Citigroup finds obeying the law is too darn hard

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Five times since 2003 the Securities and Exchange Commission has accused Citigroup Inc.'s main broker-dealer subsidiary of securities fraud. On each occasion the company's SEC settlements have followed a familiar pattern.

Citigroup neither admitted nor denied the SEC's claims. And the company consented to the entry of either a court injunction or an SEC order barring it from committing the same types of violations again. Those "obey-the-law" directives haven't meant much. The SEC keeps accusing Citigroup of breaking the same laws over and over, without ever attempting to enforce the prior orders. The SEC's most recent complaint against Citigroup, filed last month, is no different.

Enough is enough. Hopefully Jed Rakoff will soon agree.

Rakoff, the US district judge in New York who was assigned the newest Citigroup case, is saber-rattling again, threatening to derail the SEC's latest wrist-slap. The big question is whether he has the guts to go through with it. Twice since 2009, Rakoff has put the SEC through the wringer over cozy corporate settlements, only to give in to the agency later.

That the SEC went easy on Citigroup again is obvious. The commission last month accused Citigroup of marketing a $1 billion collateralized debt obligation to investors in 2007 without disclosing that its own traders picked many of the assets for the deal and bet against them. The SEC's complaint said Citigroup realized "at least $160 million" in profits on the CDO, which was linked to subprime mortgages. For this, Citigroup agreed to pay $285 million, including a $95 million fine -- a pittance compared with its $3.8 billion of earnings last quarter.

Looking deliberate

On top of that, the agency accused Citigroup of acting only negligently, though the facts in the SEC's complaint suggested deliberate misconduct. The SEC named just one individual as a defendant, a low-level banker who clearly didn't act alone. Plus, the SEC's case covered only one CDO, even though Citigroup sold many others like it.

Here's what makes the SEC's conduct doubly outrageous: The commission already had two cease-and-desist orders in place against the same Citigroup unit, barring future violations of the same section of the securities laws that the company now stands accused of breaking again. One of those orders came in a 2005 settlement, the other in a 2006 case. The SEC's complaint last month didn't mention either order, as if the entire agency suffered from amnesia.

The SEC's latest allegations also could have triggered a violation of a court injunction that Citigroup agreed to in 2003, as part of a $400 million settlement over allegedly fraudulent analyst-research reports. Injunctions are more serious than SEC orders, because violations can lead to contempt-of-court charges.

The SEC neatly avoided that outcome simply by accusing Citigroup of violating a different fraud statute. Not that the SEC ever took the prior injunction seriously. In December 2008, the SEC for the second time accused Citigroup of breaking the same section of the law covered by the 2003 injunction, over its sales of so-called auction-rate securities. Instead of trying to enforce the existing court order, the SEC got yet another one barring the same kinds of fraud violations in the future.

It gets worse: Each time the SEC settled those earlier fraud cases, Citigroup asked the agency for waivers that would let it go about its business as usual. (This is standard procedure for big securities firms.) The SEC granted those requests, saying it did so based on the assumption that Citigroup would comply with the law as ordered. Then, when the SEC kept accusing Citigroup of breaking the same laws again, the agency granted more waivers, never revoking any of the old ones.

Legal standard

Rakoff seems aware of the problem, judging by the questions he sent the SEC and Citigroup last week. Noting that the SEC is seeking a new injunction against future violations by Citigroup, he asked: "What does the SEC do to maintain compliance?" Additionally, he asked: "How many contempt proceedings against large financial entities has the SEC brought in the past decade as a result of violations of prior consent judgments?" We'll see if the SEC finds any. A hearing is set for Nov. 9.

The legal standard Rakoff must apply is whether the proposed judgment is "fair, reasonable, adequate and in the public interest." Among Rakoff's other questions: "Why should the court impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?" And this: "How can a securities fraud of this nature and magnitude be the result simply of negligence?"

A Citigroup spokeswoman, Shannon Bell, said, "Citi has entered into various settlements with the SEC over the years, and there is no basis for any assertion that Citi has violated the terms of any of those settlements." I guess it depends on what the meaning of the word "settlement" and "violated."

Rakoff gained fame in 2009 when he rejected an SEC proposal to fine Bank of America Corp. $33 million for disclosure violations related to its $29.1 billion purchase of Merrill Lynch & Co. Rakoff said the settlement punished Bank of America shareholders for the actions of its executives, none of whom were named as defendants.

Months later, though, Rakoff approved a $150 million fine for the same infractions, on the condition that the money would be redistributed to Bank of America stockholders who supposedly were harmed. The stipulation was classic window dressing. Even so, Rakoff became something of a folk hero, simply for daring to question an SEC settlement. Most other judges are rubber stamps.

Rakoff would serve the public well by rejecting any deal that leaves the truth of the SEC's allegations undetermined or fails to treat Citigroup as a repeated offender. Grandstanding alone won't cut it anymore. Rakoff has come a long way already. Here's hoping this time he goes the distance.

Jonathan Weil
Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.

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