Citigroup 2007 Disclosure: Why It Bothers the SEC

Last week while appearing on FOX Business Network I was repeatedly asked why the SEC was bothering with a civil enforcement action against Citigroup (C) for alleged bad 2007 mortgage portfolio disclosure. My FOX Business friends thought that the SEC’s action was dumb because the U.S. Government is the largest stakeholder in Citigroup and effectively controls and funds the company. They assumed that the SEC action could never amount to more than the SEC getting money from the U.S. Treasury through a Citigroup fine.

I disagreed with everyone that morning and shocked them by saying that I was worried that the SEC wasn’t being tough enough.

The SEC’s proposed action against Citigroup fits right into the model for effective regulatory enforcement even though my FOX friends didn’t see it.

During my first year of law school I learned that there are three principal objectives that every law enforcement and regulatory agency needs to try to achieve. The Citigroup SEC action meets all three objectives and therefore should be pursued.

• Law Enforcement Objective #1 – Retribution
  

  Retribution is a nice way of saying punishment, i.e., “an eye for an eye”. It is usually achieved through jail time or the payment of fines. The SEC action against Citigroup is a civil case so the payment of a fine is the form of retribution being sought.

  Since the U.S. Treasury is the largest stakeholder in Citigroup, my FOX friends didn’t understand why a fine will punish wrong doers. Everyone assumed that the fine would be indirectly paid by Treasury.

  Of course, the government isn’t the only owner of Citigroup (private shareholders will pay their share) and Citigroup does have directors and officer’s insurance coverage. Most likely the majority of any fine will be reimbursed through directors and officers insurance and won’t come from the U.S. Treasury. While punishment of Citibank’s insurers isn’t a SEC objective, the insurance industry will be a lot more careful about making sure other companies pay attention to securities laws if insurers feel financial pain.

  Also, if Citigroup is found to have violated the securities laws (which is needed to assess the fine), such a finding will likely trigger Citigroup’s right to sue its former employees who were responsible. Also, lawsuits brought by former shareholders against Citigroup and its officers and directors will have a much better chance of success if the SEC finds that Citigroup violated the law and assesses civil penalties against the company.

• Law Enforcement Objective #2 – Segregation
  

  Segregation takes place when the government forces a “time out” and preventing offenders from breaking the law again and again. It is a simple technique that works just as well on adults as children.

  Segregation often, but not always, means jail time. However, without sending people to jail, law enforcement professionals can segregate non-violent offenders and stop future bad actions. As an example, a driver who receives too many speeding tickets can lose his license and be given a time out from driving too fast. And, a stock broker who repeatedly lies to his clients can be given a time out from being a stock broker and won’t have the opportunity to lie to more clients.

  The SEC has the authority to force Citigroup employees to take a time out from being directors or executive officers of another publicly traded company.

  While the SEC is not alleging that Citigroup’s 2007 mortgage portfolio disclosures were criminal, they are saying that they were wrong and didn’t comply with securities law. A finding of civil liability is more than enough for the SEC to force a permanent time out for Citigroup’s officers and directors that were responsible for the 2007 mortgage disclosures.

• Law Enforcement Objective #3 - Deterrence
  

  Deterrence is achieved when potential wrong doers are afraid of punishment if they are caught and therefore try to avoid doing bad things.

  If the SEC gives Citigroup and its executives a “get out of jail free” card because of the bailout, the SEC will set a bad precedent for other companies in which the U.S. government has a financial stake. And that precedent will be looked at by millions of employees who work at companies in which the U.S. government has a direct or indirect stake. The SEC needs to make sure that it doesn’t convert financial bailouts into an immunity and pardon program.

  Deterrence is a very personal thing; in little kids and adults alike, the fear of being caught and punished is what often deters people from doing bad things. Concern for consequences has to be the same for companies in which the government has a stake as for companies in which the government doesn’t have a stake. The SEC needs to draw a line in the sand and show that they aren’t a paper tiger when the government has an investment.

The thing that I found most unsettling about my conversations last week at FOX, both on and off air, was how much our culture had changed since the bank and thrift crisis of the 1980s. Back then it was a certainty that if a banker was suspected of violating any securities or banking law he would be investigated and prosecuted. And, if investors lost billions or the government had to step in with aid there were definitely going to be consequences. Today, enforcement is something to be debated and, apparently, it is acceptable for some individuals and corporations not to be held responsible for their bad actions.

The long-term survival of the U.S. as an economic superpower depends upon the integrity of our financial markets and everyone needs to take for granted that securities laws will be enforced. The consequences of violating the law can’t be different for different companies. Anything short of vigorous enforcement is inconsistent with the U.S. retaining its special place in the global economy and our culture of fundamental fairness.

Comments

[msgtb:]

The real question who is going to give the Federal Reserve a time out?

Dave

Jun 04 01:57 AM

[Moon Kil Woong:]

Mark Sunshine, thanks for your legal clarifications and their reasons and implications. People must stop thinking of just protecting the banks and start thinking about identifying and stopping the types of bad disengenuous or outright fradulent activities in disclosure that undermine the integrity of our whole market system. That is what the SEC is for. I hope they investigate a lot more even if it falls on the shoulders of financial institutions controlled by the government.

In the end, these institutions were miserable failures before the SEC got to them. That is the real shame. We need the SEC to shine sunlight on bad practices long before companies start begging for bailouts.

Jun 04 02:21 AM

[User 305589:]

the bigger the crime and the nearer the crooks are to the ruling elite - the lesser any enforcement or punishment. This isn't just a matter of culture, it is a matter of deeply entrenched corruption and nepotism that has developed over the decades. Americans used to point at some third world banana republic in earlier decades where this stuff occurred. Nowadays, the USA has gotten to the same state of affairs. If history is any guide, the real economy and the living standards of the people will follow suit. If the economy and the financial system and public finances(!!!) are increasingly run for vested interests everybody suffers big time. except those vested interests, of course.
It will be most interesting to watch whether Obama DOES anything about that - or whether he just prefers to make a couple more 'historic' speeches.

Jun 04 08:38 AM

[Between The...:]

I greatly appreciate you going on TV and standing up for the rule of law. The idea that companies that are partially government owned are now suddenly above the law (because the governement would bear some financial liability for Citi's transgressions) is a farcical line of reasoning in my book. The foundation of banking, and money itself, is trust, and it is shocking to me how quickly some seem willing to abrogate rules and regulations that enforce that trust. As you wrote, the system's very future "depends upon the integrity of our financial markets."

Jun 04 06:16 PM

[John Lounsbury:]

Mark - - -

Great article. Sorry I didn't get to it until late.

You didn't state it as bluntly as this, but I would say your position on this subject could be stated as a question:

Where is the accountability?

Jun 04 07:41 PM

[PainfullyAware:]

Yes - Let The Investigations Run With Fury.

Mark Sunshine, Thanks for being a solid citizen.

Jun 04 08:55 PM