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On Tuesday, U.S. District Judge Jed Rakoff unwillingly approved Citigroup Inc. (C - Analyst Report) a U.S. Securities and Exchange Commission (SEC) settlement of $285 million. The decision comes two months after the 2nd U.S. Circuit Court of Appeals in Manhattan rescinded Jed Rakoff’s decision to reject the settlement in June. The settlement was to compensate investors who were misled by Citigroup with a housing market related collateralized debt obligation (CDO).

The settlement amount includes payment of $95 million as civil penalty and $30 million in interest. Moreover, Citigroup agreed to focus on internal controls more efficiently over a three-year period to safeguard against future infringements.

Background

The federal judge rejected the settlement in Nov 2011, citing that it was not fair, reasonable or adequate and not in public interest. The judge objected to the practice of settlement by the SEC, under which the companies neither agree nor deny the charges made by the defendants. The settlement, which involved a loss of over $700 million by investors, has been referred to as a “pocket change” by the judge.

As per Rakoff, such protective shields provided to banks by regulators would further encourage them to indulge in such acts. These unlawful activities by the banks have affected the total economy to a large extent. Any wrong step in support of the banks would prevent these facts from emerging in the interest of the public.

Notably, the SEC accused Citigroup of misleading investors while selling a $1 billion fund in 2006 and 2007, which was invested in mortgage-related securities. Citigroup was accused of not letting investors know that it was betting against many of the assets. Incidentally, Citigroup neither admitted nor denied the wrongdoing that it had been accused of.

On the contrary, the SEC was not convinced of the judge’s decision and demanded more judicial power to take decisions while increasing the agency's authority to levy a fine on the companies and individuals. According to the SEC, the judge committed a legal error by setting a new standard, which in turn would deprive investors of substantial, certain and immediate relief.

Therefore, the 2nd U.S. Circuit Court of Appeals gave a green signal to the SEC for determining whether the settlement requires admission of wrongdoings or not in such settlements. Moreover, such a ruling will help regulators return money to aggrieved investors even without admission of wrongdoings.

Conclusion

Post the financial crisis, the SEC ramped up its efforts to regulate institutions and penalize them for wrongdoings and misrepresentation of facts while selling their investment products. Besides Citigroup, others that reached settlements or have been penalized in the past include Bank of America Corp. (BAC - Analyst Report), Wells Fargo & Co. (WFC - Analyst Report) and The Goldman Sachs Group Inc. (GS - Analyst Report).

We believe that while such settlements dent the company’s financials to some extent, they also reduce the litigation overhang. Currently, Citigroup carries a Zacks Rank #3 (Hold).

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