Is the SEC colluding with banks on CDO prosecutions?

By Felix Salmon
October 20, 2011
Jesse Eisinger and Jake Bernstein get an astonishing on-the-record admission today, from a Citigroup flack, that that might indeed be the case:


" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

Is the SEC colluding with Wall Street’s biggest banks to let them off lightly with respect to their dodgy CDOs? Jesse Eisinger and Jake Bernstein get an astonishing on-the-record admission today, from a Citigroup flack, that might indeed be the case:

The bank says it has settled all of its potential liability to a key regulator – the Securities and Exchange Commission — with a $285 million payment that covers a single transaction, Class V Funding III…

[The SEC] 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. “This means that the SEC has completed its CDO investigation(s) of Citi,’’ the spokesman asserted in an e mail.

The SEC, of course, denies this — but it carries the ring of truth. Just look at the SEC’s own list of CDO prosecutions to date: there’s exactly one enforcement action per bank.

And the idea is held more broadly, too — look for instance at Peter Henning’s article on the subject today.

The settlement — in which the financial firm agreed to pay $285 million without admitting or denying guilt — appears to be of little concern to Citigroup investors. They’re likely to be happy that the bank has put the issue to rest.

What makes Henning think that Citigroup has put this issue to rest? As Eisinger and Bernstein demonstrate, Citi had lots of synthetic CDOs — not just Class V Funding III — where someone other than the ostensible CDO manager was intimately involved in choosing the contents, and had a vested interest in picking securities which were extremely likely to fail.

There’s every indication, here, that the banks are doing nod-and-a-wink deals with the SEC. The SEC brings its single strongest case, and the banks agree to a nine-figure fine, on the implicit understanding that the fine covers all their other CDO deals as well. That saves the SEC from having to laboriously put together a separate case for each CDO deal, and it allows the banks to put much of their contingent liability behind them.

But if that is going on, it’s a scandal. For one thing, it’s incredibly unfair to everybody who bought one of the dodgy CDOs which is not prosecuted. Investors in Class V Funding III, for instance, are getting all their money back as a result of this latest settlement. But what about investors in Citi’s other synthetic CDOs, like Adams Square Funding II, or Ridgeway Court Funding II, or even Class V Funding IV? Not to mention the $6.5 billion of Magnetar deals, where — according to all ProPublica’s reporting — Magnetar was intimately involved in choosing what went in and what didn’t. The big sin, remember, in both the Goldman and Citi deals, was one of disclosure: the banks didn’t disclose to investors that the short side of the trade was hand-picking the contents of the deal. And you just know that there were dozens of deals — not just one per bank — where that key disclosure was missing.

Is the SEC trying to protect the banks it’s meant to be prosecuting? Is it quietly agreeing on a one-prosecution-per-bank model? If so, we should be told. And if not, it had better bring prosecution #2 against someone pretty soon. Because right now the pattern is decidedly fishy.

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
16 comments so far

Fishy – check.
Regulatory Capture – check.
Entirely expected and understandable – check.
Ok, I’ll admit that is a completely cynical statement, but in a world where an entire continent is busy Kicking The Can Down The Road, why should we expect *anything* other than us vigorously and pointedly doing the same?
In fact, there is a strange sort of elegance to this solution. This – pretty effectively – shifts the attention from Citi to the SEC (you have to admit that it does so at least a wee bit!). And as is quite apparent, the SEC doesnt give a rats ass about appearing to be captured…

Posted by dieswaytoofast | Report as abusive

If an individual fraudulently sells the same bad deal to many individuals they receive concurrent sentences proportional to the number of cases. It should be no different with CDOs. The SEC should have arranged for all CDOs to be grouped together and the bank agree to a haircut compensation deal for all the CDO holders. If they don’t do this the SEC are basically saying that a Corporation has more rights than an individual, and that’s not in the US Constitution, is it?

It’s not like the banks aren’t used to packaging rubbish investments together…

Posted by FifthDecade | Report as abusive

In US Financial System space you have the Regulators/Regulatees and the Rest of the World. The RoW has come to the point in this relationship where “how stupid do they think we are?” has evolved into utter disgust at the corruption of the system. The RR’s have decided bald-faced lies boldly asserted and implausibly maintained are indeed fact. The US Financial System has reached the Great Divide between truth and lie. It’s broken ..

Posted by Woltmann | Report as abusive

Do you remember this article about the official Justice Dept. policy of (often) not prosecuting corporate crime?:
http://www.nytimes.com/2011/07/08/busine ss/in-shift-federal-prosecutors-are-leni ent-as-companies-break-the-law.html
Here’s a key quote:

“Federal prosecutors officially adopted new guidelines about charging corporations with crimes — a softer approach that … helps explain the dearth of criminal cases despite a raft of inquiries into the financial crisis….While “deferred prosecution agreements” were used before the financial crisis, the Justice Department made them an official alternative in 2008 …
Defending the department’s approach, Alisa Finelli, a spokeswoman, said deferred prosecution agreements require that corporations pay penalties and restitution, correct criminal conduct and “achieve these results without causing the loss of jobs, the loss of pensions and other significant negative consequences to innocent parties who played no role in the criminal conduct, were unaware of it or were unable to prevent it.””

You know — we should all be robbing banks, cause for a while we’ll make a lot of money, and then when we’re caught, well, prosecuting me would cause significant negative consequences to my wife and kids, who are innocent and rely on my to support them; so it’s much better to let me pay back the robbery you caught me for with some penalties and set me free, right? Oh … you mean the law is different for the 99%?

Posted by ken61 | Report as abusive

If Jesse Eisinger says X then it almost certainly means not X is true.

The article is almost a template for the usually crappy reporting scumbag “churnalists” have perfected since 2007.

