When Robert Khuzami took the reins as the SEC’s director of enforcement in February 2009, white-collar and securities lawyers who remembered his days as a Manhattan federal prosecutor predicted Khuzami wouldn’t pull any punches in his new role.

“Rob was willing to look for the limits of what was permissible to be prosecuted [in the Southern District],” Sullivan & Cromwell’s Steven Peiken told sibling publication The American Lawyer at the time.

Less than two years later, the SEC’s own inspector general’s office is investigating allegations that Khuzami caved to pressure from a Citigroup lawyer and told his staff to go easy on two Citi executives in the agency’s much-criticized $75 million settlement with the bank last year. As Bloomberg first reported, SEC inspector general David Kotz opened the probe after Senator Charles Grassley (R-Iowa) forwarded an anonymous fax containing the accusations.

We’ve gotten hold of the unsigned fax that sparked the IG’s investigation; true or not, it makes for compelling reading. Moreover, the fax contains purported inside details about the SEC’s negotiations with Citi that suggest it wasn’t written by a random disgruntled Iowan, but by someone with knowledge of the SEC’s handling of the Citi case.

“In the Citigroup investigation involving hiding/failing to disclose more than $50 billion of subprime securities from investors, the [SEC] staff had negotiated a settlement with one individual that included fraud charges and was prepared to file contested 10(b) fraud charges against another individual,” the fax states. “But just before the staff’s recommendation was presented to the commissioners, enforcement director Robert Khuzami had a secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend of Khuzami’s and a fellow former SDNY alum, and who was counsel for the company.”

The fax alleges that Khuzami agreed in the “secret” meeting to drop securities fraud charges against the second individual, and that he afterward forced SEC staffers to strip fraud charges from the agency’s settlement with the other individual. (Former Citi CFO Gary Crittenden paid $100,000 and former investor relations head Arthur Tildesley paid $80,000 as part of Citi’s 2010 settlement with the SEC.)

“The two individuals were also represented by SDNY alums and friends of Khuzami’s, creating the appearance that his decision was made as a special favor to them and perhaps to protect a Wall Street firm for political reasons,” the anonymous tipster claimed. “That decision also had the effect of protecting the company in private litigation that it faces.”

Citi was represented in the SEC case by Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison and Lawrence Pedowitz of Wachtell, Lipton, Rosen & Katz, among other lawyers from the two firms. John Carroll of Skadden, Arps, Slate, Meagher & Flom represented Crittenden. Tildesley had Simpson Thacher & Bartlett’s Mark Stein. Karp, who is not a former Manhattan federal prosecutor, declined to comment Tuesday; Pedowitz, Carroll, and Stein (who are all former SDNY assistant U.S. attorneys) didn’t return our calls.

An SEC spokesperson sent us this e-mail statement: “The [Citi] settlement appropriately held the company and individuals accountable. It was the product of a thorough investigation and a careful evaluation of the evidence and the applicable law. We stand ready to assist and cooperate fully with the IG’s review.” Enforcement division lawyer Andrew Feller, who was listed in a press release as the SEC’s lead investigator in the case, declined to comment when we reached him Tuesday.

As we’ve reported ( here, here, and here), the SEC’s $75 million Citi settlement drew plenty of criticism last year for its size and scope — not least from Washington, D.C., federal district court judge Ellen Segal Huvelle, who only grudgingly approved the deal last fall. Judge Huvelle told lawyers in September 2010 that she was baffled as to why the SEC singled out the two Citi execs in a separate administrative action but didn’t name a single individual at the bank in its settled complaint. Khuzami himself defended the settlement in an interview with DealBook’s Andrew Ross Sorkin, in which Khuzami told Sorkin that targeting an institution rather than individuals can be a more effective deterrent. “It sends a message to the industry,” the enforcement director said.

The internal Citi investigation isn’t the first time the SEC IG’s office has looked into the agency’s handling of a bank case. As we reported in December, Kotz also examined allegations that the SEC showed favoritism to Bank of America in its much-maligned investigation of BofA’s merger with Merrill Lynch. The IG’s office concluded that SEC staff members limited their investigation, offered BofA concessions in negotiations in order to bring their case quickly, and passed on opportunities to sue individual defendants. The report, however, did not find that the SEC acted improperly.

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