9

Beating the SEC

My spirit wasn’t broken. Daily prayers and meditation enabled me to gather my strength, pick myself up, and prepare to fight. My first important decision: I would not settle any SEC charges against me. This was a point of honor and a statement of faith and allegiance to my family and all those colleagues who had worked with me and believed in me that they had not been mistaken and put their trust in an unworthy person. I simply could not concede any wrongdoing on my part, and I would not accept any regulatory sanction, no matter how minor, if it implied that I was in some degree guilty of civil fraud as charged by the SEC.

I knew enough about the law to understand that the SEC would probably have extreme difficulty obtaining evidence to substantiate “scienter” on my part. “Scienter” is a legal term meaning “knowledge of and intent to commit wrongdoing.” This is a requisite element to obtain conviction for civil or criminal fraud in the U.S. judicial system, and it is one of the most important protections for defendants. In my case, it meant that my efforts to involve Citigroup Asset Management attorneys in all aspects of the transfer agency contract, coupled with the failure of those attorneys to signal any concerns or misgivings of any sort, would provide protection from a legal conclusion that I knew something was wrong and knowingly intended to commit that wrong.

My decision to challenge the SEC led me to a second important decision, because I understood that I would probably be unemployable in the regulated financial services industry while fighting the charges. Since it was unrealistic to hope that any SEC-regulated financial institution would want to employ a senior executive who was embroiled in an antagonistic legal battle with the SEC, I needed to be self-employed for however many years the fight would require. I started thinking about a strategy to accomplish this.

My third important decision was to fight back against Citigroup as well. I did this by retaining a “junkyard dog” litigator to bring suit against Citi-group, Chuck Prince, and Promontory Financial Group and its CEO Eugene Ludwig for wrongful termination. I knew that Chuck Prince was unlikely to be willing to subject himself to document discovery, deposition under oath, and cross-examination by my attorneys regarding the role of Citigroup’s legal department in approving the transfer agency contract while he was company general counsel, and CAM’s attorneys who vetted and approved the contract reported to Prince. And I knew that Prince and Ludwig were unlikely to be comfortable with being subjected to document discovery, sworn depositions, and cross-examination under oath regarding Prince’s role in shaping the Promontory report and questions about whether the report given to Citigroup’s board was changed after I was shown a draft containing only minimal and peripheral criticism directed at me.

I retained Stanley Arkin, a Californian and Harvard Law graduate who had founded the New York law firm Arkin Kaplan LLC. Arkin had famously and successfully tried many complicated Wall Street cases, including the very first prosecution for insider trading, and I knew he had a reputation for toughness, even nastiness, and for winning. He would represent me against Citigroup, Promontory Financial Group, Prince, and Ludwig.

In addition to launching a public relations campaign in support of Chuck Prince and his purported efforts to improve Citigroup’s business ethics and culture, Citigroup also moved quickly to sell two of my three former business units. Citigroup CFO Todd Thomson later told me that Prince’s initial meetings with my former senior management team did not go well. “Your people are extremely loyal to you,” Todd said to me. I was also hearing from others inside Citigroup that many of the senior leaders in my former business units just weren’t buying Prince’s storyline. They had firsthand knowledge and experience of my ethical standards. And I was told they were vocal in saying it was absurdly unfair that I had been fired at the first hint of regulatory problems in my business unit and was being charged by the SEC, following years of scandals in the corporate and investment banking business unit which had cost billions of dollars in fines and penalties and class action settlements, but with no business unit head being held accountable by separation from the company or SEC charges.

Citigroup provided background information for a December 3, 2004, New York Times story reporting that Citigroup was considering a shift in strategy by selling the asset management business. Then Citigroup provided background information for a Wall Street Journal story on January 31, 2005, noting that Citigroup was close to selling the Travelers Life & Annuity business unit. Both these transactions came to fruition in short order. On June 27, 2005, Citigroup announced an asset swap in which its asset management business was transferred to the investment management firm Legg Mason in exchange for Legg Mason’s brokerage business. And on July 5, 2005, Citi-group announced the sale of Travelers Life & Annuity to Met Life.

