Special Access in Connection with the Division of Enforcement's

Information is from REPORT OF INVESTIGATION
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
OFFICE OF INSPECTOR GENERAL
Investigation into Allegations of Improper Preferential Treatment and
Special Access in Connection with the Division of Enforcement's
Investigation of Citigroup, Inc.
Case No. OIG-559
September 27,2011


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
OFFICE OF INSPECTOR GENERAL
Investigation into Allegations of Improper Preferential Treatment and
Special Access in Connection with the Division of Enforcement's
Investigation of Citigroup, Inc.
Case No. OIG-559
Introduction and Summary of Results of the Investigation
On January 11,2011, the Securities and Exchange Commission ("SEC" or "Commission") Office of Inspector General ("OIG") opened an investigation as a result of information received in an anonymous complaint, dated January 3,2011, alleging "serious problems with special access and preferential treatment" at the SEC. Specifically, the complaint alleged that during the SEC's investigation ofCitigroup, Inc.' s ("Citigroup's") failure to disclose "more than $50 billion" in sub-prime securities, the staff of the SEC's Division of Enforcement ("Enforcement") negotiated a settlement with one individual, which included a fraud charge, and was prepared to file contested 1O(b) fraud charges against a second individual.

The complaint further stated that just before the staff s recommendation was presented to the Commission, Enforcement Director Robert Khuzami had a "secret conversation" with his "good friend" and former colleague, a prominent defense counsel representing Citigroup, during which Khuzami agreed to drop the contested fraud charges against the second individual. The complaint further alleged that the Enforcement staff were "forced to drop the fraud charges that were part of the settlement with the other individual," and that both individuals were also represented by Khuzami's friends and former colleagues, creating the appearance that Khuzami's decision was "made as a special favor to them and perhaps to protect a Wall Street firm for political reasons."

The complaint also alleged that Khuzami's decision had the effect of protecting Citigroup from private litigation, and that by not telling the staff about his secret conversation, Khuzami "directly violated recommendations by Inspector General Kotz in previous reports about how such special access and preferential treatment can cause serious appearance problems concerning fairness and integrity of decisions that are made by the Enforcement Division."

The OIG investigation found that on July 29,2010, the SEC filed a settled civil action against Citigroup in the U.S. District Court for the District of Columbia. The SEC's complaint in that action alleged that during the fall of2007, Citigroup made a series of misstatements about its investment bank's exposure to sub-prime mortgages, representing that it had $13 billion in sub-prime exposure when, in fact, it had more than $50 billion. On that same date, without admitting or denying the allegations in the complaint, Citigroup consented to the entry of a final judgment that (1) permanently enjoined it from violations of Section 17(a)(2) of the Securities Act of 1933, Section
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This document is subject to the provisions of the Privacy Act of 1974, and may require redaction before disclosure to third parties. No redaction has been performed by the Office ofInspector General. Recipients of this report should not disseminate or copy it without the Inspector General's approval.

l3(a) of the Securities Exchange Act of 1934, and Exchange Act Rules 12b-20 and l3a11, and (2) ordered it to pay penalty and disgorgement of $75,000,001.

In addition, Enforcement staff pursued charges against Citigroup' s Chief Financial Officer, Gary Crittenden ("Crittenden"), and Citigroup's Head ofInvestor Relations, Arthur Tildesley ("Tildesley"). Crittenden and Tildesley ultimately consented to an administrative order that they cease-and-desist causing any violations of Section 13(a) of the Securities Exchange Act of 1934, and Exchange Act Rules 12b-20 and 13a11, and undertook to pay $100,000 and $80,000, respectively.

The OIG investigation found that while the settlements entered into with Tildesley and Crittenden were non-fraud settlements negotiated just one month before the case was filed, and a few days after Khuzami had a telephone conversation with his former colleague from the U.S. Attorney's Office for the Southern District of New York, Mark Pomerantz, who was representing Citigroup, the evidence did not establish that those settlements were the result of a special favor. Instead, the OIG found that the settlements were part of a negotiation process that involved several members of the Enforcement staff working on the Citigroup investigation.
In addition, the OIG investigation did not find evidence that Khuzami violated prior OIG recommendations or the provisions of the Enforcement Manual applicable to all Enforcement staff regarding external communications, which were issued to address concerns raised in connection with previous OIG investigations. Although Khuzami did discuss settlement with a former colleague in a telephone call that did not include other staff members, the evidence showed Khuzami did not commit to any specific settlement in that telephone call. The evidence further demonstrated that when he understood that Pomerantz had believed such a commitment had been made, Khuzami immediately reached out to Pomerantz to disabuse him of any notion that a settlement had been reached. Moreover, Khuzami reported back to the Enforcement staff about the matter the following day and further discussions were conducted with the Enforcement staff before a final decision on the settlement was made. In addition, Khuzami informed the Enforcement staff working on the Citigroup investigation that if the Enforcement staff were not "comfortable" with the settlement, he would reject it and move forward with a contested action.

