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The limits of enforcement: Citigroup and Wylys

The headline-grabbing cases unveiled by the SEC on Thursday -- Citigroup and the Wyly brothers -- have exposed the great limits of financial regulation and enforcement.

Whatever the merits of these important cases, they both show how regulators struggle to bring cases in a timely manner and devise punishments that meet the (alleged) crimes.

Let's start with Citigroup.

Citigroup is accused of committing violations of securities law in 2007, before the floor fell out from under the economy and the bank's shares lost almost all their value. Citigroup is accused of misleading investors into thinking that its exposure to the sub-prime mortgage market was less than a quarter of what it actually was ($13 billion versus $50 billion). That's information any investor -- big or small -- would want to know, and could have made the difference between many investors continuing to own or choosing to sell their shares.

The SEC spent years investigating and came up with a case it thought it could win: a charge that Citigroup should have disclosed its greater exposure to sub-prime mortgages, even though it did not deliberately act to deceive investors. (In essence, the bank's defense was that it was exposed to the sub-prime mortgages through super-safe investments that the bank never thought would go bad.)

What's the punishment? A $75 million fine for the bank, a $100,000 fine for the former chief financial officer, and an $80,000 fine for the former head of investor relations.

There are plenty of problems with this settlement -- some based in perception, others based in reality.

Many wonder why, after concealing nearly $40 billion in toxic assets from its shareholders, Citigroup is only paying a $75 million fine. It sounds almost laughable. But there's circularity to this question because of the difficult philosophical and practical questions raised by assessing a public company a fine.

Who got hurt when Citigroup allegedly hid its exposure to sub-prime? The company's shareholders. Who ultimately pays when Citigroup writes a settlement check to the U.S. Treasury? Shareholders.

Now, let's consider the punishment for the executives involved. The SEC doesn't have criminal authority and so it can't use that ultimate weapon -- jail -- to deter and punish financial misconduct.

Taking a chunk of cash out of someone's pocketbook is another reasonable way to punish wrongdoing.

But the $100,000 fine for the Citigroup CFO, Gary Crittenden, seems marginal.

In 2007, the year of the alleged wrongdoing, Crittenden took home nearly $13 million in compensation, including $3 million in cash. He knew about the $50 billion in sub-prime exposure, but took steps that led the public to believe that the bank had only $13 billion in exposure, according to the SEC. For his alleged role in misleading shareholders, he is agreeing to pay less than 1 percent of 2007's compensation. (In defense of the arrangement, much of that compensation was reduced when Citigroup's shares collapsed, but he's still paying just 3 percent of his cash salary in 2007.)

What if the reality is that, in the SEC's view, Citigroup's alleged crimes weren't such a big a deal, in the big scheme of things? What if any more severe a punishment against the bank or its executives would be disproportional to the alleged wrongdoing?

If that's the SEC's view, then why bring the case in the first place? Because Citigroup was a big actor in the financial crisis, and regulators needed to show that it would be punished -- however lightly -- for wrongdoing that helped feed the crisis. That's called symbolism. And symbolism might have value, so long as we call it what it is.

*

Let's move on to the Wylys. The SEC said the billionaire brothers Charles and Sam Wyly created an elaborate and clandestine network of overseas accounts and companies which they used to trade more than $750 million in stock in four public companies on whose boards they served, without filing the disclosures required for corporate insiders. In one case, the SEC alleged that the Wylys traded based on insider information they learned as board members, netting a profit of $32 million.

The SEC alleged that the brothers reaped more than a half-billion dollars in profit as a result of a scheme that lasted 13 years.

The first question that comes to mind is one of timeliness. Why did the SEC allow this alleged fraud to continue for so long? Its own complaint against the Wylys says that the SEC first learned about the potential fraud in November 2004 when the Wylys' bank, Bank of America, asked to verify assets they claimed they had offshore and was told no.

It took investigators working for the Senate Permanent Subcommittee on Investigations a fraction of the time it took the SEC to come up with some of the same findings that the SEC marshaled in its complaint Thursday.

In August 2006, Senate investigators completed a 400-page report saying that the Wylys secretly used offshore accounts to control shares in public companies on whose boards they serve. The investigators tracked how the Wylys transferred abroad options and warrants given to them by the companies on whose boards they served, exercised those options and warrants to turn them into cash, and then used that money in what the investigators called "the most elaborate offshore operations reviewed by the Subcommittee."

It's not the first time the SEC could not bring a case for years and years despite knowing of potential wrongdoing: Both the Bernard Madoff and R. Allen Stanford frauds were exposed many years after the SEC first got clues about wrongdoing.

In the Wyly case, there's also a question of penalty. The SEC will seek north of $550 million in penalties from the brothers and could quite easily bankrupt them. But even if the SEC triumphs after years of litigation, the Wyly brothers will be left without their riches but free. Maybe that's okay -- but it means that the Wylys will not have to pay any greater price than losing their money after many years of enjoying it.

