On Monday, November 7, 2011, the SEC filed its Brief in response to questions posed by the Court regarding the proposed settlement in SEC v. Citigroup, No. 11-cv-7387 (S.D.N.Y.). In answering the Court’s questions, the Commission emphasized that "[t]he proposed consent judgment embodying this settlement is fair, adequate, and reasonable, and should be entered by this Court." The brief submitted by the Commission provided a broader-than-normal look at the Commission’s approach to settling cases (although the SEC did argue that the Court was not entitled to consider some of the issues it had raised). Judge Jed Rakoff has scheduled a hearing for Wednesday, November 9, 2011 to consider the proposed settlement.
As discussed here, on Wednesday, October 19, 2011, the SEC announced a settlement with Citigroup’s principal U.S. broker-dealer, Citigroup Global Markets, Inc., who has been charged with misleading investors about a $1 billion collateralized debt obligation ("CDO") tied to the housing market. The Commission alleged that "[t]he marketing materials Citigroup prepared and distributed to investors did not disclose Citigroup’s role in selecting assets for [the CDO] and did not accurately disclose to investors Citigroup’s short position on those assets." The Commission further alleged that the materials were misleading in that they "suggested that Citigroup was acting in the traditional role of an arranging bank," instead of disclosing its actual role and short position. The SEC claimed that after the CDO defaulted within months, investors were saddled with losses, but Citigroup Global Markets made $160 million in fees and trading profits. Citigroup agreed to pay $285 million (consisting of $160 million in disgorgement, $30 million in prejudgment interest and a $95 million civil penalty), which "will be returned to investors," according to the SEC.
On the same day that the Complaint was filed, the Commission submitted a seven-page memorandum in support of the settlement (available here). On October 27, 2011, Judge Rakoff issued an Order (discussed here) scheduling a hearing for November 9, 2011 and raising a series of questions that he wants answered at that hearing to assist in determining whether the proposed judgment is fair, reasonable and in the public interest.
Both the SEC and Citigroup filed briefs on Monday, November 7, 2011. In the SEC’s brief (available here), it argued that the proposed settlement is fair, adequate and reasonable because it:
reasonably reflects the scope of relief likely to be obtained by the Commission under the applicable law if successful at a trial on the merits, also taking into account the litigation risks likely to be presented, the benefits of avoiding those risks, the willingness of Citigroup to consent to a judgment and not deny liability, and the opportunity to detail publicly in this forum the facts that led the Commission to pursue this action. In addition, a settlement allows the Commission to devote resources that may have been required for this matter to investigate other fraud and misconduct resulting in loss and harm to investors not before the Court.
In further support of its argument, the Commission emphasized the limitations it believes are imposed on the Court in considering whether the proposed settlement was fair, adequate and reasonable:
• "in reviewing a proposed consent decree, it is not a court’s ‘function to determine whether this is the best possible settlement that could have been obtained, but only whether it is fair, adequate and reasonable;’"
• " judicial review of a proposed consent decree should not involve a court attempting to resolve factual disputes in the matter;" and
• "a district court should not ‘reach beyond the complaint to evaluate claims that the government did not make and to inquire as to why they were not made.’"
The SEC also responded to each of Judge Rakoff’s questions from his October 27, 2011 Order. The brief marks one of the lengthier submission’s by the SEC in support of its settlement in recent memory and is worth reviewing.
First, the Commission responded to the Court’s question as to 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. The SEC argued that use of such consent judgments "has been long endorsed by the Supreme Court" and "criticism of consent decrees for not including … an admission is ‘unjustified.’" The SEC traced the history of its policy, emphasizing the desire to "preclude denials both in the consent decree itself and elsewhere." The Commission argued that, based on the fact that Citigroup does not deny the allegations in the Complaint, the "approach has clearly succeeded in clearly conveying that the conduct alleged did in fact occur."
