Tony West, the government's lead Citigroup negotiator and the Justice Department's No. 3 official.Credit Susan Walsh/Associated Press Related Links The stage was set for another public shaming of a Wall Street bank.
The Justice Department flew in a lead prosecutor from Colorado and planned for a news conference in Washington to announce a lawsuit against Citigroup over mortgage securities that had imploded during the financial crisis.
But an event a world away that day in June unexpectedly changed the Justice Department's plans. The capture of a suspect in the deadly attack on the United States Mission in Benghazi, Libya, led federal prosecutors to conclude that those headlines would overshadow the Citigroup case. The prosecutors, knowing that the Citigroup case represented one of their last chances to send a public message that the government was holding Wall Street accountable for the crisis, were loath to squander that opportunity.
"We've got a lot going on right now, so we're putting the lawsuit temporarily on hold," Tony West, the government's lead negotiator and the Justice Department's No. 3 official, said to the bank's lawyers in a phone call just hours after he told them that a lawsuit was coming, according to people briefed on the matter.
That twist of fate — which some bank officials viewed as the Justice Department looking to escape its own costly legal battle — opened the door to last-minute negotiations that have now culminated in a $7 billion settlement the government expects to announce on Monday, the people briefed on the matter said.
The deal caps months of heated talks that began with a $363 million offer by Citigroup followed by a $12 billion demand from the Justice Department. The reasons for such a yawning gap, the people said, were the radically divergent methods used to calculate the cost of the settlement.
Citigroup linked its initial offer to the bank's relatively small share of the market for mortgage securities, the people said. The Justice Department, however, rejected that argument, emphasizing instead what it saw as Citigroup's level of culpability based on emails and other evidence it had uncovered.
At one point, one of Mr. West's deputies told the bank's lawyers before a meeting that "there's no way you'll get anywhere with us if you are only going to make the market share argument."
A behind-the-scenes account of the negotiations, based on interviews with the people briefed on the matter, who were not authorized to speak publicly, shows for the first time that the government's bargaining position often hinges not only on a huge penalty but also on a desire to destroy Wall Street's argument that market share should dictate punishment.
The dollars and cents of the final Citigroup settlement reflect that strategy. Citigroup had already raised its offer to $7 billion — the same size as the final settlement — when the Justice Department planned to announce the lawsuit last month.
The main breakthrough toward a settlement took a simple feat of accounting: The bank agreed to shift a portion of the settlement from state attorneys general to the Justice Department. That move, the people said, prevented Citigroup from claiming a tax deduction on the settlement. More important for the Justice Department, it meant that the bank would pay a far heftier sum than one based entirely on market share.
The mortgage settlements are among the last chapters in Wall Street's six-year struggle to shed the baggage of the financial crisis. Since 2008, the housing market has rebounded, the economy has improved and Congress has passed new laws to rein in Wall Street excess. Yet one item of unfinished business — the Justice Department's investigations into whether banks duped investors into buying defective mortgage securities that generated billions of dollars in losses — has stalled the banks' efforts to move on and ignited lingering tensions with the government.
The conflict over the huge settlement figures stems in part from an obscure federal law created in the aftermath of the savings-and-loan crisis a quarter-century ago. Under the law, the Financial Institutions Reform, Recovery and Enforcement Act, or Firrea, prosecutors can demand unusually large penalties: $1.1 million per violation.
The Citigroup case includes a $4 billion cash penalty to the Justice Department — a record for Firrea — as well as $2.5 billion in so-called soft dollars earmarked for aiding struggling consumers and $500 million to state attorneys general and the Federal Deposit Insurance Corporation.
At the outset, the bank expected to pay a fraction of that $7 billion.
The two sides met for the first time in November at the library in the office of the United States attorney for the Eastern District of New York, in Brooklyn, which was investigating the case along with the United States attorney's office in Colorado and the Justice Department in Washington. The meeting offered the Justice Department a preliminary opportunity to outline evidence in the case and doubled as a show of government force: The 39 federal officials, from prosecutors to federal housing regulators, far outnumbered the eight Citigroup lawyers who attended, one of the people briefed on the matter said.
