It always drives me nuts to see stories to the effect that “Corporation X agreed Thursday to pay a $500 gazillion penalty to settle federal fraud charges, but the company admitted no wrongdoing.”
Apparently, U.S. District Court Judge Jed Rakoff of the Southern District of New York agrees with me.
In a sharp rebuke to such deals, Rakoff this week rejected a $285 million proposed settlement between Citigroup and the Securities and Exchange Commission, calling the deal “neither fair, nor reasonable, nor adequate, nor in the public interest.”
As Rakoff lays out the allegations against Citigroup in his opinion:
“… after Citigroup realized in 2007 that the market for mortgage-backed securities was beginning to weaken, Citigroup created a billion-dollar fund that allowed it to dump some dubious assets on misinformed investors. This was accomplished by Citigroup’s 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 negative projected assets and had then taken a short position in those very assets it had helped select.”
In other words, it knowingly created and peddled a bad investment to its clients, and then bet against those clients that the investment would fail.
Which of course it did.
Investors lost $700 million in the deal, while Citigroup made a tidy profit of $160 million. Under the settlement negotiated with the SEC but rejected by Rakoff, the company would have to cough up the profits it earned and pay an additional $95 million fine to make it all go away.
Amazingly, the SEC chose to charge Citigroup only with negligence, rather than outright fraud. Not only was the fine it proposed insufficient, Rakoff wrote, the deal ensures that the American public “is deprived of ever knowing the truth in a matter of obvious public importance.”
“In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives,” Rakoff wrote in his opinion, “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 SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges.”
Rakoff went on to note that it was hard to determine what the SEC was getting from the settlement “other than a quick headline.” Citigroup was a repeat offender in such cases, “and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup.”
To some degree, I can sympathize with the SEC’s position. The agency is grossly underfunded and has to deploy its limited resources carefully. Getting involved in a lengthy court fight with a deep-pockets defendant such as Citigroup would eat up a lot of staff time. The temptation is to cut a deal and move on.
And while the Obama administration has requested additional funding for the SEC and its sister agency, the Commodity Futures Trading Commission, House Republicans have refused to approve that request, preferring to keep the Wall Street watchdogs toothless and on a short leash.
Personally, I think we ought to consider solving the funding problem by giving the SEC and CFTC a cut of the money that they recover, just as other law-enforcement agencies get a cut of what they recover in drug-trafficking cases. That’s “running government like a business,” right? If you want them to do a good job, you give them a financial incentive to do their job more aggressively.
Furthermore, since the money being recovered would by definition come from law-breakers rather than those who do business honestly, it could hardly be considered a tax increase.
But as we all know — Judge Rakoff included — that isn’t going to happen.
– Jay Bookman