After several months of negotiations with Citigroup attorneys, On March 5, 2005, my attorneys at Arkin Kaplan delivered a “nearly final draft complaint” to Citigroup legal counsel outlining the legal action we intended to file the following week in New York State Supreme Court against Citi-group, Chuck Prince, Promontory Financial Group, and Eugene Ludwig. The draft complaint was a thirty-four-page detailed recitation showing how the events in Japan had been manipulated and distorted by Prince and Ludwig to justify my termination from Citigroup. The complaint requested $100 million in damages for defamation and wrongful termination.

This action had its intended effect. In April 2005 we reached an out-of-court settlement with Citigroup. The terms included Citigroup’s commitment to invest $50 million in a venture capital fund I was launching, and to pay all of my legal expenses related to any matters associated with my Citi-group employment tenure. These settlement terms were critical in insulating me from the two most common forms of SEC coercion.

First, the SEC often coerces settlements from individual defendants who are intimidated by the potential costs of a legal battle with the commission, which can run into tens of millions of dollars. This is a difficult fight for individuals to wage with only their personal financial resources, and it is an unfair fight because the legal costs of combating the SEC are usually non-recoverable even if the defendant wins. This means that those individual defendants who do win are nonetheless subjected to severe financial punishment. Consequently, many individuals make a rational economic decision to settle cases for small fines or other “slaps on the wrist.”

Second, the SEC often coerces settlements from individual defendants because they face severe economic pressure to return to employment in the regulated financial services industry.

My settlement with Citigroup insulated me from both of these sources of coercion: it secured self-employment income from an investment fund which I controlled, and it secured virtually unlimited legal defense resources designated and controlled by me but paid by Citigroup.

My legal defense team against the SEC was headed by Irving Terrell, a senior litigator in the Houston office of Baker Botts LLP. I had come to know the firm during the SEC and OFHEO investigations of Freddie Mac in 2003–4, when Baker Botts was retained by the board of Freddie Mac to represent the independent directors; the lead attorney in that case was James Doty, a former SEC general counsel. I was impressed with Baker Botts’s attention to detail and the success the firm achieved in avoiding charges against any Freddie Mac independent directors. I had a good basis for my assessment of Baker Botts’s capabilities, as I arguably spent more time with its team than any other independent director of Freddie Mac, because my position as chairman of the audit committee had put me in the investigative bull’s-eye. I felt comfortable turning to Jim Doty to represent me in fighting the SEC fraud allegations at Citigroup, and Doty brought in Baker Botts’s top litigator—Irving Terrell. An additional important consideration in my selection of Baker Botts was that it was not a New York law firm with substantial economic ties to Citigroup, so I considered it a low probability that Chuck Prince would be able to directly or indirectly influence or manipulate the firm behind the scenes.

On August 8, 2005, the SEC filed civil fraud charges against me, and on the same day Baker Botts released this statement, issued by James Doty on my behalf. It was intended to put the SEC’s lawyers on alert that they were in for a battle, and there would be no concessions of wrongdoing on my part:

My case was assigned to Judge Richard Casey in U.S. District Court for the Southern District of New York. Jim Doty and Irv Terrell told me that Casey’s reputation was as a “tough, usually pro-government, but fair” judge. Eighteen months of discovery, depositions, and dueling legal motions then ensued. The SEC repeatedly extended feelers to my attorneys indicating that the case could be settled if I would accept a minor slap on the wrist, such as a small fine as low as $5,000. I refused any settlement short of exoneration and instructed my attorneys to tell the SEC’s lawyers that they would get nothing from me unless they won it in court.

