If only Manhattan's U.S. District Judge Jed Rakoff could be cloned, maybe Wall Street wouldn't act with such impunity.
Rakoff is making headlines because he so far has refused to approve a $285 million settlement between Citigroup and the Securities and Exchange Commission — in part because it would allow Citigroup to simply pay a fine and walk away without admitting any wrongdoing. "Doesn't the SEC have an interest in what the truth is?" he asked in a hearing last week. Rakoff is standing up for the public interest rather than business as usual. It's as refreshing as it is rare.
The allegations against Citigroup couldn't be much more disturbing. The investment giant is accused of misleading clients in a $1 billion deal involving toxic mortgage securities. Citigroup allegedly told investors that the packaged mortgages were independently chosen, when actually Citigroup did the choosing and then bet against the securities and its customers. In the end, Citigroup made a profit of $160 million and its customers lost $700 million.
The SEC has asked Rakoff, a former prosecutor with the U.S. Attorney's Office in New York, to approve a civil settlement that would allow Citigroup to pay $160 million in disgorged profits, $95 million in penalties and $30 million in interest, while not admitting any malfeasance. Meanwhile, its customers are out a fortune.
Citigroup would also have to agree not to engage in this conduct again, a toothless concession since, according to Bloomberg News, the SEC has two prior cease-and-desist orders against the same Citigroup unit relating to violations of the same section of securities law.
Federal judges applying federal securities law have an obligation to approve only those SEC settlements deemed "fair, reasonable, adequate and in the public interest." This caution hasn't stopped most judges from merely rubber-stamping whatever deals the regulators and financial firms bring to them.
But Rakoff is taking his duty seriously. He pointedly asked how the SEC came to describe Citigroup's misdeeds as "negligence" rather than intentional fraud. He also chided the SEC for failing to seek injunctions against repeat offenders, which would at least give judges the power to find the wrongdoers in contempt of court.
Rakoff's actions may push the SEC to do a better job of making fraud allegations against Wall Street really sting. Settlements should be commensurate with the fraud perpetrated and should require an admission of wrongdoing. Rakoff will soon decide whether to give approval to the deal between the SEC and Citigroup, but his example has already shown other federal judges what a legal watchdog for the public's interest looks like.