There are 41 federal judges in the Southern District of New York, the jurisdiction where the Securities and Exchange Commission sued Citigroup for knowingly selling toxic mortgage securities to clients.
For most, approval of the SEC’s $285 million settlement with the banking giant would be a mere formality. But not in the court of U.S. District Judge Jed Rakoff, who, much to the chagrin of SEC lawyers, was randomly assigned the case.
On Monday, Rakoff spiked the SEC’s proposed settlement with the bank and told the parties to prepare for a July 16 trial. Rakoff concluded the deal was “neither fair, nor reasonable, nor adequate, nor in the public interest.”
The judge once again challenged how Wall Street’s top regulator does business. The deal would have allowed Citigroup to walk without admitting guilt for its actions — just like every other defendant that agrees to pay the SEC a fine instead of going to trial.
- Michael Dell, founder of the giant computer manufacturer, agreed to pay $4 million to settle accounting fraud charges;
- Steven Rattner, the Obama administration’s one-time auto czar, agreed to pay $6.2 million to settle pay-for-play charges involving the New York state pension fund;
- Paul George Chironis, a broker-dealer at a now-defunct firm, paid $350,000 to settle charges that he defrauded a group of elderly Sisters of Charity nuns in the Bronx.
None of these men admitted or denied guilt.
In the Citigroup case, the government alleged that the bank had misled investors about the soundness of a $1 billion collateralized debt obligation that was stuffed with subprime residential loans. Investors lost about $700 million, according to the SEC, while Citigroup earned a $160 million profit.
This type of boilerplate language protects companies from lawsuits filed by other parties. If Citigroup admitted guilt, for example, it would have given ammunition to plaintiffs in other lawsuits.
The SEC has routinely included a “without admitting or denying” clause in its civil consent agreements at the request of defendants since at least the 1970s.
And other federal agencies, including the Federal Deposit Insurance Corp., do so as well.
David Martin, a former SEC attorney who now practices at Covington & Burling in Washington, D.C., said that such language simply states a fact and in his experience is not controversial. “We don’t have to negotiate for this,” he said.
But Judge Rakoff doesn’t like it.
Earlier this year, he slammed the SEC for not being more muscular with defendants in a settlement with a semiconductor company and its executives.
“The defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the SEC; but, by gosh, he had better be careful not to deny them either,” the judge wrote. “Only one thing is left certain: the public will never know whether the S.E.C.’s charges are true, at least not in a way that they can take as established by these proceedings.”
He said that allowing defendants to walk away without admitting guilt is a “palpable” disservice to the public interest.
“Here an agency of the United States 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.’”
In 2010, Judge Rakoff “reluctantly” approved a $150 million agency settlement with Bank of America over its Merrill Lynch acquisition, after having rejected an earlier, smaller deal.
But make no mistake: Judge Rakoff is an outlier. Most judges, including his colleagues on the bench in New York, typically bless these types of deals.
U.S. District Judge Barbara Jones recently approved the agency’s $535 million settlement with Goldman Sachs, and federal judge Richard Berman recently OK’d a $154 million settlement with JPMorgan Chase.
And despite Judge Rakoff’s treatment of their cases, the SEC is unlikely to change. That’s because the agency is outgunned and outmanned by the financial industry that it is supposed to regulate. Trying cases is costly and uncertain — it is far safer to announce a settlement deal as a “win” for investors.
Thomas Gorman, a partner at Dorsey & Whitney who writes the SEC Actions blog, said that only a small percentage of SEC cases go to trial and even fewer result in a verdict — usually, less than 10 each year.
Yet still, the agencies batting average is pretty good. In 2011, the SEC has tried 19 cases and won 14 of them.
As to Citigroup, Gorman said he doubts that either party wants to try the case. Instead, the SEC and Citigroup might try to bridge a deal that looks like what happened when Judge Rakoff eventually signed off on the Bank of America case — some kind of statement of facts, significantly enhanced procedures to prevent a future reccurrence and a much larger fine.
If he can’t change the way the SEC does business, perhaps Judge Rakoff’s actions may lead to more sunshine in how cases are resolved.
“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 his recent decision.
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