CommunityThe Bullpen

SEC Blows Easy Prosecution of Toxic CDO Salesman

The SEC managed to lose a layup of a case against former Citigroup executive Brian Stoker, in a case which revolved around CDO sales where Citi has already agreed to pay fines on the grounds that they misled investors and took the other side of the bet.

The Securities and Exchange Commission had accused Brian Stoker, a former midlevel Citigroup executive, with negligence related to his role in creating exotic mortgage securities known as collateralized debt obligations, or C.D.O.’s. In a lawsuit filed last October, the government said that Mr. Stoker, who prepared sales materials for C.D.O.’s, knew or should have known that he was misleading investors by not disclosing that Citigroup helped select the underlying mortgage securities in the C.D.O. and then placed a large bet against it.

The jury rejected the S.E.C.’s case, concluding that Mr. Stoker was not liable under the securities laws. In addition to handing up its verdict, the jury also issued an unusual statement.

“This verdict should not deter the S.E.C. from investigating the financial industry, to review current regulations and modify existing regulations as necessary,” said the jury’s statement, which was read aloud in the courtroom by Judge Jed S. Rakoff, who presided over the two-week trial in Federal District Court in Manhattan.

In other words, please, please keep doing your job, SEC, just don’t give us terrible cases to adjudicate anymore.

Stoker’s lawyer argued that he was being made a scapegoat for the entire financial industry’s misconduct, and that managed to sell the jury. But it’s irrelevant. At issue is whether Stoker’s sales materials for CDO’s were misleading. That’s it. If they were, he’s guilty. That the SEC couldn’t make this sale displays a pretty rank incompetence on their part:

Even though this case was argued before a jury (ooh, scary! They might go into My Eyes Glaze Over mode on CDO details), the basic issues were simple. The CDO squared that Citigroup director Brian Stoker marketed to investors was presented as having its assets selected by an independent asset manager […] In fact, the manager on the deal in question (Credit Suisse) was NOT independent, but was chosen because it would go along with Citi’s plan to design the CDO to satisfy the interest of short investors, most important, Citi itself, which took down over half the CDS in the deal, and also stuffed $92 million of its toxic bonds in the cash portion (the non-CDS component). Citi made $160 million while investors lost roughly $700 million.

So what did the SEC’s strategy appear to be? This seems to have been a parallel to the approach in the Goldman suit against Goldman’s Fabrice Tourre: to target an non-executive and get him to roll the higher ups. But Tourre and Stoker were both enough made men to be willing to fight. Stoker had a $2.2 million guarantee for 2007. Guys like that do not want to lose their access to the industry meal ticket.

Sadly, if the SEC can’t secure a conviction in a relatively open and shut case like this, it’s almost certain that they will fold up their tent and stop even a semblance of aggressive prosecutions against the banks. It doesn’t appear they have the personnel available to do the job. After 20 years of near-consistent defunding, I’m not that surprised.

Previous post

9th Circuit ruling favorable for Occupiers to hold police, gov'ts accountable for excessive force

Next post

What Chick-fil-A's money supports - a video montage of homophobia

David Dayen

David Dayen