Moral Low Ground

Economy

‘The Moral High Ground’: Federal Judge Jed Rakoff Tosses Proposed $285 Million SEC- Citigroup Settlement

A federal judge in New York has rejected a $285 million settlement between the Securities and Exchange Commission (SEC) and financial services giant Citigroup Monday, a bold move that places the regulatory agency and the companies it is supposed to be regulating on notice that they may face future difficulties when attempting to reach settlements that allow banks to pay token fines without admitting to any wrongdoing.

A courageous ruling. (Photo: Rick Kopstein)

The 15-page ruling by Judge Jed S. Rakoff of the U.S. District Court in Manhattan is being widely hailed as a game-changer that could force the SEC to get serious about enforcing financial regulations.

Judge Rakoff’s courageous ruling said that he could not determine whether the proposed settlement was “fair, reasonable, adequate and in the public interest” because the SEC failed to prove that Citigroup had committed fraud as claimed. The SEC alleges that Citigroup intentionally sold a billion dollars worth of mortgage securities to investors in 2007 that the bank was betting against, enabling it to profit handsomely when the fund’s value plummeted. The deal earned Citigroup a $160 million profit; investors lost a whopping $700 million. According to the SEC, the fraud occurred when Citigroup lied to investors, telling them that an independent entity was picking the securities in the fund.

Rakoff also attacked the SEC’s “long-standing policy, hallowed by history but not by reason” of permitting settlements in which the offending financial institutions aren’t required to admit any wrongdoing. The judge said that the SEC “has a duty, inherent in its statutory mission, to see that the truth emerges.” He also slammed settlements amounts, even the $285 million in this case, as “pocket change to any entity as large as Citigroup.”

SEC enforcement director Robert Khuzami released a statement decrying the ruling and arguing that the proposed Citigroup settlement “reasonably reflects the scope of relief that would be obtained after a successful trial.” The decision, he said, “ignores decades of established practice throughout federal agencies and decisions of the federal courts.”

But it is exactly that history that needs to be corrected if the SEC is to regain credibility as a legitimate regulatory body and not just a toothless accomplice of Wall Street criminals.

The SEC has not yet announced whether or not it will appeal the decision; Judge Rakoff has set a trial date for July, 2012.

As for Citigroup, Edward Skyler, a spokesman for the megabank, spoke in favor of the scuttled settlement. “We believe the proposed settlement is a fair and reasonable resolution to the SEC’s allegation of negligence, which relates to a five-year-old  transaction,” he said in a statement. “We also believe the settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges.”

But Judge Rakoff called Citigroup a repeat offender which has previously settled fraud cases without admitting to any wrongdoing. The bank has repeatedly agreed to follow the law after such settlements, but knowing that contempt charges are a rare animal (they haven’t been filed against repeat offenders in more than ten years), it is easy for banks to agree to and then violate the SEC’s terms.

A New York Times investigation found that 19 companies broke fraud laws that they agreed never to violate again– 51 times.

Clearly, Judge Rakoff’s ruling is a major step in the right direction. Being located in Lower Manhattan, his court has jurisdiction over Wall Street. The SEC and financial services firms will at least have to pretend as if they’re on the level from now on. It’s far too early to predict what long-term impact Rakoff’s decision will have, but the fact that such a ruling happened is cause for celebration.

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