unconventional means to call out conduct that may have been legal even though it was harmful. In the absence of evidence that Lehman Brothers Holdings Inc. technically violated accounting rules before it collapsed in September 2008, enforcement attorneys have weighed the option of issuing a report rebuking the firm’s use of questionable accounting maneuvers instead of pursuing an enforcement action, according to three people with direct knowledge of the matter.


In addition, SEC investigators are opting to bring more cases based on negligence claims such as failing to disclose, a lower legal standard than intentional or reckless fraud, in order to reach more individuals, a person with direct knowledge of the matter said.

Frustration with that policy has erupted in a number of court cases. For instance, U.S. District Court Judge Jed Rakoff rejected a $33 million agreement between the SEC and Bank of America Corp. in 2009 over the company’s disclosures about bonuses and losses while acquiring Merrill Lynch & Co. Rakoff, who later approved a $150 million settlement covering broader allegations, questioned why officers or directors hadn’t been sued.

Rakoff’s opinion was echoed last year by U.S. District Court Judge Ellen Huvelle, who reviewed the SEC’s proposed $75 million settlement with Citigroup to resolve claims the bank misled investors about its exposure to subprime mortgages in 2007.

‘Who’s Responsible?’

“When you bring this long complaint and make it sound like there have been all these misdeeds, who’s responsible?” Huvelle asked the SEC at an August 2010 hearing in Washington. “These things don’t happen without individuals.”

The agency has targeted firms across the mortgage industry, including loan originators such as Countrywide Financial Corp., investment banks, collateral managers and, recently, credit-rating firms. Standard & Poor’s, the world’s largest provider of credit ratings, said last month it may face SEC sanctions for giving top grades to a mortgage-backed security before it plummeted in value.

The agency said it has sanctioned 39 senior officers for conduct related to the financial crisis, including Angelo Mozilo, the former Countryside chief executive officer who agreed last year to pay $67.5 million to resolve claims he misled investors about the lender’s exposure to subprime loans.


Under the Dodd-Frank Act, the SEC can sue an individual who “recklessly” aids a fraud even if the person isn’t aware of the wrongdoing. Previously, lawyers had to show the person knowingly assisted the misconduct. The law also allows the agency to sue senior officers, directors or other people directly or indirectly accountable for the fraud. Those provisions, passed in 2010, cannot be applied retroactively to conduct connected to the financial crisis.

Particularly in cases involving CDOs, the SEC has failed to bring cases against executives other than relatively junior employees, said James Cox, a securities law professor at Duke University in Durham, North Carolina.

“These are big products, large numbers, with lots of people’s involvement,” said Cox. “It’s not the sort of thing that you let somebody loose on and not pay attention to it as a supervisor.”

Cases Dropped

In some instances, the SEC has developed cases against more senior employees only to balk at bringing claims.

The SEC sued Goldman Sachs trader Fabrice Tourre in April 2010 after dropping a plan to file claims against his boss, Jonathan Egol, according to interviews with SEC enforcement staff conducted by the agency’s inspector general, which were made available to Bloomberg News through a Freedom of Information Act request.

In its $153 million CDO settlement with JPMorgan Chase & Co. in June, the SEC sued Edward Steffelin for his role as collateral manager, dropping a plan to sanction Michael Llodra, who was a senior executive at JPMorgan involved in the deal. Tourre and Steffelin are both fighting the SEC claims in court.

“We’re never going to put a face or faces on this crisis,” said Cox. “It’s going to be the crisis of anonymity.”

To contact the reporters on this story: Joshua Gallu in Washington at; Jesse Hamilton in Washington at

To contact the editor responsible for this story: Lawrence Roberts at