The SEC offered lenient plea bargains to my co-defendants in an effort to secure their testimony against me. CAM executive vice president Michael Yellin, a thirty-year Citigroup employee, accepted a plea bargain because he was emotionally exhausted by what Citigroup had done to us and was planning to retire from full-time employment. Mike just didn’t have the energy to engage in a protracted battle with the SEC, so he agreed to a plea bargain that entailed a small monetary fine and regulatory censure. After negotiating the plea bargain with Yellin, the SEC was furious when Yellin’s subsequent sworn deposition did not provide any incriminating testimony against me. The SEC staff went so far as to threaten to revoke Yellin’s settlement, which in turn prompted a complaint from my attorneys protesting the commission’s efforts to intimidate and coerce the witness. I suspected that the SEC’s fury was caused in part by the dawning realization that it had been duped into bringing a case that wasn’t warranted. The SEC was discovering that the CAM business team had relied on advice from Citigroup attorneys at every step of the transfer agency transaction. There was no evidence of fraud to be found.

On September 26, 2006, Baker Botts filed for summary judgment of our case: “After over nine months of discovery, Plaintiffis utterly without evidence to substantiate the key elements of its case against Defendant Thomas Jones. Although Plaintiff’s Complaint accuses Jones of aiding and abetting CAM’s alleged fraud of withholding pertinent information from the Fund’s Boards of Directors, the record incontrovertibly establishes Jones’ innocence.” Baker Botts went on to argue that since total mutual fund fees were indisputably disclosed clearly and accurately to the mutual fund boards and shareholders, there could be no fraud or harm deriving from the underlying allocation of those fees between the First Data transfer agent and the CAM transfer agent. My attorneys also argued that all aspects of the transfer agency contract and mutual fund board disclosures had been reviewed and approved by Citigroup’s legal department, so there was no “scienter” element of intent to commit fraud.

On February 26, 2007, just a few weeks before the trial was scheduled to commence, Judge Casey issued a “Memorandum & Order” in which he ruled, “Defendants’ motion for summary judgment is GRANTED in its entirety.” The case against both me and Smith Barney CFO Lewis Daidone was decided in our favor and dismissed “with prejudice,” which meant the judge would not allow an appeal. We had beaten the SEC.

On February 27, 2007, the Wall Street Journal and the New York Times published stories reporting on Judge Casey’s decision, but neither story included comments from Irv Terrell or me. And each story was afforded far less prominence than the headlines two years earlier that had announced the SEC enforcement action against me. The Wall Street Journal article, “Judge Discusses Suit over Transfer Agent: SEC Had Accused Two Ex-Citigroup Executives,” read in part, “A federal judge dismissed a Securities and Exchange Commission lawsuit that accused two former Citigroup executives of cheating mutual-fund customers…. U.S. District Judge Richard C. Casey in Manhattan granted a summary judgment motion by Thomas W. Jones, the former chief executive of Citigroup Asset Management…. The SEC had requested civil penalties, a permanent injunction … and disgorgement.”

Neither did the SEC issue a statement regarding Judge Casey’s summary judgment decision. This contrasts with the press conference and major publicity efforts on August 8, 2005, when the SEC announced it was filing charges against me. Eventually, in 2008, even as its official website continued to trumpet the original August 2005 announcement of enforcement action against me, the SEC grudgingly posted a banner headline in red above the August 2005 announcement reading, “NOTE: On February 26, 2007, the United States District Court for the Southern District of New York granted motions for summary judgment filed by defendants Jones and Daidone, dismissing the case with prejudice.” The SEC belatedly and grudgingly started posting these notices on its website following press criticism that the commission routinely tries to “bury” the cases it loses, without ever acknowledging that it has wrongfully charged innocent individuals or taking any remedial steps to alleviate the unjustified damage it has inflicted on the reputations of those individuals. An egregious and ongoing example of this abuse is that the SEC website continues to broadcast its original charges against me, despite the fact that those charges were dismissed in federal court.

