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Categorized | Financial

US jury rejects SEC charges over CDO sale

Posted on July 31, 2012

A US jury has rejected the Securities and Exchange Commission’s allegations that a former Citigroup banker misled investors who bought a $1bn mortgage product by failing to tell them the bank had bet against it.

Tuesday’s loss comes as the SEC faced the first courtroom test of its allegations that investors, including hedge funds and insurers, were misled by banks during the financial crisis when they bought mortgage-linked securities. Citigroup agreed to pay $285m to settle the allegations, without admitting or denying wrongdoing, but the pact was rejected by a judge and is on appeal.

    The verdict also comes as the SEC has been under pressure to hold individuals accountable for the financial crisis. The SEC accused Brian Stoker, the former Citigroup banker, of being negligent – a charge with a lower burden of evidence than accusing him of intentionally misleading investors – when he failed to disclose that Citigroup selected some securities referenced in the portfolio, a collateralised debt obligation known as Class V Funding III, and had placed a bet against it.

    Several investigations into the sale of CDOs and residential mortgage-backed securities are under way. Two other bankers who were sued in connection with CDO sales are fighting the allegations.

    In delivering its verdict, the jury had a written message for the SEC, saying, “This verdict should not deter the SEC from continuing to investigate the financial industry, to review current regulations and modify existing regulations as necessary.”

    Robert Khuzami, the SEC’s director of enforcement, said “We respect the jury’s verdict and will continue to aggressively pursue misconduct arising out of the financial crisis.”

    John Keker, a lawyer for Mr Stoker said: “We are grateful that justice was done. Now Brian Stoker has his life back.”

    Mr Stoker’s legal team, lead by Mr Keker, argued during the two-week trial that the investors involved, including insurer Ambac, were sophisticated and had all the information they needed to access the CDO investment. He argued that the offering documents were standard for the industry and that it was not common to disclose interests of the bank arranging the security.

    One challenge for the SEC was that most of its witnesses were employees of Citigroup who described how the product was put together as a regular part of their business.

    Mr Stoker lost a bid to argue that Citigroup’s internal and external lawyers were involved in the structuring of the deal but several witnesses testified that lawyers were involved in the process. The SEC maintained the lawyers were not given complete information at the time.

    Citigroup said, “We agree with the jury’s verdict, and hope to secure final judicial approval of our settlement with the SEC and put this matter behind us.”

    In addition to the SEC, the Department of Justice has been criticised for not holding individuals accountable for conduct that contributed to the financial crisis; government officials have said errors were made but they did not rise to criminal conduct. They have pointed to the layers of review from lawyers making it difficult to prove any statements were intentionally misleading.

    Tuesday’s verdict follows a decision last October when an administrative law judge threw out a SEC case against two State Street bankers accused of misleading investors about a fund’s exposure to subprime mortgages.

    Commenting on the Stoker case, Jacob Frenkel, a securities lawyer said, “It’s reasonable for the jury simply to have concluded that the structure of this transaction was not rooted in fraud, period.”

    Mr Frenkel said he doesn’t expect this verdict to chill the SEC’s enforcement efforts.