*

How do you reconcile these issues? How do you make the SEC a more nimble and rapid responder? The agency says it's trying, but perhaps it needs more authority, or perhaps the Justice Department needs more resources to bring criminal charges, or perhaps the law needs to change to make it easier to send businessmen to jail for wrongdoing.

One model might be the Martin Act in New York, which gives the state's attorney general a lot of flexibility to file civil and criminal charges for financial wrongdoing, act swiftly and issue threats.

The SEC approach is slow, methodological and conservative. Perhaps we need a more daring agency.

But of course, there's risk with that approach, too: an agency of unbridled investigators who are filing cases that never win in court but unfairly punish innocent executives -- and stifle business and innovation at the same time.

By Zachary Goldfarb  |  July 30, 2010; 1:01 PM ET
 
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Comments

It seems to me Lone Star Bro's just wish to follow in the steps of the Hunt's, and corner not the silver market, but ShutUpSport!OKOKOK

Posted by: WindLessBreeze | July 30, 2010 1:49 PM | Report abuse

When will we accept the fact that the power structure of any society establishes a legal system designed to keep the "rabble" in line which providing the wealthy as much license as they can afford. Our society's laws and their enforcement are no exception.

Posted by: jackburris1 | July 30, 2010 2:22 PM | Report abuse

When will we accept the fact that the power structure of any society establishes a legal system designed to keep the "rabble" in line while providing the wealthy as much license as they can afford. Our society's laws and their enforcement are no exception.

Posted by: jackburris1 | July 30, 2010 2:25 PM | Report abuse

this column is a lot of mental maturbation to justify continued criminality (as in the case of the
Wlyls) or continued coddling of white collar fraud when it is done under the auspices of a public corporation.

Securities laws are already clear as in the case of the Wlyls. What is needed here is a stepped up investigative and auditing capability by whichever Federal agency is inclined to protect the public interest most aggressively.
How many more cases of "off shore" corporations set up to evade taxes do we need to hear about before either Justice of the SEC establishes a dedicated task force to root out such evasion, yes evasion of taxes, which last time I looked was a crime.

Investigations and enforcement of cases such as the one at Citi could be enhanced by an expanded whistleblower campaign which would reward those who come forward with information on how corporatiions and executives like Mr. Crittenden are cooking the books at the expense of shareholders and taxpayers.

Finally, let us be clear about what happened in the Citi case. The Federal government and U. S. taxpayers have given Citi over 45 billion dollars to bail it out of the hole it dug with both incompetence and fraud. Had we not done so there would not have been any "shareholders" to absorb any future expense, legal or otherwise. Now we are asked to have this criminal activity forgiven for a transfer of 75 million dollars of our money back to the Treasury. In other words, after paying 45 billion to save the sorry -----
of this company's management, we are now expected to subsidize the fine?

Only in America.

Posted by: bobfbell | July 30, 2010 2:26 PM | Report abuse

this column is a lot of mental maturbation to justify continued criminality (as in the case of the
Wlyls) or continued coddling of white collar fraud when it is done under the auspices of a public corporation.

Securities laws are already clear as in the case of the Wlyls. What is needed here is a stepped up investigative and auditing capability by whichever Federal agency is inclined to protect the public interest most aggressively.
How many more cases of "off shore" corporations set up to evade taxes do we need to hear about before either Justice of the SEC establishes a dedicated task force to root out such evasion, yes evasion of taxes, which last time I looked was a crime.

Investigations and enforcement of cases such as the one at Citi could be enhanced by an expanded whistleblower campaign which would reward those who come forward with information on how corporatiions and executives like Mr. Crittenden are cooking the books at the expense of shareholders and taxpayers.

Finally, let us be clear about what happened in the Citi case. The Federal government and U. S. taxpayers have given Citi over 45 billion dollars to bail it out of the hole it dug with both incompetence and fraud. Had we not done so there would not have been any "shareholders" to absorb any future expense, legal or otherwise. Now we are asked to have this criminal activity forgiven for a transfer of 75 million dollars of our money back to the Treasury. In other words, after paying 45 billion to save the sorry -----
of this company's management, we are now expected to subsidize the fine?

Only in America.

Posted by: bobfbell | July 30, 2010 2:26 PM | Report abuse

Criminal justice as applied to white collar crime is a complete joke. If I steal a car worth $20,000 I am absolutely going to jail. If I am instrumental in *intentionally* misleading thousands of investors for my own financial gain and it results in losses in the billions of dollars, I pay a fine that barely stings.

Punishment is supposed to be largely about deterrence. What's wrong with this picture?

