The Securities and Exchange Commission and Citigroup (C) pushed back after a federal judge rejected their settlement Monday over losses tied to an allegedly misleading collateralized-debt obligation. Both the regulator and the bank warned of the consequences for forcing litigation. The settlement would have returned $285 million to investors in the $1 billion CDO. The SEC said in a Nov. 9 hearing before U.S. District Court Judge Jed Rakoff that investors actually lost $700 million in the deal the agency alleged Citi knew contained faulty mortgages. “The proposed consent judgment is neither fair, nor reasonable, nor adequate, nor in the public interest,” Rakoff wrote in his order rejecting the settlement Monday. “While we respect the court’s ruling, we believe that the proposed $285 million settlement was fair, adequate, reasonable, in the public interest, and reasonably reflects the scope of relief that would be obtained after a successful trial,” said Robert Khuzami, director of division of enforcement at the SEC, in a statement released Monday evening. Khuzami said the penalty was limited by securities law based on what the defendant profited from the deal. In this case, Citi netted $160 million in profits. Rakoff complained neither the SEC nor Citi provided enough facts in the settlement proposal, and it prevented Citi from having to admit t. Khuzami said they did provide enough facts. One CDO trader allegedly characterized the Class V III portfolio as “dogsh!t” and “possibly the best short EVER!” in an internal message obtained and provided by the SEC in the case. Khuzami added the reforms and penalties for Citi outweigh any admission of guilt. However, investors armed with such an admission could go after the bank individually in court to collect more of their losses. “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,” Khuzami said in warning of forcing the two sides into litigation. In a statement sent to HousingWire, Citi also disagreed with Rakoff called the settlement “a fair and reasonable resolution.” Ron D’Vari, CEO of financial advisory firm NewOak Capital Advisors, said if judges reject settlements because a defendant did not have to admit guilt, litigation would almost be certain. “Defendants would most likely put up rigorous fights against the SEC if they have to admit guilt in order to reach a settlement with them,” D’Vari said. “Admission of guilt in legal settlements with the SEC would make defendants more susceptible to subsequent civil law suits. Having to go to a full trial to determine all the relevant facts, disclosures and admissions through expert and legal analysis is going to drag these cases on much longer.” Both the SEC and Citi said they would take a look at the next possible steps, but the bank said it was prepared for court. “We also believe the settlement fully complies with long-established legal standards,” Citi said. “In the event the case is tried, we would present substantial factual and legal defenses to the charges.” Write to Jon Prior. Follow him on Twitter @JonAPrior.

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