Judge Rejects Citi’s Efforts to Buy Justice


Judge Jed S. Rakoff stunned the SEC and Citigroup by rejecting their proposed $285 million settlement of a case involving Citigroup’s sale to investors of a CDO that Citigroup allegedly “built to fail” and bet against. The judge’s decision made a dent in the SEC’s longstanding policy (“hallowed by history, but not by reason”) of allowing defendants to settle without admitting to any of the underlying facts. Judge Rakoff ordered the parties to be ready to try the case on July 16, 2012.

According to the Court’s order, Citigroup allegedly created a billion-dollar CDO known as Class V Funding III (the “Fund”) “that allowed it to dump some dubious assets on misinformed investors ‘ by misrepresenting that the Fund’s assets were attractive investments rigorously selected by an independent investment adviser, whereas in fact Citigroup had arranged to include in the portfolio a substantial percentage of negatively projected assets and had then taken a short position in those very assets it had helped select. ‘ Having structured the Fund as a vehicle for unloading these dubious assets on unwitting investors ‘Citigroup realized net profits of around $160 million ‘whereas the investors as the S.E.C. later revealed, lost more than $700 million.”

Judge Rakoff’s primary reason for not approving the settlement was that it did not provide him with any facts (proven or admitted) to base his approval on, since Citigroup did not admit any of the SEC’s allegations. “[A]llowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations ‘ deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.”

The law requires that, in order to approve a proposed settlement, the court must determine that it is “fair, adequate, reasonable and in the public interest.” This is hornbook law that the SEC and Citigroup did not disagree with ? at least initially. In his Opinion and Order, however, Judge Rakoff pointedly noted that, after he had directed the parties to answer some questions he had about the proposed settlement (thereby signaling that he might not approve it), the SEC changed course and asked the Court not to consider the public interest! “[T]he public interest ‘ is not part of [the] applicable standard of judicial review,” argued the SEC. Judge Rakoff disagreed.

Perhaps seeing the Judge’s disagreement coming, the SEC next suggested that, “if the public interest must be taken into account, the [SEC] is the sole determiner of what is in the public interest in regard to Consent Judgments settling [SEC] cases.” Judge Rakoff found that “fall-back” argument to be unpersuasive as well. That is not the law, he said.

In determining whether a settlement is adequate, Judge Rakoff wrote, “the settlement must be adequate to ensure that the public interest is protected.” In determining whether the settlement is fair, it must be fair “to the parties and the public.”

A consent judgment that does not contain any admissions and results in only a modest penalty is not in the public interest. It is just a cost of doing business to a firm like Citigroup; that is the position taken by Citigroup, the judge wrote. The monetary penalty is mere “pocket change” to a firm like Citigroup that had revenues of $3.8 billion in one quarter alone, according to the Washington Post (“Judge Jed Rakoff courageously rejects SEC-Citigroup settlement,” by James Downie).

Judge Rakoff points out that Citigroup was able, without admitting any wrongdoing, to get the SEC to (i) only charge it with negligence (even though it charged Citigroup with intentional wrongdoing in a related case), (ii) enjoin Citigroup (“a recidivist” lawbreaker) to not violate the securities laws any more, knowing the SEC had not enforced such an injunction in 10 years, and (iii) impose inexpensive preventative steps for three years. That’s a great deal if the SEC’s charges are true, and not bad even if they are not true, said the judge, since for a very modest cost it gets rid of four-year, broad investigation into all of Citigroup’s mortgage-backed securities activities.

It is harder to see what the SEC is getting out of it, wrote Judge Rakoff, “other than a quick headline.”

Most damning of all, Judge Rakoff took the SEC down for falsely claiming to protect investors. “While the [SEC] claims that it is devoted, not just to 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 [SEC] to returning any of the total $285 million obtained from Citigroup to the defrauded investors but only suggests that the [SEC] ‘may’ do so. Even worse, it “still leaves the defrauded investors substantially short-changed” [they lost over $700 million in this one CDO] and wipes out any potential benefit to litigants by inserting the “neither admits nor denies” language.

The most important defect of the proposed settlement is that it hides the truth. In Judge Rakoff’s words: “Finally, in 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 fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”

Page Perry commends the courage and wisdom of what was clearly a very difficult decision for any judge to make. Page Perry is an Atlanta-based law firm with over 170 years collective experience protecting investor rights and fighting Wall Street greed.