Posted by: st50taw | July 30, 2010 2:29 PM | Report abuse

Oh my well yes you are smart enough to ask the question with the obvious answer, but you don't want to hear the answer.

Timing, tim ing, ti ming, is what it's all about. Clearly this case was a non-starter under Bush II, it went nowhere.

So in comes Obama and some attempt at regulation and enforcement. Well here is their highest profile case ever! Are they going to muck it up and lose in the courtroom on a technicality? Remember these are rich people and they will have the best lawyers! Don't press your case unless it is airtight!

You don't think this can take over a year for a complex case?

Posted by: frantaylor | July 30, 2010 3:18 PM | Report abuse

The SEC knew that Computer Associates was defrauding it's stockholders in 1999. In 2005 when stockholders finally learned about the fraud, the SEC was forced to take action. The SEC settled for $300,000 on a $1.7 billion fraud. Why? Because Computer Associates threatened to reveal that the SEC knew of the fraud all along and also knew there was senior Federal Officials who had participated in the fraud in return for contract kickbacks.

Posted by: Anonymous | July 30, 2010 3:23 PM | Report abuse

Global financial reforms are long overdue. And the mega-banks had to be stabilized, they are too interconnected in the financial system we are all dependent on. Now they should be broken up into smaller pieces so this cannot happen again.

-- Balkingpoints / www

Posted by: RField7 | July 30, 2010 3:27 PM | Report abuse

And the Post buried the story no big democrat donor Nemazee recently convicted of fraud. THIS PAPER IS A JOKE.

Folks, go to the Washington Examiner's site if you want both sides of the story (no I don't work for them).

If you're a liberal lemming who only seeks the comfort of life viewed through a leftwing lens, then keep reading the Post.

Posted by: Frishoo | July 30, 2010 3:51 PM | Report abuse

But, Why is Obama Destroying America. If you truly want to know what is going on; Then you will have to accept these things as the TRUTH. Once you understand the following things; All things will be understood. So I tell you Obama is the Anti-Christ, Satan on Earth, Lawless One, or what ever else you want to call this Demonic Figure. His words describe him, He is a False Hope, If you listen to him you will love him. He carries a Bow without an Arrow. He will conquer all through his speech, his false hoods will capture all who sit and listen to him.
2 Thessalonians 2:11-12
11And for this reason God will send them strong delusion, that they should believe the lie, 12 that they all may be condemned who did not believe the truth but had pleasure in unrighteousness.

Posted by: makom | July 30, 2010 4:18 PM | Report abuse

Let me get this correct.
White american wall street broker makes $3 million dollars cash, pays $100.000 and no jail time.
Black or latin makes less than a $1000.00 selling dope, to one of there own, (no international retirement fund managers included) and gets 10-25 years in prison.
White american CEO of a major bank, gives $75,000.000.00 to the government for lieing to investors. No prison or jail time.
Black and latin americans except deals every day for 3-5 years in prison, regardless to if they did or didnot commit the crime basically because the DA and judge indicated take the deal, or if you go to trail and lose, You will get triple the sentence. They afford a lawyer, no money, take the deal.
I wonder if Scottdale, Az. is there vacation place, considering law enforcement will protect them, but pull over and search the dickens out of anyones car that's black or latin...

Posted by: Anonymous | July 30, 2010 4:41 PM | Report abuse

Investors are denied due process.
Labor is denied due process.

If you go into a game of chance, say, a poker game, knowing that if you win you will go to the next game and if you lose you will shoot the winner, steal the money, then go to the next game, then you are a CEO.

Are all CEO's thieves and murders ? Only for what they are capable of when faced with a personal loss. This is a pathology, not a crime. In huge fraud cases, a Court ordered psychiatric evaluation might be a useful tool.

Posted by: gannon_dick | July 30, 2010 4:42 PM | Report abuse

Zach buddy,

I enjoyed your phrase "unfairly punish innocent executives -- and stifle business and innovation at the same time."

There are so small a number off innocent executives in this world that I don't care if the SEC becomes the Rat Patrol and investigates public AND private companies.

I feel as if we are back in the sixties and the haves and have nots are fast approaching a clash of Titan proportions.

Posted by: walkerrussellc | July 30, 2010 5:02 PM | Report abuse

Most acts of murder result in a single death.
As we have seen with the Wall Street and banking casino economics the lives of thousands have been permanently damaged leading, unquestionably, to premature deaths.

In China, economic crime is punishable by jail and execution, depending on the impact the crime has on society. All economic crimes are considered crimes against society and judged accordingly.

In principle, I am against capital punishment but find myself arguing with myself about the subject over certain heinous crimes and crimes such as those committed by the Wyly brothers and their ilk.

I usually lose the argument and remain opposed to the death penalty but continue to believe that in some cases the idea has a nice ring to it.

Posted by: apspa1 | July 30, 2010 5:10 PM | Report abuse

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