Judge Rakoff Whacks SEC Yet Again, This Time Over Citi CDO Settlement

Judge Jed Rakoff’s latest ruing, nixing a $285 million settlement between the SEC and Citigroup over a billion dollar fund that came a cropper, has broader implications than simply embarrassing the securities regulator (which given the fallen standing of the agency, and low standards in Washington generally, is harder to do than it ought to be). Rakoff has effectively said judges have no business sanctioning settlements in which the accused party admits to nothing.

What has Rakoff’s dander up is that the allegations made by the SEC in its lawsuit were that Citigroup stuffed the fund full of crappy CDO tranches and went short against them, and got investors to buy it by telling them the assets were selected by an independent party. Citi was a typically inefficient looter, earning about $160 million while investors lost $700 million (note that Rakoff had to pry that information out of the parties). Citi is admitting only to negligence when the violations the SEC described its filing and in a related case amount to fraud, or in securities speak, scienter.

Rakoff’s ruling calls the entire process a sham:

Here, the S.E.C.’s long-standing policy – hallowed by history, but not by reason – of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.

Rakoff’s job is to determine whether the ruling is “whether the proposed Consent Judgment … is fair, reasonable, adequate, and in the public interest.” Since Citi admits to essentially nothing, he has no factual foundation for determining the adequacy of the settlement. He also notes that this deal clearly helps the big bank, since it’s a screaming deal if Citi did the bad things the SEC claimed it did in its initial lawsuit, and is a mere cost of doing business if it didn’t. It isn’t obvious to him what the SEC gets, beyond a headline. And he notes it leaves investors worse off, since the SEC has not said whether or not it will give any of its fines to them, plus the settlement means they cannot pursue private securities law claims based on negligence, so they are actually worse off.

The settlement includes injunctive relief, which in this case is to permanently restrain and enjoin Citi from violating certain provisions of securities regulations, and for three years to implement certain internal programs to prevent staff from undertaking this fraud. Rakoff pooh poohed that, noting that the SEC showed Citi to be a recidivist. The New York Times confirmed Rakoff’s dim view:

A recent analysis by The New York Times of the agency’s fraud settlements with Wall Street firms found 51 instances, involving 19 companies, in which the agency claimed that a company had broken fraud laws that they previously had agreed never to breach.

Dealbreaker (hat tip reader Alexis) raises a related issue: why should the SEC file suits when it can just use administrative actions and collect fines and slap wrists that way? Author Matt Levine points out that they get better headlines, and I assume better settlements (more potential for embarrassment makes it even more important for a suit to go away). The New York Times concurred:

Securities law experts said that the ruling presents the agency with a tough dilemma. In future cases, it will have to consider the risk that another judge may be reluctant to approve a settlement given the Rakoff ruling.

But it isn’t as if the SEC can avoid the court system either. As Levine notes:

Bringing lawsuits in the Southern District of New York is a good way to get the SEC’s failings noticed. Bringing SEC administrative actions, announcing big fines with upbeat press releases, and not having them subject to any review, is a good way to sweep them under the rug. The more scrutiny that the SEC gets when it goes to court, the more tempted it will be to handle cases like this on its own.

One thing that might give them pause, though. The SEC has, in the wake of recent expansions of its powers under Dodd-Frank, experimented with moving away from the courts and towards administrative actions when its case against supposed wrongdoers maybe isn’t so hot. It’s already been slapped down for doing so. By Jed Rakoff.

Rakoff announced a trial date of July 16. It’s going to be hard for the SEC to wriggle its way out of this one.

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  1. tawal

    Enough already! Who are the individuals who picked the dreck mortgages? Who are the individuals that made fraudulent profitable swaps? Who are the salesmen who lied to the investors? The SEC has some more work to do. I’m sure that there are at least a 1/2 dozen individuals that will go to jail, return bonuses, and be banned from the securities for life.

  2. SteveA

    Well, SEC could always put its greenest lawyers on this, and not present all of the evidence it has. I wouldn’t put that past them.

