Yesterday, in testimony before Congress, former MF Global CEO Jon Corzine attempted to insulate himself from the firm’s massive bankruptcy and the potential fraud associated with $1.2 billion of customer funds that remain missing. “As the chief executive officer of MF Global, I ultimately had overall responsibility for the firm. I did not, however, generally involve myself in the mechanics of the clearing and settlement of trades, or in the movement of cash and collateral,” Corzine testified. Thus begins the long process of determining Mr. Corzine’s guilt or innocence. Yet if a recent court case is any indication, a paradigm shift away from an odious status quo may have occurred – and Mr. Corzine may be the first major financial figure prosecuted in this new legal environment.

On November 28th, a funny thing happened on the way to a deal between the Securities and Exchange Commission (SEC) and Citigroup. U.S District Court Judge Jed S. Rakoff rejected a settlement allowing the bank to pay a $285 million fine without admitting they did anything wrong. He further took the SEC to task for allowing repeat offenders like Citi to avoid fraud charges and other statutory consequences that should accrue to serial violators of the law. “Applying these standards to the case in hand, the Court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, nor in the public interest,” Rakoff wrote in his summation.

The case itself is an appalling example of fraud. According to the SEC, Citigroup put together a $1 billion collateralized debt obligation (CDO) tied to the American housing market and sold it to investors. Citi then turned around and bet against those investors when the housing market began to “show signs of distress.” The CDO defaulted within months of its inception, and investors were stuck with the loss. At the same time, Citigroup made $160 million in fees and trading profits.

“The SEC alleges that Citigroup Global Markets structured and marketed a CDO called Class V Funding III and exercised significant influence over the selection of $500 million of the assets included in the CDO portfolio," noted the Commission on its website. "Citigroup then took a proprietary short position against those mortgage-related assets from which it would profit if the assets declined in value. Citigroup did not disclose to investors its role in the asset selection process or that it took a short position against the assets it helped select.”

If a brokerage firm secretly betting against its own creation, shafting its own investors, and making a profit in the process has a familiar ring to it, that’s because Goldman Sachs wiped out investors in a similar kind of deal. In 2007, hedge fund manager John Paulson, convinced the housing market was about to tank, put together a portfolio of mortgage-backed securities designed to do exactly that – tank. ACA Management handled the portfolio and Goldman Sachs banker Fabrice Tourre, aka “Fabulous Fab,” marketed the deal, even as emails reveal he knew the fund was failing. When it did indeed fail, Paulson made a cool $1 billion.

The SEC investigated and the resulting $550 million fine was the largest penalty ever paid by a brokerage firm. Goldman admitted it “failed to provide vital information” to investors. Yet the SEC allowed the firm to avoid fraud allegations, and while the fine seems large, it amounts to about two weeks’ worth of profit for a firm that made $3.3 billion in the first quarter of 2010.

In other words, the SEC did nothing that would discourage the kind of dubious deals that have generated a level of contempt for Wall Street – and by unfortunate extension, capitalism – that has resonated among a substantial portion of the electorate. Yet the SEC was quite proud of its accomplishment. “This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” wrote Robert Khuzami, director of the SEC’s Division of Enforcement.

Judge Rakoff wasn’t about to let history repeat itself. "As a matter of law, an allegation that is neither admitted nor denied is simply that, an allegation,“ Rakoff said of the settlement between the SEC and Citigroup. He then told both parties that unless they can come to an agreement regarding Citibank’s culpability, the case will go to trial in front of a jury. Rakoff scheduled the trial for July 16, 2012. The trial will also include a related case against Brian Stoker, who both structured and marketed the jerry-rigged CDO.

This ruling stands in stark contrast to what the SEC was willing to settle for. A guilty verdict against Citi at a trial permits the filing of additional lawsuits by aggrieved investors. On the other hand, the settlement would have shielded the bank from litigation arising from the SEC’s findings. In his ruling, Rakoff took both Citigroup and the SEC to task. With respect to Citigroup, the judge noted that "a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup’s positon in this very case.”

Yet he reserved his harshest rebuke for the SEC:

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. 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.

Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., 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.

Contrivances may be an understatement. Calling Citigroup as a “recidivist” because it had settled previous cases with the SEC in exactly the same manner, Rakoff contended that the financial institution is more than willing to agree to such terms because the SEC hasn’t monitored settlement compliance or brought contempt charges against repeat offenders in at least 10 years. Citigroup is certainly aware of that fact. It agreed not to violate the same anti-fraud statute involved here “ever again” on four other occasions, in April 2000, March 2005, May 2006, and July 2010.

And Citigroup is hardly alone. Nineteen Wall Street companies have been repeat offenders over the past 15 years: American International Group, Ameriprise, Bank of America, Bear Stearns, Columbia Management, Deutsche Asset Management, Credit Suisse, Goldman Sachs, JP Morgan Chase, Merrill Lynch, Morgan Stanley, Putnam Investments, Raymond James, RBC Dain Rauscher, UBS and Wells Fargo /Wachovia.

Why hasn’t the SEC cracked down harder? The excuse is tiresomely familiar. Better to take the sure fine than risk losing in court to firms with legions of high-priced lawyers willing to defend them. Perhaps so. But maybe winning in court is more difficult due to the reality that at least 219 “major officials” have left the agency – only to return as a representative of a client with business before it. Senate Finance Committee member Sen. Charles Grassley (R-IA) illuminates the obvious. “The SEC’s revolving door seems more active than ever,” he noted, adding that such a system leaves the SEC unable to effectively regulate Wall Street. Roberta Karmel, a former SEC commissioner, was equally blunt. “Who do you want representing these clients before agencies such as the SEC with very, very complex rules?” she asked. “Lawyers who know nothing about the rules – or lawyers who do?”

In fairness, former SEC employees are barred for life from working on any matters they were working on while employed by the Commission. Furthermore, the SEC can only file civil litigation. The Justice Department must file any and all criminal charges against brokerage firms.

So where is the DOJ? Nowhere. "We have brought hundreds of criminal cases for mortgage fraud, investment fraud and other white-collar crimes. When we find evidence to prove beyond a reasonable doubt that a crime was committed, we will not hesitate to pursue criminal charges,“ said a DOJ spokesman.

So how many criminal charges have been brought by the FBI against business executives? Zero. Ostensibly the burden of proof is too high. "There’s been a realization and a more deliberate targeting by the Department of Justice before we launch criminally on some of these cases,” said David Cardona, former deputy assistant director at the Federal Bureau of Investigation . The Justice Department has decided it is “better left to regulators” to take civil-enforcement action on those cases, he added.

That would be regulators who are willing to administer a financial wrist slap without an admission of guilt and tolerate multiple violations of the same statutes without pursuing contempt violations – for at least a decade. Ten days ago, Judge Rakoff made it clear that the SEC’s self-inflicted impotence will no longer be tolerated.

As for the DOJ, $1.2 billion of missing customer funds and a Sarbanes-Oxley Act that holds CEOs criminally accountable for company malfeasance would appear to make Jon Corzine the proverbial poster boy for prosecution, no matter how high the burden of proof. When the integrity of the entire financial system is at stake, DOJ’s reticence to prosecute is no longer acceptable.

Judge Jed S. Rakoff has essentially blazed a trail. It behooves the SEC, the DOJ and other judges to follow his lead.