The Citi-SEC ruling’s unintended consequences

By rejecting a settlement between Citigroup and the SEC, a Federal judge seems to have struck a blow for transparency and investor protection. But the ruling could backfire.

By The Fiscal Times Nov 29, 2011 6:53PM

By  Suzanne McGee

Maybe the Occupy Wall Street movement is making everyone just a little bit more thoughtful about the roles and responsibilities of both the financial services industry and its regulators toward investors.


At least, that’s one possible conclusion we can draw from the unexpected decision by Judge Jed Rakoff, of the  Federal District Court judge for the Southern District of New York, to nix the proposed $285 million settlement between the Securities & Exchange Commission (SEC) and Citigroup over allegations that the bank didn’t disclose to investors that it was involved in selecting investments for a mortgage-bond investment pool -- as it continued to sell those investments short.


It’s long been the custom for the SEC and its targets to hammer out deals behind closed doors in which the banks or other offending parties agree to pony up big sums to settle allegations -- without either admitting or denying those allegations. It’s also been the tradition for judges to rubber-stamp said deals.


Everyone, it seems, has been reluctant to air the complex details of the transactions underpinning SEC charges: regulators worry about the difficulty of getting a jury that grasps the details while the banks worry that publicly parading the charges will result in more mud being flung around, some of which will stick. Besides, why not settle if you don’t have to admit you did anything wrong.


In the new world that Judge Rakoff envisages, that’s just not acceptable. "In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives," he wrote in the ruling tossing out the Citigroup settlement, "there is an overriding public interest in knowing the truth."


Without an admission on the part of Citigroup (C) -- or any other institution targeted in a regulatory investigation -- the truth of the matter remains unknown. It doesn’t matter that Citigroup agreed to fork over a sum of money. What matters is why. Thus, Rakoff wrote, the quid pro quo at the heart of countless SEC settlements "serves no lawful or moral purpose and is simply an engine of oppression."

Now, everyone in the financial markets knows what lies behind the wording of a settlement in which a target agrees to cough up millions of dollars to make regulatory offenses go away, even while neither admitting nor denying the charges. Wink, wink, nudge, nudge. But Rakoff wants to go beyond that and hold financial institutions truly liable for their actions and -- sometimes --their inaction. That kind of stand is not going to win the judge many fans either in Washington or on Wall Street, where neither admitting nor denying wrongdoing is a cozy little game.

But it’s hard not to wonder what the unintended consequences of not allowing Wall Street institutions to save face in this way may prove to be. For instance, the SEC may be more selective in the kind of investigations it undertakes, knowing that some will be extremely hard to prosecute in the courts and that the Goldman Sachs (GS) of the world are unlikely ever to agree to admit culpability, and thus throw open the door to scores of civil suits from counterparties or clients who feel aggrieved.

Will settling fewer cases in this traditional "out of court" manner be in the best long-term interests of investors, even if it enhances transparency? It has been hard enough to get to the bottom of some of the problems that undermine the relationships between investment banks and their clients. Moving from a situation where both sides have a vested interest in settling these cases to one where both anticipate the result of pursuing a case to be nothing but trouble is a worrying scenario.

As the sages have said, sometimes the quest for the perfect outcome is the enemy of the solution (that may just be good enough to live with).

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Nov 30, 2011 1:49AM

Thx Judge Rakoff!! It's about time the good ol' boy game of making a billion and paying a million in fines is called into question. This standard practice has made a fool of us all long enough.

It's time Republicans, Democrats and Independents unite to bring down these crooks and start holding them accountable.  


Nov 29, 2011 11:49PM

“Maybe the Occupy Wall Street movement is making everyone just a little bit more thoughtful about the roles and responsibilities of both the financial services industry and its regulators toward investors.”


Isn’t it about time? How is this for unintended consequences? Fear of exposure and later reprisal from the grass roots causes the investment bankers to change their behavior? Isn’t that what regulations and regulatory agencies are supposed to be doing? Promoting good behavior by discouraging bad behavior with punitive damages? What a novel concept?


It is pretty common practice for corporations to make financial calculations in regards to potential law suites. They weigh out the risk rewards of bad behavior and ignore the rules when the payoff exceeds the costs, and then there are the rewards when not getting caught. It is just “good business”. Although, I doubt the victims of their externality would agree.


Hypothetically, if investment bankers can screw investor out of $200 million it is well worth paying the SEC $20 million dollar settlements for the privilege. Is it not the purpose of the SEC to stop the behavior in the first place with fear of punitive damages? These kinds of practices seem to encourage not discourage externality.


To discourage the behavior shouldn’t the settlement be $500 million even if it puts the offender out of business? Making the investor whole and funding further prosecution with punitive rewards seems prudent. Letting the SEC keep the difference would also encourage spirited enforcement.


I can’t help but notice that the amounts of the investor losses are not mentioned in these types of press releases. The press should be demanding at least that much or casting doubt that justice was served. Suzanne, keep up the good work. How else is the public going to gage how good the regulators are doing and put pressure on law makers to make changes?


I hear the Wall Street types defending this settlement practice without full disclosure stating that the tax payer is served because the practice saves court costs. To the American people who are the real victims, this reeks of the preferential treatment that leads to “Super Class Status”. The government spends hundred of thousands to collect $200 with penalties and assessments from common citizens. All men are apparently not created equal? Some are more equal then others like those who have the resources to keep law firms on retainer to handle the current nuisance claim system they set up for themselves. Wink Wink nod nod here is your slap on the wrists and you may keep your gains. In the eyes of the public, this practice is currently casting doubt on the SEC’s reputation and its ability as a legitimate regulator.  


I'm not even remotely concerned about the SEC becoming more lax in its enforcement efforts, not with the occupy folks looking for hanging trees in local parks. Judge Jed Rakoff better watch his step or he may become a grass roots folk hero. The head line could start reading Hanging Judge Jed Rakoff rejects yet another sweet deal.


Excellent Article.

Nov 30, 2011 2:30PM
"Everyone, it seems, has been reluctant to air the complex details of the transactions underpinning SEC charges: regulators worry about the difficulty of getting a jury that grasps the details"

This article could be titled "How to Control the Ignorant Masses". While allowing education to become unaffordable; the "elite', make our decisions for us... behind closed doors. The government has a more than adequate database.  I am sure there would be no problem selecting jury members with appropriate educational backgrounds. Modify Jury rules if necessary. This is a matter of national importance and "peers" should at least understand the issues they are being asked to contemplate.

While we are making changes; how about looking into the ridiculous salaries being paid to some of the upper management at our local Colleges and Universities. Fire the top 3% of management, and perhaps we will all be able to afford an education and "self" govern. It is unbelievable to me that the University of Washington is allowed to publicly admit that they limit local attendance in favor of out of state students, because out of state students pay more. This is a disgrace, and the root cause of many of our national issues; the only way out of our current crisis in the long term,  is through mass education.
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