    If I had any faith in Congress, I’d say a congressional look-see into whether this case was discussed outside SEC (say with Justice, Treasury, or the WH) would be warranted.

  3. Patrick

    For years the SEC has been handing out the equivalent of “Traffic Fines” to the financial community. They have become a cost of doing business, inconvenient but deductible. And like “traffic fines” they do nothing to change the behavior of the offenders. And no one pays any notice to them.

    Rakoff’s decision my change that. But regulatory capture is almost total, so I suspect that the SEC will find ways around this and it will be back to BAU in short order.

    1. burnside

      . . . except that Rakoff now undertakes to deny defendant ‘no admission of wrongdoing’ – not available via SEC action – and leaves open the option of civil, class action suit.

      It’s not nothing.

  4. psychohistorian

    It does my heart good to know that there is a certain someone in the SEC squirming. This guy has time to make childish prank harassment calls but not time to do his job for the American public.

    Evolution cannot come too soon.

    Thank you judge Rakoff!!!

    Thank you Yves.

  5. nickj

    presumably the sec could just turn itself into a protection racket? or, on the mers model, an alternate government / bureaucracy?

  6. Greg R

    I’m sure they are having a kick-off breakfast this morning for a Dirty Tricks campaign to get to Rakoff, or someone that matters to him. July 16th is a long way off.

    1. LeonovaBalletRusse

      This comment is no joke. Does Judge Rakoff and his family have protection through a Security detail THEY can trust?

      Recall that “nuclear” Russian tea party gambit for elimination of a truth teller. The Syndicate has it all: assassins, chemical weapons to fill the “Cancer Ward,” the “Gulag Archipelago,” and all other *FOREIGN power* solutions. Or what’s *Security* for?

      Just ask Henry Kissinger, the savior of YALE in this domaine. See at http://www.therealnews.com — “How Private Warmongers and the US Military Infiltrated American Universities” posted by Allen Ruff. Open your eyes.

      Starr & Co. at Johns Hopkins are not mentioned in this blog. Do they constitute a competing Security interest? Yeah, right.

      It’s all ONE big happy *family*. Got a problem with that?

  7. za

    Rather sad that we’re reduced to the recognition that the justice system is the only possible defender of the public interest.

  8. Woodrow Wilson

    “inefficient looter, earning about $160 million while investors lost $700 million” –

    Like other looters, it amazes me people like these are not hanging from lampposts.

  9. K Ackermann

    How can they have it both ways? If corporations are people, then Citi is an anti-social, habitual criminal offender incapable of operating in the agreed norms of society. Just google “Citi Fined”, and you will see they are completely psychotic, and a despicable citizen. A serial, habitual, crime wave operating continuously outside the law.

    Isn’t it time to shut it down? The government should give one warning that they will shut it down the next time it is caught. That should be enough warning for anyone foolish enough to be hold C to bail out as fast as they can.

    Drive it to zero and be done with it. Owning C is morally about the same as dealing dope.

    1. patrick

      Maybe we need a ‘three strikes your out’ law for corporate governance. Like to see the outrage, and who would be outraged, if that was proposed.

    2. LeonovaBalletRusse

      K, the only “government” that can do this is *We the People*. Our Constitution stands ready to guide us; it has already endowed us with the permission to *end it*, for there can be no question that we are being governed by a criminal global Reich–a *foreign power*–and we KNOW who is holding highest Office at their behest: the three branches of *government* in 2011.

      Bring RICO. Cry *TREASON*. Arrest. Detain. Convict. Execute the sentences in order to enact *Justice for All*.

  10. Peter Bernhardt

    And then we have this from a Jakob Frenkel, former SEC “enforcement officer, now attorney with a firm that works for the “people” like Citigroup:

    “Well, I think … that there would be gridlock and chaos in SEC litigation brought in the federal courts if parties were required to admit that there be some type of admission, some type of culpability, because that admission would have a collateral effect in all other litigation.”

