NYT’s James Stewart Runs PR for Compromised SEC Chief Khuzami Against Judge Rakoff on Proposed $285 Million Citi CDO Settlement

Tom Adams, an attorney and former monoline executive, provided considerable input into this post.

There is nothing more useful to people in authority than when a writer with an established brand name does their propagandizing for them.

Harvard Law graduate and Pulitzer Prize winning author James B. Stewart penned a remarkable little piece in the New York Times over the weekend. Titled “Few Avenues for Justice in the Case Against Citi,” it contends that Judge Jed Rakoff’s ruling against a proposed $285 million SEC settlement with Citigroup over a $1 billion CDO (Class V Funding III) that delivered $700 million in losses to investors and $160 million in profits to Citi is misguided. Stewart argues, based on “some reporting,” that the SEC is unlikely to do better in the trial that Rakoff has forced on the agency by nixing the settlement.

We will look at the caliber of Stewart’s “reporting” in due course, since his article reads like dictation from the SEC’s head of enforcement Robert Khuzami (the SEC’s interests are aligned with Citi’s in wanting the settlement to go through). Stewart either did not read or chose to ignore critical information in the underlying complaints, which the Rakoff ruling cites, and he also overlooked relevant cases.

But let’s first examine the dead body in the room that Stewart and other commentators have conveniently managed to overlook.

Why hasn’t the SEC been tough on CDOs, even though they were at the heart of the crisis? As we discussed at length in ECONNED, it was the collapse in the value of AAA tranches of so-called asset backed CDOs (ones based heavily on subprime-related exposures) that blew holes in bank balance sheets around the world. They had not only served as collateral for short term funding (repo) but were also used for bonus gaming by traders (the “negative basis trade”). This is the big reason why so many banks had large CDO exposures when the credit markets started backing up. While they were stuck with some unsold inventory,the big reason is that traders loaded up on them to loot their own firms.

So why has the SEC not pursued this area more vigorously? Rakoff is puzzled by the SEC’s willingness to enter into the Citi agreement:

It is harder to discern from the limited information before the Court what the S.E.C. is getting from this settlement other than a quick headline.

The SEC went after Goldman only on one Abacus deal out of 25 in its program. Even though the $550 million settlement was limited to that transaction, it was widely understood that the SEC was not going to pursue Goldman on other CDOs. And it hasn’t. The SEC has gone through the motions in this arena: it poked around some Magnetar deals (not surprisingly, after the hedge fund got some real press about its destructive strategy) and negotiated a $153.6 million settlement with JP Morgan on a particularly noxious Magnetar trade, a CDO squared imaginatively called Squared.

Look no further for an answer than the SEC chief of enforcement, Robert Khuzami, Stewart’s primary and probably sole source for this article. He was General Counsel for the Americas for Deutsche Bank from 2004 to 2009. That means he had oversight responsibility for the arguable patient zero of the CDO business, one Greg Lippmann, a senior trader at Deutsche, who played a major role in the growth of the CDOs, and in particular, synthetic or hybrid CDOs, which required enlisting short sellers and packaging the credit default swaps they liked, typically on the BBB tranches of the very worst subprime bonds, into CDOs that were then sold to unsuspecting longs. (Readers of Michael Lewis’ The Big Short will remember Lippmann featured prominently. That is not an accident of Lewis’ device of selecting particular actors on which to hang his narrative, but reflects Lippmann’s considerable role in developing that product).

Any serious investigation of CDO bad practices would implicate Deutsche Bank, and presumably, Khuzmami. Why was a Goldman Abacus trade probed, and not deals from Deutsche Bank’s similar CDO program, Start? Khuzami simply can’t afford to dig too deeply in this toxic terrain; questions would correctly be raised as to why Deutsche was not being scrutinized similarly. And recusing himself would be insufficient. Do you really think staffers are sufficiently inattentive of the politics so as to pursue investigations aggressively that might damage the head of their unit?

And notice: this article quotes Khuzami directly, Khuzami, and not a single other source. There is no “reporting” of opposing views, say of attorneys pursuing CDO litigation or law professors who are willing to criticize financial services industry practices like John Coffee at Columbia or, perhaps William Bratton at Penn.

It’s also in keeping that Stewart missed M&T Bank v. Gemstone. In this case, Deutsche (!) sold an ABS CDO to M&T Bank which promptly tanked.

M&T Bank sued for various breach of contract and fraud claims. The court denied Deutsche’s motions to dismiss on a variety of grounds, including fraudulent misrepresentation. The also granted some specific fraud claims, leaving more than enough for M&T Bank to proceed on.

This is an obvious precedent that Rakoff is almost certainly aware of, even if Stewart is not. If a complaint can survive a motion to dismiss, then it is strong enough to force some real fact finding and compel the defendants to come to a settlement that reflects the real costs and conduct (and that per Rakoff includes meaningful punishments for culpable individuals).

In addition, the appellate division of the Supreme Court of New York nixed a motion to dismiss a similar CDO fraud suit by China Development Industrial Bank against Morgan Stanley.

