SEC Settlements: Justice Served or Hush Money?

600px-us-securitiesandexchangecommission-sealsvg"he S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges." -- Judge Jed Rakoff, U.S. District Court

The Securities and Exchange Commission (SEC) often settles claims out of court, a relatively clean method of retribution and compensation that allows the public to avoid paying for a lengthy trial, the federal agency to say it did its job and the company under fire to escape not only litigation, but having to admit to its shareholders that it committed any wrongdoing.


But last month, this time-honored technique of setting right the balance of justice in the financial world was hit by a judicial bomb when Judge Jed S. Rakoff of the United States District Court in Manhattan dismissed a settlement of USD 285 million between Citigroup and the SEC to resolve allegations of fraud arising from the handling of a USD 1 billion mortgage fund.

The agency claims the fund was designed to fail so that the bank could bet against its own customers, reaping a profit when its value eventually declined. The failure of the fund resulted in a USD 700-million loss for investors and a USD 160-million profit for Citigroup. To put these figures into context, the bank reported a Q3 net income of USD 3.8 billion (compared to USD 2.2 billion for the same period last year).

Rakoff, an opponent of the SEC's extensive use of settlements, said in his ruling that the agency's settlement policy was "hallowed by history, but not by reason" and is rife for possible abuse as "it asks the court to employ its power and assert its authority when it does not know the facts." He also said that he could not determine if the agency's settlement with Citigroup was "fair, reasonable, adequate and in the public interest."


The New York Times said that the ruling could throw the agency's enforcement work "into chaos, because a majority of the fraud cases and other actions that the agency brings against Wall Street firms are settled out of court, most often with a condition that the defendant does not admit that it violated the law while also promising not to deny it."

Earlier this month, the House Financial Services Committee announced that they will hold hearings on the SEC's settlement policy early next year, a move that received bipartisan support. The committee chairman, Representative Spencer Bachus (R-Ala.), said that the agency’s "practice of using ‘no-contest settlements’ has raised concerns about accountability and transparency."


In addition to not being actually punitive for banks, which can easily afford the agreed-upon amounts, the main problem with settlements is that they effectively end governmental investigations into potential criminal activity.

"In announcing a case, the SEC said it had identified one low-level employee, Brian Stoker, as responsible for the bank’s misconduct," reports ProPublica. "It made no mention of the dozens of similar collateralized debt obligations, or CDOs, Citi sold to investors before the crash. A bank spokesman said the SEC would not be examining any of those deals."

Judge Rakoff makes a simple but important point: Instead of paying what amounts to a slap-on-the-wrist fine and ending the whole sordid affair, let's find out what happened. The current technique of "don’t admit, don’t deny, just pay" simply uses the grease of the capitalist system -- money -- to quiet a squeaky wheel. But that grease also occludes any possibility for transparency, which is what the public deserves and pays its government's agencies to ensure.


Ibid., 1.

image: Seal of the United States Securities and Exchange Commission (Wikimedia Commons)