A federal judge in Manhattan made a rare move yesterday when he refused to approve a settlement between the Securities and Exchange Commission and Citgroup, over charges the bank mislead investors with junk mortgage-backed securities in the run-up to the financial crisis. Federal judges usually rubber-stamp settlement agreements between regulatory agencies and many corporate offenders, but the judge’s angry rebuke in this case might alter that tradition.

US District Judge Jed Rakoff was reviewing a $285 million settlement the SEC reached with Citigroup over the 2007 sale of a $1 billion collateralized debt obligation, or CDO, to investors. The SEC alleged that Citigroup loaded that CDO with mortgage-backed securities it knew would likely fail, so that the bank could then bet against its own customers when that happened. Quite notably, that was actually legal: the specific fraud SEC charged was that Citigroup lied to investors about who chose the securities in the CDO. The bank said an independent party chose them, when in fact the bank itself did. Citigroup made $160 million and investors lost $700 million.

The settlement agreement between Citigroup and the SEC followed a typical format for many recent settlements by the agency—it contained no admission of wrongdoing from the bank, just a cash payment and a promise never to break that particular law in the future.

Federal judges usually approve these pre-arranged settlements, but Rakoff felt the SEC simply wasn’t doing its job. He blasted the small cash payment as an irrelevant “cost of doing business” for a bank like Citigroup, which had $86.6 billion in revenue last year.  He noted that the promises never to break the law again are rarely if ever enforced, and that the SEC had basically abrogated its duties as a defender of the public:

“An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous,” Rakoff wrote in an opinion dated Monday.

The judge added that it was difficult to discern “from the limited information before the court what the SEC is getting from this settlement other than a quick headline.”

He said the proposed settlement was “neither reasonable, nor fair, nor adequate, nor in the public interest.”

These types of settlements have become common between the SEC and publicly traded companies, since the companies are loathe to admit any wrongdoing lest they face an onslaught of investor lawsuits. They will spend massive amounts of money to avoid this outcome in a trial, and the SEC simply doesn’t have the money to go toe-to-toe with companies like Citigroup over a long amount of time. (The SEC’s enforcement officer argued that point publically yesterday, and said such settlements were necessary because of the “risks, delay and resources required at trial.”)

This is an unfortunate dynamic, though one that was created quite intentionally. Republicans in Congress have targeted the SEC budget many times in recent years, which the Center for American Progress’s Pat Garofalo accurately describes as “deregulation by defunding”:

Between 2000 and 2008, the regulatory agencies faced downward pressure on their budgets, with the SEC experiencing an overall budget reduction between 2006 and 2007, and the CFTC seeing the same between 2002 and 2003. During these years, the financial industry was exploding at a rate that would have made it difficult for regulators to keep up under the best of circumstances.

Indeed, US Chamber of Commerce President Tom Donohue has promised an effort to “starve to death financially” agencies that regulate the financial sector, and the SEC budget has been frequently targeted by House Republicans this year.     

But the SEC may now have to spend money taking Citigroup to trial, since Rakoff has at least temporarily killed any settlement agreement. Moreover, while Rakoff’s decision is not binding to other judges, it could still “severely undermine agency’s enforcement efforts if it eventually blocks the agency from settling cases in which the defendant does not admit the charges,” notes the New York Times. That’s bad news for Wall Street—and makes an even stronger case for increased SEC funding. They might really need it now.