The SEC responded to Judge Rakoff’s second question ("Given the SEC’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the SEC’s charges are true?") by stating its position that transparency was provided "by the public filing of the allegations in the Commission’s Complaint, which Citigroup has not denied." The SEC argued that requiring a factual resolution in the name of transparency would run afoul of the principal that the settlement not be turned into a trial.
In answering the third question, which involved how the amount of the total loss to the victims was calculated, the SEC pointed out that, "[a]s a general rule, the Commission does not recover ‘damages’ suffered by victims of a securities fraud scheme." The Commission acknowledged that calculating the exact amount of losses caused by Citigroup "is a difficult and imprecise exercise" because the "total losses to investors in a transaction are not necessarily the same as total losses to investors ‘as a result of’ a defendant’s proper actions." Accordingly, the Commission may seek disgorgement of Citigroup’s ill-gotten gains, which in this case was at least $160 million.
In the fourth question, Judge Rakoff asked "[h]ow was the amount of the proposed judgment determined?," pointing out that the $95 million penalty portion of the settlement was considerably less than the $535 million penalty paid by Goldman Sachs in 2010. The Commission argued that, based on its "extensive, industry-wide investigation into certain abuses that contributed to the recent financial crisis … the SEC is well-positioned to make comparative judgments regarding the relative culpability of the entities and individuals involved." The Commission noted that Goldman Sachs was charged with scienter-based violations, which was worthy of a more significant sanction.
As a fifth question, Judge Rakoff about the nine factors (cited in the SEC’s original October 19 brief in support of the settlement) used to assess the amount of the penalty. The analysis of those factors included the SEC’s conclusions that Citigroup directly benefited from that transaction (counseling in favor of a significant penalty), but that there was not widespread complicity in the violation, nor was there sufficient evidence to establish an intent to defraud (counseling in favor of a reduced monetary sanction).
In answering the sixth question regarding what the SEC does to maintain compliance, the Commission mentioned that Citigroup, as a broker-dealer, will be subject to regular examination by the office of Compliance, Inspections and Examinations. The Commission acknowledged that it does not frequently pursue civil contempt proceedings (and has not done so against a large financial entity in the last ten years).
For his seventh question, Judge Rakoff asked "Why is the penalty in this case to be paid in large part by Citigroup and its shareholders rather than by the ‘culpable individual offenders acting for the corporation?’ … If the SEC was for the most part unable to identify such alleged offenders, why was this?" The Commission argued that "Citigroup shareholders were not the victims of the fraudulent transaction, but rather its indirect financial beneficiaries. … To the extent the fraud succeeded, Citigroup shareholders received an indirect financial benefit at the expense of CDO investors." In response to the inquiry regarding individual offenders, the Commission pointed out it has brought actions against Brian Stoker, the Citigroup employee primarily responsible for structuring the CDO transaction, and Credit Suisse Asset Management’s portfolio manager, Samir Bhatt. But, the Commission also argued that "[t]he extent to which the Commission has identified or asserted claims against individual offenders is not a proper basis for evaluating the proposed settlement with Citigroup."
In response to the eighth question, the SEC identified the "control weaknesses" which led to the events in the Complaint as Citigroup’s failure to ensure that complete and accurate disclosures were made to the investors. The Commission listed the "remedial undertakings" by Citigroup – which had been previously identified in the Consent Decree.
In response to the final question ("How can a securities fraud of this nature and magnitude be the result simply of negligence?"), the SEC told Judge Rakoff that "[e]valuation of a settlement is not an opportunity to ‘reach beyond the complaint to evaluate claims that the government did not make and to inquire as to why they were not made.’" The Commission said that the claims it did make are supported by the allegations and its "decision not to pursue additional charges is ‘committed to an agency’s absolute discretion.’"
Citigroup also submitted a brief (here) urging the Court to approve the settlement. In an interesting note, Citigroup cited a June 2010 speech and a 1994 article by Judge Rakoff regarding the consequences of the settlement for Citigroup in support of its argument.