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The odds that Citigroup's $285 million securities settlement with the Securities and Exchange Commission would avoid the courtroom of Judge Jed Rakoff were 97%. Citi's luck was not good.
November 4
Federal Judge Jed Rakoff held a hearing on a proposed $285 million settlement between the Securities and Exchange Commission and Citigroup Wednesday afternoon in which he had a lawyer for the government squirming.
Rakoff, a U.S. District Court Judge for the Southern District of New York, called the hearing to give the parties an opportunity to respond to questions he had previously raised about their proposed settlement. The high-profile case involves allegations that Citi defrauded investors in a collateralized debt obligation that it had structured during the housing boom. Specifically the SEC charged that a low-level Citi employee "neglected" to put wording into disclosure documents that described Citi's role in the CDO deal. Citi both selected the collateral and bet against it.
Rakoff began the hearing by attacking the SEC's assertion that it was inappropriate for the judge to consider whether the settlement was in the public interest. He also cast doubt on the value of a settlement that recovers only a "fraction" of investors' prior losses and fails to establish guilt.
"Why is [no admission of liability] a sensible way to go instead of establishing what the facts are?" Rakoff asked the SEC. "Last time I checked, anyone can make an allegation."
In particular, Rakoff cited the lack of an admission of guilt as hindering the very private litigation the SEC is supposed to encourage.
"Why would you require private parties to re-prove what you believe you can already prove?" Rakoff asked. "Does not the SEC of all agencies have an interest in establishing what the truth is?"
He also suggested the punitive fine of $95 million was an insufficient deterrent.
"I won't get cute and ask what portion of Citi's net worth $95 million represents because I don't have a microscope with me," the judge quipped.
He went on to question the SEC's seriousness in enforcing injunctions in previous settlements like the one it's currently seeking.
"Why are you asking for an injunction when you never intend to use them?" he asked Matthew Martens, the SEC's chief litigation counsel.
Martens generally stayed away from elaborating on the details of the SEC's case during the hearing. But he hinted that the case had its limits. While he acknowledged that the SEC had substantial evidence that the assets in the Citi CDO "had been adversely selected" and that this had not been disclosed to investors, he suggested that holding higher-level individuals at Citi responsible was not easy.
"The problem is identifying an individual who was [both aware of Citi's plans to short the deal] and was involved in the disclosure process," he said.
When Rakoff turned his attention to Brad Karp, Citigroup's counsel, the judge questioned how the injunction and accompanying requirements would prevent future violations of the securities laws. Karp argued that provisions of the settlement would require Citi's employees to meticulously sign off on what disclosure they had reviewed, and require that the a log of such actions be audited.
Karp also said that Rakoff should consider the time frame in which the alleged misconduct occurred, and noted that much of the bank's leadership and fixed income staff has since been replaced.
"Citi's policies and procedures have been totally overhauled," he said, adding that the bank's poor decision to build a heavy exposure to CDOs cost it $30 billion.
Rakoff deferred to a later date a ruling on whether to accept the proposed settlement. The judge appeared to enjoy the attention the case had drawn, in part because of the presumption that he would aggressively challenge the attorneys over some of the settlement's provisions.
"I'm reminded of Humphrey Bogart in Casablanca," he said at the start of the hearing. "Of all the joints in the world, you chose to come here."
