Not so fast, judge tells SEC, Citi
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Like other federal jurists, U.S. District Court Judge Jed S. Rakoff's schedule includes dozens of cases. But unlike his colleagues -- who arguably serve justice and taxpayers by blessing settlements that avoid costly, lengthy trials -- Judge Rakoff is frequently inclined to say: "Let's stop and think about this."
Which is what he did in no uncertain terms Monday. Judge Rakoff refused to swallow a proposed $285 million settlement between the Securities and Exchange Commission and Citigroup.
The SEC had charged the bank with negligence over selling about $1 billion in dubious mortgage-backed securities to investors, then betting some of the mortgages would fail. The SEC alleges Citigroup made $160 million from the deal, including $126 million from betting against its own investors.
Calling Citigroup a "recidivist," Judge Rakoff questioned why the SEC did not bring more serious charges and chastised the agency for agreeing to what he said were "very modest penalties." He said if the allegations were true, the settlement was "a very good deal" for Citigroup. If they were false, the $285 million "is a mild and modest cost of doing business" for the bank, the judge wrote.
The SEC's long-standing policy of allowing Citigroup and other defendants to settle without admitting or denying what they are charged with is "hallowed by history, but not by reason," the judge wrote. He insisted on getting more facts, saying he did not want to be "a mere handmaiden to a settlement privately negotiated on the basis of unknown facts."
"Judge Rakoff did something that probably many judges have thought about doing, but never really had the nerve to follow through on," said Duquesne University law professor Ronald J. Ricci.
It's not the first time Judge Rakoff, whose court in Manhattan isn't far from Wall Street, rejected a peace proposal involving the SEC and a major financial institution. In 2009, he took exception to a proposed $33 million settlement between the agency and Bank of America, which had been charged with lying to shareholders in a proxy statement on its $50 billion acquisition of Merrill Lynch in 2008.
The judge did not like the fact that the $33 million fine would come from the victims -- the bank's shareholders -- not from the lawyers who crafted the lies and executives who condoned them. The proposal, he wrote in his September 2009 decision, "suggests a rather cynical relationship between the parties." The SEC would get to claim it is a hard-nosed regulator and the bank "gets to claim that they have been coerced into an onerous settlement by overzealous regulators."
Judge Rakoff approved a $150 million settlement five months later.
"He's signalled for a while that he's not going to play ball with the usual process," said UCLA law professor Stephen M. Bainbridge.
As newsworthy as the judge's Citigroup opinion is, "I don't think this in any way indicates the SEC is going to have problems with other judges," Mr. Bainbridge said.
As a practical matter, the SEC does not have the budget or staff to bring every case to trial. So it settles many of them, trying to get the most justice it can by settling rather than rolling the dice on a long, costly trial against an adversary with superior funding.
Settlements also appeal to judges. If the parties to one of the dozens of cases on their docket "want to make one of those cases go away, judges are pretty happy," Mr. Bainbridge said.
Judge Rakoff, he added, "obviously doesn't mind the extra workload."
Those facing SEC charges won't settle if they are required to admit or deny the allegations, a provision Mr. Ricci said has been a standard clause in SEC settlements since the 1970s. Admitting they did something wrong would provide ammunition to investors and others suing defendants over the same conduct, said University of Illinois law professor Larry E. Ribstein.
Bank analyst Michael Mayo, a longtime critic of Citigroup, said the judge was right to question the settlement, given the bank's long history of run-ins with regulators. He estimates Citigroup has paid regulators about $10 billion over the last decade to resolve legal and regulatory issues.
"When you link all of those together and say the SEC was going to add $285 million on top of that, what's another 3 percent?" he said. "These regulatory and other infractions are treated like traffic tickets."
Judge Rakoff ordered the SEC and Citigroup to be ready to take the case to trial in July. He issued a similar order in the Bank of America case, which resulted in a bigger settlement.
Mr. Ribstein said the SEC, under the gun for letting Ponzi scheme Bernie Madoff run amok, would lose even more face if it dropped the case. But if it takes the matter to trial, "Citigroup can bring an incredible amount of resources."
"I think the judge realizes he's put the agency between a rock and a hard spot," Mr. Ribstein said.
Mr. Ricci is betting the terms of the settlement will be revised. Based on the message Judge Rakoff sent in his opinion, he expects Citigroup will have to pay more and make some admissions about its behavior.
"There are great advantages to both sides in avoiding going to trial, so you have to assume that's high on the list of possible outcomes," Mr. Ricci said.
First Published December 4, 2011 12:00 am