Judge Rakoff's Wall Street Zombies Arise In FINRA Citi Settlement

March 19, 2012

Actors dressed up like zombies wait for the tr...

Oh wow!  The Financial Industry Regulatory Authority ("FINRA") just issued a press release:  "FINRA Fines Citi International Financial $600,000 and Orders Restitution of $648,000 for Excessive Markups and Markdowns"(March 19, 2012), which heralds the settlement by Wall Street's self-regulatory organization with Citi International Financial Services LLC, a subsidiary of Citigroup, Inc.  This Citigroup subsidiary was fined by FINRA $600,000 and ordered to pay over $648,000 in restitution and interest to more than 3,600 customers arising from alleged excessive markups and markdowns (ranging from 2.73 to in excess of 10 %) on corporate and agency bond transactions, and for related supervisory violations.

Far from being an isolated miscue, the cited violations allegedly occurred over a three-year period from July 2007 through September 2010, during which time Citi International charged excessive corporate and agency bond markups and markdowns. In addition, from April 2009 through June 2009, Citi International allegedly failed to use reasonable diligence to buy or sell corporate bonds to ensure its customers were fairly charged.

Maybe We Did, Maybe We Didn't - Who Knows And Who Cares?

What struck me most about FINRA's million-dollar plus settlement was this solitary line in its press release (I have added the boldface):

In concluding this settlement, Citi International neither admitted nor denied the charges.

Hmmm, why does that refrain sound familiar? Where have we heard that same line before?


On October 19, 2011, the Securities and Exchange Commission ("SEC") announced  that it had charged Citigroup Global Markets (Citigroup's principal U.S. broker-dealer subsidiary) with misleading investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market in which Citigroup bet against investors as the housing market showed signs of distress. The CDO defaulted within months, leaving investors with losses while Citigroup made $160 million in fees and trading profits.  The SEC announced that Citigroup agreed to settle the SEC's charges by paying a total of $285 million, which will be returned to investors.

How lovely that the SEC and Citigroup sat down, sang Kumbaya, and found a way to work through the painful issue of how many dollars in fines and how soon - all neatly tied up as part of a purportedly compelling settlement presented to federal judge Rakoff for his hoped-for cursory review and prompt rubber stamp.

Rakoff Ain't Buyin' It

As I wrote in "Judge Rakoff Rejects SEC's "Contrivances" In Citigroup Settlement" (" Street Sweeper" November 29, 2011), on November 28, 2011, Judge Jed S. Rakoff, refused to approve theConsent Judgement submitted by both Citigroup and the SEC in United States Securities and Exchange Commission v. Citigroup Global Markets Inc. (SDNY, Opinion and Order, 11-CIV-7387, November 28, 2011).  In rejecting the proposed settlement, which allowed for Citigroup to neither admit nor deny the allegations, Judge Rakoff noted:

As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup's position in this very case.

Of course, the policy of accepting settlements without any admissions serves various narrow interests of the parties. In this case, for example, Citigroup was able, without admitting anything, to negotiate a settlement that (a) charges it only with negligence, (b) results in a very modest penalty, (c) imposes the kind of injunctive relief that Citigroup (a recidivist) knew that the S.E.C. had not sought to enforce against any financial institution for at least the last 10 years (d) imposes relatively inexpensive prophylactic measures for the next three years. In exchange, Citigroup not only settles what it states was a broad-ranging four-year investigation by the S.E.C. of Citigroup's mortgage-backed securities offerings, but also avoids any investors' relying in any respect on the S.E.C. Consent Judgment in seeking return of their losses. If the allegations of the Complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business. . .

By the S.E.C.'s own account, Citigroup is a recidivist, and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup. . .

Second Circuit Victory for SEC and Citi

On December 15, 2011, the SEC filed a Notice of Appeal seeking a ruling by the United States Court of Appeals for the Second Circuit that would reverse Judge Rakoff's rejection of the proposed consent judgment and his order directing the parties to prepare for trial in July 2012. In his public comment on the appeal, SEC Enforcement Direct Robert Khuzami argued that Judge Rakoff was

incorrect in requiring an admission of facts - or a trial - as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. . .

On March 15, 2012, Khuzami and his SEC got its wish.  The Second Circuit set aside Judge Rakoff's rejection of the settlement. As I commented on the SEC's victory in "The SEC Couldn't Stop Madoff or Stanford But Jams Up Judge Rakoff Over Citigroup Settlement" (" Street Sweeper" March 15, 2012):

We now find ourselves in an Alice-In-Wonderland world where the Circuit Court seems to agree that Rakoff should not be required to merely rubber stamp the SEC's settlement but, on the other hand, the judge should defer to the SEC's assessment that the settlement is fair.  A fine enough proposition but one that seems made in a vacuum of recent history.

The SEC has run off these cookie-cutter settlements without admission of liability for decades.  It is a bankrupt approach to regulation that partially contributed to the onset of the Great Recession and seems likely to saddle our society with a future filled with more impotent responses. If this regulatory policy is fair and effective, then why has it only left a swath of devastation in its historic path?

Recidivist Zombies Arise!

Clearly this never-ending predilection for the expediency of tepid settlements by Wall Street's cops shows no signs of ending.  Even as the smoke is still in the air from the SEC's barrage against Rakoff, we see yet more proof that this bankrupt regulatory policy continues unabated - not only at Wall Street's federal regulator but even at the industry's self-regulator FINRA.  Having turned back one federal judge's principled rejection of a settlement, those charged with regulating our financial markets now seem emboldened to permit the big boys to write out large checks for fines, which are ultimately paid by public shareholders, and without one word of meaningful admission of wrongdoing.  If I were one of Wall Street's Too-Big-To-Fail, I'd sure as hell find these developments encouraging.  The likes of JP Morgan, Goldman Sachs, Bank of America, Morgan Stanley, and their ilk can set up a spreadsheet and do the cost-benefits analysis.  Of course, for the small fry, I'm not so sure that all these ardent advocates at the SEC and FINRA will feel the same about their not having to admit wrongdoing and agreeing to take their checks in full settlement of violations.

Failing to contain this counter-productive and discredited regulatory practice at the SEC, we now see that it retains its vibrancy at FINRA.  Rakoff's zombies have arisen in force. Sadly, both the SEC and FINRA still think that such mealy-mouthed settlements justify self-congratulatory press releases.