COMMON SENSE
Few Avenues for Justice in the Case Against Citi
By JAMES B. STEWART
Published: December 2, 2011
Is anyone going to be held legally accountable for the financial crisis? When the Securities and Exchange Commission announced recently that it was settling fraud charges against Citigroup for a paltry (for Citigroup) $285 million, the only person actually named in the S.E.C.’s charges was Brian Stoker.
Never heard of him? He’s a 40-year-old Harvard Business School graduate and, until 2008, was a midlevel director in Citigroup’s “CDO structuring group” (he denied the charges and didn’t reach any settlement agreement). Charles Prince, the since-departed Citigroup chief executive at the time of the alleged misdeeds, isn’t mentioned. Four other Citigroup executives, including at least two senior to Mr. Stoker, are described in the complaint as being involved in the dubious transactions yet remain unnamed and uncharged.
This week Judge Jed S. Rakoff of Federal District Court issued a blistering 15-page opinion rejecting the proposed settlement, characterizing the penalty as “pocket change” for Citigroup and the overall settlement as “a very good deal” for Citigroup and a “mild and modest cost of doing business.” Confronted with allegations that Citigroup in customary fashion neither admitted nor denied, Judge Rakoff said he lacked an adequate factual basis for evaluating the settlement and ordered the parties to trial.
It looked like Citigroup and its wayward executives might finally get their due.
Or so I thought until I read the submissions in the case and did some further reporting. The S.E.C. may have been lucky to get what it did. It’s a textbook example of why it’s hard to hold anyone legally accountable for the financial crisis. You can’t fault the agency for not trying — it spent four years digging into Citigroup’s mortgagederivatives operation. If anything, the S.E.C. might be criticized for being too aggressive, using its considerable power to extract a settlement in a case whose weaknesses, if it finally goes to trial, will probably become readily apparent.
Let’s stipulate that the behavior of Citigroup and its executives is every bit as bad as the agency alleges. Though Citigroup neither admitted nor denied the allegations, in its court submissions it actually admits quite a lot, and the key facts aren’t in dispute. In February 2007, as the real estate bubble was growing increasingly overextended and the first signs of distress were surfacing in mortgage markets, Citigroup Global Markets helped put together a $1 billion package of mortgages that it marketed and sold to clients still hoping to cash in on the real estate boom.
Then Citi itself took a short position on a portion of the mortgages, betting the security it created would decline in value. The Citi mortgage package was declared in default a mere nine months later, and according to the S.E.C., Citigroup’s clients lost over $700 million while Citi raked in a $160 million profit on its short position. For his efforts, Mr. Stoker took home a $1.05 million bonus and was further rewarded with a $2.25 million “guaranteed bonus” at the end of the year.
But bad deals, even really bad deals like Citigroup’s, aren’t illegal. They’re not criminal. They’re not inherently fraudulent. If Citigroup’s clients, all of them sophisticated institutional investors, were foolish or careless enough to buy what Citigroup sold them, then arguably they deserved their losses. Their remedy, presumably, would be never to do business with Citigroup again.
This poses a major obstacle for prosecutors and the agency’s enforcers. They have to prove that bank executives misrepresented the terms of the deal and misled investors. Fraud has an even higher standard of proof: the statement must be intentionally false about a material fact. The reason Mr. Stoker and no one else was charged is that he appears to be the only Citigroup executive who had any responsibility for the disclosure materials who also knew enough about the deal to ensure their accuracy.
Stripped of its complexity, the case boils down to just two allegations: that Citigroup helped choose the mortgages in the security and withheld that information; and that Citigroup failed to disclose that it was taking a short position.
So what did Citigroup actually say to potential clients?
The offering circular describing the deal states: “the composition of the Eligible Collateral Debt Securities will be determined by the selections of the Manager” which was Credit Suisse. Citigroup suggested mortgages for the collateralized debt obligation, most of which were included (along with others identified by Credit Suisse), but maintains that Credit Suisse “determined” the assets in that it had no obligation to accept Citi’s recommendations and that Citi had no veto power over what Credit Suisse decided to include.
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