MANHATTAN (CN) - A federal judge presiding over the $600 million mortgage-fraud case against Citigroup abused his discretion in refusing to sign off on settlement he described as "pocket change," the 2nd Circuit ruled today.
The Securities and Exchange Commission had accused Citigroup Global Markets back in 2011 of hyping and selling roughly $1 billion in residential mortgage-backed collateralized debt obligations, while secretly selling those CDOs short.
"One experienced CDO trader characterized the portfolio as 'a collection of dogsh!t' and 'possibly the best short EVER!'" the complaint said. "An experienced CDO collateral manager commented, 'the portfolio is horrible.'" (Punctuation as in complaint.)
Citigroup Global Markets is Citigroup's principal U.S. broker-dealer subsidiary.
Within weeks, the parties agreed to settle for $285 million, with $95 million going to the victims.
Those plans hit a snag, however, in the courtroom of U.S. District Judge Jed Rakoff, who roasted
government regulators over what he said looked like "a slap on the wrist" for the megabank.
To no one's surprise, Rakoff blocked the proposed consent decree weeks later, saying it was "neither fair, nor reasonable, nor adequate, nor in the public interest."
The 2nd Circuit stayed that decision in a Mach 2012 opinion, which found that the SEC had a "strong likelihood of success on appeal."
On Wednesday, a three-judge panel with that court agreed that Rakoff had overstepped his bounds.
"It is an abuse of discretion to require, as the district court did here, that the SEC establish the 'truth' of the allegations against a settling party as a condition for approving the consent decrees," Judge Rosemary Pooler wrote for the court. "Trials are primarily about the truth. Consent decrees are primarily about pragmatism."
One of Rakoff's strongest objections to the deal had been that the SEC allowed Citigroup to neither admit nor deny the allegations.
Stating that this practice was "hallowed by history, but not reason," Rakoff said that "an application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous."
On remand, Rakoff can order the parties to supply more information to "allay any concerns the District Court may have regarding improper collusion between the parties," 28-page opinion states.
It is improper, however, for Rakoff to decide the "adequacy" of the settlement, or determine that the SEC's policy decision violates the public interest, the court found.
"The job of determining whether the proposed SEC consent decree best serves the public interest, however, rests squarely with the SEC, and its decision merits significant deference," the ruling states.
Government regulators must "assure the court that the settlement proposed is fair and reasonable," the judges added.
"For the courts to simply accept a proposed SEC consent decree without any review would be a dereliction of the court's duty to ensure the orders it enters are proper," Pooler wrote.
In a concurring opinion, Judge Raymond Lohier added that he believed that the parties did not need to develop the record any further.
"It does not appear that any additional facts are needed to determine that the proposed decree is 'fair and reasonable' and does not disserve the public interest," Lohier wrote.
SEC enforcement director Andrew Ceresney applauded the ruling
"While the SEC has and will continue to seek admissions in appropriate cases, settlements without admissions also enable regulatory agencies to serve the public interest by returning money to harmed investors more quickly, without the uncertainty and delay from litigation and without the need to expend additional agency resources," Ceresney said in a statement.
Citigroup did not immediately return a request for comment.