N.Y. Judge Bashes SEC Over $285 Million Fraud Settlement With Citigroup

Updated with comment from the SEC and Citigroup.

A federal judge in New York Monday rejected Citigroup's $285 million settlement of a U.S. Securities and Exchange Commission securities fraud case, telling the parties to prepare for trial.

In rejecting the settlement, U.S. District Court Judge Jed S. Rakoff of the Southern District of New York in Manhattan rebuked the SEC for obtaining a settlement agreement without getting Citigroup to admit any wrongdoing.

He also blasted the securities regulator for lodging a negligence claim against the financial institution, instead of claiming that Citigroup had intended to mislead investors.

The SEC's case against Citigroup's U.S. broker-dealer subsidiary focused on a billion-dollar fund created to dump "some dubious assets on misinformed investors," Rakoff said in recounting the agency's allegations.

These mortgage-related assets were peddled as attractive investment opportunities hand-picked by an independent investment adviser. Citigroup was also accused of using the fund to bet against investors.

While investors lost about $700 million when the fund defaulted, Citigroup profited about $160 million, according to the SEC. The agency also sued a Citigroup employee Brian Stoker in connection to the securities fraud case.

Rakoff ordered Citigroup's case to be consolidated with Stoker's and scheduled a July 16 trial date.

Robert Khuzami, director of the SEC's Division of Enforcement, in a lengthy statement, defended the size of the settlement as a reflection of the kind of relief the agency could obtain at trial. Khuzami also said that the complaint fully details the facts that support the SEC's allegations against Citigroup.

"These are not 'mere' allegations, but the reasoned conclusions of the federal agency responsible for the enforcement of the securities laws after a thorough and careful investigation of the facts," he said.

A Citi spokeswoman Danielle Romero-Apsilos said in a statement that the company disagrees with the court ruling and that if forced to go to trial, Citi would "present factual and legal defenses to the charges."

The SEC had asked for court approval of the $285 million settlement that will be returned to investors, at the same time it lodged its complaint against Citigroup.

But Rakoff wrote in his acerbic order that the proposed settlement is "neither fair, nor reasonable, nor adequate, nor in the public interest."

"The court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court," Rakoff writes, "becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance."

When the settlement was presented to the court for approval, Rakoff Oct. 27 ordered counsel for both parties to defend the deal.

The $285 million payment would be one of the largest amounts a Wall Street firm would have to pay to settle allegations of misleading investors since Goldman Sachs' $550 million deal last year, according to The Associated Press.

In addition to the penalty, Citigroup agreed to be barred from future securities violations and undergo internal prevention measures.

With investors losing more than double the amount of the proposed settlement, Rakoff said that a deal that does little to illuminate the facts of the case could hamper investors' ability to recoup money in private litigation.

Rakoff has been critical of similar deals in which firms pay a penalty and agree to fix an alleged misconduct in exchange for the SEC dropping its claims without adding any clarity to the underlying allegations.

"A consent judgment that does not involve any admissions and that result in only very modest penalties is just as frequently viewed, particularly in the business community," Rakoff wrote, "as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies."

74040599-Rakoff-Citigroup