    Thanks again to the NewsHour for letting the 1% have their say while the rest of us get nothing.

    Full transcript of last night’s segement is here:


  11. barrisj

    As I have noted previously, “financial crime” is an oxymoron in the US these days, especially when it concerns TBTF banks and Wall Street investment firms. Regulators (and most courts) treat white-collar crime as merely the normal excesses of “free-market competition”, where lines of accountability are deliberately blurred, caveat emptor an allowable defence against illegal conduct, and never, never place corporations in the position of admitting guilt when instead pleading “bad business decisions” can cover a multitude of (prosecutable) sins. Judge Ratkoff’s comments in his decision to strike down the settlement deal reads as though it was lifted from a Michael Hudson, or Tom Ferguson, or Yves Smith screed concerning decriminalisation of fraud and total lack of any
    deterrent or disincentive to dissuade unethical or illegal conduct in the future. It’s remarkable how many, e.g., shoplifters are sent to long prison terms in order to “set an example” to others tempted to commit thievery; however, dispositive judgements involving massive financial crime is simply reduced to “the cost of doing business”, and allows Big Business to just include line-item costs for future settlements in their operating budgets, and to continue with illegal practices until the next round, knowing full well that such conduct is implicitly sanctioned by “the system”.

  12. kravitz

    At the end of his piece on the CBS Evening News last night, Chip Reid mentioned getting a last minute letter from the SEC to Congress requesting the power to increase penalties.

    SEC’s Schapiro Asks to Raise Penalty Limits

    “Fines against individuals would be capped at $1 million per violation instead of $150,000 and penalties for firms could rise to $10 million from $725,000 for each act under a proposal included in a letter dated yesterday from SEC Chairman Mary Schapiro to Senator Jack Reed, the Rhode Island Democrat who leads a subcommittee that oversees the agency.”

    1. LeonovaBalletRusse

      *Money don’t mean nuthin* to these arch criminals, when it is just the price du jour of the Reich’s *Absolute Tyranny* over *We the People* of the United States and Our Treasury.

      We SEE who the Absolute Tyrants are in *elected office*.

      “Cut off their heads” said the Red Queen.

  13. barrisj

    Bloomberg Business News has got a story out on its website today concerning a meeting “Hank” Paulson conducted in July, 2008, with several big-name hedge fund managers regarding the Treasury’s view – inter alia – on how to deal with Fannie Mae/Freddie Mac as the value of their mortgage portfolios were tanking. Publicly, Paulson took the position that the two GSEs must remain shareholder-owned, and a bailout was “improbable” – his famous “…if you have a bazooka…” statement. However, in the meeting with his hedge funds buddies, Paulson indicated that some sort of “conservatorship” was indeed likely for the GSEs, and that investors would be effectively wiped out. Despite having received “information of a material nature” that was “denied to the general public” and that could clearly profit those who chose to act upon such, neither Paulson or the hedge fund managers present at the meeting have been called to account. Paulson apparently broke no hard-and-fast “rule” on what he disclosed, nor is there any evidence that the funds immediately took out aggressive short-positions on the GSEs, as such transactions (firm-specific stock-shorting) are not available as public documents. But, who’s to say some other arcane mechanism wasn’t put in play to disguise a trading firm’s short-interest position? And, what was Paulson’s motivation for disseminating such acutely sensitive information to those who make their living – for God’s sake! – on hedge-trades? The article elicits more questions than provides answers, that’s for sure.

    How Paulson Gave Hedge Funds Advance Word


    1. Yves Smith Post author

      Eeek, now I;m going to have a paranoid moment. Maybe Paulson WANTED to drive the stock price down to make the conservatorship less controversial.

  14. Don

    Can the SEC settle away private securities fraud claims through an administrative action? Maybe that is another reason to go to a judge?

  15. Ray Phenicie

    At least the Judge speaks the truth to power: I wonder if Congress, who should be yanking the chain of the SEC big time, will listen:

    “Finally, 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. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”

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