A ruling that takes corporates to task

There are scores of people who have been congregating in public places around the US, in protest. There are several things they don't like about the country, primarily the fact that the odds are loaded against the poor, the weak and the minorities. They claim to be the 99 per cent who are being pounded upon by the 1 per cent elite. One frequent charge of the protestors is that the wealthy and powerful do not pay a price for their crimes and the disasters they engineer. They accuse the corporations of controlling the government. And the role of banks and the financial services companies whose egregious behaviour led to the financial crisis in 2008.

Finally, somebody heard them. In a ruling that has shaken the world of corporate suits, Judge Rakoff on November 28 refused to approve a settlement between the federal government's Securities and Exchange Commission and Citigroup, and said that the case must go to trial. By this action, the good judge has not only answered the cries of the occupy protestors but set himself up as a candidate who deserves a statue outside the stock exchange.

The SEC routinely enters into settlements with companies to quickly bring charges to a closure. In this particular case, the SEC accused Citigroup of selling investors pieces of a $1 billion (about Rs 5,200 crore) mortgage-bond issue, without disclosing to them that it was betting about $500 million against those very assets. This led to significant losses for many of their clients. By the settlement, Citigroup would pay $285 million (about Rs 1,480 crore) without admitting or denying wrongdoing and the case would be closed. The SEC thought it would use the standard template it uses for many such settlements.

UNFAIR SETTLEMENT

Judge Rakoff found several things wrong with this settlement. He said it was ‘neither fair, nor reasonable, nor adequate, nor in the public interest.' He could not judge if it was fair since the bank had not admitted to any wrongdoing and the facts provided were insufficient to make a decision.

The penalty involved, he thought, was pocket-change for a firm of the size of Citigroup. If the allegations are true, he said it was a good deal for the company, and even if it was not true, the bank may just treat it as a cost of doing business. He wants the truth to come out and set the case for trial in July 2012.

This kind of reasoning changes the rules of the game! Companies routinely enter into settlements with government agencies without admitting any wrongdoing, because doing so will open them to private class action suits. The SEC also likes these settlements since they may not have all the evidence it needs to bring the case to a trial, yet can claim that it made a point to the company and can treat the action as another success. Everyone is happy! Now the judge is saying that we need to know the truth. And the truth may be that the powerful need to be brought to justice.

SEC'S REJECTION

As is to be expected, both the SEC and Citigroup have disagreed and rejected the ruling. The SEC thinks the judge has no business overturning established practice. Other banks and firms who are on the SEC's radar are reportedly nervous. Legal experts have pointed out that if the judge's ruling is appealed, it might lead to enshrining his ruling for use by other courts.

But the public has justifiable reasons to be thrilled. A multitude of books and films that have appeared since the 2008 crisis has heaped blame on the system as it is currently practised.

Observers have pointed out how there is a revolving door between the federal agencies, such as the Federal Reserve (the US central bank), and the US Treasury on the one hand, and the investment banks on the other.

In the recent past, three heads of Goldman Sachs, a large investment bank, have also served as Secretary of the Treasury making policies that affect investment banks and raising several questions about conflicts of interest. And one of the criticisms of the Obama administration has been that it has not done anything to bring to justice those who played very questionable roles in perpetuating the mortgage crisis.

Judge Rakoff's bio shows that he is well placed to make the kind of decision he did and stir things up. In private practice, he has headed the criminal defence sections of the firms he worked for, and has even taught a course on white-collar crime.

While working in the prosecutor's office many years ago, he was involved in the prosecution of Mr Michael Milken, a major player in the financial markets in the 1980s, who pled guilty in 1990 for violating US securities laws and went to prison. Judge Rakoff has also refused to approve a settlement once before. This was in 2009, when he rejected the deal between Bank of America and the SEC and sent it to trial. Then, the two parties came up with a new deal which he reluctantly approved calling it ‘half-baked justice at best' and said he would approve it on grounds of judicial restraint.

The present case may go down the same path since neither the SEC nor Citigroup are interested in going for a trial. If the good judge has been sufficiently inspired by the Occupy Wall Street protestors, and does not feel sufficiently restrained, we may yet be pleasantly surprised.

(The author is professor of International Business and Strategic Management at Suffolk University, Boston, US. >blfeedback@thehindu.co.in )

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