Want inside look at SEC dealmaking? Read IG’s Khuzami report

By Alison Frankel
November 21, 2011

On June 28, 2010, the Enforcement Director of the Securities and Exchange Commission, Robert Khuzami, spoke on the phone with Mark Pomerantz, a partner at Paul, Weiss, Rifkind, Wharton & Garrison. Pomerantz and Khuzami had worked together as assistant U.S. attorneys in Manhattan in the 1990s; according to Pomerantz, he was partly responsible for Khuzami’s promotion to chief of the office’s securities unit. But this wasn’t a social call. Pomerantz represented Citigroup, which had agreed to settle SEC allegations that it drastically underreported its subprime mortgage exposure. The deal was held up, however, by the agency’s insistence that Citi CFO Gary Crittenden face fraud claims for allegedly misleading investors.

Pomerantz told Khuzami, as he had many times before, that Citi would suffer collateral damage if Crittenden were accused of fraud. According to Khuzami, he just told Pomerantz to “talk to Crittenden.” But soon after the June 28 call, another Citi lawyer, Lawrence Pedowitz of Wachtell, Lipton, Rosen & Katz, told SEC Associate Enforcement Director Scott Friestad that Khuzami had agreed to back a non-fraud settlement with Crittenden.

In July 2010 the SEC announced its deal with Citi. As part of the settlement, Crittenden and another individual defendant, former Citi investor relations chief Arthur Tildesley, settled administrative actions that didn’t involve fraud allegations. Six months later, an anonymous (but obviously insider) source tipped U.S. Senator Chuck Grassley that Khuzami had forced the agency to drop fraud claims against the execs as a favor to his friends in the defense bar. The SEC’s inspector general, H. David Kotz, undertook an investigation of the complaint.

The result of the investigation, announced Thursday, is an utterly compelling 43-page report. The inspector general cleared Khuzami of violating any SEC guidelines or offering any preferential treatment to Citi. The settlement, Kotz said, was the product of long negotiations between the bank and enforcement-division lawyers. And though it would have been “advisable” if another SEC lawyer had also been on the phone when Khuzami spoke with Pomerantz on June 28, 2010, Kotz said that Khuzami cured any misunderstanding about what he said to Pomerantz when he offered in an subsequent email to Friestad to insist on fraud claims if the staff felt it was important.

“The OIG found that Khuzami also included at least some staff members on every meeting he had with defense counsel, and in instances where certain staff members could not attend, Khuzami made sure to brief them after the meetings,” the report said. “In addition, the OIG found that Khuzami held several internal meetings with the staff in which he gave the staff members ample opportunity to express their views on the Citigroup case. The enforcement staff consistently testified to the OIG that they felt they had the opportunity to express their views throughout the Citigroup investigation.”

But it’s impossible to read the public version of the IG’s report (which is, unfortunately, heavily redacted) without getting the sense that the white-collar bar is a club of insiders. This is a rare window into how SEC settlements are made — and how defense lawyers’ access to SEC decision-makers may affect the process.

Citi was represented by Brad Karp of Paul Weiss and Pedowitz of Wachtell when it reached the outlines of a deal with the SEC enforcement staff in Sept. 2009. The deal would permit the bank to resolve the SEC’s investigation of its subprime disclosures by agreeing to claims that it misled investors without the intention of defrauding them — a so-called Section 17(a) charge under the Securities Act of 1933. (Section 17(a) is considered a fraud claim, but it’s not intentional fraud.)

When the SEC resolved to charge individuals, things got more complicated. The agency appears to have sent Wells notices to a number of potential Citi defendants, but the enforcement staff eventually decided to focus on Crittenden, the CFO, and Tildesley, the former investor relations head. Crittenden hired John Carroll of Skadden, Arps, Slate, Meagher & Flom. Tildesley was represented by Mark Stein of Simpson, Thacher & Bartlett. According to the IG’s report, Citi supplemented its team with Pomerantz of Paul Weiss, specifically to make the SEC aware of the implications for the bank-which faced securities fraud class actions — if individual Citi defendants were accused of fraud.

Carroll, Stein, and Pomerantz had all intersected with Khuzami in the Manhattan U.S. attorney’s office, according to the report. (Khuzami’s deputy, Lorin Reisner, overlapped with Khuzami, Carroll, and Stein but not Pomerantz.) Khuzami worked closely with Stein and Pomerantz, and he stayed in touch with Pomerantz after he left the prosecutors’ office and joined the legal department at Deutsche Bank. Khuzami actually hired Pomerantz on a long-running matter for Deutsche Bank.

