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N.Y. Judge Rejects SEC’s $285M Deal With Citigroup as ‘Unfair, Unreasonable’

November 28, 2011 at 12:00 AM EST
A federal judge on Monday rejected a settlement between the Securities and Exchange Commission and Citigroup over mortgage deals dating back to the housing bust and the financial crisis. Ray Suarez discusses the latest developments with Edward Wyatt of The New York Times and Jacob Frenkel of Shulman Rogers Gandal Pordy & Ecker.
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JUDY WOODRUFF: Now, a federal judge rejects a settlement between the government and a major Wall Street bank over mortgage deals dating back to the housing bust and the financial crisis.

Ray Suarez has the story.

RAY SUAREZ: Citigroup and the Securities and Exchange Commission had sought court approval for a $285 million settlement. The settlement was reached after the SEC accused Citi of failing to disclose to investors that it was betting against a billion-dollar subprime mortgage investment.

But today, U.S. District Court Judge Jed Rakoff in New York rejected the deal with pointed criticism, saying it was neither fair, nor reasonable, nor adequate in the public interest. Rakoff was also critical since Citigroup didn’t acknowledge fault.

The judge wrote that he could not approve it because, “The court has not been provided with any proven or admitted facts upon which to exercise a modest degree of independent judgment.”

The SEC disagreed strongly with his ruling, an order that may have significant implications.

We get more on all this with Edward Wyatt of The New York Times and Jacob Frenkel, a former federal prosecutor and former SEC enforcement lawyer who’s now in private practice at Shulman Rogers.

Edward Wyatt, let’s start with you.

Explain the machinery here. Why did Judge Rakoff have to sign off on this deal in the first place once it was negotiated between the erring bank and a regulator?

EDWARD WYATT, The New York Times: Well, the SEC brought the case in federal district court. And it was asking for an injunction which would prevent Citigroup from violating the securities laws again.

And because of that and because it’s a federal agency, it had to get a judge’s approval for the decision. Now, Judge Rakoff has been a frequent critic of the SEC in these types of settlements. And he has raised points in rejecting settlements before, saying that the SEC wasn’t being strong enough and it wasn’t proving anything to him.

And that’s what he said here: There’s no way that I can tell that Citigroup actually did these things. And, therefore, I don’t have any basis to judge whether this settlement is in the public interest.

RAY SUAREZ: Even on the occasion when a settlement is rejected by a federal court, is it rebuffed with this kind of thoroughness and this kind of language?

EDWARD WYATT: Well, certainly, when Judge Rakoff rejected a settlement with Bank of America over its acquisition of Merrill Lynch and not telling shareholders about certain things that it knew about Merrill Lynch beforehand, he has used very pointed language and has raised questions about particularly the aspect of the settlement in which the company neither admits nor denies the charges.

This is a typical SEC settlement. It allows companies to do this because it’s a way to get a settlement and avoid a trial that would be very expensive for the SEC and beneficial to a company that has deep pockets like Citigroup or Goldman Sachs.

RAY SUAREZ: Jacob Frenkel, this is a world you know well. What did you see in the 15-page order entered today by Judge Rakoff?

JACOB FRENKEL, former Securities and Exchange Commission enforcement lawyer: What I really saw was Judge Rakoff saying to the SEC and really to Citigroup as well, you didn’t tell me, the judge, enough for me to be able to sign off on the settlement, because this practice of the SEC settling cases without admitting or denying allegations, although Judge Rakoff certainly did criticize that methodology, the fact is that it’s very important for the SEC and really for the federal judiciary from a program perspective because this is an agency that brings hundreds upon hundreds of cases every year and settles most of those cases before they’re brought.

I think really what the judge was responding to was the SEC’s brief in which it basically said, well, we think this is a fair settlement, so take our word for it. And the judge is saying, no, I have a duty to the American public to look deeper, to look beyond.

There’s plenty of language in there that suggests to me that the exact settlement terms that were agreed on between Citigroup and the SEC are the terms that he ultimately will accept if he gets the additional information that he is looking for from both parties.

RAY SUAREZ: So, Judge Rakoff is reacting to the structure, the way these things are done, rather than the particulars of the deal that the SEC struck with Citigroup?

JACOB FRENKEL: Well, I think what he wants to be able to do is to kick the tires. He was talking about accountability and transparency. And he wants to make certain that this is a fair settlement for the American public, because, again, the SEC — the SEC’s responsibility in bringing a case relates to the integrity of the markets.

They’re not representing a private plaintiff alleging monetary damages. What they’re basically saying here is we believe that an institution, a prominent institution violated certain provisions of the federal securities laws, and, after investigating, determining that it was appropriate to bring a case, what they have done is, they have agreed on a compromise of that case.

And that’s exactly what was put in front of the judge. And the judge is saying, I really need to know more about what is underlying this case in order to sign off on this agreed resolution.

RAY SUAREZ: Edward Wyatt, again and again, Judge Rakoff returned to the opaque nature of the deal between the bank and the regulator, and also that lack of admission of guilt.

But if you were to go for guilt either in court or for an admission from the company, would the SEC be able to bring as many actions or would each one be slower, just of necessity?

EDWARD WYATT: Well, the SEC says that it would be able to bring far fewer actions because of the cost in manpower of taking a case to court, that it couldn’t bring anywhere near the number of cases that it brings now.

But what Judge Rakoff has done is said the public needs to be able to tell whether or not Citigroup in this case did these things. And he goes even further in making a point about the separation of powers between the judiciary and the executive branch, saying, you can’t just come to a judge and ask them to rubber-stamp your decision. The potential for abuse is rampant there that the executive branch could punish people without providing any real evidence. And I, as a judge, am not going to say, yes, I approve this unless you give real proof that there is something here that was done wrong.

RAY SUAREZ: Jacob Frenkel, what do you make of that point? Judge Rakoff says, in effect, don’t try to make me the enforcer of something that you won’t let me know what’s inside it.

JACOB FRENKEL: Well, I think that’s exactly the point, but also I think, to the question you just posed to Edward, is 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.

It would take away the incentive of any party accused by the SEC to settle. So I really do think that it would be an undue burden on the federal courts. And I think one of the things that the SEC would do ultimately would consider bringing these cases in an administrative forum, which would mean probably the need to add 30 administrative law judges, which is why, ultimately, I truly believe that this is a settlement that will be accepted once the judge is satisfied about the underlying basis for the settlement as proposed.

RAY SUAREZ: Adding how much to the timeline? How long before we know how this all ends up?

JACOB FRENKEL: Well, I think a lot of this may play out behind the scenes, in other words, not in open court.

I mean, I think within the next four to six weeks, although we’re coming up on the holidays, you know, it could be early January, but I don’t think it will be that long before it resolves.

RAY SUAREZ: Jacob Frenkel, Edward Wyatt, gentlemen, thank you both.

JACOB FRENKEL: Thank you.