'Best short EVER!' ends up costing Citigroup $285M

Citigroup Inc. has agreed to pay $285 million to settle federal allegations that its broker-dealer subsidiary misled investors about a complex $1 billion mortgage investment that the company was secretly betting would fail. The Securities and Exchange Commission said Citigroup Global Markets Inc. made a deal with Credit Suisse Group AG's asset management unit for the latter to purportedly act as an independent adviser and assemble a collateralized-debt-obligation portfolio tied to the U.S. housing market. In fact, Credit Suisse agreed to let Citigroup pick about half of the assets. Citigroup took a $500 million short position in the specific group of assets that it had selected for the underlying investments, according to the SEC complaint filed in U.S. District Court for the Southern District of New York. The CDO defaulted in November 2007 and left investors with a worthless investment, while Citigroup made $160 million in fees and trading profits. On Feb. 28, 2007, the day that the transaction closed, an experienced CDO trader wrote in an e-mail that the portfolio was “dogsh*t” and “possibly the best short EVER!” the SEC said in its complaint. Another experienced investment manager said, “The portfolio is horrible,” the SEC said. “Investors were not informed that Citigroup had decided to bet against them and had helped choose the assets that would determine who won or lost,” said Robert Khuzami, director of the SEC's Division of Enforcement. Credit Suisse also settled SEC administrative charges by agreeing to pay $2.5 million in fines and restitution for allowing Citigroup to “exercise significant influence” over choosing what assets were included in the portfolio, the commission said.

NO ISOLATED INCIDENT

This is the latest in a string of SEC cases related to complex financial products tied to subprime mortgages that imploded as the housing market declined in 2007 and 2008. The Goldman Sachs Group Inc. agreed in July 2010 to pay $550 million to resolve claims that it failed to tell investors in a mortgage-linked product that a hedge fund betting against the CDO helped select the underlying assets. JPMorgan Chase & Co. agreed in June to pay $153.6 million to resolve similar claims related to its sale of a CDO in 2007. The SEC last week also sued Brian Stoker, the Citigroup employee mostly responsible for structuring the transaction, for securities fraud. After discussions began with Credit Suisse to act as collateral manager for the investment, he allegedly sent an e-mail to his supervisor saying that Credit Suisse had agreed to terms “even though they don't get to pick the assets.” Mr. Stoker was responsible for the pitch book and offering circular that were the primary marketing tools used to attract investors in the CDO, the SEC alleged. His attorney, Fraser Hunter, said that the SEC shouldn't blame his client for the allegations against Citigroup, adding that he will present a vigorous defense for his client. “There is no basis for the SEC to blame Brian Stoker for these alleged disclosure violations,” Mr. Hunter said. “He was not responsible for any alleged wrongdoing; he did not control or trade the position, did not prepare the disclosures and did not select the assets.” Kenneth Lench, chief of the structured- and new-products unit within the SEC's enforcement division, said: “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.” The Credit Suisse portfolio manager chiefly responsible for the transaction, Samir Bhatt, also settled SEC charges by agreeing to a six-month suspension from the industry. Attorneys for Citigroup and Credit Suisse didn't return calls seeking comment. Mr. Bhatt's attorney, James Masella, declined to comment. This story was supplemented with reporting from Bloomberg News. Email Liz Skinner at lskinner@investmentnews.com