The meeting, which took place on the same day the Justice Department announced its record $13 billion settlement with JPMorgan Chase over the bank's sale of mortgage securities, also encapsulated the debate over market share. Using the JPMorgan settlement as a template — $2 billion of the $13 billion came in the form of cash penalties from Firrea — Citigroup's lawyers from Paul, Weiss, Rifkind, Wharton & Garrison argued that their client faced a far smaller settlement. After all, Citigroup had sold roughly half as many mortgage securities as JPMorgan had through its various subsidiaries.
But Geoffrey Graber, who runs a Justice Department task force that handled the cases against Citigroup and JPMorgan as well as a lawsuit against the ratings agency Standard & Poor's, warned the lawyers not to draw too close of a parallel, the people said. Market share would be only one metric for deciding the penalty.
Months later, in April, Citigroup made its first settlement offer. But the bank's opening bid of $363 million was swiftly rebuffed. The government didn't even bother to make a counteroffer, the people said, telling the bank to come back with something better.
After balking, Citigroup decided to raise its offer to $700 million, again basing that figure largely on an analysis of the bank's market share.
That only aggravated the situation. On the last weekend of May, lawyers from Paul Weiss and Citigroup's general counsel were all in Cambridge, Mass., attending Harvard graduations, when they received an email from Mr. West. The Justice Department, Mr. West said in the email, was demanding a settlement of $12 billion, including a mix of cash penalties and relief for consumers.
Inside the bank, frustrations grew. Executives grumbled that prosecutors were making unfair and arbitrary demands. Citigroup raised its offer, but only slightly, to $1 billion.
Time was running out. The Justice Department had set a deadline of June 13 for Citigroup to present its best offer, and the bank asked for an extension. By this point, however, Mr. West had traveled to Alaska on business. On a midnight call with Brad Karp and Theodore Wells Jr., two of the bank's lawyers at Paul Weiss, Mr. West and Mr. Graber denied the request. The deadline would stand, they said.
With only hours to go, Citigroup was dealt a rude shock. News reports indicated that the Justice Department was planning to sue the bank.
To Citigroup, the message from the Justice Department was stunningly clear: Ratchet up the offer or face a long and bruising court battle. That evening, with the threat looming, Mr. Wells phoned Mr. West to raise the prospect of a broader settlement that would include the state attorneys general from California and elsewhere, as well as the F.D.I.C. Mr. West, whose sister-in-law is the attorney general of California, suggested an extra $900 million payment for the states and the F.D.I.C.
While the plan was preliminary, it gave Citigroup some extra time. And so over Father's Day weekend, Citigroup's board held a meeting to debate whether to meet the Justice Department's demands, even as it prepared to defend against a lawsuit.
Then, as the next week began, Citigroup raised its offer to $3.6 billion in cash to the Justice Department, $2.5 billion in consumer relief and $900 million to the states and the F.D.I.C.
But the offer came with a catch: In exchange for the extra payouts, the bank wanted the Justice Department to forgo any potential cases against Citigroup over collateralized debt obligations, the complex financial instruments that the bank sold in the years before the crisis. Paul Weiss relayed the offer to Mr. West, who struck an optimistic tone — but also demanded substantially more cash.
When the bank declined to raise its offer further, the people briefed on the matter said, Mr. West met with Attorney General Eric H. Holder Jr. to discuss the Justice Department's options. Rather than lower the demands, Mr. Holder authorized the lawsuit. The decision prompted a lead prosecutor in the case, John Walsh, the United States Attorney in Colorado, to fly out to Washington. Mr. West then phoned Paul Weiss to say that the case was going to be filed the next day.
But just a few hours later, after another Citigroup board meeting, Mr. West's number reappeared on Mr. Wells's cellphone. Mr. West was calling to say that an arrest had been made in Libya, and the Justice Department was temporarily postponing the lawsuit.
"It looks like Citi got a reprieve," Mr. West said, according to the people briefed on the matter, while adding that he was "always open to talk."
Within weeks, Mr. West agreed to Citigroup's request about forgoing any C.D.O.-related cases and offered to shift $400 million from the state attorneys general and the F.D.I.C. to the Justice Department, forming the basis of the current settlement.
"That's tough," Mr. Wells replied, "but if it buys us global peace, then I think we can get this done."
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