A federal judge in New York refused on Monday to endorse a $285 million consent agreement with the SEC that would have allowed Citigroup Global Markets, Inc., to avoid any admission of wrongdoing in a deceptive securities transaction that earned Citigroup $160 million in profits while investors lost $700 million.
Under terms of the proposed agreement, Citigroup was not required to admit or deny any illegal conduct alleged in a Securities and Exchange Commission complaint, and the firm would pay what the judge termed “only very modest penalties.”
“If the allegations of the complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business,” US District Judge Jed Rakoff wrote in a 15-page opinion.
“It is harder to discern from the limited information before the court what the SEC is getting from this settlement other than a quick headline,” he said.
“By the SEC’s own account, Citigroup is a recidivist, and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup,” the judge said.
Instead of accepting the agreement between Citigroup and the SEC, Judge Rakoff told both sides to be prepared to go to trial on July 16.
SEC officials defended the proposed settlement, saying the government was unlikely to obtain more if it took Citigroup to court. The SEC enforcement director, Robert Khuzami, said the settlement helped free up investigative resources for other cases, according to the Associated Press.
At issue in the case was a 2007 effort by Citigroup to create and market a billion-dollar fund of problematic mortgage-backed securities just as the nation’s housing bubble was about to burst. The arrangement allowed Citigroup to dump assets of questionable quality on misinformed investors.
Citigroup told prospective investors that the fund’s assets had been hand-picked by an independent investment adviser, when, in fact, Citigroup used the fund to jettison $500 million in risky assets.
In addition, unknown to the investors, Citigroup had also taken a short position on those same assets, counting on the securities losing their value. When they did, Citigroup realized net profits of $160 million in addition to $34 million in fees it charged to set up the investment. In contrast, the investors lost everything – more than $700 million.
The SEC undertook a four-year investigation. The SEC announced the settlement agreement Oct. 19. It called for Citigroup to pay $285 million. That amount included a $95 million fine, and disgorgement of the $160 million in profits and $30 million in interest.
The agreement asked the court to order Citigroup to refrain from future violations of specific provisions of the securities laws, and to adopt a series of internal policing measures.
The proposed agreement does not require the SEC to use any of its recovered funds to compensate defrauded investors. In addition, the agreement undercuts efforts by the investors to recover their losses by suing Citigroup, according to the judge.
“The combination of charging Citigroup only with negligence and then permitting Citigroup to settle without either admitting or denying the allegations deals a double blow to any assistance the defrauded investors might seek to derive from the SEC litigation [by filing a private lawsuit],” Rakoff said.
Private investors may not sue on claims of negligence and since Citigroup is not required to admit wrongdoing, the settlement may not be used as evidence to support a civil lawsuit by investors.
In most cases, judges routinely approve proposed settlement agreements involving government regulatory agencies. Not Judge Rakoff.
The judge complained in his order that he had been provided no facts upon which to render an independent judgment about the agreement since Citigroup was not required under the agreement to admit any wrongdoing.
“The court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, or in the public interest,” Rakoff said.
“This is because it does not provide the court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards.”
The judge added: “The court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.”