My case is a good example of why it is unfortunate that the Dodd-Frank legislation passed after the 2008 financial crisis gave new powers to the SEC to bring charges through its “administrative judge” procedures. If my case had been tried under these rules, I am certain that the SEC would have worked very hard to force its weak case against me into the administrative judge process. Studies have shown that the SEC has a much higher probability of securing a guilty verdict from one of its administrative judges than in the federal courts. It is fundamentally unfair to deny any defendant the full protections of the United States judicial system in federal courts.

At Citigroup the attorneys responsible for the erroneous legal advice supporting the transfer agency contracts, Michael Rosenbaum and Christine Sydor, were quietly eased out of the company. I suspected that Citigroup did this to avoid drawing attention to the fact that its legal department bore significant responsibility for the transfer agency imbroglio while Chuck Prince was general counsel. Citigroup never acknowledged publicly that when the transfer agent contracts were signed and the mutual fund board presentations occurred, CAM attorneys Rosenbaum and Sydor had a direct functional reporting relationship to Prince in his capacity as company general counsel, as well as reporting to me as CAM business unit head. Under Citigroup’s matrix organization structure, the company general counsel was co-equal to business unit heads with regard to legal staff performance evaluation and compensation decisions. Similarly, the SEC also chose to ignore the role the Citigroup legal department played in the CAM transfer agent contracts.

By the “accountability standard” that Citigroup applied in the Japan private bank regulatory problem, which was to hold the senior business unit executive and the senior functional executive jointly responsible for regulatory infractions, Chuck Prince should have been held equally accountable with me in the CAM transfer agency case. The documentary evidence and witness testimony established beyond any doubt that Citigroup attorneys had been consulted at all stages of the negotiations and had reviewed the contract prior to signing and raised no red flags to the CAM management team. The Citigroup legal staff simply gave bad advice to the business team. That’s all there was to the transfer agency case. But the business team were the only ones charged by the SEC, and the only ones hung out to dry by Citigroup.

Over five years later, in August 2012, Judge William Pauley of the U.S. District Court, Southern District of New York, dismissed the class action civil fraud lawsuit filed against me as a piggyback to the SEC civil fraud litigation. On August 15, 2012, the Reuters news service issued a news release under the headline “Citigroup, Smith Barney Win End to Fund Fee Lawsuit.” It read in part:

And so, after nearly eight years, stretching from October 2004 to August 2012, I was finally done with this chapter of my life. Unlike in 2004 and 2005, when headlines trumpeted the SEC charges filed against me, there were no headlines now trumpeting “Former Citigroup Executive Tom Jones Vindicated after Eight-Year Legal Ordeal.” But that’s okay, because I fought to defend my honor and my reputation. It was very personal right from the start.

Bob Willumstad left Citigroup in July 2005 as it became apparent that Chuck Prince did not regard him as a partner, and by late 2007 Prince had pushed out most of the business unit heads who had reported to Sandy Weill. It is not uncommon for CEOs who are insecure to surround themselves with subordinates who are adept at feeding the leader’s ego, telling him what he wants to hear and not delivering bad news. This is the pattern that developed at Citigroup under Chuck Prince, and the company was on the verge of collapse by the end of 2007. Once again, Global Corporate and Investment Bank (GCIB) was at the center of the storm. GCIB was headed by Robert Druskin, who had been Sandy Weill’s senior back office systems administrator for most of his career. Druskin had befriended Chuck Prince over the years and was arguably Prince’s closest confidant at Citigroup. Druskin had no experience managing and controlling investment bankers and traders. It was like putting the inmates in charge of the asylum, and their insanity soon destroyed the company.

In October of 2007, Standard & Poor’s downgraded mortgage-backed bonds, an area where Citigroup had enormous exposure and was largely unprotected against losses. Citigroup then suffered billions of dollars in new losses in its third quarter, and Chuck Prince, finally seeing his support from the board and from Sandy Weill dissolve, resigned.

