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Judge Blocks ‘Dangerous’ Citigroup Settlement

MANHATTAN (CN) - As expected, a federal judge rebuked the Securities and Exchange Commission on Monday for trying to grab a "quick headline" by allowing Citigroup to settle alleged $600 mortgage fraud claims for "pocket change," without admitting wrongdoing.

"The court concludes, regretfully, that the proposed consent judgment is neither fair, nor reasonable, nor adequate, nor in the public interest," U.S. District Judge Jed Rakoff wrote in a 15-page order. He suggested that the SEC's longstanding practice of settling cases without establishing facts is precursor to totalitarianism.

"In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found," Rakoff wrote. "But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances."

On Oct. 19, the SEC 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 complaint repeatedly indicated that "Citigroup knew" about the illegal conduct.

"Although this would appear to be tantamount to an allegation of knowing and fraudulent intent ('scienter,' in the lingo of securities law), the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence," Rakoff wrote.

The SEC offered to settle with Citigroup for $285 million, with $95 million going to the victims.

Rakoff wrote that, "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."

Earlier this month, the judge roasted an SEC attorney at a hearing for allowing the bank to settle without admitting guilt, and he ruled today that he could not grant an injunction without such an admission.

"Here, the S.E.C.'s long-standing policy - hallowed by history, but not by reason - of allowing defendants to enter into consent judgments without admitting or denying the underlying allegations, deprives the court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact," Rakoff wrote.

"An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous," he added. "The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts - cold, hard, solid facts, established either by admissions or by trials - it serves no lawful or moral purpose and is simply an engine of oppression."

Rakoff puzzled over what the SEC hoped to gain from the proposed deal.

"It is harder to discern from the limited information before the Court what the S.E.C. is getting from this settlement other than a quick headline," he wrote. "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."

"Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth," he concluded.

The case will go to trial on July 16, 2012.

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