U.S. District Court Judge Jed Rakoff rejected a proposed settlement between Citigroup (C) and the Securities and Exchange Commission that would have returned $285 million to investors of a $1 billion collateralized debt obligation tied to risky mortgages. “The proposed consent judgment is neither fair, nor reasonable, nor adequate, nor in the public interest,” Rakoff wrote in his order Monday. Rakoff held a hearing Nov. 9 to review the proposed settlement. Commentators previously said it was highly possible Rakoff would reject it. The SEC sued Citi in October, alleging that in early 2007, financiers there created the Class V Funding III, allowing it to dump weakening mortgage-backed securities. According to the SEC, Citi allegedly misrepresented investors in the CDO and took a short position on the very assets it selected for the offering. Citi netted $160 million in profits on the deal, when investors lost more than $700 million, the SEC revealed in the Nov. 9 hearing, more than double the $285 million settlement. The agreement with Citi would also free the bank from admitting any wrongdoing. Rakoff said in his written order that during the hearing, neither Citi nor the SEC provided enough facts, which he said is required if he was to approve a settlement the agency submits to a public court. The SEC erroneously argued that in order for Rakoff to approve the settlement, “the public interest…is not part of (the) applicable standard of judicial review,” the judge wrote. Rakoff begrudgingly gave in to a settlement between the SEC and Bank of America (BAC) in March when the bank allegedly lied to investors when it failed to disclose $5.8 billion in bonuses to Merrill Lynch employees. But Rakoff and other judges have grown weary of the SEC using their courts to enforce settlements without providing enough facts, especially when the agency has the power to administer settlements administratively. “When a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance,” Rakoff wrote Monday. Citi and the SEC now have the option of going back to the bargaining table and coming back with either a larger settlement figure or to settle the claims outside of court. Neither Citi nor the SEC immediately replied to requests for comment. Write to Jon Prior. Follow him on Twitter @JonAPrior.

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