WASHINGTON — Global banking giant Citigroup has agreed to pay $285 million to settle charges that it misled investors about a complex financial instrument tied to the now-crippled housing market, the Securities and Exchange Commission said Wednesday.
The announcement was unlikely to satisfy critics of Wall Street and Washington's bailout of its banks who've waited years for any major Wall Street executive to be jailed for practices that led to the global financial meltdown in 2008, which still roils the U.S. economy.
The SEC alleged that Citigroup's main broker-dealer subsidiary duped investors who had bought portions of a $1 billion offshore deal known as a collateralized debt obligation. CDOs are bundles of bonds tied to the performance of mortgages and other loans. The deal in question was precisely the kind of engineered financial product that blew up in 2008 and nearly brought down the global financial system.
In the complaint, the SEC alleged that Citigroup Global Markets selected about $500 million worth of assets in the deal, but in marketing materials suggested to investors that Swiss bank Credit Suisse had conducted the selection.
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That gave the appearance that it was an arms-length transaction. In reality, said the SEC, Citigroup's subsidiary selected the assets and then bet against the investors in the very product it was selling. Betting that a bond will default is known as shorting, or going short.
With the settlement, Citigroup joins other major banks that collectively have shelled out more than $1 billion to settle SEC enforcement cases. Investment titan Goldman Sachs last year agreed to a $550 million civil settlement. Earlier this year JPMorgan Chase also settled on similar charges, agreeing to pay more than $153 million.
This sort of "heads I win, tails you lose" behavior by Wall Street is what prompted last year's extensive revamp of financial regulation, known as the Dodd-Frank Act, which several GOP presidential candidates vow to repeal. It's also what has driven many Americans to support the Occupy Wall Street protest movement growing in cities across the nation.
"It's not called Occupy Wall Street because it's a random geographical location," said Bartlett Naylor, who heads financial policy for advocacy group Public Citizen, which wants criminal charges filed against Wall Street executives. "The details (of this case) are the face of the problem that brings Occupy Wall Street protestors to the streets. We have theft from actual people. In the end these are pension fund beneficiaries ... it's clear we know the names of the perpetrators, and yet these people are apparently not heading to jail."
In a statement on its website, Citigroup neither admitted nor denied guilt.
"We are pleased to put this matter behind us and are focused on contributing to the economic recovery, serving our clients and growing responsibly," the statement said.
Citigroup had previously reached a $75 million settlement with the SEC in July 2010 for failing to adequately disclose how much risk it carried on junk mortgages. A federal judge first rejected that settlement as too light, before agreeing later to accept it.
Prompted by allegations from Iowa Republican Sen. Charles Grassley, the SEC's inspector general began investigating whether enforcement chief Robert Khuzami, a former general counsel for Deutsche Bank, gave preferential treatment to executives in reaching that settlement. Results of that inquiry haven't been disclosed, but it apparently won't sideline Khuzami, who made Wednesday's announcement.
SEC documents released Wednesday spell out how the Citigroup transaction, known as Class V Funding III, closed on Feb. 28, 2007, and that by November about 83 percent of the assets in the complex deal had defaulted. Citigroup still walked away with staggering profits.
As part of Wednesday's settlement, Citigroup agreed to pay a $95 million penalty. It also committed to return $160 million in fees and profits and another $30 million in interest payments. Credit Suisse agreed to pay $2.5 million in penalties for its alleged role in misleading investors about who selected the assets for the deal.
Former Citigroup executive Brian Stoker, also charged with civil fraud, refused a settlement and chose to fight the SEC in civil court.
Big bucks and minimal transparency characterized the world of structured finance, where Wall Street sliced and diced $2 trillion in loans into complex securities that eventually went bust. McClatchy Newspapers reported exclusively in 2009 on how Moody's Investors Service was complicit by giving AAA ratings to junk bonds, and how Goldman Sachs secretly bet against its mortgage products while safely exiting a cresting housing market before its collapse.
During a Wednesday news conference, Khuzami read from an email sent by a veteran CDO trader that referred to the Citigroup's deal as "the best short ever." In SEC documents, this same trader refers to the deal as "dog shit."
Somehow this deal still got a gold-plated AAA rating from both Moody's and Standard & Poor's, yet neither was charged in the Citigroup case or any other one. Khuzami declined to answer questions from McClatchy about the role of ratings agencies in the deal and whether they were complicit in misleading investors.
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The deal and others like it did raise internal debate within the rating agencies. In testimony before Congress and the Financial Crisis Inquiry Commission, former analysts from Moody's said they were unaware of the secret bets and were pressured to give good ratings to bad deals.
The SEC filed a suit in April 2010 accusing Goldman Sachs of civil fraud for allegedly allowing a hedge fund client, Paulson & Co., to stack a billion-dollar, 2007 offshore deal with highly risky residential mortgage securities without telling investors that Paulson was betting they would default. When the securities collapsed, Paulson reaped a $1 billion profit, much of it at the hands of European banks. In July 2010, Goldman agreed to a $550 million settlement.
Still unclear is the degree to which the SEC, with limited resources, is investigating an estimated $1.3 trillion in complex Cayman deals by major U.S. banks in which investors, often foreign banks, absorbed huge losses, mostly on risky mortgage securities.
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