Judge Jed S. Rakoff of the Federal District Court in Manhattan is my new hero. He’s overseeing a proposed settlement between Citigroup and the SEC over Citigroup’s practice of selling crap mortgage derivatives products to unwitting clients, thereby stealing about $700 million. The SEC wants to slap them with a penalty that would include “$160 million in disgorged profits, a $95 million penalty and $30 million in interest.” In other words, their “penalty would let them walk away with a $400 million profit. The judge wondered why he should approve such theft.
On Wednesday, the judge homed in on the issue of banks who settle with the S.E.C. and pledge to not violate the securities laws, yet repeatedly do so. Why then, Judge Rakoff asked, had the commission not brought any contempt charges against large financial firms in the past 10 years?
Mr. Martens, the S.E.C. lawyer, said that the agency felt that there were better and more appropriate ways to deal with chronic misconduct. The S.E.C. has said that striking settlements is often preferable to a costly and protracted lawsuit that it might lose.
Judge Rakoff called the contempt power — a judge’s ability to punish a party for disobeying a court order — “the backbone of the judiciary.” He questioned whether the S.E.C. was really serious about ever seeking an injunction against repeat offenders.
“It’s just for show,” Judge Rakoff said.
“We’re not saying that we will never use injunctive relief,” said the S.E.C. lawyer.
“Hope springs eternal,” the judge replied.
The S.E.C.’s current enforcement action against Citigroup is at least the fifth time that the commission has reached a settlement with the bank related to civil fraud accusations.
Citigroup’s main brokerage subsidiary, its predecessors or its parent company has agreed to not violate the antifraud laws in prior settlements with the S.E.C. dating as far back as April 2000.
A Citigroup spokesman said that “there is no basis for any assertion that Citi has violated the terms” of any agreement with the S.E.C.
After being slow to enter the subprime mortgage loan packaging business, Citigroup plunged headfirst just as the housing boom neared its peak. When the market melted down, Citigroup was saddled with more than $30 billion in losses and ultimately needed two federal bailouts.
The bank also found itself in the crosshairs of securities regulators and Congressional investigators, as well as the target of large private investor lawsuits.
It is unclear whether Judge Rakoff will allow the bank to resolve this case under its current settlement terms. On Wednesday, the judge criticized the $95 million penalty against the bank, pointing out that the S.E.C. estimated investors’ total losses on the mortgage deal at $700 million.
“So the net effect of this is that you’re only returning a small fraction of what the investors lost, yes?” Judge Rakoff asked the S.E.C. lawyer.
Later in the hearing, the judge teased Brad S. Karp, the lawyer for Citigroup, about the penalty amount.
“I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me.”
Obviously, there is some value in avoiding the costs of extended litigation that the SEC could potentially lose, but it seems like the minimum penalty should at least match the value of the money their clients lost. This deal only goes about halfway towards doing that.
This reminds me of a recent conversation between Rep. Joe Walsh (R-Deadbeat Dad) and one of his smart progressive constituents.
