Is the SEC Selectively Enforcing the Securities Laws?


Reuters blogger Felix Salmon seems to see evidence of the SEC colluding with banks to let them off the hook for most of their “built to fail” synthetic (derivatives-based) CDOs (see “Is the SEC colluding with banks on CDO prosecutions?”). What has raised eyebrows was an email from a Citigroup spokesperson saying that Citigroup has settled all its potential liabilities with the SEC by agreeing to pay $285 million in a case involving a single collateralized debt obligation (CDO) transaction (i.e., Class V Funding III). According to this email, Citigroup believes “the SEC has completed its CDO investigation(s) of Citi” and will not be examining any of the dozens of similar CDO deals.

While the SEC denies it, it has “the ring of truth” to Mr. Salmon. There were many other CDO deals in which “someone other than the ostensible CDO manager was intimately involved in choosing the contents and had a vested interest in picking securities which were extremely likely to fail,” according to the article. It would save the under-resourced SEC from the trouble and expense of multiple litigations against Citigroup involving the similar transactions. If it is true, there is a certain logic to it.

It is also a scandal if it is true, says Salmon. He points out that investors in Class V Funding III deal will be compensated while investors in other CDO deals, who were damages by the same type of misconduct (i.e., the nondisclosure that the short side of the trade had played a role in selecting the underlying assets), will not be compensated, if the SEC does not pursue those cases.

The SEC does not prosecute criminal actions, but refers certain of its civil cases to the U.S. Department of Justice for possible criminal prosecution. With that clarification, Salmon concludes: “Is the SEC trying to protect the banks it’s meant to be prosecuting? Is it quietly agreeing on a one-prosecution-per-bank model? If so, we should be told. And if not, it had better bring prosecution #2 against someone pretty soon. Because right now the pattern is decidedly fishy.

Judges who have been asked to approve proposed settlements between the SEC and Bank of America and Citigroup have questioned and refused to approve them as they were initially presented. U.S. District Court Judge Jed Rakoff rejected a $33 million agreement between the SEC and BofA, questioning why officers and directors had not been sued. Judge Rakoff later approved a $150 million settlement.

Similarly, U.S. District Court Judge Ellen Huvelle, reviewing a proposed $75 million settlement between the SEC and Citigroup regarding Citi’s misleading investors about its subprime exposure, observed: “These things don’t happen without individuals.”

Others have also criticized the SEC for not suing members of senior management. According to Duke University securities law professor James Cox, that failure is particularly noticeable in cases involving CDOs.

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