Accordingly, the OIG investigation did not substantiate the allegations in the anonymous complaint and this report is being provided for informational purposes.

Scope of the Investigation

The OIG obtained and reviewed the e-mail records of nine current SEC employees who worked on the Citigroup investigation for the period January 1,2010, to October 31,2010. The OIG also reviewed the entries regarding the Citigroup case in the
2

SEC's case management and tracking databases known as The Hub I and the Name Relationship Search Index (NRSI).l
The 0.IG also took on-the-record, sworn testimony from the following seven witnesses who had knowledge of the facts and circumstances surrounding the SEC 's Citigroup investigation:

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\) DIvIsion of Enforcement, Secuntles and Exchange Commission; taken on April 4, 20 11 1(bX6),(bX7xC) ~estimony Tr."). Excerpts of testimony transcript are attached at Exhibit I.
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Exchange CommiSSIOn; taken on Apnl 15, 201 1 , Testimony Tr.' ). Excerpts of testimony transcript are attached at x t61T2.
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3) l D1 VtStOn of Enforcement, Secunttes and Exchange Commission; taken on April 29, 2011 IlbX51.1bX1XC) Testimony Tr."). Excerpts of testimony transcript are attache at x I It 3.
4) Scott Friestad, Associate Director, Division of Enforcement, Securities and Exchange Commission; taken on May 9, 20 11 (" Friestad Testimony Tr."). Excerpts of testimony transcript are attached at Exhibit 4.
5) Lorin Reisner, Deputy Director, Division of Enforcement, Securities and Exchange Commission; taken on May 23, 20 II ("Reisner Testimony Tr."). Excerpts of testimony transcript are attached at Exhibit 5.
6) Robert Khuzami, Director, Division of Enforcement, Securities and Exchange Commission; taken on June 10, 2010 (" Khuzami Testimony Tr."). Excerpts of testimony transcript are attached at Exhibit 6.
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In addition to the sworn testimony described above, the OIG interviewed Citigroup attorney Mark Pomerantz on July 19, 2011 , and summarized that interview in a memorandum (" Pomerantz Interview Memorandum"), attached at Exhibit 8.
1 The Hub provides electronic case management and tracking for Division of Enforcement offices nationwide.
2 NRSI IS used by the SEC's Enforcement siaffto research whether a person or entity IS mvolved m an open investigation.
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Relevant Statutes, Regulations and Policies
Commission Conduct Regulation
The Commission's Regulation Concerning Conduct ofMembers and Employees ofthe Commission ("Conduct Regulation"), at 17 C.F.R. 200.735-1 et seq., sets forth the standards of ethical conduct required of Commission members and employees. The Conduct Regulation states in part:
The Securities and Exchange Commission has been entrusted by Congress with the protection ofthe public interest in a highly significant area of our national economy. In view ofthe effect which Commission action frequently has on the general public, it is important that ... employees ... maintain unusually high standards of honesty, integrity, impartiality and conduct. They must be constantly aware ofthe need to avoid situations which might result either in actual or apparent misconduct or conflicts ofinterest. ...
17 C.F.R. 200.735-2(a).
Commission's Canon of Ethics
The Commission's Canon ofEthics in the Code ofFederal Regulations requires the maintenance ofindependence and the rejection of any impressions of influence: "A member should not, by his conduct, permit the impression to prevail that any person can improperly influence him, that any person unduly enjoys his favor or that he is affected in any way by the rank, position, prestige, or affluence ofany person. '.' 17 C.F .R. 200.61 (emphasis added). See also 17 C.F.R. 200.51 (requiring SEC employees to bear in mind the provisions ofthe Canon ofEthics).
Enforcement Manual
The Commission's Division ofEnforcement Manual, dated February 8, 2011, establishes the following best practices to be applied to all situations in which senior officials (at the Associate Director level and above) engage in material communications with persons outside the SEC relating to ongoing, active investigations:
Generally, senior officials are encouraged to include other staff members on the investigative team when engaging in material external communications, and should try to avoid initiating communications without the knowledge or participation of at least one ofthe other staff members. However, "participation" could include either having another staff member present during the communications, or having a staff member involved in preparing the senior official for the communications ....
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If a senior official entertains a communication without the
participation or presence of other staff members, then the
senior official should indicate to the outside person that the
senior official will be infonning other members of the
investigative team of the fact of the communication, along
with any pertinent details, for their infonnation and
consideration.
Within a reasonable amount of time, the senior official
should document material external communications related
to the investigation involving, but not limited to, potential
settlements, strength of the evidence, and charging
decisions. The official may take contemporaneous notes of
the communication, send an e-mail to any of the assigned
staff, prepare a memo to the file, or orally report details to
any of the assigned staff (who may then take notes or
prepare a memo to the file).
The senior official should at all times keep in mind the
need to preserve the impartiality of the Di vision in
conducting its fact-finding and information-gathering
functions. Propriety, fairness, and objectivity in
investigations are of the utmost importance, and the
investigative team cannot carry out its responsibilities
appropriately unless these princi ples are strictly
maintained. The senior official should be particularly
sensitive that an external communication may appear to be
or has the potential to be an attempt to supersede the
investigative team 's judgment and experience.
Enforcement Manual, Section 3.1 I, February 8, 2011, (emphasis in original) at Exhibit
9.
Results of the Investigation
I. The Enforcement StafT Investigated Citigroup and Considered Various Charges and Settlement Oluions
A. The Enforcement StafTOpened an Investigation into Citigroup
In December 2007, the SEC opened an investigation into what it tenned "[p JotentialIy false & misleading statements made by Citigroup and several of its senior officials ... regarding Citigroup's exposure to sub-prime mortgages in its investment banking unit." See Excerpt from The Hub, at Exhibit 10, The Enforcement team
, i(bX6).(bK7Kc) assigned to the case conSIsted O~L ___________________~
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In his OIG testimony, Friestad described the nature of the Citigroup investigation
as follows:

