Bloomberg News reported on Monday that the SEC’s inspector general is investigating Robert Khuzami, its chief enforcement official, after getting an anonymous letter claiming that Khuzami watered down the agency’s Citigroup enforcement effort after talking to a pal at the bank.
Bloomberg:
According to the letter, the SEC’s staff was prepared to file fraud claims against both individuals. Khuzami ordered his staff to drop the claims after holding a “secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend” of his and “who was counsel for the company, not the individuals affected,” according to a copy of the letter reviewed by Bloomberg News.
If true—and be warned that we just don’t know the credibility of the accuser since the letter is anonymous—this will be a big story.
And while we don’t know anything about the accuser, recall how odd it seemed that the SEC didn’t hit Citigroup (a CJR funder) and the two executives it focused on much harder. Here’s what The Wall Street Journal reported at the time:
Some critics complained that the agency’s charge of unintentional fraud was relatively minor. Boston University law school professor Cornelius Hurley, after reading the complaint, said he thought the SEC made a case for tougher fraud charges. “But it appears they pulled their punch,” he said. Given the damage Citi caused itself and the industry, a $75 million penalty “doesn’t hurt Citigroup and it doesn’t send a message to the industry that it’s wrong.”
Indeed, it’s pretty clear from the SEC’s own complaint that the two Citi executives knew that they were concealing billions of dollars in losses from shareholders. The Journal, in July, again:
The SEC complaint detailed several points when Citi’s top financial officials were made aware of the higher exposures but chose to omit them from earnings reports.
And American Lawyer got hold of the actual fax and notes that it “contains purported inside details about the SEC’s negotiations with Citi that suggest it wasn’t written by a random disgruntled Iowan, but by someone with knowledge of the SEC’s handling of the Citi case.”
Here’s the text of the fax, which is awfully specific and ought to be very easy to prove or disprove (emphasis mine):
In the Citigroup investigation involving hiding/failing to disclose more than $50 billion of subprime securities from investors, the [SEC] staff had negotiated a settlement with one individual that included fraud charges and was prepared to file contested 10(b) fraud charges against another individual,” the fax states. “But just before the staff’s recommendation was presented to the commissioners, enforcement director Robert Khuzami had a secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend of Khuzami’s and a fellow former (Southern District of New York) alum, and who was counsel for the company.
American Lawyer helpfully points out who represented Citi in the SEC settlement talks and which of them also worked at the SDNY.
Citi was represented in the SEC case by Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison and Lawrence Pedowitz of Wachtell, Lipton, Rosen & Katz, among other lawyers from the two firms. John Carroll of Skadden, Arps, Slate, Meagher & Flom represented Crittenden. Tildesley had Simpson Thacher & Bartlett’s Mark Stein. Karp, who is not a former Manhattan federal prosecutor, declined to comment Tuesday; Pedowitz, Carroll, and Stein (who are all former SDNY assistant U.S. attorneys) didn’t return our calls.
Khuzami is a former prosecutor, but he’s also yet another in that line of Obama’s Wall Street-friendly appointments. Khuzami came over from the German giant Deutsche Bank. So this story also has a revolving-door angle. Yves Smith on that:
This is why prominent lawyers and other high level fixers earn as much as they do. They have ongoing personal relationships with influential figures and can pull strings when they need to. But how a seasoned and supposedly tough prosecutor like Khuzami ever thought this settlement would pass muster is beyond me. Did he really think no one would notice or care, that this was a sufficiently old matter that any objections to it would die down quickly?
Remember, Khuzami and the SEC settled with Goldman Sachs, too, despite having a good case against the firm. And it’s worth emphasizing that Khuzami, as the WSJ put it in a headline in April, “Oversaw Deutsche CDOs” before he jumped to the SEC:
Before taking his current job at the SEC last year, the 53-year-old Mr. Khuzami spent five years running the U.S. legal division of Deutsche Bank, one of the largest issuers of collateralized debt obligations in 2006 and 2007. As part of that job, he worked with lawyers who advised on the CDOs issued by the German bank and how details about them should be disclosed to investors. The group included more than 100 lawyers who also defended the bank against lawsuits and vetted other financial products, these people said.
Deutsche Bank has faced allegations of inadequate disclosure over its creation of CDOs.
Why somebody with such an obvious conflict of interest is allowed to head up the SEC’s enforcement division, which was once actually feared on Wall Street, is beyond me. CDOs are instruments at the heart of the financial crash.
This story is one worth watching closely.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.