Now let’s turn to Stewart’s brazen and remarkably fact free assertions in defense of the SEC and Citi against Rakoff. Now it is narrowly true that the SEC may well do less well at trial than it would in the settlement. If you force someone into a fight he does not want, he may underperform just to show he was right. And the SEC may want more to make its political point about Rakoff’s ruling than win the case. But any honest reading of the complaint that Rakoff discusses, the one against mid-level Citi employee Brian Stoker, as well as the SEC cease and desist order against Credit Suisse Alternative Capital for its action on this very same Citigroup deal shows that, contra Stewart, the SEC has a strong case. It’s no wonder Rakoff was ripshit.

As an aside, it’s also telling that Stewart didn’t even bother to understand the deal. He says Citi “put together a package of $1 billion of mortgages” when the deal was a CDO squared. That means it was uber dreck, a way for Citi to get rid of lower rated CDO tranches that it could not otherwise dispose of. But getting rid of toxic assets wasn’t good enough for Citi. The deal was part cash bonds, largely unsold lower rated CDO tranches in Citi’s portfolio, and part synthetic (credit default swaps, in this case on A rated subprime mortgage bonds) chosen by Citi so it could go short (more on that below).

Let’s start with the key section of Stewart’s whitewash:

But bad deals, even really bad deals like Citigroup’s, aren’t illegal. They’re not criminal. They’re not inherently fraudulent. If Citigroup’s clients, all of them sophisticated institutional investors, were foolish or careless enough to buy what Citigroup sold them, then arguably they deserved their losses. Their remedy, presumably, would be never to do business with Citigroup again.

This poses a major obstacle for prosecutors and the agency’s enforcers. They have to prove that bank executives misrepresented the terms of the deal and misled investors. Fraud has an even higher standard of proof: the statement must be intentionally false about a material fact….

The offering circular describing the deal states: “the composition of the Eligible Collateral Debt Securities will be determined by the selections of the Manager” which was Credit Suisse. Citigroup suggested mortgages for the collateralized debt obligation, most of which were included (along with others identified by Credit Suisse), but maintains that Credit Suisse “determined” the assets in that it had no obligation to accept Citi’s recommendations and that Citi had no veto power over what Credit Suisse decided to include.

Remember how these deals worked. The key party in the transaction was the asset manager, also known as the collateral manager, who chose the exposures that would go into the CDO. Investors relied on the belief that the asset managers were independent and were looking out for their interest. Thus an asset manager that was presented as independent but was in fact working in cahoots with the seller of assets (and worse, cooperating them in setting up the deal so their short trade would work out) is a HUGE omission. As we described in Chapter 9 and Appendix II of ECONNED, collateral managers of synthetic and hybrid (partially synthetic) CDOs knew full well whose interest they were really serving, namely, the short side, not the nominal investors.

Now let’s look at some sections of the SEC cease and desist order against the asset manager on this deal, Credit Suisse Alternative Capital, for its actions on this very transaction:

SEC Order With Credit Suisse 33-9268

From the cease and desist order:

[Samir] Bhatt was the portfolio manager at CSAC primarily responsible for the Class V III transaction. Bhatt was responsible for selecting the assets in accordance with CSAC’s stated processes, as well as for negotiating and executing the purchase of those assets on behalf of Class V III. Bhatt and CSAC understood that Citigroup was seeking to short assets into Class V either for itself or for its customers (though did not necessarily know which), and thus that Citigroup was representing economic incentives potentially adverse to those of Class V III and its investors.

Rather than follow CSAC’s stated asset selection process, Bhatt provided Citigroup with a list of potential assets with which he had some familiarity, and allowed Citigroup to select from the list the names on which it wanted to purchase protection. The CDO securities on which Citigroup bought protection had a notional value of approximately $500 million, representing half of the Class V III investment portfolio. Citigroup’s selections were weighted towards assets that were regarded by the market as particularly risky

And the SEC does have the smoking gun. Here is part of the detail:

At approximately 9:58 AM on January 8, 2007, the Citigroup salesperson responsible for the CSAC account forwarded to Bhatt an email from a Citigroup CDO trader. The Citigroup CDO trader had written, “Here are the names where we would like to buy protection from CSAC,” and had selected 25 names from the Bhatt December 21 List (the “Citigroup January 8 List”). All 25 of the names on the Citigroup January 8 List were mezzanine CDOs, and 24 of the 25 were from the 2006 vintage. Sixteen of the 25 names on the Citigroup January 8 List were also on the Citigroup November 1 List. Five of the nine names from the Citigroup November 1 List that were not on the Citigroup January 8 List were actually on the CSAC December 21 List, but Citigroup did not seek to short those names on January 8.

By approximately 10:57 AM, less than one hour later, CSAC had agreed to include all 25 of the names from the Citigroup January 8 List in the Class V III investment portfolio.

So you gotta love it. The person feeding Stewart information was narrowly truthful. CSAC did select the short exposures…a long list from which Citi picked the real dreck it wanted.

