Citigroup-SEC Mortgage Securities Accord Rejected by Judge

Judge Rejects SEC Settlement with Citigroup
A Citibank branch in Washington. Photographer: Andrew Harrer/Bloomberg

Citigroup Inc.’s $285 million settlement with the U.S. Securities and Exchange Commission over a mortgage-backed securities fund was rejected by a federal judge who said he hadn’t been given enough facts to approve it.

U.S. District Judge Jed Rakoff in Manhattan rejected the settlement in an opinion released today and set a trial date. He has criticized the SEC’s practice of letting financial institutions such as New York-based Citigroup settle without admitting or denying liability.

Citigroup, the third-biggest U.S. lender, agreed last month to resolve a claim by the SEC that it misled investors in a $1 billion collateralized debt obligation linked to subprime residential mortgage securities. Investors lost about $700 million, according to the agency. A trial could establish conclusions that investors could use against Citigroup, as could a new settlement that includes admissions by the bank.

“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 School of Law. “This puts the SEC in a very difficult spot.”

Danielle Romero-Apsilos, a spokeswoman for Citigroup, said the bank disagreed with Rakoff’s ruling.

‘Fair and Reasonable’

“The proposed settlement is a fair and reasonable resolution to the SEC’s allegation of negligence,” she said 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.”

Rakoff today consolidated the case with another SEC suit against former Citigroup employee Brian Stoker and scheduled the combined case for trial on July 16, 2012. The parties may try to reach a revised settlement, which must be approved by Rakoff to take effect.

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 seeking comment on the SEC allegations.

‘Public Interest’

“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 in a statement. Khuzami didn’t say what action the agency will take in response to Rakoff’s decision.

At a hearing this month, Rakoff asked whether 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 any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth,” Rakoff wrote in the opinion. The proposed settlement is “neither fair, nor reasonable, nor adequate, nor in the public interest,” he said.

BofA Settlement

In September 2009, Rakoff rejected Charlotte, North Carolina-based Bank of America’s settlement with the SEC over claims it misled investors about bonuses at Merrill Lynch & Co., which the company had taken over that year. In February 2010, he approved a revised settlement in which Bank of America agreed to pay $150 million to resolve broader allegations about misstatements to investors, including those on the Merrill Lynch bonuses.

This year, Rakoff criticized another SEC settlement, in a case involving 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 settlement.

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.

SEC Claims

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, according to the agency.

“If the allegations of the complaint are true, this is a very good deal for Citigroup,” Rakoff wrote in today’s opinion. “Even if they are untrue, it is a mild and modest cost of doing business.”

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 suits. 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.

Investors could use any admissions by Citigroup against the bank in private litigation, he said.

Unproved Allegations

Rakoff said he can’t endorse the proposed settlement based only on the unproved allegations in the SEC’s complaint.

“The court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment,” he said.

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 the 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.”

‘Established Practice’

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.”

Citigroup rose $1.42, or 6 percent, to $25.05 today in New York Stock Exchange composite trading. The shares have declined 47 percent this year.

The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-cv-7387, U.S. District Court, Southern District of New York (Manhattan).

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