If the SEC really wanted to reduce the chances of embarrassing itself, besides better Internet monitoring software it really ought to look into filing securities lawsuits outside of New York. Every bank is incorporated in Delaware and does all of its activities everywhere – surely they could find a CDO investor in California. But the SEC keeps suing in New York, they keep drawing Judge Rakoff in the suspiciously random assignment system, and he always goes and does this:

A federal judge has raised questions about why he should approve the government’s $285 million civil settlement with Citigroup, suggesting that he is skeptical of the pact. … He posed nine questions to the parties, including how a fraud of this nature and magnitude could be the result simply of negligence. The judge also asked why the court should approve a settlement in a case in which the S.E.C. alleged a serious fraud but the defendant neither admits nor denies wrongdoing.

They’re good questions, including “Why … is the penalty in this case less than one-fifth* of the $535 million penalty assessed in SEC v. Goldman Sachs … ?” And you do get the sense that most other judges wouldn’t have bothered with them and would skip straight to “wow, that’s a lot of money, willing buyer willing seller, I’ll approve the settlement.”

That would be … kind of fine, right? Willing buyer willing seller. Except that the SEC has mostly operated in kind of a vacuum in these CDO-fraud cases. If nothing else, these cases should be an absolute bonanza for (lawyers for) all of the investors who lost money on the CDOs that no one likes any more. There’s a private Abacus lawsuit but it seems like no biggie, and no one seems to have sued any banks in advance of SEC actions. The takeaway may be that private securities class action lawyers, normally quite entrepreneurial, aren’t about to wade through CDO docs and are waiting for the SEC to do the work. But the SEC’s work is focused on dumb-ass emails, so it’s not exactly kickstarting a deluge of lawsuits.

Given the general lack of interest elsewhere in doing anything (other than making signs) about these CDO cases, you could forgive the SEC – and the banks – for thinking that CDO fraud settlements are just NBD bilateral negotiations, where nobody is really all that convinced that the deals were that bad, but where they settle to give everyone a small win and get it out of the way. The injection of the rule of law into this process, in the form of Judge Rakoff, will be pretty jarring for the SEC, and may make things a lot messier.

Citi should have mixed feelings about this, since the judge’s questions suggest that he’s not in my “what’s the big deal” camp on CDO shenanigans (e.g. “How can a securities fraud of this nature and magnitude be the result simply of negligence?”). But on the bright side (?), he’s looking out for Citi shareholders:

Why is the penalty in this case to be paid in large part by Citigroup and its shareholders rather than by the “culpable individual offenders acting for the corporation?” … If the S.E.C. was for the most part unable to identify such alleged offenders, why was this?

Sort of a fair question, although here Citi really did make something like $160mm on its prop short position in the CDO, which in theory accrued to Citi shareholders before being washed out by comp/huge losses elsewhere. Punishing one set of suckers who invested with Citi in order to reward another set of suckers who invested with a different bit of Citi doesn’t sound like something the SEC should be doing. Though it does sound more like something private plaintiffs’ lawyers will be doing.

Judge Rakoff Skeptical of S.E.C. Settlement With Citigroup [DealBook, order]

* I know, it’s weird. Apparently Citi’s “penalty” is $95mm.

52 comments (hidden to protect delicate sensibilities)
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Comments (52)

  1. Posted by Douche-i-bank | October 27, 2011 at 7:15 PM

    The SEC's brain hurts once you get into the business of CDO-Squared. That was a clusterfuck matched only by the human cent-I-pad.

    So, creating a new CDO that feeds cash in from the equity tranches of an already-shitty CDO is not a Ponzi scheme… how, exactly?

  2. Posted by Guest | October 27, 2011 at 7:20 PM

    Does this Rakoff guy think NY is in the 9th circuit…. What some (authors) consider logical questions the rest of America rightly considers judicial activism. Am I right, or am I right?

  3. Posted by Spanishmoon | October 27, 2011 at 8:23 PM

    So I guess his gig as spokesman for Old Grand Dad bourbon didn't work out for hizzoner….

  4. Posted by Guest | October 27, 2011 at 9:02 PM

    In what way is it a ponzi scheme?

  5. Posted by Guesticles | October 27, 2011 at 11:00 PM


    According to the law, fraud "must be proved by showing that the defendant's actions involved five separate elements:

    "(1) a false statement of a material fact", check

    "(2) knowledge on the part of the defendant that the statement is untrue", check

    "(3) intent on the part of the defendant to deceive the alleged victim," we're three for three

    "(4) justifiable reliance by the alleged victim on the statement", you betcha

    "and (5) injury to the alleged victim as a result." , I'll say.

    You know what though, your'e right. "What's the big deal?" So, Matt, I've got $300 million dollars worth of prime real estate that is effectively risk free here; AAA rated stuff. It'll generate 10% a year for the next 5 years. I'll sell it to you for the low low price of $100 million. Deal?

  6. Posted by Guest | October 28, 2011 at 12:00 PM

    Uh, no.

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