Citi and CSAC also colluded on pricing to the detriment of investors (this is something Tom Adams has discussed at length in earlier posts):

The offering circular for Class V III represented that the assets in the portfolio were purchased at “fair market value.” This statement was inaccurate. Rather than seeking market bids, CSAC and Bhatt purchased most of the synthetic assets (i.e. those referenced by the sale of protection via CDS) in two separate portfolio trades with Citigroup. After determining that Citigroup had paid prices well below what was available in the market for individual assets (i.e. Citigroup had purchased protection for lower premium payments than it would have had to pay for the individual assets in a market transaction as of that day) for the first portfolio trade, CSAC and Bhatt nevertheless proceeded with a second portfolio trade with Citigroup. The prices CSAC and Bhatt obtained in that second trade were higher than for the first trade, but well below what was available in the market for individual assets. CSAC and Bhatt did not take meaningful action to verify that CSAC was obtaining market prices in the transactions with Citigroup.

The cease and desist order provides specific information to support its claim that Citigroup was getting falsely low CDS premiums (low premiums = cheap price). This ripped off investors two ways. Not only were they cheated out of a market price, but they also were deprived of market signals. If they realized how much spreads had widened (a sign of rising risk) that alone might well have put them off the deal.

Oh, and in case you doubt whether this was misleading:

The offering circular states in at least six separate locations that the portfolio was “selected” by CSAC, and emphasizes the importance of CSAC’s process for asset selection.

In addition, Citigroup also provided the warehouse line to CSAC, yet another way in which the relationship was less than arm’s length.

Stewart tries running the CDO version of the “rogue trader” defense: if anything was done wrong, it was Stoker acting alone. The SEC presented e-mails to the contrary in its complaint.

SEC Complaint Against Citi 2011 214

From page 10:

On or about November 3, 2006, the senior CDO structurer drafted an engagement letter for CSAC and circulated it internally with the subject line “CSAC CDO squared.”

Later that day, in response to receiving the draft engagement letter, the senior CDO structurer’s immediate supervisor inquired, “Are we doing this?” The structurer responded: “I hope so. This is [Trading Desk Head]’s prop trade (don’t tell CSAC). CSAC agreed to terms even though they don’t get to pick the assets.” The term “prop trade” is shorthand for “proprietary trade,” meaning a trade undertaken for a firm’s own account, rather than on behalf of the firm’s customer(s).

Notice the “prop trade” idea, which was understood from the very outset of the deal, also debunks another defense of the SEC settlement that comes straight from Mr. Something to Hide Khuzami, namely:

Citi will also argue that it disclosed that it was the initial short counterparty and said it might keep the position or sell it on.

What are you gonna believe if you are a judge, a contemporaneous e-mail trail, or Citi’s efforts to claim out of whole cloth that this wasn’t a prop deal?

And Stoker was not a lone actor. The head desk trader is usually at least a director, often a managing director. The separate Stoker complaint describes him as

…a Director in the CDO structuring group at Citigroup from March 2005 through August 2008. Stoker was the principal Citigroup employee responsible for overseeing the structuring of Class VIII and the drafting of the offering memorandum and pitchbook

In the earlier snippet, the “senior CDO structurer’s immediate supervisor” and the head trader are certain to be senior to Stoker. The idea that he cooked up the collusion in this deal all on his own and none of the higher ups had the foggiest idea is patent nonsense (although Citi loved making the usual pious-sounding misrepresentations about how their deals were client-driven, as the FCIC testimony by its CDO business co-head attests). What may have happened is that Stoker was targeted, just as the Fabulous Fabrice Tourre of Goldman was, in the hope he’d roll more senior staffers, but that plan was trumped by the settlement deal (perhaps the plan was to quietly dispose of the Stoker case after Rakoff blessed the settlement, which now is not going to happen)

Let’s step back and review.

The facts in this case are strong. Citi’s behavior is much worse than Goldman’s on the Abacus trade in which the SEC reached a $550 million settlement. Citi was executing a clear and successful plan to short for its own profit at the expense of investors (while Goldman was working with a third party short, John Paulson, at least initially, and lost money on its trade). It hired a bogus manager to act as a cover, selected the majority of the bonds and short positions, and knowingly misrepresented the role of the manager in the offering documents and related communications (one section of the complaint even describes how Citi rescripted CSAC when its pitch was falling flat). The staff is to be commended for the caliber of investigation embodied in these documents.

The e-mails of “senior traders” should be enough to put Citi desk and business unit heads in jail (well, if you assume the Department of Justice believed in prosecuting anyone from A Company You Heard Of), but they go after a mid level structurer on civil charges instead.

Rakoff is right to be outraged that the SEC wants to allow Citi to get away without admitting or denying guilt. The SEC staff has Citi nailed. But the SEC senior management, meaning Khuzami, wants to let Citi get off easy. And with apologists like Stewart in his camp, he’s still trying to turn the public’s eyes away from the predatory and extraordinarily destructive conduct in this arena.

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  1. ZeroInMyOnes

    Our main problem is that most of our FBI agents were re-assigned to Homeland Security after 9/11. We would need to add many, many FBI agents in order to investigate our large banks.

    Hiring more FBI agents would be a VERY good investment of the People’s money. It would pay for itself in the form of reduced skimming by large banks.

    1. Sleeper

      So let’s see –

      More money should be allocated to the FBI really ?

