Rakoff SEC-Citigroup Ruling Sends Chills Through Wall Street

Rakoff SEC-Citigroup Ruling Sends Chills Through Wall Street

Monday’s rejection by a federal judge of a $285 million settlement between Citigroup and the U.S. Securities & Exchange Commission (SEC) has spooked corporate defendants who fear this may signal an end to the long-standing practice of paying up without having to admit wrongdoing. In the litigious U.S., this could signal lengthy and costly litigation with regulators and/or expose them to the wrath of private class-action law suits.

Judge Rakoff of the Southern District of New York, who famously dragged his heels in approving the SEC’s settlement with Bank of America and most recently Vitesse, this week blocked the SEC-Citigroup settlement for the same reason: He objects to the SEC’s practice of routinely permitting corporate defendants in securities matters to settle civil litigation without admitting the Commission’s allegations and takes exception to the lack of (high ranking) individual defendants.

Background on the SEC-Citigroup Case

According to the SEC’s complaint, “after Citigroup realized in early 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.”

Accusing Citigroup of a “substantial securities fraud,” the SEC said that the bank “realized net profits of around $160 million, whereas the investors… lost more than $700 million.”

On October 19th it was announced that Citigroup had agreed to pay $285 million to settle SEC charges that it had “misled investors in a $1 billion collateralized debt obligation linked to risky mortgages.”

Banking on a Gagging Order

According to Fortune, “about 90% of SEC cases are currently concluded by consent decree, and the lynchpin for virtually every one of those is that the defendant doesn’t admit wrongdoing.”

The “neither admit nor deny language” clause in settlements is seen by many as a “win-win for both parties” writes Compliance Week. “The defendants put the case behind them without admitting wrongdoing, which would open them up to potentially huge civil liability; and the SEC gets to bring enforcement actions, collect fines, and hopefully create a deterrent effect without the risk and cost of taking cases trial,” explains the magazine.

This practice has not been without nay-sayers, with Judge Rakoff leading the charge and refusing to sign the SEC-Citigroup consent decree until both parties could answer nine searching questions at a hearing earlier this month. Not satisfied with the responses to his questions, Judge Rakoff rejected the decree and trial is now set for July 16, 2012.


United States District Court for the Southern District of New York1) Why should the Court impose a judgment in a case in which the S.E.C. alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?

2) Given the S.E.C.’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.’s charges are true? Is the interest even stronger when there is no parallel criminal case?

3) What was the total loss to the victims as a result of Citigroup’s actions? How was this determined? lf, as the S.E.C.’s submission states, the loss was “at least” $160 million, what was it at most?

4) How was the amount of the proposed judgment determined? In particular, what calculations went into the determination of the $95 million penalty? Why, for example, is the penalty in this case less than one-fifth of the $535 million penalty assessed in SEC v. Goldman Sachs? What reason is there to believe this proposed penalty will have a meaningful deterrent effect?

5) The S.E.C.’s submission states that the S.E.C. has “identified… nine factors relevant to the assessment of whether to impose penalties against a corporation and, if so, in what amount.” But the submission fails to particularize how the factors were applied in this case. Did the S.E.C. employ these factors in this case? If so, how should this case be analyzed under each of those nine factors?

6) The proposed judgment imposes injunctive relief against future violations. What does the S.E.C. do to maintain compliance? How many contempt proceedings against large financial entities has the S.E.C. brought in the past decade as a result of violations of prior consent judgments?

7) 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?

8) What specific “control weaknesses” led to the acts alleged in the Complaint? How will the proposed “remedial undertakings” ensure that those acts do not occur again?

9) How can a securities fraud of this nature and magnitude be the result simply of negligence?

What Does this Mean for D&Os?

While Boards on Wall Street weigh up what this case will mean for future SEC settlements and whether other judges will follow Rakoff’s lead, one of Rakoff’s concerns that will ring alarm bells in the minds of directors and officers is question seven: “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’?”

A move to add individual defendants to SEC enforcement actions, especially high ranking executives, could drive up the price tag for already costly litigation. On the plus side, it might please the Occupy Wall Street protestors…

About Ann Longmore

Ann is Executive Vice President of Willis' Executive Risks practice. Based in New York, she has been with the compa…
Categories: Directors & Officers, Financial Services | Tags: ,

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