Citigroup Inc. (C) has stood by $75 million settlement with the Securities and Exchange Commission (SEC), urging the U.S. judge to approve the arrangement. The settlement is to square off charges for the misleading disclosures of subprime exposures made by Citi in 2007. Besides allegations against the company, the charges also individually targeted two of the Citi executives for preparing and approving deceptive statements.
Citi has accepted the agreement as fair, reasonable and in public interest, in line with what SEC stated last week while defending the deal. As per the filings, Citi had initially planned to appeal the allegations and the penalty decided by the SEC as its current shareholders would have to bear the expense, but later decided to resolve the matter to avoid any further expensive public trial.
Last month, U.S. District Court Judge Ellen Segal Huvelle had asked both the parties for further information before the accord’s approval. Judge Huvelle was not satisfied with the settlement and questioned why the current shareholders of Citi should suffer for the alleged misdoings of Citi’s executives.
SEC defended the settlement size by stating that it represents less than 0.3% of Citi’s second quarter 2010 revenues and charging this amount would neither unduly hurt the company’s operations nor impact the current shareholders substantially. The penalty is justified by the gravity of the misconduct, according to the SEC.
SEC Charges and the Settlement
According to the SEC allegations, Citi had repeatedly issued misleading statements regarding its subprime exposure in its earnings calls and public filings between July and October 2007. The company had claimed to have reduced its subprime exposure during that period from $24 billion to $13 billion reported at the end of 2006, while it had still possessed around $40 billion in “super senior” tranches of collateral debt obligations backed by subprime mortgages and related instruments named “liquidity puts.” This announcement was only made as late as November 2007.
Charges were also levied against Gary Crittenden, former chief financial officer of Citi, and Arthur Tildesley, former head of investor relations and currently head of cross marketing at Citi. They decided to settle the charges separately by paying a penalty of around $100,000.
However, Citi claimed making the disclosures as soon as it became clear to the company that they had undervalued the risks associated with some of the ‘safe’ securities.
Following the recent meltdown of the subprime market, SEC has intensified its scrutiny into the subprime exposure and related misdeeds of Wall Street companies. In July, Goldman Sachs Group Inc. (GS) was involved in a $550 million settlement with the SEC over a civil fraud suit linked with subprime mortgage investments.
Our Take
While the SEC charges and the penalty are a dent on both Citi’s reputation and its financials, we believe that the settlement would remove the litigation overhang on the stock. Additionally, Citi’s restructuring initiatives are welcome news and its global footprint is encouraging. Nevertheless, the shrinking of its revenue base and the negative impact of the financial reform bill would not spare the company. The positive and the negative arguments are somewhat balanced at this point.
Citi is currently rated as Zacks #3 Rank (Hold), implying no clear directional pressure on the stock over the next one to three months. We also have a Neutral recommendation on the stock.
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