Judge blocks Citigroup settlement with SEC over fraud charges

A federal judge on Monday blocked the Securities and Exchange Commission (SEC) from settling a fraud investigation into Citigroup’s mortgage-backed securities business and ordered the parties to proceed to trial in July.

The case is seen as a bellwether for federal attempts to deal with the troubled mortgage-backed securities industry and could establish a precedent that limits the ability of the SEC to deal with such matters without undertaking costly court cases.

The SEC announced last month that Citigroup had agreed to pay investors $285 billion to settle charges that it stocked an investment vehicle with shoddy mortgages in 2007, sold it to investors and then bet against it without disclosing those moves to purchasers.

In a ruling with potentially far-reaching implications, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York ruled that the SEC is wrong to strike such settlements with a party that does not admit any wrongdoing, as was the case with Citigroup. Such consent judgments are standard practice at the SEC.

The judge also noted that investors lost some $700 million due to the alleged fraud. The settlement only states that the SEC “may” seek $285 million to repay the investors.

“In any event this still leaves the defrauded investors substantially shortchanged,” Rakoff writes in his ruling. He added the settlement “is neither fair, nor reasonable, nor adequate, nor in the public interest.”

Rakoff ruled that it is not in the public interest for the SEC to ask a court to approve a settlement when the facts remain legally unknown. He called the SEC practice of making such settlements “hallowed by history, but not by reason.”

The judge writes that it is hard see what “the SEC is getting from this settlement other than a quick headline,” Rakoff writes. 

“By the SEC’s own account, Citigroup is a recidivist, 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,” Rakoff writes.

Rakoff ordered the settled case to be combined with an ongoing case against Citigroup employee Brian Stoker for his alleged role in the case and for the case to go to trial.

Robert Khuzami, director of the SEC’s division of enforcement, stood by the agency’s settlement and said such decisions are necessary to keep down cots.

The ruling “ignores decades of established practice throughout federal agencies and decisions of the federal courts,” he said in a statement.

“Refusing an otherwise advantageous settlement solely because of the absence of an admission also would divert resources away from the investigation of other frauds and the recovery of losses suffered by other investors not before the court,” he said. 

He also said that judge was wrong to criticize the SEC for the size of the financial penalty, as laws limit the size of such penalties.

“It was for this reason that we sought to recover close to $300 million — all of which we intended to deliver to harmed investors,” he said. 

In a statement, Citigroup said the SEC settlement was "fair and reasonable."

"We respectfully disagree with the court's ruling. We believe the proposed settlement is a fair and reasonable resolution to the SEC's allegation of negligence, which relates to a five-year-old transaction. We also believe the settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges," Citigroup said.

The ruling comes at a time of simmering anger at Wall Street and over the role that financial giants such as Citigroup played in the fostering the housing crisis, which led in 2008 to the deepest economic crisis since the Great Depression.

—Updated at 5:14 p.m.