Better Markets Goes to Court to Stop Indefensible SEC-Citigroup Settlement

Nov 6 2011 - 1:24pm

Better Markets has gone to court to stop an indefensible settlement between the Securities and Exchange Commission and Citigroup that rewards securities fraud and shows crime pays.  Using inside information, Citigroup sold worthless toxic securities to its customers in a 2007 deal it designed to fail, which Citigroup secretly bet against with a $500 million short, according to the SEC.

“The settlement should not be approved because the alleged fraud was so extensive and the fine is less than trivial.  Also, of the numerous Citigroup employees involved, the SEC is only charging one personally and holding no one else accountable.  Maybe worst of all, the SEC failed to tell the court key facts about the fraud, about Citigroup and about the scope of the settlement,” said Dennis Kelleher, president and CEO of Better Markets, a nonprofit organization that promotes the public interest in the financial markets.

“Unfortunately, the SEC seems more interested in issuing press releases and wrapping up its investigations than punishing Wall Street for its massive frauds that not only caused enormous investor losses, but also caused the financial system and the economy to collapse.  Such settlements don’t deter crime.  They reward it,” Mr. Kelleher said.

The nonpartisan group noted the SEC has alleged Citigroup caused at least $847 million in investor losses in a $1 billion collaterized-debt obligation (CDO) derivatives deal that Citigroup designed to fail.  Citigroup took in more than $600 million when the CDO deal failed after just a few months, Better Markets said.

“For all this, the SEC proposes to fine Citigroup only $95 million.  That is a trivial amount given that investors lost at least $847 million and Citigroup took in more than $600 million.  Citigroup is a huge global bank that has $2 trillion in assets and had more than $20 billion in revenues in just the last three months,” Mr. Kelleher said.  “A $95 million fine isn’t even a rounding error to a corporation of that size.”

The SEC’s action also shows the involvement of many Citigroup employees from throughout the company, including the syndicate, trading, structuring, marketing and sales departments.  Yet, the SEC is only charging one employee personally for his role in the fraud.  The SEC failed to hold anyone else at Citigroup accountable or to even disclose who did what when it bet against its own customers who invested in the deal that it secretly shorted.

“Going after only one employee and giving everyone else a free pass will only incentivize people to engage in fraud because even getting caught doesn’t have consequences.  Frankly, the SEC’s settlement shows that crime pays,” Mr. Kelleher said.

“Even more troubling, although no one told the court, Citigroup’s position is that, in exchange for this one settlement and this one fine, the SEC has agreed to drop all of its investigations into all of Citigroup’s CDO deals,” said Mr. Kelleher.  In 2007, Citigroup was the world’s top issuer of CDOs, placing almost $50 billion.  In total, Citigroup did more than $145 billion of CDO deals over the years.

“No one knows how much fraud, if any, was involved in Citigroup’s other $145 billion of CDO deals, but no one will ever know if the SEC stops investigating in exchange for this meaningless settlement,” Mr. Kelleher said.

Better Markets is arguing to the court that settlements like this one do nothing to discourage fraud.  In fact, it was recently reported that Citigroup has been similarly “sanctioned” by the SEC five times in the last eight years for securities fraud.  Given the very serious fraud alleged in the case, it does not appear that those prior sanctions had any affect.  “Citigroup’s history as a repeat offender should have been brought to the attention of the court and the SEC should have explained why the court should approve this settlement in light of Citigroup’s prior record of securities law violations,” Mr. Kelleher said.  

The SEC has also failed to disclose even basic information about the settlement itself, depriving the public of information necessary to evaluate the SEC’s conduct and the merits of the settlement.  “The SEC provided the court with so little information that it is effectively asking the Court to be a rubber stamp for the SEC’s settlement,” Mr. Kelleher said.

“The SEC and other regulators failed miserably in their duty to protect the American people from Wall Street before the financial catastrophe that has devastated our country.  Sadly, this settlement and the SEC’s press campaign touting it look like they are still more interested in appearing tough than being tough,” Mr. Kelleher said.

“The only way to correct that is for the SEC to provide a full accounting of all the facts and circumstance of this case, including sufficient information to determine that this settlement, which looks like a sweetheart deal, is not one.  The public interest deserves no less,” Better Markets states in its filing.

Procedurally, Better Markets has requested that the court allow it to intervene in the case to protect the public interest in the proposed settlement.  (U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., Civil Action Number 1:11-cv-07387-JSR.) The SEC is opposing that request and asking the court to deny it.  The court ordered the SEC to file their opposition to Better Markets on Monday, Nov.7.

If the court approves the request, Better Markets will file an opposition to the settlement, which is scheduled for a Wednesday hearing when the Court will consider the SEC’s request to approve the settlement.  The standard the court will apply to the SEC request is whether or not the settlement is fair, adequate, reasonable and in the public interest, which Better Markets will argue it is not.  

 

KEY FACTS OF THE CASE:

 

*Among the evidence cited by the SEC are emails from sophisticated market participants, including statements that the portfolio Citigroup was marketing and selling to its customers was a “collection of dogsh!t.” “Possibly the best short EVER!” and “The portfolio is horrible.”

*The SEC did a full-court media press when it filed this settlement in court, trumpeted that Citigroup was paying $285 million. Yet, the vast majority of that was $160 million (plus $30 million in interest) in so-called disgorgement, which is Citigroup just giving up its ill-gotten gains from the deal (although Citigroup took in more than $600 million). Hence, only $95 million of the $285 million is an actual penalty.

*The SEC identifies no individuals, other than by amorphous references to “Personnel on Citigroup’s CDO syndicate, trading and structuring desk…a senior Citigroup CDO structurer…CDO salesperson…Citigroup’s Risk Management Organization” and others.

*The SEC has sued one Citigroup individual personally.  Citigroup increased his bonus by more than 100 percent to $2.25 million at the very same time Citigroup was marketing and selling this built-to-blow-up deal to investors.  Any settlement worthy of approval must provide a complete and total accounting of the bonus pool, which would provide a roadmap of who did what in the deal.

*Citigroup went to great lengths to deceive investors, the SEC alleges. Among the key information it hid from investors: it picked 50 percent of the derivatives and related securities; it sold almost $100 million of worthless securities to the deal at inflated prices; it handpicked an investor representative only after confirming it would enable the scheme; and, it shorted $500 million of the $1 billion deal.

* $490 million of Citigroup’s $500 million short were “naked” shorts, i.e., a pure bet where the bank had no ownership in the underlying assets.

*The deal became worthless in a matter of months and was the second-fastest CDO deal to ever default.

*The SEC has failed to detail how much Citigroup made from the alleged fraud and what investors lost. The commission only states that the bank realized “net profits” of “at least” $160 million without any other disclosure.   There also is no specific mention of how much credit protection was paid to Citigroup and by whom. All revenues and benefits to Citigroup must be disclosed in detail.

*A $95 million fine is trivial to a huge global mega-bank. For example, just one individual, Citigroup’s CEO, was paid slightly less than $90 million from 2004 to 2008.  And, the compensation of Citigroup’s top 8 executives in 2007 alone was $70.5 million.  A broader look shows that Wall Street wages in 2007 were $73 billion, with bonuses at $33.2 billion. The $95 million fine also pales in comparison to other Citigroup expenditures. For example, the bank was reported to have spent more than $600 million on advertising in 2007.

*The $95 million penalty is almost the exact amount of the $92.25 million in the soon-to-be worthless securities Citigroup removed from its proprietary books and sold to the deal at inflated prices. Thus, the entire fine merely equals the bank’s gain from just a slice of the overall package.