      This is the same FBI that was unable to track down the UniBomber on it’s own, the same FBI that sent notes to ML King suggesting he commit suicide, the same FBI that was controlled by a self loathing homosexual megalomanic for years and who hand picked his special agents, the same FBI that hounded Bruce Ivins (sp) to his death, the same FBI that routinely says “We never comment on investigations” while leaking documents on various and sundry “militia groups”.

      These guys act as a quasi secrete / political police.
      If there every was a time and place for less government this is it. Cut the FBI budget by half

      1. Karl Rove's Contrariantard Brian

        Great idea “Sleeper”! Cut the number of criminal investigators into white collar crime down to zero if we can. If there’s one thing that the last decade has proven, it’s that markets regulate themselves best!

        1. Sleeper

          Really ?

          The FBI has failed to investigate any of the criminal activities by the good old boys (and yes they are mostly old fat white men).
          FBI spokesmen has publicly stated that the FBI will not be investigating and not to send any complaints to them. The FBI is part of the Baanking association’s trade group.

          The only possible conclusion is that the feds (including the FBI) have taken the role of protecting the 1%.
          Make no mistake their role is to keep the lid on not to see justice done.

    2. LeonovaBalletRusse

      Connect dots: ENRON-Bush-TomRidge – Ridge-Homeland Security-FBI — Bush’s getting the FBI away from Wall Street prosecution, while stacking the SEC with cronies made this *stroke of genius* a twofer for the looting class!

    3. Bilejones

      If the FBI would close down its terrorist plot manufacturing facilities it would have ample manpower to bang up the Dimon and Blankfein mega-crooks.

  2. Sleeper

    What a surprise !!!

    The regulatory agencies have for years played the good old boy game of protecting those folks who are connected either through dollars or through some connection to the government.

    This is official defacto policy – make no mistake. While the 99% can and should howl and use creative means to impede the accumulation of wealth, until there are real criminal prosecutions and prison terms we can expect this lawlessness to continue.

    1. jake chase

      Stewart is probably right when he says the SEC is unlikely to get more from Citi after a trial. The agency probably doesn’t employ 4 attorneys who know what a CDO is, and half of those have never appeared in court. The others would have trouble finding their ass during a power outage. What the SEC does is public relations for Wall Street, creating the impression that it exists to protect investors, giving the investor sheep waiting to be shorn a warm fuzzy feeling about all those regulated brokers who will go to jail should they tell the mildest fib about an “investment”. Even before Reagan,Bush,Bush began dismantling the regulatory environment, the SEC was unable to punish anything except the occasional insider trading scam, and it could only prosecute these after a Dennis Levine got caught with a shopping bag filled with money and started spilling his guts and naming everyone in his Rolodex. Securities regulation has always been a joke and this Khuzami is just the latest empty suit PR joker in charge.

      1. Yves Smith Post author


        You are dead wrong here. Read the complaints. They SEC is clearly way down the curve on the tradecraft.

        1. jake chase


          I have been watching the SEC since 1968. Its idea of enforcement is a press release and a consent order. Writing a complaint and prosecuting a case to judgment are two very different things. Can’t wait to see these paper shufflers marshalling evidence and examining witnesses.

    1. Woodrow Wilson

      “And so we Occupy.” –

      TPTB still don’t care. OWS received some press and some sympathy and now, for the most part, have been crushed, as expected.

      As CONgress moves to pass Legislation in the name of “Safety & Security“, on our own soil, against fellow Americans, The People are running out of options. My guess is most will evolve into total serfdom, a slave, or be jailed or killed for dissent, there’s just not enough of us to fight, which is what is needed in a completely corrupt Plutocracy.

      1. Mike S.

        not enough? By numbers alone, there are enough, but this is not the relevant consideration.
        Suppose worst case scenario: outright massacre of the general population to maintain control.
        The question: will the armed forces and police be willing to go through with it? Will they act on orders such as those or will they i) refuse en mass and/or ii) turn against their masters?
        Solzhenitsyn asserts repeatedly that the Soviet gov’t would bring in forces composed of other ethnicities, non-Russian, even non-slav, to do the dirty work of suppressing public revolt. Even under that regime it was hard for Russians to fire on their own countrymen (the public, non-prisoners). Under the worst case, the question for those in the armed forces might be this: are we all Americans? to what degree, and how far do we have to go for it to matter?

        1. wunsacon

          “Send in the drones.” Drones have no allegiance to any ethnicity.

          As Ross Perot used to say: “Problem solved!”

        2. LeonovaBalletRusse

          Mike S., this has already been accomplished: the police state operatives are a *global* force. Acutally, is seems that a *NATO* police force with *foreign* operatives in each location is the way tha tthe Power obviates the threat to THEM. All *police* everywhere are now never *local*.

    1. K Ackermann

      Thanks for the link, and indirectly to this link.

      Does Stewart not read these things, or should I just write his name under the 1% scum column?

      Khuzami should have his head stoved in with a bat.

    2. LeonovaBalletRusse

      Yves should get the complete dossier on the traitor Khusami. The link is a keen reminder of how the *elite* law firms are *blood brothers* with looter-traitors.

      Compare *American* history of money men: Prescott Bush, Allen Dulles, Sullivan and Cromwell Third Reich for profit conspirators.

      Wall Street looters and lawyers are one. All to the slammer.