Firstly, use your hindsight to criticise investment decisions. I mean if a asset when down in price then OBVIOUSLY it was always going to go down and OBVIOUSLY only banks could know this “fact” despite the fact they didn’t have access to any more information on the underlying than the buyers.

Secondly, don’t quote anyone competent. If you get some low-level monkey to say something incriminating then make sure it is “people say”, whilst quoting at length someone who has a vested interest in “backing up” your article.

Thirdly, show a fundamental misunderstanding of how the products you are “exposing” actually work. These were CDO squared deals whose remit was explicitly to invest in other CDO tranches.

Finally when all else fails, feel free to resort to lying. Citi couldn’t sell highly rated **vintage** CDO tranches in early 2007? Don’t believe it for a minute. Citi sold those tranches in early 2007 **knowing** they were going to head south? One quick glance at the hits those traders took on their bets, that were made at EXACTLY THE SAME TIME – quickly disposes of that assertion.

Again this shows just how much the field of “journalism” has declined to the state where mentally retarded, lying scum who don’t bother doing the slightest bit of fact checking like Eisinger are not laughed out of a job but rather taken seriously.

Posted by Danny_Black | Report as abusive

The problem, quite simply, is that the SEC is outgunned legally. Defendants have huge war chests and armies of lawyers…the SEC has comparatively few resources and a budget that is always under attack.

In any given case, the defendant can probably outspend the SEC 10:1 while mounting their defense. So is it really and surprise that the SEC settles for whatever it can get?

What is really needed in this case is some good class-action lawyers to take on the banks, not underpaid, resource-starved government prosecutors.

Posted by mfw13 | Report as abusive

Jesse Eisinger: the guy who spent 7 months investigating Magnetar and still doesn’t understand the trades.
Great journalist according to his fellow ultracrepidarian journos, total moron for everybody else.

Posted by alea | Report as abusive

Felix, the truth is that the US regulatory and legal system are bleeding legitimacy by the month. Legitimacy is the lifeblood of nations and states. OWS is a cry for justice and an outrage at lack of legitimacy.

A regime that loses legitimacy has to resort to repression and force to protect its claim on power.

Thank you for pointing out the interests of the other defrauded parties in this. Parties which the SEC was created to protect after 1929. A free market requires truth in accounting and enforcement of the rule of law.

Posted by Finster | Report as abusive

While it may seem outrageous, the reasons that the SEC chooses a “model” case per bank for settlement is in all likelihood much more mundane. The SEC does not have the financial or personnel resources to pursue multiple cases per bank. And the situation here is not like the ARS or market timing, where you had significant numbers of retail investors with no access to information about the wrongful conduct. The parties on the other side of these CDOs arguably failed to do their own due diligence and to consider macroeconomic trends, and any decent defense lawyer would get to make hay of the fact that the victims here are hardly “innocent.” Maybe the investors in those managers’ funds were innocent, but that isn’t the law.

Also keep in mind Khuzami comes out of the US Attorneys’ Office. Criminal fraud cases are regularly settled on single count informations. This makes great sense from a resources perspective, even if “morally” unsatisfying.

Posted by Squam | Report as abusive

Squam, not only that but it is a bit harder to extort money out of sell-sides unless you allow them to clear the decks.

Posted by Danny_Black | Report as abusive

I still believe the arrangements made by the SEC with the banks for a single case solution are avoiding the object of the SEC: to protect the innocent investors. Yes, some investors in one particular tranche won some money back, but it would be far more equitable to have spread this money across all of the deals where investors lost out because of the fraud.

That might mean investors only get 50% or perhaps as little as 10% on the dollar, and that is a big haircut, but that would be better than nothing. The banks would be in the same position financially, but with all the loose ends tied up, and so could afford to make a settlement covering all of the issues, even admitting guilt (not that they would of course; they’re far too selfish). Investors would get two things back: cash, and a lesson learned.

Posted by FifthDecade | Report as abusive

Let’s not be delusional, most of the major banks we’re talking about here are presently only just barely solvent if you get there by relaxing a lot accounting standards. If you were to factor in where they would be if Justice, Treasury, and SEC went after them to the full extent of their criminality, most of these upstanding “pillars” of capitalism would laughing-stocks. Ultracrepidarian and proud of it ..

Posted by Woltmann | Report as abusive

If banks are barely solvent, should they be allowed to continue paying huge bonuses and dividends which weaken their solvency? Should they be allowed to continue to offer investment products they can’t cover if they go wrong?

It seems to me that at the moment the wrongdoers remain in their jobs, paid enormous sums of money whether the bank they ‘work for’ makes a profit or not out of their actions. There just isn’t enough culpability. In fact, there is in some cases no culpability at all.

Not prosecuting banks who have done wrong solely because they might go bust is crazy. Individuals don’t get such cute get out of jail free cards.

Posted by FifthDecade | Report as abusive

too stupid, how bout you redneck?

Posted by Woltmann | Report as abusive

I hear Shanghai’s nice this time of year ..

Posted by Woltmann | Report as abusive

Felix — it’s a settlement agreement, so yes it’s agreed to by both the SEC and Citi. And Citi (or any other company) would only agree to a settlement if they were pretty darn clear that the settlement, for all intents and purposes, ended their liability for such actions with the government.

If Citi thought there was potential for the SEC to go after every single CDO, they would fight it tooth and nail, because — to be honest — they most likely have a decent chance of winning based on the law in many cases. Disclosure cases aren’t easy cases. The SEC simply cannot afford to fight each and every case. So they agree to settle. It’s in the best interest of the SEC and the subject company. If that’s what you call collusion, then, yeah, it’s collusion.

Posted by MrAbeFroman | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/