Judge Jed S. Rakoff, who presides over a federal district court in Manhattan, issued a ruling Monday that should make American citizens rejoice. He refused to sign off on a wrist-slap $285 million settlement the Securities and Exchange Commission had proposed to sign with Citigroup that would have allowed the giant Wall Street investment bank to avoid admitting defrauding investors of $700 million.
He was right to deny the settlement. It involved the very sort of duplicitous investment trading on Wall Street that rose to its zenith in 2007, and then led to the Street's self-induced financial implosion in 2008. That implosion nearly threw the global economy into another Great Depression, and it still will haunt the American economy, among others, for years to come.
The settlement that Judge Rakoff denied rested on the limp agreement by the SEC to close a five-year investigation of Citigroup's role in a derivative investment that the SEC itself charged was designed to fail. The agency said Citigroup created a billion-dollar package of mortgage securities that included enough toxic assets to ensure its failure. It then marketed the package to clients as a sound investment while betting against it with other swaps. When it failed in the 2008 financial crash that brought down the casino market that Citigroup and most other Wall Street investment firms had helped rig, Citigroup made $160 million on its bets against the rigged securities package, while its clients lost $700 million.
Judge Rakoff objected to approving the no-fault settlement, he said, because it would have allowed Citigroup to sign a "no-admit/no-deny" clause and go on its merry way. Though its actions would seem to constitute fraud by any normal definition of the word, he said Citigroup would not have had to admit to fraud or to any other criminal offense, or see any of its executives or agents sent to jail for fraud.
He admonished the agency to discharge its "duty inherent in its statutory mission to see that the truth emerges." He said he would not rubber-stamp an agreement that provides nothing other than "a quick headline" for the SEC and that is "pocket change to any entity as large as Citigroup," and that is commonly seen by Wall Street "as a cost of doing business." He rightly dismissed objections by both the SEC and Citigroup and ordered the case to trial in July.
Agency officials complained that the SEC doesn't have the resources or time to go to trial over such cases against Wall Street's deep pockets. Citigroup complained that the settlement was typical and fair, and that there was no precedent for the court to reject it.
That may be the case, but Judge Rakoff embraced the opportunity to press both sides. He said the proposed agreement and the agency's settlement policy undermined its public mission to illuminate wrongdoing and foster more appropriate regulation. Approving such an agreement without acknowledgment of the facts would undermine the constitutional separation of power, he said. It would also allow "recidivist" violators like Citigroup to evade real accountability for their actions.
These points are clearly correct. Where there is no real penalty for wrongdoing, it will continue. A recent New York Times analysis of SEC fraud settlements confirms that.
The paper's review of 51 settlements involving 19 firms over the past 15 years, it said, showed that these companies continued to engage in fraudulent practices "that they previously had agreed never to breach" again. Citigroup, for example, had six prior fraud cases that were settled with promises for better conduct going forward. Other cases involved such Wall Street icons as Goldman Sachs and JPMorgan.
If Judge Rakoff's ruling sets a precedent, it will be a good bellwether. It should force improved conduct and transparency by Wall Street traders, help stabilize financial and investment markets, and reinforce legislation designed to maintain and strengthen the new financial and banking regulations that Republicans already are wrongly seeking to dismantle. All that would benefit ordinary Americans whose retirement, pensions and savings funds wrongly lose value when Wall Street's investment chiefs cheat and defraud institutional investors and their fund managers.