The $285-million deal would have imposed penalties on Citigroup even as it allowed the company to deny allegations that it misled investors on a complex mortgage investment.
A federal judge angrily blocked Citigroup Inc.'s proposed $285-million (U.S.) settlement over the sale of toxic mortgage debt, excoriating the top U.S. market regulator over how it reaches corporate fraud settlements.
U.S. District Judge Jed Rakoff in Manhattan said the U.S. Securities and Exchange Commission appeared uninterested in actually learning what Citigroup did wrong, and erred by asking him to ignore the interests of the public.
"An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous," Judge Rakoff wrote in an opinion dated Monday.
The judge added that it was difficult to discern "from the limited information before the court what the SEC is getting from this settlement other than a quick headline."
He said the proposed settlement was "neither reasonable, nor fair, nor adequate, nor in the public interest."
In response, the SEC's director of enforcement, Robert Khuzami, said in a statement that $285-million "reasonably reflects the scope of relief that would be obtained after a successful trial" but without the "risks, delay and resources required at trial."
Danielle Romero-Apsilos, a Citigroup spokeswoman, declined immediate comment.
In its complaint, the SEC accused Citigroup of selling a $1-billion mortgage-linked collateralized debt obligation, Class V Funding III, in 2007 as the housing market was beginning to collapse, and then betting against the transaction.
One Citigroup employee, director Brian Stoker, was also charged by the SEC. He is contesting those charges. Judge Rakoff consolidated the two cases and set a July 16, 2012, trial date.
Judge Rakoff has been a thorn in the side of the SEC. In 2009 he rejected its initial proposed settlement with Bank of America Corp. over its takeover of Merrill Lynch & Co.
Monday's decision throws into question the SEC's policies toward settlements with publicly traded companies, at a time when the regulator is trying to burnish its reputation for tough enforcement amid skeptics in Congress and elsewhere.
In fact, securities lawyers in both the U.S. and Canada have been watching this case. This kind of "no-contest" settlement criticized by Judge Rakoff is currently not an option for people or companies being investigated by the Ontario Securities Commission. But the OSC said last month that is was considering adopting the practice in select cases. The OSC said the move was meant to speed up settlement talks, which tend to bog down over admissions of wrongdoing as respondents fear the effects on other lawsuits they may face.
Judge Rakoff called the Citigroup accord too lenient, noting that the bank was charged only with negligence, neither admitted nor denied wrongdoing, and could avoid reimbursing investors for more than $700-million of losses. Private investors cannot bring securities claims based on negligence.
"If the allegations of the complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business," the judge wrote.
"In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers," Judge Rakoff said. "Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances."
The settlement would have required the third-largest U.S. bank to give up $160-million of alleged ill-gotten profit, plus $30-million of interest. It also would have imposed a $95-million fine for the bank's alleged negligence, less than one-fifth what Goldman Sachs Group Inc. paid last year in a $550-million SEC settlement over a different CDO.
Judge Rakoff called the $95-million fine "pocket change" for Citigroup and said investors were being "short-changed."
In the SEC's response to the ruling, Mr. Khuzami said the regulator "will continue to review the court's ruling and take those steps that best serve the interests of investors."
In striking down the SEC's $33-million settlement with Bank of America over Merrill, Judge Rakoff said it punished shareholders. He later approved a $150-million accord.
With files from Globe and Mail reporter Jeff Gray and The Associated Press