After federal district court judge Jed Rakoff “forcefully rejected” a $285 million settlement between the SEC and Citigroup, Susan Beck bravely decided to read the prospectus for the Class V Funding III CDO at the center of the controversy, in order to see the disclosures that Citigroup says are adequate. What she found was a “brain-scrambling, obfuscating collection of words.” (“Susan Beck’s Summary Judgment: The Problem with Citi’s Disclosure Argument,” AmericanLawyer.com).
The SEC had accused Citigroup of failing to disclose to investors in the CDO that it had a role in selecting one-half of the $1 billion of assets in the deal and then bet against some of them. The investors lost $700 million while Citigroup made $160 million on the deal. Citigroup argued that its disclosures to investors were adequate, given that the investors were “sophisticated.”
Ms. Beck related how New York Times columnist James B. Stewart had read the documents and had spoken with SEC Chief Robert Khuzami, and come to the conclusion that the offering materials may have included enough information about Citi’s role to meet its legal obligations. An admirer of Stewart, Ms. Beck decided to curl up with the prospectus and a cup of cocoa to see for herself. She did so, and here is her reaction:
“Holy liverwurst on a cracker! If Stewart read the prospectus in its entirety, he’s got a lot more stamina and journalistic dedication than I do. ‘ [I]magine reading 209 pages of this brain-scrambling, obfuscating collection of words.”
The only thing clear about the prospectus, Ms. Beck concluded, is that it was designed to provide legal cover, not to inform.
According to Stewart, the informative language states that the bank “may be expected to have interests that are adverse” to buyers. Ms. Beck writes:
“It’s true, the offering document does say this?on page 46, in the midst of an 8,600-word paragraph that begins on page 40 and ends on page 51. The disclosure is buried in an avalanche of tortured legalese. Here’s my idea of adequate disclosure: ‘Citigroup will play a role in selecting the assets that go into the CDO’s portfolio, and may bet against these assets.’ In bold print. At the top of the offering document.”
Instead, Citigroup misled the investors by stating that the portfolio’s composition would be “determined by” Credit Suisse Alternative Capital. This raises a number of questions, according to Ms. Beck, such as:
How did Citi and Credit Suisse interact in selecting the assets? Were the Credit Suisse employees dominated by the Citi employees? Did they have incentives to go along with Citi’s “suggestions?” Were the Credit Suisse employees aware that Citi might bet against some of the assets?
Judge Rakoff’s primary reason for rejecting the settlement was that he did not have any facts before him to do what he is required by law to do?determine whether the settlement is in the public interest. “[W]e need answers to questions like these before we can decide whether the SEC settlement is in the public interest,” Ms. Beck concludes, “And I imagine that these are just the kinds of answers that Judge Rakoff wants too.”
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