Is this really what we mean by holding Wall Street accountable?
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Last week, the Securities and Exchange Commission announced that it had reached a $75 million settlement with Citigroup. The S.E.C. had accused Citigroup of failing to inform shareholders of more than $40 billion of subprime mortgage investments — the same kind of investments that led the bank to require a huge bailout from taxpayers.
On its face, the settlement looked like a victory for the good guys. The S.E.C. was finally holding Wall Street responsible for misleading shareholders. But take a step back and ask this question: Who is paying that $75 million fine?
The answer is Citigroup’s shareholders — the same people who were arguably defrauded by its failure to disclose its exposure to subprime mortgages in the first place. And that means you and I are liable, too. Taxpayers own 18 percent of the company.
As the S.E.C. becomes increasingly aggressive about enforcing the rules on Wall Street, the headline-grabbing, eye-popping settlements it has been reaching — and been promising to secure more of — may require the public to do a double-take.
“A class of innocent shareholders is being asked to pay for the misconduct of corporate officers,” said Harvey L. Pitt, a former S.E.C. chairman and now chief of Kalorama Partners, a consulting firm. The settlements, he said, “raise some fascinating intellectual questions.”
That is not to suggest that the S.E.C.’s new effort to hold Wall Street’s feet to the fire is mistaken. But it does point up a problem in a system that is supposed to hold the financial industry accountable and instead seems to leave shareholders with the bill.
Robert Khuzami, the S.E.C.’s director of enforcement, acknowledged that sometimes awkward outcome, but he said that suing a corporate entity could be a more powerful deterrent than suing an individual.
“It sends a message within the company,” he told me. Moreover, “it sends a message to the industry.”
As the former general counsel of the Americas for Deutsche Bank, Mr. Khuzami knows a thing or two about the way Wall Street thinks. And he considers deterrence more important than the fines themselves. “It’s much more important to deter the misconduct before it occurs than deal with it afterward,” he said.
Still, institutions are nothing more than their constituent parts — individuals who make choices on behalf of the organization. Some of those choices are good and some are bad. When they are very bad, the decision makers should suffer the consequences.
“The most effective way to deal with this is to impose the fines and penalties on the individuals,” Mr. Pitt argued. “They should feel the sting of it.”
In the case of Citigroup, the S.E.C. also settled with two former officers: Gary L. Crittenden, its former chief financial officer, and Arthur H. Tildesley Jr., its former head of investor relations.
But the amount of the penalties — Mr. Crittenden paid $100,000 while Mr. Tildesley paid $80,000 — was paltry compared with the $75 million that shareholders will shoulder. (To put this in perspective, Mr. Crittenden made about $32 million in total during 2007 and 2008, even as the company was foundering.)
The most forceful speaker on this issue has been Judge Jed S. Rakoff of Federal District Court in Manhattan. Last year, he rejected a proposed $33 million settlement between the S.E.C. and Bank of America over claims that the bank had defrauded investors by not disclosing Merrill Lynch’s losses before a merger of the two firms was completed. The settlement, he wrote, “is not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the bank’s alleged misconduct now pay the penalty for that misconduct.”
In that case, the S.E.C. had argued that fining the corporation “sends a strong signal to shareholders that unsatisfactory corporate conduct has occurred and allows shareholders to better assess the quality and performance of management.”
Mr. Khuzami made a similar argument to me: Shareholders can better hold the boards and corporate officers accountable as a result of such cases.
But the judge doesn’t buy it.
“The notion that Bank of America shareholders, having been lied to blatantly in connection with the multibillion-dollar purchase of a huge, nearly bankrupt company, need to lose another $33 million of their money in order to ‘better assess the quality and performance of management’ is absurd,” Judge Rakoff ruled in that case.
Worse, investors often lose twice — once for a fraud and again when the company’s share price takes a hit after a lawsuit.
None of this is to suggest that a corporation should never be sued by the S.E.C. and that shareholders should not take it on the chin.
In a much bigger case, Goldman Sachs agreed last month to pay $550 million to settle claims that it had misled investors. But that case was about how the firm might have defrauded its clients, meaning that that revenue was arguably ill-gotten and represented a windfall for shareholders that should be returned. In some case, the S.E.C. creates a “fair fund” to help pay back shareholders who were affected.
Mr. Pitt offered a cynical, yet practical reason the S.E.C. was tougher on companies than individuals: companies are quicker to settle given the potential damage to their stock price and reputation as headlines linger.
If the S.E.C. were to just pursue cases against individuals, Mr. Pitt said, “they will be getting far less settlements, which means they will have to litigate more cases, which means they will bring less cases.”
But there is a practical consideration: corporations have deeper pockets than individuals. Since passage of the Sarbanes-Oxley Act of 2002 through the end of last year, the S.E.C. has recorded $3.7 billion worth of settlements with corporations, according to the National Economic Research Associates. For individuals, the total comes to $600 million.
“Therefore, on an overall basis, companies pick up nearly 87 percent of the settlement tab,” the research associates wrote in a research report last year.
And that’s the problem. If shareholders are left holding the bag, it feels as if Wall Street may have found a way to win again.
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