The limits of enforcement: Citigroup and Wylys
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.
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