  3. matt weidner

    Excellent, as usual…until The People, understand that these financial products are not abstract, far away planets that they don’t need to pay attention to, things will not change. Every bank account, every 401k, every little grandmother’s annuity is tied directly into these crimes……

    1. Susan the other

      The lack of transparency was clearly intentional. “Depriving investors of market signals” was critical to selling anything. It is one thing to bundle and sell mortgages as securities. It is totally another to chop up bundles and again chop up bundles of bundles in order to hide the contents of the securities and pretend they are some kind of commodity-filled security sausage backed by sausage default insurance contracts which were themselves also derivatives of the sausages some of which could be traded separately. And all of it akin to some kind of long term commodity contract. They were intended to be traded and re-traded long after any rational expiration date. What kind of hybrid is that? How can anybody sort through this?

  4. The Hube

    everyone seems to be missing the most important thing. There is no monetary penalty, no matter the amount, that will deter similar behavior in the future. Banks don’t commit criminal acts – the people working for them do. Only when there is a real fear of jail time by the actors will behavior change. If I rob a bank and the penalty if I get caught is that the bank has to give the government money, I will keep robbing that bank until the calculus changes.

    The road map for this is the tax shelter industry. As soon as people started facing jail time, behavior changed almost overnight.

    1. Ms. G

      This is absolutely true, and the obvious argument for why Glass Steagall, banning TBTF, and other simple but politically (apparently) impossible actions are the only solution.

  5. joe thompson

    Yves – i thought of you the entire time I read Stewart’s column…..you never let me down….your contributions are vital and hopefully, in time, will break a camel’s back….

  6. mary

    I have wanted to forward a few articles to friends and tried sending them to my email to then forward on. They never get to my inbox or spam folder but this sites indicates they were sent. Anyone else having that problem?

    1. Alex R.

      Have you tried just sending the link? Copy the link from the URL bar into your email and send it off. Then your relative only needs to click the link and their browser should open.

  7. mary

    What has become of J.B. Stewart?
    His ‘Den of Thieves’ was a fine book
    and he’s recently been touting a new
    work on “taking responsibilty”. Why
    is Stewart so myopic about this Citi

  8. john

    This is a beautiful work of investigative journalism. Thanks, Yves, for all of your hard work. You are a national treasure.

    I am slowly changing the opinions of my email group in regards to Wall Street with the assistance of this site. My group is composed of mostly libertarian leaning, successful (i.e. wealthy) businessmen/professionals who up until recently have bought the party line about Wall Street being a bastion of free market capitalism. We started this group in 2007 and it is interesting to see how opinions about the financial class have evolved over the last year. No longer am I hearing back retorts to my criticism of the large banks such as: “But, they paid back the TARP”. More and more this group is coming around to seeing that Wall Street is a parasite sucking the life out of their own businesses (software, law, medicine, advertising). More importantly they are seeing how their own employees are increasingly getting screwed by the debt purveyors. And they are very worried about the world their children (mostly college age) are inheriting.

    People are slow to shed their biases, but eventually most will see the truth and then hopefully take action. Already most of my group (nearly all Republican) has figured out that Newt and Romney are Wall Street lackeys and will not vote for them. A few want Ron Paul to win, one is holding out for Ralph Nader, but most are at a loss as to who to support.

    Thanks again.

    1. Joe Rebholz

      John, Thank you. This is great news. If there is one of you out there, there must be more. I have never been able to believe that all business people could be taken in by this neoliberalism, this “government bad, corporations good” simplemindedness, this fraud, this looting, etc.

      Each of us should start a group like yours.

      1. LeonovaBalletRusse

        Thanks, john, you are a true patriot, and living proof that people can and do learn, change their minds on the evidence, and help others to do the same.

  9. 2laneIA

    Nice shredding. I went and read the column and it is everything you say, plus I can’t believe the guy made it through law school, (never mind Harvard), with that kind of level one thinking.

  10. john

    Yves and her collaborators are building highly compact and convincing alternative to the WP and NYT. This is journalism at its very best.

  11. spooz

    I was hoping to see the comments section on Stewart’s piece in the New York Times, knowing he would have been ripped to shreds. Figures NYT doesn’t have a comments section for this one. Is there some rhyme or reason to which pieces are open for comments? Confirms my opinion of them as a propaganda rag.

    1. Ms. G

      I asked this very question of Michael Powell when I noticed that routinely, his somewhat critical-of-Bloomberg, columns never had comment sections. The response was bland — words to the effect that it is “random” or “arbitrary” and something to do with server capacity. Yeah, right.

  12. David Fiderer

    I’d frame the problem differently. Citigroup was selling these investments who, legally, were “sophisticated investors,”and as such, could not simply abdicate their obligations to perform due diligence to the assets they were buying. It’s didn’t matter what the Citigroup said about its motivation, anyone who did a cursory exam to figure out the hyperleverage of the investments and the sensitivity to loss would have walked away from the deal.

    The Supreme Court, in its longstanding effort to define deviancy down with regard to securities laws, declared in Gustafson v. Alloyd that private placement disclosures could be very deceptive, yet not illegal.

