There are times when I have a very jaded view of the judicial system in this country. The O.J. Simpson and Casey Anthony verdicts showed that justice is not always done in criminal cases. Civil cases are much worse. The securities industry routinely victimizes its clients with impunity. A cozy mandatory arbitration system administered by FINRA, which is basically a shill for the securities industry, often serves the interest of its benefactors at the expense of its clients. If investors recover anything, it's typically a fraction of what they deserve. Hopefully, mandatory arbitration for all consumers will be banned by Congress, but I am not optimistic.
In last week's blog, I wrote about the proposed settlement with Citigroup over its sale of $1 billion in toxic housing debt. Citigroup allegedly didn't tell the investors who bought this debt that it exercised significant influence over the selection of $500 million of the assets in the portfolio and then took a short position against those assets. The investors lost everything. Citigroup pocketed $34 million for structuring and marketing the transaction and an additional $126 million by betting against the interest of its investors.
The proposed settlement involved the payment by Citigroup of $285 million. As is customary in these cases, Citigroup did not admit to any wrongdoing. This legal fiction permits companies to defend against civil lawsuits arising out of this conduct, and forces plaintiffs in those cases to relitigate the issue of liability.
Settlements of this sort are required to be submitted to the Federal Courts, where Judges routinely sign off on them without further inquiry.
Not U.S. District Court Judge Jed Rakoff.
Judge Rakoff is a Clinton appointee who joined the federal bench in 1996. He was previously a federal prosecutor and a defense attorney in white collar criminal cases. He has a long history of asking prickly questions about settlements with big Wall Street firms, and the Citigroup case was no exception.
He wants an explanation of how Citigroup can be accused of serious securities fraud, but not be required to admit or deny wrongdoing. The response will be interesting. To the average citizen, engaging in the kind of conduct alleged in the Citigroup complaint looks like fraud. If they are guilty, why shouldn't they admit their guilt?
He would like to know if the public interest would be better served by a trial, which would determine conclusively whether the charges are true. He is right. Either Citigroup should admit its guilt or there should be a trial where all the evidence will be made public and a jury can determine guilt or innocence.
He is concerned that the amount of the proposed $95 million penalty might not have deterrent effect. It won't. It is a drop in the bucket for Citigroup, which reported third quarter 2011 revenues of $20.8 billion.
Here's his real zinger: Why is the penalty in this case to be paid in large part by Citigroup and its shareholders rather than by the "culpable individual offenders acting for the corporation." There is no good reason why those who engage in this kind of conduct should not be personally responsible for the consequences of their actions.
Finally, he asks how this alleged conduct can be characterized as mere negligence rather than fraud. It clearly is fraud. You don't "negligently" fail to disclose this kind of conduct.
Judge Rakoff should be commended for taking on a system that encourages fleecing of investors by their "trusted" advisors. Usually, the only penalty is a slap on the wrist, which actually encourages repeat behavior of this sort. Exposing the legal fiction of these settlements is a service to all investors.
Dan Solin is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, was released in September, 2011.The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.