NEW YORK, United States – A judge on Monday used unusually harsh language to strike down a US$285-million settlement between Citigroup and the Securities and Exchange Commission over toxic mortgage securities, saying he couldn’t tell whether the deal was fair and criticising regulators for shielding the public from details of the firm’s wrongdoing.

US District Judge Jed Rakoff said the public has a right to know what happens in cases that touch on “the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives”. In such cases, the SEC has a responsibility to ensure that the truth emerges, he wrote.

Rakoff said he had spent hours trying to assess the settlement but concluded that he had not been given “any proven or admitted facts upon which to exercise even a modest degree of independent judgment”.

He called the settlement “neither fair, nor reasonable, nor adequate, nor in the public interest”.

The SEC shot back in a statement issued by Enforcement Director Robert Khuzami, saying the deal was all four of those things and “reasonably reflects the scope of relief that would be obtained after a successful trial”.

SEC Chairman Mary Schapiro, meanwhile, sent a letter to a key senator Monday asking for Congress to expand the agency’s authority to fine companies and individuals. She is seeking to raise the limits on fines under current law and make other changes.

Such changes would “further enhance the effectiveness of the (SEC’s) enforcement programme,” Schapiro told Senator Jack Reed, D-RI, who heads the Senate Banking subcommittee on securities.

The SEC had accused Citigroup of betting against a complex mortgage investment in 2007 — making US$160 million in the process — while investors lost millions. The settlement would have imposed penalties on Citigroup but allowed it to deny allegations that it misled investors.

Citigroup said in a statement that it disagreed with Rakoff because the proposed settlement was “a fair and reasonable resolution to the SEC’s allegation of negligence” and was consistent with long-established legal standards.

“In the event the case is tried, we would present substantial factual and legal defenses to the charges,” it added.

This wasn’t the first time that the judge struck down an SEC settlement with a bank, and Rakoff has made no secret of his disdain for settlements between the government agency and banks for paltry sums and no admission of guilt.

“The SEC’s longstanding policy — hallowed by history, but not by reason — of allowing defendants to enter into consent judgments without admitting or denying the underlying allegations, deprives the court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact,” he wrote in Monday’s decision.

Adam Pritchard, a professor of securities law at the University of Michigan Law School, said courts could become clogged with cases that would normally be settled if other judges adopt Rakoff’s reasoning and deprive companies of their incentive to avoid trial.

He called it a powerful SEC tool to encourage settlements “and Judge Rakoff is taking that away from them”.

The SEC’s consent judgment settling the case was filed the same day as its lawsuit against Citigroup, the judge noted.

“It is harder to discern from the limited information before the court what the SEC is getting from this settlement other than a quick headline,” the judge wrote.

“In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers,” Rakoff said. “Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”

He set a July 16 trial date for the case.

Khuzami said in the SEC statement that Rakoff made too much out of the fact that Citigroup did not have to admit wrongdoing. He said forcing Citigroup to give up profits, pay fines and face mandatory business reforms outweigh the absence of an admission “when that relief is obtained promptly and without the risks, delay and resources required at trial”.

Khuzami added: “Refusing an otherwise advantageous settlement solely because of the absence of an admission also would divert resources away from the investigation of other frauds and the recovery of losses suffered by other investors not before the court.”

Rakoff said the power of the judiciary was “not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated”.

He added: “If its deployment does not rest on facts — cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.”

In the civil lawsuit filed last month, the SEC said Citigroup Inc traders discussed the possibility of buying financial instruments to essentially bet on the failure of the mortgage assets. Rating agencies downgraded most of the investments just as many troubled homeowners stopped paying their mortgages in late 2007. That pushed the investment into default and cost its buyers’ — hedge funds and investment managers — several hundred million dollars in losses.

Earlier this month, Rakoff staged a hearing in which he asked lawyers on both sides to defend the settlement.

At the hearing, Rakoff questioned whether freeing Citigroup of any admission of liability could undermine private claims by investors who stand to recover only US$95 million in penalties on total losses of US$700 million.

In his decision, he called the penalties “pocket change” to a company the size of Citigroup and said that, if the SEC allegations are true, then Citigroup got a “very good deal”. If they are untrue, the settlement would be “a mild and modest cost of doing business”, he said.

In 2009, Rakoff rejected a US$33-million settlement between the SEC and Bank of America Corp calling it a breach of “justice and morality”. The deal was over civil charges accusing the bank of misleading shareholders when it acquired Merrill Lynch during the height of the financial crisis in 2008 by failing to disclose it was paying up to US$5.8 billion in bonuses to employees even as it recorded a US$27.6 billion yearly loss.

In February 2010, he approved an amended settlement for over four times the original amount, but was caustic in his comments about the US$150-million pact, calling it “half-baked justice at best”. He said the court approved it “while shaking its head”.

Citigroup’s US$285 million would represent the largest amount to be paid by a Wall Street firm accused of misleading investors since Goldman Sachs & Co agreed to pay US$550 million to settle similar charges last year. JPMorgan Chase & Co resolved similar charges in June and paid US$153.6 million.

All the cases have involved complex investments called collateralised debt obligations. Those are securities that are backed by pools of other assets, such as mortgages.

Rakoff’s ruling Monday was the latest in a series of setbacks for the SEC under Schapiro’s leadership. Rakoff has said he doesn’t believe the agency has been sufficiently tough in its enforcement deals with Wall Street banks over their conduct prior to the financial crisis.

The SEC told Rakoff recently that US$285 million was a fair penalty, which will go to investors harmed by Citigroup’s conduct, and that it was close to what the agency would have won in a trial.