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SEC “Slap on the Wrist” Promoted Fraud

Posted by Larry Doyle on December 9, 2009 3:06 PM |

When the punishment does not fit the crime, is there any surprise that crimes, frauds, and other unsavory behaviors will persist? Human nature and pervasive greed on Wall Street being what they are, the environment for fraud was a breeding ground.

Many thanks to a loyal reader for sharing a recent story which highlights this dynamic in a favorite topic here at Sense on Cents, auction-rate securities. McClatchy writes, For the Feds, Some Firms Are Too Big to Punish:

Then in 2006, the SEC cited Citigroup and other firms for improperly marketing “auction rate securities,” bonds issued by municipalities, student loan entities and corporations. The agency censured Citigroup and fined it $1.5 million, and Citigroup promised to clean up its sales practices. The SEC indicated that was good enough: In its attempt to deter more lawbreaking, the SEC declared, “this settlement is appropriate.”

Two years later, however, Citigroup was back under SEC scrutiny. This time, the SEC said the firm had improperly marketed auction rate securities, violating the same section of law at issue in 2003.

A $1.5 million fine? A deterrent? For an entity the size and scale of Citigroup, that figure was not even a rounding error.  What is the result? The behavior persists and more fraud and shoddy sales practices occur.

Citigroup again settled with the SEC, and while not admitting the allegations, it again agreed to not violate that key federal securities law.

It was one of those auction rate investments that went sour on KV Pharmaceutical.

Citigroup first approached the firm in 2005 to invest in the securities, pitching them as safe and dependable — perfect for KV’s needs. When the market started souring in 2007, however, Citigroup never passed those concerns on to KV, according to a lawsuit the drugmaker eventually filed in federal court.

KV bought $10.7 million in the securities, then another $16.9 million. And it kept right on buying them, long after Citigroup traders were receiving e-mails like this one intended to boost sales: “Hit all bids . . . Times like these, we need to do whatever is necessary. Just make sure all hands are on deck and paper is sold,” according to court records.

KV, in its lawsuit, said Citigroup “put its economic interests before KV’s” in an effort to save Citigroup’s own faltering finances. All along, KV said, it was assured there was nothing to worry about.

The auction rate securities market failed in February 2008, and KV was left holding more than $70 million it couldn’t spend.

While the settlements the SEC negotiated with Citigroup and other banks could make some customers whole, it didn’t help KV in time. In February, facing a cash crunch, it said it was cutting 700 jobs, due in part to its auction rate problems.

Its lawsuit is pending; neither KV nor Citigroup would comment.

Meanwhile, Citigroup filed its application for a waiver, and the SEC granted it.

In theory, securities law allows the SEC to levy heavier fines or extract greater punishment from companies that violate their previous “permanent” injunctions.

“The SEC has a miserable record of policing and keeping track of recidivism even of prior violations,” said James Cox, a Duke University law professor and an expert on financial regulation. “I think it’s not uncommon and I think it’s a problem.”

The risks on Wall Street not only cover market risk, credit risk, counterparty risk, but very much regulatory risk. Even though the current crowds at the SEC and FINRA would have us believe that things have changed and investors will be protected going forward, the culture and relationships of these organizations are so deeply embedded with Wall Street that investors should remain on guard.

Just ask KV.


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