Citigroup (NYSE: C) packaged $1 billion of subprime mortgages into a security and sold it to investors. The US Securities and Exchange Commission alleged Citigroup took proprietary positions that bet against the performance of the pool.
The SEC said Citigroup made $160 million from fees and trading profits. Investors lost $700 million of their investment in a short time. The SEC accused Citigroup of fraud. Citigroup agreed to pay a $285 million fine without admitting guilt. This week, Jed Rakoff, a US District Court judge in Manhattan, taking a swipe at the SEC's practice of allowing companies to settle cases without admitting that they had done anything wrong, rejected the settlement.
The SEC claims it does not have the staff or resources to take Citigroup to court to prove it committed fraud -- because Citigroup has deep pockets, and it employs or retains a large number of high-powered attorneys.
We know Wall Street firms rarely admit guilt for criminal acts because it opens the door to investor lawsuits: in this case, suits from the unfortunate investors who lost $700 million. We also know paying a fine is the quickest, cheapest way to make the problem go away with the smallest amount of adverse publicity. Wall Street also knows investors have short memories, so it will be business as usual as soon as the bank's acts become old news.
I have three major problems with the SEC's position:
- First: Big Wall Street firms can get away with criminal acts because they have a lot of money and employ a lot of attorneys.
- Second: Companies don't commit fraud. The executives who run the companies commit fraud.
- Third: Fines are not a deterrent for big firms. They are a cost of doing business.
Think about it. Key executives are paid multi-million bonuses for decisions that damage thousands of investors. If they are caught, their companies pay fines without admitting the executives did anything wrong. I guess we are supposed to believe knowingly selling $1 billion of non-investment grade mortgages was a negligent act.
What a crock. The SEC claims Citigroup committed fraud but does not commit the legal resources to prove its claim. Citigroup pays a fine -- a small percentage of its annual profits -- without admitting it did anything wrong.
The SEC should restate its role: "We protect investors from bad guys if they have limited legal resources and we can coerce them into admitting guilt without a lengthy court process".
Citigroup wants the problem to go away. This type of publicity is bad for business. Investors may not have blind faith the next time Citigroup representatives want to sell them the latest hot product. However, something really stinks here, and when something smells this bad, politicians are usually involved.
If we dig a little deeper, I bet we'd find there's more to the story. I suspect the SEC's position is based on pressure from politicians who control SEC funding and resources. Wall Street companies spend more than $300 million per year on lobbyists to buy protection from supportive politicians who are more interested in re-election than protecting the public.
—Jack Waymire spent 28 years in the financial services industry, and for 21 of those years, he was the president of a registered investment advisory firm. He left the industry in 2004 for a career as an author and blogger. You can reach him at Jack@InvestorWatchdog.com.