WASHINGTON — As the housing market began its collapse, Wall Street firms and sophisticated investors searched for ways to profit. Some of them found an easy method: Stuff a portfolio with risky mortgage-related investments, sell it to unsuspecting customers and bet against it. Citigroup on Wednesday agreed to pay $285 million to settle a civil complaint by the Securities and Exchange Commission that it had defrauded investors who bought just such a deal. The transaction involved a $1 billion portfolio of mortgage-related investments, many of which were handpicked for the portfolio by Citigroup without telling investors of its role or that it had made bets that the investments would fall in value.
In the four years since the housing market began its steady descent, securities regulators have settled only two cases related to the financial crisis for a larger sum of money. This is also the third case brought by the S.E.C. accusing a major Wall Street institution of misleading customers about who was putting together a security and about their motive. Goldman Sachs and JPMorgan Chase & Company both settled similar cases last year.
The settlement will refund investors with interest and include a $95 million fine — a relative pittance for a giant like Citigroup. On Monday, the company reported that in the third quarter alone it earned profits of $3.8 billion on revenue of $20.8 billion. The settlement may also have trouble getting approval from Jed S. Rakoff, the federal district judge in New York who must ultimately sign off on the fine and who has taken a hard line on S.E.C. settlements.
Neither the S.E.C. nor the Justice Department would say whether the case raised questions about whether Citigroup had been involved in any criminal wrongdoing. But the case highlights a growing frustration felt by foreclosed homeowners, investors and Wall Street protesters alike that few, if any, senior banking executives have faced criminal charges for losses growing out of the financial crisis.
Citigroup has settled one case stemming from the crisis. Last year, it agreed to pay $75 million to settle federal claims that it hid from investors vast holdings of subprime mortgage investments that were losing value during the crisis and that ultimately prompted the federal government to rescue the bank.
“The securities laws demand that investors receive more care and candor than Citigroup provided” to investors in the security, said Robert Khuzami, director of the S.E.C.’s enforcement division, referring to Wednesday’s action. “Investors were not informed that Citigroup had decided to bet against them and had helped to choose the assets that would determine who won or lost.”
The complex amalgamation of investments known as Class V Funding III produced $126 million in profits for Citigroup’s brokerage subsidiary, and another $34 million in fees for putting it together. All of that, including interest and the $95 million fine, will now be going back to the investors; the government will not receive anything.
In a statement, Citigroup noted that the S.E.C. did not charge it with “intentional or reckless misconduct.” Rather, it settled charges that its actions were negligent and misleading to investors. Despite its profits on the current deal, over all Citigroup lost tens of billions of dollars on its holdings of mortgage-related investments.
“We are pleased to put this matter behind us and are focused on contributing to the economic recovery, serving our clients and growing responsibly,” the company said in a statement. “Since the crisis, we have bolstered our financial strength, overhauled the risk management function, significantly reduced risk on the balance sheet and returned to the basics of banking.”
The S.E.C. on Wednesday also brought a case against Credit Suisse, which played a smaller role in the transaction, and against one individual at each company. But those individuals were midlevel employees in each company’s investment and trading departments; no senior executives at either company were charged.
Credit Suisse, which managed the portfolio of mortgage bonds that served as collateral for the deal, agreed to pay $2.5 million, half of it in penalties, to settle the case. The company declined to comment.
Samir H. Bhatt, 37, a former portfolio manager at Credit Suisse, also agreed to settle, paying no fine but agreeing to a six-month suspension from association with any investment adviser.
Only Brian H. Stoker, 40, a former Citigroup employee who was primarily responsible for putting together the deal, has decided to fight the S.E.C.’s case. He left Citigroup in 2008.
“There is no basis for the S.E.C. to blame Brian Stoker for these alleged disclosure violations,” said Fraser L. Hunter Jr., a lawyer at WilmerHale who is representing Mr. Stoker. “He was not responsible for any alleged wrongdoing — he did not control or trade the position, did not prepare the disclosures and did not select the assets. We will vigorously defend this lawsuit.”
Mr. Stoker joined Citigroup at the height of the housing boom in 2005, and worked as a director on the structured product desk. His job tasks were largely behind the scenes, crunching numbers and assembling deals like Class V Funding III.
After the deal closed on Feb. 28, 2007, more than 80 percent of the portfolio was downgraded by credit ratings agencies in less than nine months. The security declared “an event of default” on Nov. 19, 2007, and investors soon lost hundreds of millions of dollars, the S.E.C. said, while Citigroup gained.
Among the losers was Ambac of New York, which insured financial instruments and was the largest investor in the deal, according to the S.E.C. Ambac’s role in the transaction was to assume the credit risk associated with a $500 million portion of the portfolio. When the value of the portfolio fell, Ambac had to make payments to those who had bet against the bonds, as Citigroup had.
In part because of losses tied to the financial crisis, Ambac filed for bankruptcy last year.
Criminal prosecutions related to the financial crisis have been few. Two former Credit Suisse brokers were sentenced to jail in their roles for misleading clients about purchases and thus inflating their sales commissions. Six executives at a mortgage company, Taylor, Bean & Whitaker, have pleaded guilty in a scheme to issue false mortgages to obtain federal mortgage money and bank bailout funds. Lee B. Farkas, a former chairman of Taylor Bean, was sentenced to 30 years in prison for his role in the case, which resulted in the demise of Colonial Bank of Montgomery, Ala.
Those crimes started long before the financial crisis. A prosecution of two former executives of Bear Stearns, the failed investment bank, ended in acquittals.
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Source: New York Times
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