In October, the Securities and Exchange Commission filed a Complaint against Citigroup Global Markets, Inc., accusing Citigroup of substantial securities fraud. This was based on Citigroup’s creation of a billion-dollar fund used to dump some dubious assets on misinformed investors. These “assets” were mortgage-backed securities that Citigroup was trying to sell to investors while the company had taken a short position itself on the same investments. Citigroup made profits of around $160 million on this Fund while, according to the SEC, investors lost more than $700 million. Simultaneously with the filing of its Complaint, a proposed consent judgment was jointly filed by Citigroup and the SEC agreeing to settle the claims. The Consent Judgment requested District Judge Rakoff of the Southern District of New York to approve the following:

• permanently restrained and enjoined Citigroup and its agents, employees, etc., from future violations of Sections l7(a) (2) and (3) of the Securities Act,

• required Citigroup to disgorge to the S.E.C. Citigroup’s $160 million in profits, plus $30 million in interest thereon, and to pay to the S.E.C. a civil penalty in the amount of $95 million, and

• required Citigroup to undertake for a period of three years, subject to enforcement by the Court, certain internal measures designed to prevent recurrences of the securities fraud here perpetrated.

The Court refused to approve the proposed Consent Judgment, rather than rubber stamp it, as is done quite often in this type settlement. Judge Rakoff’s opinion focused a spot light on what he clearly sees as the SEC’s lack of true enforcement. In most all SEC Consent Judgments the Defendant is not required to admit any wrongdoing and the fine is just chalked up as a cost of doing business. Judge Rakoff stated:

As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup’s position in this very case.

The opinion goes further and calls out the entire practice of accepting settlements without any admissions as basically a “bankrupt approach to regulation.” It was stated by Judge Rakoff in his ruling:

Of course, the policy of accepting settlements without any admissions serves various narrow interests of the parties. In this case, for example, Citigroup was able, without admitting anything, to negotiate a settlement that (a) charges it only with negligence, (b) results in a very modest penalty, (c) imposes the kind of injunctive relief that Citigroup (a recidivist) knew that the S.E.C. had not sought to enforce against any financial institution for at least the last 10 years, and (d) imposes relatively inexpensive prophylactic measures for the next three years. In exchange, Citigroup not only settles what it states was a broad-ranging four-year investigation by the S.E.C. of Citigroup’s mortgage-backed securities offerings, but also avoids any investors’ relying in any respect on the S.E.C. Consent Judgment in seeking return of their losses. If the allegations of the Complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business.

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. By the S.E.C.’s own account, Citigroup is a recidivist, and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup. While the S.E.C. claims that it is devoted, not just to the protection of investors but also to helping them recover their losses, the proposed Consent Judgment, in the form submitted to the Court, does not commit the S.E.C. to returning any of the total of $285 million obtained from Citigroup to the defrauded investors but only suggests that the S.E.C. “may” do so. In any event, this still leaves the defrauded investors substantially short-changed. . .

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts – cold, hard, solid facts, established either by admissions or by trials – it serves no lawful or moral purpose and is simply an engine of oppression.

[I]n 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 it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.

Judge Rakoff summarized his holding quite well, leaving no doubt as to how he viewed the proposed deal, writing:

The Court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, nor in the public interest. Most fundamentally, this is because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards. Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint. But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.

The court’s refusal to approve the Consent Judgment has made some rather strange bedfellows. Both Citigroup and the SEC have appealed the court’s ruling. The Second Circuit has stayed proceedings at the District Court level pending the outcome of the appeal. Whatever the outcome, lawyers in our own firm who handle these cases are hopeful that this opinion will curtail the perceived practice of agencies settling with wrongdoers on a cost of doing business basis and without any real thought as to the recovery for wronged investors. If you need additional information on this opinion or the subject generally, contact Scarlette Tuley, a lawyer in our Consumer Fraud Section, at 800-898-2304 or by email at Scarlette.Tuley@beasleyallen.com.