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Settling with Government – SEC Gets Paid and Subprime Mortgage Securities Investors Suffer Huge Losses

Robert M. Siegel

Citimortgage Admits Liability

On February 15th, 2012, in a clearly pre-negotiated deal between the US Attorney’s Office, on behalf of the Department of Housing and Urban Development and CITIMORTGAGE, INC. (a subsidiary of CITIBANK, N.A., and “CMI”), a complaint was filed against CMI in the US District Court in Manhattan and simultaneously settled for $158.3 million.

The complaint charged CMI, a participant in the Direct Endorsement Lender program administered by FHA, with engaging in risky lending practices which had caused HUD, FHA’s parent, to incur losses on a large volume of loans that CMI never should have originated. In what was dubbed as the use of “Brute Force,” CMI apparently pressured its quality control personnel to reduce or downgrade their findings of defects and challenged adverse findings by QC, in an effort to drive down rates.

This settlement is noteworthy because it signals a continuation of a very recent change in the requirements for an accused wrongdoer to be able to reach a settlement with a prosecuting governmental unit. In November 2011, CITIBANK had attempted to reach a settlement with the SEC in the SDNY regarding the SEC’s claim that CITIBANK had led investors to believe that mortgage investments were safer than they actual were. This resulted in losses of approximately $1 billion in subprime mortgage securities. In that litigation, Judge Rakoff rejected the proposed $285 million settlement, because it was premised on payment being made to the SEC in exchange for CITIBANK not having to admit guilt for the SEC’s charges.  [Click here to view complaint].

In the “Brute Force” settlement, CITIMORTGAGE “admits, acknowledges and accepts responsibility” for certain conduct alleged in the Complaint – including failing to comply with all HUD-FHA requirements with respect to certain loans and submitting certifications to the agency that these loans were eligible for FHA mortgage insurance – acknowledging that “in fact they were not.”  The $158.3 million CITIMORTGAGE has agreed to pay to settle this suit is in addition to the amount its parent company agreed to pay (along with the other co-defendants), in connection with the “Robo signing” mortgage servicing settlement announced earlier this month.  The CMI settlement was approved by US District Court Judge, Victor Marrero.

In the SEC matter, Judge Rakoff took a stand, and it has had a significant ripple effect.  In December 2011, US District Judge Rudolph Randa, in Milwaukee, told the SEC that its proposed settlement with the Koss Corp. was too vague and asked the agency to provide more facts. In January, 2012, the SEC modified its settlement policy for enforcement actions that also involve a criminal conviction or admission by a defendant of criminal violations. Under its new policy, the traditional “neither admit nor deny” language will be deleted from settlement documents.  Instead, the SEC will recite the facts and nature of the related criminal proceedings.  SEC enforcement staff will have the discretion to incorporate into SEC settlement documents any relevant facts admitted by the defendant in the criminal proceedings. This policy change, however, does not affect the SEC’s “neither admit nor deny” settlement approach in cases without a parallel criminal resolution (See Steve Schefer, SEC Rule Change Doesn’t Mean Much for Wall Street, Forbes, January 6, 2012).

HUD, the SDNY US Attorney’s Office, and CMI are not swimming in ambiguity over CMI’s misconduct this time around, and we have no doubt that Judge Rakoff would be pleased. However, in view of the SEC’s limited policy change, we must await further actions to determine whether the SEC and other governmental units employing a similar policy in reaching settlements will pass judicial muster.

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