Maybe the Occupy Wall Street movement is making everyone just a little bit more thoughtful about the roles and responsibilities of both the financial services industry and its regulators toward investors. At least, that’s one possible conclusion we can draw from the unexpected decision by Judge Jed Rakoff, of the Federal District Court judge for the Southern District of New York, to nix the proposed $285 million settlement between the Securities & Exchange Commission and Citigroup over allegations that the bank didn’t disclose to investors that it was involved in selecting investments for a mortgage-bond investment pool – as it continued to sell those investments short.
It’s long been the custom for the SEC and its targets to hammer out deals behind closed doors in which the banks or other offending parties agree to pony up big sums to settle allegations -- without either admitting or denying those allegations. It’s also been the tradition for judges to rubber-stamp said deals. Everyone, it seems, has been reluctant to air the complex details of the transactions underpinning SEC charges: regulators worry about the difficulty of getting a jury that grasps the details while the banks worry that publicly parading the charges will result in more mud being flung around, some of which will stick. Besides, why not settle if you don’t have to admit you did anything wrong.
In the new world that Judge Rakoff envisages, that’s just not acceptable. “In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives,” he wrote in the ruling tossing out the Citigroup settlement, “there is an overriding public interest in knowing the truth.” And without an admission on the part of Citigroup – or any other institution targeted in a regulatory investigation – the truth of the matter remains unknown. It doesn’t matter that Citigroup agreed to fork over a sum of money. What matters is why. Thus, Rakoff wrote, the quid pro quo at the heart of countless SEC settlements “serves no lawful or moral purpose and is simply an engine of oppression.”
Now, everyone in the financial markets knows what lies behind the wording of a settlement in which a target agrees to cough up millions of dollars to make regulatory offenses go away, even while neither admitting nor denying the charges. Wink, wink, nudge, nudge. But Rakoff wants to go beyond that and hold financial institutions truly liable for their actions and – sometimes – their inaction. That kind of stand is not going to win the judge many fans either in Washington or on Wall Street, where neither admitting nor denying wrongdoing is a cozy little game.
But it’s hard not to wonder what the unintended consequences of not allowing Wall Street institutions to save face in this way may prove to be. For instance, the SEC may be more selective in the kind of investigations it undertakes, knowing that some will be extremely hard to prosecute in the courts and that the Goldman Sachs of the world are unlikely ever to agree to admit culpability, and thus throw open the door to scores of civil suits from counterparties or clients who feel aggrieved.
Will settling fewer cases in this traditional “out of court” manner be in the best long-term interests of investors, even if it enhances transparency? It has been hard enough to get to the bottom of some of the problems that undermine the relationships between investment banks and their clients. Moving from a situation where both sides have a vested interested in settling these cases to one where both anticipate the result of pursuing a case to be nothing but trouble is a worrying scenario.
As the sages have said, sometimes the quest for the perfect outcome is the enemy of the solution (that may just be good enough to live with).