In talks with the SEC enforcement staff, Tildesley and Stein agreed pretty quickly to a Section 17(a) settlement. Not Crittenden and his counsel, Carroll of Skadden. (Khuzami told the IG’s investigators that Crittenden was concerned he’d have to step down from a position in his church if he settled the SEC claims.)

Pomerantz of Paul Weiss, meanwhile, repeatedly contacted Khuzami to argue that Citi would suffer if the SEC charged Crittenden with securities fraud. According to the IG report, he sent an email directly to Khuzami on April 6, 2010; Khuzami immediately forwarded it to the enforcement staff. In June, Pomerantz emailed Khuzami to ask him to meet with Citi’s board chairman, Dick Parsons. Khuzami, Reisner, and Friestad all attended the Parsons meeting, which didn’t seem to change the dynamic of discussions between the SEC and Crittenden.

Then came the crucial June 28 phone call between Pomerantz and Khuzami. Pomerantz, who gave testimony to the SEC inspector general, said he recalled Khuzami suggesting in that call that it might be possible to charge Crittenden with something other than securities fraud. “Pomerantz described Khuzami’s comment as ‘a little crack in the door’ and ‘a light and the light was not an upcoming train’ and noted that it reflected ‘some willingness to consider whether the staff could entertain a non-fraud resolution as to Crittenden,’” the report said. Khuzami, by contrast, told the IG that he never agreed to any such thing. “[He said] there was no such agreement, and [he] didn’t agree to any such thing, and [he] couldn’t agree to such a thing,” the report said.

Pomerantz, however, told his Citi co-counsel Pedowitz and Crittenden counsel Carroll that the SEC had moved away from charging Crittenden with fraud. Pedowitz emailed Friestad, and in a follow-up phone call, said Khuzami was now backing a non-fraud settlement with Crittenden. Friestad told the IG’s office that Pedowitz’s assertion came as news to him, but he pretended to know what the Citi lawyer was talking about. Then he went to Reisner since Khuzami was out of the office. (Reisner’s reaction is redacted.)

When Khuzami got word that Citi believed he’d agreed to a non-fraud settlement for Crittenden, according to the IG’s report, he was none too pleased. In a call on July 1, 2010, he told Pomerantz that the Paul Weiss lawyer had read too much into their previous discussion. Pomerantz told the IG’s office, however, that by the end of the July 1 call, he still believed Khuzami would support a non-fraud settlement with Crittenden, even though Khuzami told him the deal would have to be negotiated with Carroll, not with the Citi lawyers. “Pomerantz said that by the end of the conversation, he was ‘certain the state of play was that hopefully we would be back on track,’” the report said.

Carroll, according to the report, was surprised when Reisner and Friestad informed him that the SEC was still pursuing fraud claims against his client, whatever he had heard from Pomerantz. “Confusing day,” Carroll said in an email to Friestad; in a subsequent phone call, Friestad told the IG, Carroll said, “What the heck is going on? I’ve known you for 16 years. I don’t think I’ve ever had a call like this in my life from you guys.”

On July 3, 2010, Khuzami sent an email to Friestad that weighed heavily in the IG’s evaluation of his conduct. It’s partly redacted but said, “Regardless of whatever miscommunications or strategy is behind what Larry or Mark told John,” Friestad should “confirm the [enforcement team] is OK [with a non-fraud deal for Crittenden].”

Frustratingly, the public version of the report does not disclose how the enforcement staff came to accept a non-fraud deal with Crittenden. (Those terms were eventually offered to Tildesley as well.) But it was the IG’s conclusion that 43-page report Khuzami never intended to cut the enforcement staff out of decision-making or to confer preferential treatment on Citi.

SEC spokesman John Nestor told Reuters reporter Aruna Viswanatha that the agency is “pleased that the report found the anonymous allegations were completely without merit.” I left messages for Pomerantz, Carroll, and Pedowitz but didn’t get a response.

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One comment

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The redacting under the Privacy Act of 1974 in a case such as this is disturbing. It’s not as though these actors are discussing someone’s HIV status, personal checking accounts activity or premarital sexual activities.

These negotiations end up substituting for and actually preventing a legal trial and after reading the 43-page report, I am not at all convinced that those negotiations were in my best interest as a citizen taxpayer. These negotiations should be much more fully a matter of public record… another compelling reason for having a low threshold for elevating financial wrongdoing out from the jurisdiction of the SEC and into the jurisdiction of the federal courts.

The federal courts might at first be heavily burdened by all of the chicanery that is going on, but I think that a few successful RICO prosecutions might fundamentally improve this cohort’s behavior… and isn’t that one of the reasons for having laws in the first place?

Posted by breezinthru | Report as abusive