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Federal Judge Wants To Know Why SEC Is Only Charging Citi 1/5th As Much As It Charged Goldman For Ripping Off CDO Investors

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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.


Appellate Court Willing to Entertain the Possibility that Citi Was Not Committing Fraud

I've had some fun these last few days proposing counterintuitive theories for why Citi might not suck as much as you probably think it does and it's nice to see others joining in the pastime, even if this sounds a little far-fetched: The district court’s logic appears to overlook the possibilities (i) that Citigroup might well not consent to settle on a basis that requires it to admit liability, (ii) that the S.E.C. might fail to win a judgment at trial, and (iii) that Citigroup perhaps did not mislead investors. That piece of rank conjecture is from the Second Circuit's opinion on an appeal* of Judge Rakoff's rejection of the settlement between the SEC and Citi over some mortgage-backed securities. Here's DealBook: