The Securities and Exchange Commission has summarily granted Citigroup two waivers from regulatory restrictions arising out of the federal court injunction entered against it under a $285 million settlement with the SEC. These little-noticed acts of clemency, granted last Friday, September 26, 2014, without any explanation or analysis, further confirm that the agency’s current approach to enforcement via settlement can do little to promote accountability on Wall Street.
U.S. District Court Judge Jed Rakoff initially rejected the proposed settlement in 2011 and Citigroup and the SEC lodged a joint appeal to force his hand. Better Markets filed an amicus brief in the Second Circuit, supporting Judge Rakoff’s refusal to rubber stamp a consent judgment where the record provided by the parties was unreliable, inconsistent, and riddled with gaps and omissions. The Second Circuit reversed and Judge Rakoff reluctantly entered the consent judgment on August 5, 2014.
The law provides that persons subject to such injunctions are “bad actors” and therefore deprived of important regulatory exemptions under SEC rules 506 and 405. Rule 506 enables the banks to participate in large, private offerings (typically of hedge fund shares) requiring much less disclosure to investors. Rule 405 enables a “well-known seasoned issuer” such as a large bank to streamline the process for offering securities, giving it much more flexibility when raising capital. The law also provides, however, that the SEC may preserve the benefits of those exemptions even for “bad actors” if it determines, upon a showing of “good cause,” that a disqualification is not “necessary.”
To secure relief from the SEC, Citigroup attempted to downplay the nature of its unlawful conduct in every conceivable way: that its misconduct was not “scienter-based” (i.e. not willful), that it involved only a single CDO transaction, that it was a long time ago, and so forth. But in reality, Citigroup engaged in what can only be viewed as egregious fraudulent conduct in the structuring and marketing of investments keyed to residential mortgage-backed securities, causing over $700 million dollars in immediate harm to investors, and more importantly, contributing directly to the worst financial crisis and economic downturn since the Great Depression.
In fact, the only reason that Citigroup could even attempt to minimize the significance of its violations was the SEC’s own willingness in the settlement negotiations to dramatically limit the scope of the complaint to one transaction among countless others, to allege only negligence rather than outright fraud, and to refrain from naming any top executives. Moreover, nowhere in Citigroup’s petitions or the SEC’s orders is there any mention of the bank’s extensive recidivist history spanning years of repeated violations of the securities laws, as detailed on pages 39 and 40 of Better Markets’ amicus brief.
Citigroup also argued that without relief, it “would not be able to participate in certain offerings and transactions,” thus “creating a disadvantage to [its] business opportunities.” But that’s the whole point of the disqualifications—protecting other market participants by preventing a demonstrated wrongdoer from engaging in certain types of securities transactions and reaping the benefits. If the SEC is sold on Citigroup’s concerns about the harm to third parties who have a stake in future dealings with the bank, then it has unfortunately embraced a variation on a familiar theme sounded by the U.S. Department of Justice: the “too-big-to-jail” banks are also too big and interconnected to punish aggressively through civil enforcement actions.
Not surprisingly, the SEC granted Citigroup’s request in two perfunctory orders (a page each) that offered no explanation of how or why it decided the bank should be spared from the collateral consequences of its own illegal conduct—exemplifying the same lack of transparency that marked the entire settlement process in the case. The bottom line is that the SEC’s enforcement effort has been too lenient and short on public accountability.