    The entire CDO market was predicated on the notion that there were enough “sophisticated investors” who were no more than suckers because they relied on bogus credit ratings and nothing else.

    Over the last 20 years, the law has evolved in ways to insulate people whom you and I would say committed fraud.

    1. David Fiderer

      I forgot to add that Stewart’s piece should be seen in the context of a broader trend among certain big name journalists–such as Roger Lowenstein http://www.businessweek.com/print/magazine/content/11_21/b4229060222515.htm and Robert Samuelson, http://www.wilsonquarterly.com/article.cfm?AID=1768, and almost any talking head on CNBC–who go out of their way to whitewash dishonesty on Wall Street. Their media platforms remain secure, and they almost never acknowledge that they were wrong.

  13. orionATL

    i suspect the doj (eric holder) and its little brother, the fbi (robert mueller), have been waived off any systematic investigation of major-bank fraud by the obama whitehouse.

    if so, adding 500 fbi agents would not change a damned thing.

    1. LeonovaBalletRusse

      Bush’s 911 coverup FBI guy, Robert Mueller. With FBI’s John O’Neil “disappeared” on 911, and with SEC documents with evidence of former Bush-related crimes conveniently *ruined* on 911, and with Kerick on tap to do the bidding of the Pope’s representative in NYC (before and )after 911, the Puppet Mueller was put into place to serve global fourth reich purpose of *financial Lebensraum* uber alles.

  14. Francois T

    Masterful refutation of Stewart’s drivel Yves! Thanks a lot!

    This post is why NC is a mandatory stop for me every day.
    I read Stewart’s article last night and I somehow knew it was utter bullshit; yet, I do not have Yves’s deep expertise to dissect the particulars and point to where the cockroaches are hiding.

    I have to admit it is sad to witness a financial writer as famed as Stewart to stoop so low.

    Sign of the times, I guess!

  15. Fraud Guy- Also

    In Stewart’s article, Khuzami is arguing that Cit has a good defense that they only “suggested” the contents of the CDO-squared. It seems to me that this is very much akin to a mafia don being tried for murder saying that he only “suggested” to his henchmen that they kill someone. The fact that mafia dons do get convicted in these scenarios suggests to me that juries are smart enough to look through these sham claims and understand that a power relationship and a cynical understanding of the law will cause an instruction to be phrased as a “suggestion”. I’m not saying that the SEC is sure to win at trial, just that they are likely to win most of the time with this kind of case, which is good enough.

    Also, what’s the deal with Khuzami giving an interview on the record about pending litigation? That is clearly contrary to policy across all levels of government. The fact that he got clearance to waive the policy in order to “get their side of the story out” shows just how shaken the agency is by Rakoff’s decision.

    1. psychohistorian

      The agency is shaken enough to have at least one SEC employee making harassment calls to folks (me) having asked them to do their job.

      I would sure like to see some perps in jail and their affiliated government co-conspirators out of work, permanently.

      It can’t happen soon enough.

    2. Greg R

      Yes, in much the same way, Khuzami only “asked” SEC Associate Enforcement Director Scott Friestad is he was ok in proceeding without fraud claims(that were initially included) against Citi CFO Gary Crittenden in this other Citigroup case.

      ‘On July 3, 2010, Khuzami sent an email to Friestad that weighed heavily in the IG’s evaluation of his conduct. It’s partly redacted but said, “Regardless of whatever miscommunications or strategy is behind what Larry or Mark told John,” Friestad should “confirm the [enforcement team] is OK [with a non-fraud deal for Crittenden].”‘


  16. barrij

    I’ve posted about “Gemstone” before, where surely the actions of DB staff flogging these “investments” rise to the level of criminal fraud, as the lawyers like to say. Does the SEC need to make a referral to DOJ for a criminal investigation to occur, or can Justice/Holder launch a probe on its own initiative? Not than that even has a remote chance of ever happening. Financial crime on an institutional and systemic level has now passed into the caveat emptor realm, not worthy of prosecution, as “proof of criminality” becomes inseparable from “best practices” in the financial industry.

  17. Fraud Guy

    Upon further reflection, I think that the reason Stewart wrote such a lopsided piece in favor of the SEC was because the agency essentially negotiated access to Khuzami in return for favorable reporting. The SEC was in a strong position in this negotiation precisely because they were proposing to waive their standing policy of not commenting on the record regarding pending litigation, which they could present as a major concession right out of the box.

    Of course, just like in the case of the Citi CDO-squared deal, there was no actual “agreement” as to the slant of the piece. It was merely a suggestion. However, Stewart and his editor understood the consequences of not accepting the “suggestion” would be very negative for future access to SEC officials, just as Credit Suisse understood that not taking Citi’s “suggestion” would be very negative for future business opportunities with them.

  18. kravitz

    Yes I knew Yves would rather thoroughly dissect Stewart. Should I feel guilty in having so much fun reading a column like this?

    Curiously, his piece got very little play or support over the weekend. I’m thinkin more folks agree with Judge Rakoff. But there seems to be a ‘let’s see how that now very pissed off bank responds to this’ vibe. Obama’s minions have to get results. And somehow it seems they plan to do it a little closer to November 2012.

  19. LeonovaBalletRusse

    Excellent Sleuth! You, the Sherlock Holmes of high finance.

