FOR IMMEDIATE RELEASE
2011-214
Washington, D.C., Oct. 19, 2011 – The Securities and Exchange
Commission today charged Citigroup’s principal U.S. broker-dealer subsidiary
with misleading investors about a $1 billion collateralized debt obligation
(CDO) tied to the U.S. housing market in which Citigroup bet against investors
as the housing market showed signs of distress. The CDO defaulted within months,
leaving investors with losses while 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. 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.
Citigroup has agreed to settle the SEC’s charges by paying a total of $285
million, which will be returned to investors.
The SEC also charged Brian Stoker, the Citigroup employee primarily
responsible for structuring the CDO transaction. The agency brought separate
settled charges against Credit Suisse’s asset management unit, which served as
the collateral manager for the CDO transaction, as well as the Credit Suisse
portfolio manager primarily responsible for the transaction, Samir H. Bhatt.
“The securities laws demand that investors receive more care and candor than
Citigroup provided to these CDO investors,” said Robert Khuzami, Director of the
SEC’s Division of Enforcement. “Investors were not informed that Citgroup had
decided to bet against them and had helped choose the assets that would
determine who won or lost.”
Kenneth R. Lench, Chief of the Structured and New Products Unit in the SEC
Division of Enforcement, added, “As the collateral manager, Credit Suisse also
was responsible for the disclosure failures and breached its fiduciary duty to
investors when it allowed Citigroup to significantly influence the portfolio
selection process.”
According to the SEC’s complaints filed in U.S. District Court for the
Southern District of New York, personnel from Citigroup’s CDO trading and
structuring desks had discussions around October 2006 about the possibility of
establishing a short position in a specific group of assets by using credit
default swaps (CDS) to buy protection on those assets from a CDO that Citigroup
would structure and market. After discussions began with Credit Suisse
Alternative Capital (CSAC) about acting as the collateral manager for a proposed
CDO transaction, Stoker sent an e-mail to his supervisor. He wrote that he hoped
the transaction would go forward and described it as the Citigroup trading desk
head’s “prop trade (don’t tell CSAC). CSAC agreed to terms even though they
don’t get to pick the assets.”
The SEC alleges that during the time when the transaction was being
structured, CSAC allowed Citigroup to exercise significant influence over the
selection of assets included in the Class V III portfolio. The transaction was
marketed primarily through a pitch book and an offering circular for which
Stoker was chiefly responsible. The pitch book and the offering circular were
materially misleading because they failed to disclose that Citigroup had played
a substantial role in selecting the assets and had taken a $500 million short
position that was comprised of names it had been allowed to select. Citigroup
did not short names that it had no role in selecting. Nothing in the disclosures
put investors on notice that Citigroup had interests that were adverse to the
interests of CDO investors.
According to the SEC’s complaints, the Class V III transaction closed on Feb.
28, 2007. One experienced CDO trader characterized the Class V III portfolio in
an e-mail as “dogsh!t” and “possibly the best short EVER!” An experienced
collateral manager commented that “the portfolio is horrible.” On Nov. 7, 2007,
a credit rating agency downgraded every tranche of Class V III, and on Nov. 19,
2007, Class V III was declared to be in an Event of Default. The approximately
15 investors in the Class V III transaction lost virtually their entire
investments while Citigroup received fees of approximately $34 million for
structuring and marketing the transaction and additionally realized net profits
of at least $126 million from its short position.
The SEC alleges that Citigroup and Stoker each violated Sections 17(a)(2) and
(3) of the Securities Act of 1933. While the SEC’s litigation continues against
Stoker, Citigroup has consented to settle the SEC’s charges without admitting or
denying the SEC’s allegations. The settlement is subject to court approval.
Citigroup consented to the entry of a final judgment that enjoins it from
violating these provisions. The settlement requires Citigroup to pay $160
million in disgorgement plus $30 million in prejudgment interest and a $95
million penalty for a total of $285 million that will be returned to investors
through a Fair Fund distribution. The settlement also requires remedial action
by Citigroup in its review and approval of offerings of certain mortgage-related
securities.
The SEC instituted related administrative proceedings against CSAC, its
successor in interest Credit Suisse Asset Management (CSAM), and Bhatt. The SEC
found that as a result of the roles that they played in the asset selection
process and the preparation of the pitch book and the offering circular for the
Class V III transaction, CSAM and CSAC violated Section 206(2) of the Investment
Advisers Act of 1940 (Advisers Act) and Section 17(a)(2) of the Securities Act
and that Bhatt violated Section 17(a)(2) of the Securities Act and caused the
violations of Section 206(2) of the Advisers Act by CSAC.
Without admitting or denying the SEC’s findings, CSAM and CSAC consented to
the issuance of an order directing each of them to cease and desist from
committing or causing any violations, or future violations, of Section 206(2) of
the Advisers Act and Section 17(a)(2) of the Securities Act and requiring them
to pay disgorgement of $1 million in fees that it received from the Class V III
transaction plus $250,000 in prejudgment interest, and requiring them to pay a
penalty of $1.25 million. Without admitting or denying the SEC’s findings, Bhatt
consented to the issuance of an order directing him to cease and desist from
committing or causing any violations or future violations of Section 206(2) of
the Advisers Act and Section 17(a)(2) of the Securities Act and suspending him
from association with any investment adviser for a period of six months.
The SEC’s investigation was conducted by Andrew H. Feller and Thomas D.
Silverstein of the Enforcement Division’s Structured and New Products Unit with
assistance from Steven Rawlings, Brenda Chang and Elisabeth Goot of the New York
Regional Office. The SEC trial attorney who will lead the litigation against
Stoker is Jeffrey Infelise.