Citigroup was operating a pipeline of purchased mortgages in the process of being repackaged into mortgage-backed securities and resold into the market to institutional investors—pension funds, endowments, sovereign wealth funds, and insurance companies. The pipeline was largely unhedged against price movements and was too large relative to Citigroup’s equity capital. When mortgage bond prices collapsed, Citigroup was caught holding the bag on the unsold mortgages in its pipeline. The scale of the losses was so large that it essentially wiped out Citigroup’s shareholder equity, and Citigroup became insolvent. Chuck Prince’s approach to this business was reflected in his infamous line “You have to keep dancing as long as the music is playing.” When the music stopped, Citigroup was unprepared. The disaster was, at its core, a management failure to implement basic operating discipline and control—with regard to both the size of the mortgage pipeline and bond portfolio, and the oversight of portfolio risk-hedging procedures and controls.

On November 9, 2007, shortly after the forced resignation of Merrill Lynch CEO Stanley O’Neal, the Wall Street Journal ran a story by Robin Sidel, Monica Langley, and David Enrich, headlined “Two Weeks That Shook the Titans of Wall Street: As O’Neal Tottered, Sandy Weill Turned on Protégé Prince,” detailing Citigroup and Chuck Prince’s disastrous decline:

One year later, in late November 2008, Citigroup had to be rescued by the federal government. The Wall Street Journal headline on November 24 read “U.S. Agrees to Rescue Struggling Citigroup: Plan Injects $20 Billion in Fresh Capital, Guarantees $306 Billion in Toxic Assets.”

This was a total disaster for all of Citigroup’s shareholders, but especially for tens of thousands of long-tenured Citigroup employees who for many years had benefited from Sandy Weill’s compensation philosophy, which emphasized employee ownership through generous stock options and restricted stock compensation, but accompanied by stringent vesting requirements and onerous constraints on selling shares while employees were still working for the company. The Citigroup stock price plummeted to $3.77 per share on Friday November 20, 2008, compared to $47.14 per share on October 2, 2003, when Chuck Prince became CEO. The stock market valuation of Citigroup had plummeted as well from approximately $250 billion on the day Prince became CEO to less than $20 billion at the end of his tenure. This ranks as one of the greatest destructions of shareholder wealth by one short-tenured CEO in modern history.

Also from the vantage point of observing events ten years after Prince’s resignation, there is vindication for my arguments regarding what happened in Japan with the private bank. At this writing, Citigroup has been unable to satisfy Japanese regulators, despite intense focus and attention from senior management over a ten-year period. My personal view is that this is a decade-long story of Japanese regulators using ambiguous regulations and subjective regulatory examinations to systematically drive Citigroup out of the retail consumer businesses in Japan. The private bank was just the first step. In fact, Japanese regulators have driven all of the American and European banks out of Japan’s consumer banking and retail investments market.

The Sandy Weill era on Wall Street ended with the collapse of Citigroup and its subsequent rescue by the federal government. I don’t feel any resentment toward Sandy, and I don’t think he ever took any overt action that was intended to harm me. When I see him at social events we engage cordially, but I’ve never overcome the lingering disappointment that my friend Sandy failed to protect me when it mattered most. And I have been scarred by the fact that Citigroup’s board of seemingly good people condoned the brutal treatment I received, which was unwarranted and unprecedented and has to this day never been done to anyone else at a senior level in the Citigroup corporate hierarchy.

An important lesson I gleaned from my Citigroup ordeal is that board diversity doesn’t necessarily have a positive impact on corporate governance. In fact, board diversity may not matter at all unless those “diverse” directors are willing to be independent of the company’s chief executive officer. Citigroup had three women and three black directors, none of whom chose to see that the only black business head at Citigroup was the only Citigroup business head summarily terminated and simultaneously left unprotected against SEC charges in a company regulatory settlement.