Judge rejects Citigroup's settlement

Citigroup faces a day of reckoning in court over its selling of financial instruments in the run-up to the subprime mortgage crisis after a New York judge struck down a $285-million settlement with regulators, ruling that the deal obscured an “overriding public interest in knowing the truth”.

Last month Citigroup agreed to s­ettle claims that it misled clients in a $1-billion collateralised debt obligation, an investment linked to subprime residential mortgages. Investors lost about $700-million, according to the Securities and Exchange Commission, whereas the bank made $160-million in fees and trading profits.

It comes as the leading US financial institutions are still trying to reach agreements with authorities over their share of the blame in the run-up to the 2008 credit crunch, from which the world economy is still struggling to recover.

Judge Jed Rakoff said Citigroup’s out-of-court deal would have imposed penalties but allowed it to deny allegations that it misled investors.

“In any case like this that touches on the transparency of financial markets, whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth,” Rakoff wrote in his opinion.

The judge consolidated the case with a suit brought against Citigroup employee Brian Stoker, who was responsible for structuring the collateralised debt obligation, said the commission. He set a trial date for July 16 2012. Citigroup may try for a revised settlement, which would also have to be approved by Rakoff.

Chicago-based securities attorney Andrew Stoltmann called Rakoff’s decision “historic”. “This is horribly embarrassing for the Securities and Exchange Commission. A federal judge is basically telling them to do their job,” he said.

Stoltmann said federal judges had often been little more than a rubber stamp of approval for the commission. “Imposing fines without admitting liability is a legal charade that has been going on for decades,” he said.

It is common for the commission to reach settlements with banks that do not contain an admission of liability. Formally admitting liability would give a powerful boost to investors suing the bank as well as landing the bank with a public-relations problem. For the commission it reduces the chances of a costly court case and avoids the uncertainty of a trial.

Rakoff has been a consistent critic of the commission’s tactics. In September 2009 he rejected the regulator’s settlement with Bank of America over claims it misled investors about bonuses paid to Merrill Lynch, which the company had taken over that year. The deal suggested “a rather cynical relationship between the parties,” he said. “The Securities and Exchange Commission gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger,” Rakoff said.

“The bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense of not only the shareholders but also of the truth.”—