MANHATTAN (CN) - With obvious relish, a federal judge held an SEC attorney's feet to the fire for proposing a settlement with Citigroup that represents a fraction of an alleged $600 million mortgage fraud and does not require the bank to admit wrongdoing.
Citigroup sold $1 billion in mortgage-backed CDOs, which a Citigroup trader called "a collection of dogsh!t," while secretly shorting the securities.
SEC attorney Matthew Martens urged U.S. District Judge Jed Rakoff not to factor the public interest into his decision on whether to approve the deal.
"That's an interesting position," Rakoff replied with acid understatement. "I'm supposed to exercise my power, but not my judgment."
The SEC on Oct. 19 accused Citigroup Global Markets of hyping and selling roughly $1 billion in residential mortgage-backed collateralized debt obligations, while secretly selling the CDOs short.
Citigroup Global Markets is Citigroup's principal U.S. broker-dealer subsidiary.
According to the SEC complaint: "One experienced CDO trader characterized the portfolio as 'a collection of dogsh!t' and 'possibly the best short EVER!' An experienced CDO collateral manager commented, 'the portfolio is horrible.'" (Punctuation as in complaint.)
The SEC offered to settle with Citigroup for $285 million, with $95 million going to the victims.
But Judge Rakoff said that the "net effect is you're only returning a small fraction of what investors were allegedly defrauded."
Typically, investors could sue for the difference. But the SEC's allowing Citigroup to neither admit nor deny wrongdoing complicates things, Rakoff said.
"They remain unproven in a court of law," Rakoff said, adding with faux naïveté: "Correct me if I'm wrong. ... It was my understanding that anyone can make an allegation."
Martens replied that the complaint's allegations were detailed enough to eliminate doubt to the public.
Rakoff tested that theory by asking Citigroup's attorney Brad Karp whether the bank's press department would admit guilt.
"We do not admit the allegations," Karp said, adding, to laughter in the courtroom, "but if it's any consolation, we don't deny them."
Rakoff said he would not "get cute" and ask what percentage of the allegations the bank would admit because, "I don't have a microscope that looks at objects that small."
Martens stood uncomfortably as Rakoff described presiding over other financial cases in which defendants take "the proverbial slap on the wrist," while "their PR machines" attribute the decision to settle to avoiding "the costs of litigation."
Martens said the terms of the settlement prohibit Citigroup publicists from denying their guilt.
But Rakoff blasted the SEC for allowing defendants to ignore court injunctions, using the violations as a "bargaining chip" and "another weapon in our pockets in settlement talks."
"We're not really serious that we would bring these folks to task," Rakoff said. "You didn't say, 'Judge, they're flouting your order.'"
Martens replied: "We categorically reject that." He said SEC attorneys would send a judge such a letter if a bank's violations were egregious enough.
"Hope springs eternal," Rakoff said, quoting Alexander Pope.
Rakoff wondered aloud why SEC prosecutors described the allegations in the complaint as "negligence."
Paraphrasing the complaint to omit the profanity, Rakoff asked Martens whether the SEC complaint had quoted Citigroup executives as calling the CDOs "real dogs," then summarized several allegations.
Martens rephrased Rakoff's summary with more technical and euphemistic language.
"So it's what I just said?" Rakoff said.
"Yes," Martens acknowledged.
With that, Rakoff stopped grilling the prosecutor, but warned him not to get "too comfortable" as he moved on to Karp, Citigroup's lawyer.
Rakoff asked Karp whether the settlement's gag order would prevent Citigroup from denying their guilt if investors sued them.
Karp replied that Citigroup would be "free to use any and all defenses."
"We're as innocent as lambs," Rakoff said.
When asked what in the settlement would deter Citigroup from another alleged fraud, Karp replied that the contract included a consent decree with strict oversight.
"Is this another, forgive me, window dressing?" Rakoff asked.
Karp insisted that there would be "strict accountability going up the chain."
Though skeptical of the proposed settlement, Rakoff reserved decision on it, saying he would issue a written opinion.