    Will you be a witness for the prosecution? If so, got your food taster, security detail, *undisclosed location* as you give your deposition for use in trial, whether you live or die?

    Thank you for this great work for *We the People*.

    1. LeonovaBalletRusse

      Aaallright, Doc. The *suits in the middle* who arent’ Eton alums (notice the accent) are gonna be on OUR side? This is great news indeed. Thanks for the link.

  20. Oliver Budde

    Glad to see several people picking up on Stewart’s lame effort to spin this in favor of TBTP; I too was quite disappointed by the article. Stewart has done some good work in the past, which makes this effort of his all the more depressing. And this is not the first time he has come off as a lap dog either. For shame Jimmy; for shame.

    Yves rightly calls out Deutsche as a major CDO malefactor. And as the NYT pointed out a month ago, Deutsche is a serial violator of securities laws—no different from any other big bank of course.

    Deutsche’s lousy behavior and outright securities law violations since 2001 have occurred on the watch of Deutsche’s current general counsel, Dick Walker. Walker had come to Deutsche directly from the SEC, where he had spent ten years, the last three as SEC enforcement head, which is of course Khuzami’s current job. The circumstances of Walker’s move to Deutsche were less than exemplary. In 2001 SEC examiners had compiled a strong case of insider trading against Deutsche Bank, but in July of that year higher-ups in the enforcement division terminated the investigation, and ten weeks later Walker quit the SEC and went to work for Deutsche. (Matt Taibbi revealed this in RS in an 8/11 article.)

    Walker’s ties to Khuzami are interesting. Much of Deutsche’s bad behavior over the past decade occurred while Khuzami himself was there at Deutsche, as Yves pointed out, having been hired by Walker in 2004. And it is well known that Khuzami was recommended for his current job by Walker to SEC head Mary Shapiro (she of the $9 million goodbye gift from FINRA).

    What I find fascinating is that when Walker hired Khuzami into Deutsche in 2004 it was the second time he had given ol’ Bob a job. Twenty years earlier, in 1984, Walker gave Khuzami his first job as a lawyer, hiring him into the firm of Cadwalader, Wickersham & Taft. Walker began there in 1976, and he and Bob remained there together until 1991, when Walker went to the SEC and Khuzami went to the Manhattan US Attorney’s office.

    I happen to be an ex-Lehman Brothers attorney, so please allow me to now tie all this in to Lehman, a bit of unfinished business that I would guess most readers agree still needs attending to. When Khuzami was hired by the SEC in 2009, he was replaced at Deutsche by Joe Polizzotto, ex-general counsel of Lehman. As we all know, none of Lehman’s executives have yet been charged by Khuzami (or Preet Bharara, currently in charge of the Manhattan US Attorney’s office, where Khuzami had been before going to Deutsche). For Polizzotto, just like it was for Khuzami, it was the second time Dick Walker had taken him under his wing: Polizzotto too had gotten his first job from Walker and his partners at Cadwalader, and was there from 1980 to 1989.

    Polizzotto’s boss while at Lehman Brothers, Tom Russo, is now the top lawyer at AIG. Before joining Lehman in 1993 Russo was at—you guessed it—Cadwalader, where he worked from 1971 to 1975 and again from 1978 to 1993 (spending the time he wasn’t there, of course, at the SEC as well as at the CFTC). So Russo and Walker were together at Cadwalader from 1978 to 1991, with their younger charges Polizzotto and Khuzami overlapping with them there for several years each. In other words, four happy friends, going way, way back, and apparently still looking out for each other, watching each others’ backs. As I see it, the investments Walker and Russo made in Khuzami and Polizzotto are now paying off handsomely: Walker’s hiring of Lehman’s Polizzotto at Deutsche is a very elegant way of keeping Khuzami under control (if in fact it is even necessary), both as to Deutsche’s misdeeds and as to Lehman’s, and a very nice favor by Walker to his old pal Russo, who would be immediately blamed for as much as possible by Dick Fuld and his assorted henchmen if anyone were ever to bring the heat to Lehman.

    1. readerOfTeaLeaves

      I assume the strategy is for Khazumi to remain at SEC until the statutes of limitations run out? How long might that be?

    2. Ms. G

      Great, factually-rich, addendum Oliver. Precise anatomy of one chrony-capitalist “family.” One could probably apply this template of incestuous connections between DOJ/SEC/Banks/Insurance Companies/Other Finance/Insurance Regulators (Fed and State and Local) myriad-fold and pretty much cover the executive staff of all institutions and agencies concerned.

  21. LAS

    Great essay, Yves.

    It’s psychological warfare. We’re supposed to give-up on justice because of the hypnotic pr. [Compare this to the days when we were called upon as a people to put man on the moon. Now, the message is that we are a people that can’t possible do something actually quite close at hand.]

    The Peccora hearings almost did not occur, either. Despite calculated efforts otherwise, a man with integrity and energy happened into an position of sufficient authority to act.

  22. psychohistorian

    Thank you for your efforts on behalf of humanity yearning to see REAL rule of law and miscreants in jail.

