For more on pending litigation in the structured finance market see Euromoney’s February 2011 issue. Subscribe now to access this information as soon as it is published.
The aggressive tone adopted by the SEC in its investigations into the CDO businesses of the major Wall Street banks has been hailed as evidence that the government aims to get tough with the banks over their behaviour during the excesses of the structured credit bubble. But that perception has now been called into question by the revelation on Monday that the SEC’s enforcement chief is now under internal investigation by its own watchdog for allegedly giving preferential treatment to Citigroup in the settlement of a case related to its exposure to subprime mortgages.
Robert Khuzami SEC enforcement director
Citigroup settled the case – brought by the SEC in July and relating to the bank’s understatement of its exposure to risky mortgages – for $75 million. But an anonymous letter sent to Senator Charles Grassley and Representative Darrell Issa this month claims that the SEC’s enforcement director Robert Khuzami had agreed to drop certain elements of the fraud charge against certain Citi employees in conversation with the bank’s defence lawyer, who was a “good friend” of his. The allegation is now being investigated by SEC inspector general David Kotz. "The settlement appropriately held the company and individuals accountable," says SEC spokesman John Nester. "It was the product of a thorough investigation and a careful evaluation of the evidence and the applicable law." Citi declined to comment.
The outcome of Kotz’s deliberations will have a far-reaching impact on hundreds of lawsuits that have been or may be filed against the banks relating to their structured finance business. According to Total Securitization, 450 CDOs have defaulted to date with a total value of $397 billion. Despite this just 17 class action lawsuits related to the credit crisis have so far settled - mostly in relation to sub-prime mortgage underwriting. “The outcome of the many investigations now underway at the SEC and the Justice Dept will be crucially important in dictating whether actions are brought against the banks,” explains one litigation expert at a Wall Street law firm. “If we were to see a series of government investigations resulting in settlements then lawsuits become much easier to bring. Indeed, it becomes difficult to justify to investors not bringing cases where wrongdoing has been shown by the government.” Indeed, the case recently filed by monoline insurer ACA against Goldman Sachs is a good example of this – the SEC Abacus investigation last year having done the heavy lifting and paved the way for other suits to follow.
If the allegations against Khuzami are upheld the SEC will be under increased pressure to show that it really is determined to bring abuses to book. Investigations now underway include a $1.1 billion JP Morgan CDO completed in May 2007 and a February 2007 CDO squared deal arranged by Citi called Class V Funding III. Banks that are understood to have received subpoenas from the SEC in relation to their CDO businesses include Citi, Deutsche Bank, JP Morgan, Morgan Stanley and UBS. Khuzami, who until last year worked for Deutsche Bank, will need to convince investors that his poacher-turned-gamekeeper appointment will bring abuse to light and punish it. Not least because they will then be able to launch the wave of me-too cases that have been building up since the market collapsed. He could have some way to go.