Judge Jed Rakoff from the U.S. District Court of the Southern District of New York today rejected Citigroup's settlement with the Securities and Exchange Commission (SEC) regarding the sale of a $1 billion CDO linked to subprime MBS.

The SEC accused Citigroup of substantial securities fraud for misleading investors in the sale of the CDO. The bank agreed last month to a settlement with the SEC, which would have meant that investors in the said transaction would have gotten back $285 million.

In response, the court in an order dated Oct. 27 put some questions to the parties regarding the proposed settlement or consent judgment.

In an opinion released today, Rakoff called the settlement "neither fair, nor reasonable, nor adequate, nor in the public interest. " He said that this is because it does not offer the court with enough evidence to determine whether the requested relief is justified.

"Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint," Rakoff wrote. "But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are."

Otherwise, Rakoff wrote, the court merely becomes a "handmaiden" to a settlement that is privately negotiated based on unknown facts. Thus the public is not given the truth in a matter of "obvious public importance."

SEC's Response

Robert Khuzami, director of the SEC division of enforcement, responded to the court's refusal to approve settlement in Citigroup's case.  For a full copy of the statement please click here.

Khuzami said that the court's denial of the settlement "ignores decades of established practice throughout federal agencies and decisions of the federal courts."

He added that refusing the "advantageous settlement" just because of the lack of an admission diverts resources away from the investigation of other frauds as well as the recovery of investor losses not before the court.

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