  23. darms

    Yves, thanks again for your insight & analysis. The question I always think of when reading articles like this is “What would have happened had, in this case Citigroup, been caught selling marijuana?” In that case it’s likely they would have been in REAL Trouble.

  24. LeonovaBalletRusse

    Role of Bush Dynasty SEC and Justice Department still:

    “The BUSH family has had a longstanding interest in ensuring LOYALIST CONTROL of the SEC and the Justice Department to squelch special prosecutors and investigations–back in the late 1980’s, journalist Jonathan Kwitney wryly remarked on how the 1060-66 SEC filing for Bush’s Zapata Offshore corporation had been inadvertently destroyed in 1981. Then, in 2001, George W. Bush’s inauguration ushered in a new preoccupation with suppressing public access to the papers of former presidents and information on White House and departmental decision making. In November 2001, George W. Bush signed an executive order reestricting public access to the papers of former presidents, following up his earlier decision to ship his own Texas gubernatiorial papers off to his father’s president library at Texas A&M University, where they became INACCESSIBLE. Texas A&M is a second-string Texas University with close Bush ties. Its president is former CIA director Robert GATES, a Bush loyalist whom critics have sought to tie to the October Surprise, Iran-Contra, and Iraqgate alike.
    “Attorney General John Ashcroft, for his part, promulgated new restrictiions on what agencies must release under the Freedom of Information Act. Civil liberties lawyers complained that 9/11 was becoming an unwarranted cloak for secrecy. If national security was obviously involved, dynastic security had become a hidden new context.” (348)

    “Besides trumpeting ENRON-modeled electricity DEREGULATION in Texas, GEORGE W. [Bush] threw his support behind the company’s nationwide lobbying campaign to restructure and open up as many other states as possible. In 1997, Bush telephoned Pennsylvania governor TOM RIDGE to convince him that the state would benefit by letting ENRON and the marketers IN. Shorthly Thereafter, Pennsylvania DEREGULATED.

    “By the end of the 1990’s, the Houston firm had become a major political power in Texas and Washington alike. (161)

    “Indeed, the fruits of the larger reach of ENRON influence–donations to George W. Bush in 2000 by the Texas energy firm’s bankers, investors, insurerers, and accountants–were also juicy. (163)

    “When the election would up in the courts, [Ken] LAY doubtless breathed a sight of relief as the BUSHES called in the A-Team: JAMES A. BAKER III, the ex-secretary of state who had traveled tthe world for ENRON, and his long-time liuetenant, ROBERT ZOELLICK, also an ENRON advisor. Baker and Zoellick, sometimes called ‘Bakers’s Second Brain,’ earned their pay, and it was later revealed that ENRON had been a major contributor to funding the Republican support team in the Florida recount.” (163)

    [Unusual caps mine. Connect the dots above with SEC and Justice Department “dynastic secrecy” unto 2011. It’s about global DYNASTIC CONTROL of arms, energy, money, war–going back to Walker-Bush-Dulles-Sullivan and Cromwell involvement in “German” Third Reich dynastic profits from petro-chem-shipping-banking nexus before and during World War I. The same game continues today, with the same DNA].

    “AMERICAN DYNASTY: Aristocracy, Fortune, and the Politics of Deceit in the House of Bush” by Kevin Phillips (New York, VIKING Penguin, 2005).

    See also: “TRADING WITH THE ENEMY: The Nazi-American Money Plot 1933-1949” by Charles Higham (1983; New York, Barnes & Noble, 1995).

    Does the German banking connection surprise anyone?

  25. Dan G

    The Fraud is soo deep it hurts to think about it. Capitalism would experience peaks and troughs without leverage; with the leveraged derivative products they have literally bankrupt the world. It is a sad irony that the same leverage is being used to prolong the agony longer by debasing the currency and speculate on limited assets with unlimited fiat, inflating real value.
    Frank and Dodd should be ashamed of themselves for the millions they received in bank lobby money to keep the Ponzi going longer.
    I guess people will have to get real hungry before they revolt,

  26. Roger Bernard Houghton

    There are so many comments on this I regret I have not had time to read them all. If this has been said before, please excuse me.

    Commercial people don’t want their companies dragged through the courts as they will appear to be inveterate criminal organisations. Most of government supports that view but wishes to assert itself over the moneymen and avoid the broadening perception that the administration is itself under the control of ‘anything goes’ capitalists. The expedient adopted has been ‘plea bargaining.’

    The Treasury opposes these bargains but can hardly state its reasons publicly. It will stimulate and covertly support opposition by the Judiciary (we may see Judges being revalued soon). The judicial complaint is that people should not be punished unless they are convicted of something. The Constitution supports them.

    I think ‘plea bargaining’ is an extra-judicial attempt by the administration to get back into the driving seat of government.

    We have commercial men running embassies around the world as honorary ambassadors where USA Inc is still perceived as ‘yankee traders.’ Perhaps the logical alternative would be to amend the Constitution and put citizenship on a capitalist basis. The chap with, say $100,000 capital, gets a vote; the chap with a million gets ten, and so on. That makes the reality of the national situation more transparent.

    We can’t have it both ways, asserting on the ideological plane that we care about freedom and self-determination, whilst on the plane of reality we only care about the money and about getting everyone else in the same hole.

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