The essence of the case is that during summer and fall of
2007, Citigroup made disclosures to its investors about the
size of its exposure to subprime and subprime related
securities.

In a nutshell, their disclosures were that they had a small
exposure to subprime securities, and it was being reduced
through the course of that year.

More specifically, they would say things to investors along
the lines of we staned with about $24 billion of exposure to
subprime. We have worked that down to $13 billion. It's
continuing to decrease.

Sort of implicit in that is don't worry, you know, we've got
things under control, the exposure is not that great and it's
declining.

In fact, their exposure to subprime securities and subprime
related securities was far greater than that. It was north of
$50 billion, if you added in the two types of sub prime
securities that we refer to as super seniors and liquidity
puts. The theory of our case was that by not disclosing the
fact that the real exposure was north of$50 billion, you are
misleading investors when you are saying it's $13 billion.
The company had made misleading disclosures to its
investors, and that's the gist of the case.
Friestad Testimony Tr. at 13-14.
further testified that the Citigroup case "had to do with [Citigrou 's] dis:'c'co"'su"r"e"s",,,artO'i!mg in Jul of2007 ... about what their subprime position was." 01""'..[,,,'.,,"",,'----, Testimony Tr. at 13:~:~i(b} tated that there were two disclosures in July 2007 an two disclosures in October 2007, and that in those disclosures Citigroup was alleged to have "misled the market to thinking that they had $13 Billion in [subprime exposure], and they in fact had in excess of 50." Id. at 13-14.
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B. Khuzami Became Director of Enforcement and Began Overseeing the Citigroup Investigation
In early 2009, the Enforcement staff working on the Citigroup inves .igatiol1:>",~'", having internal discussions with regard to a possible settlement of the case. bXti).(bX7XG) Testimony Tr, at 13. Linda Thomsen was the Director of Enforcement at that time and participated in the initial discussions. Friestad Testimony Tr. at IS.
In March 2009, Robert Khuzami replaced Linda Thomsen as the Director of Enforcement. Khuzami Testimony Tr. at 8, 17. Prior to joining the SEC, Khuzami worked from 1990 to 2002 in the U.S. Attorney's Office for the Southern District of New York . Id. at 8. He was a line prosecutor for the first eight of those years, and he then became Deputy Chief and later Chief ofthe Securities and Commodities Task Force. Id. at 8. He left the U.S. Attorney's Office for a position at Deutsche Bank in 2002, where he worked until coming to the SEC as Director of Enforcement in 2009. Id. at 8; see also SEC Release 2009-31, February 19,2009 (announcing Khuzami named SEC Director of Enforcement), ~ In August 2009, Khuzami hired Lorin Reisner to be the Deputy Director of Enforcement Reisner Testimony Tr. at II ; see also SEC Release 2009-150, July 2, 2009, (announcing Reisner will join Division of Enforcement as Deputy Director in early August).6 Khuzami had previously worked with Reisner at the U.S. Attorney's Office in New York where Reisner was an Assistant U.S. Attorney from 1990 to 1994. Reisner Testimony Tr, at 6; Khuzami Testimony Tr. at 15.
http://www.sec.gov/foia/docs/oig-559.pdf