In the run-up to the global financial collapse, Citigroup’s bankers
worked feverishly to create complex securities. In just one year, 2007, Citi
marketed more than $20 billion worth of deals backed by home mortgages to
investors around the world, most of which failed spectacularly. Subsequent
lawsuits and investigations turned up evidence that the bank knew that some of the
products were low quality and, in some instances, had even bet they would fail.
The
bank says it has settled all of its potential liability to a key regulator
– the Securities and Exchange Commission — with a $285 million payment
that covers a single transaction, Class V Funding III. ProPublica first raised
questions about the deal in August 2010. In
announcing a case, the SEC said it had identified one low-level employee, Brian
Stoker, as responsible for the bank’s misconduct.
It
made no mention of the dozens of similar collateralized debt obligations, or
CDOs, Citi sold to investors before the crash.
A bank
spokesman said the SEC would not be examining any of those deals. “This means
that the SEC has completed its CDO investigation(s) of Citi,’’ the spokesman
asserted in an e mail.
“The $285 million settlement resolves only the Class V Funding III CDO, and we will not hesitate to bring further charges where we determine that there has been unlawful conduct,” an SEC spokesman said.
Did
Citi get a sweet deal? Some observers think so.
“Citibank
arranged countless CDOs that were built to fail, but the SEC apparently limited
its case to a single CDO where they had particularly vivid and powerful proof,”
says Stephen Ascher, a securities litigator at Jenner & Block, which has
sued Citibank on various structured finance transactions.
“This
represents extreme caution, at best — and a failure to grapple with the
magnitude and harmfulness of the misconduct, at worst.”
ProPublica
has been investigating the practices of the investment banks in the lead-up to the
financial crisis for three years. Our research found a number of Citi CDOs
similar to the deal featured in the SEC’s Class V complaint, and more
information on Citi’s CDO business has emerged in lawsuits and subsequent
investigations. Responsibility for these practices did not begin or end with
Mr. Stoker. Among the questions still unanswered: How much did Stoker’s immediate
bosses know? What did the heads of Citigroup’s CDO business, fixed income
business and trading businesses know about Citi’s CDO dealings?
In
the settlement announced this week, the SEC charged Citigroup with misleading
its clients in the $1 billion Class V Funding III. The regulator said that the
bank failed to disclose that it, rather than a supposedly independent
collateral manager, had played a key role in choosing the assets in the deal
when the bank marketed it to clients. Citigroup also failed to tell its clients
that it retained a short position, or bet against, the CDO it created and sold.
In addition to the $285 million fine, the SEC also charged Credit Suisse
Alternative Capital, which was supposed to choose the assets that went into the
CDO, and a low-level executive at that firm, with securities law violations.
Stoker
becomes only the second investment banker after Goldman Sachs’ Fabrice “Fabulous Fab” Tourre to
be charged by the SEC in conjunction with the business of creating CDOs, which
were at the heart of the financial collapse in the fall of 2008. According to
the SEC, Stoker played a leading role in structuring Class V Funding III.
Stoker declined to comment. His lawyer has said he is fighting the charges.
The
SEC complaint shows that Stoker was regularly communicating with other Citi
executives about his actions. One top Citi executive coaches employees in an
email that Credit Suisse should tell potential buyers of Class V about how it
decided to purchase the assets, even though Citi, not Credit Suisse, was making
the calls.
In
October 2006, people from Citi’s trading desk approached Stoker about shorting
deals that Citi arranged. Later, in Nov 3, 2006, Stoker’s immediate boss
inquired about Class V Funding III. Stoker told his boss that he hoped the deal
would go through. He wrote that the Citi trading group had taken a position in
the deal. Citi’s trading desk was shorting Class V Funding III, betting that
its value would fall. Stoker noted that Citi shouldn’t tell Credit Suisse
officials what was going on, and that Credit Suisse had agreed to be the
manager of the CDO “even though they don’t get to pick the assets.’’ Less than
two weeks later, this executive pressed Stoker to make sure that their group at
Citi got “credit” for the profits on the short.
This
Citi official, unnamed in the complaint, was not charged by the SEC.
If Class
V Funding III was some outlier, the SEC’s action might make more sense. But it
wasn’t. Citigroup’s CDO operation
churned out at least 18 CDOs around the same period. Often they were large
CDOs, created with credit default swaps, effectively a bet that a given bond
will rise or fall. Most of the CDOs included recycled Citi assets that the bank
couldn’t sell. By purchasing pieces of its older deals, Citigroup could
complete deals and keep the prices for CDO assets higher than they otherwise
would be. Some investors helped picked the assets and then bet against them,
facts that Citi didn’t clearly disclose to other investors in the deals.
Closing
the book on Citi’s CDO business means the public may never know the true story
of Citigroup’s, and Wall Street’s, actions during the financial crisis. One of
the largest victims of the CDOs was the bond insurer Ambac.
The now-bankrupt firm settled with Citi in 2010, long before it got to the root
of the problems with securities Citi convinced it to insure. A shareholder class
action lawsuit that is wending its way through the courts has the potential to reveal
some details, but often such cases are settled with evidence then sealed from
public view.
Among
the unresolved questions: What was Citigroup’s role in a series of deals
involving Magnetar, an Illinois-based hedge fund that
invested in small portions of CDOs and then made big bets against them? Our investigation showed that Citi put
together at least 5 Magnetar CDOs worth $6.5 billion. Did Citi mislead the investors who lost
big on these deals?
Here
are some other questions about Citi CDOs created around the time of Class V
Funding III:
- 888
Tactical Fund. A February 2007, $1 billion deal, it
had a significant portion of other Citi deals in it. Did the bank have
influence over the selection of the assets, as it did in Class V Funding III? - Adams
Square Funding II. A $1 billion March 2007 deal. The pitch-book to clients for
Class V Funding III was adapted almost wholesale from this deal, according to
the SEC complaint. Was Citigroup shorting this deal, or adding assets that were
selected by others to short the deal? And was that adequately disclosed to
clients? - Ridgeway
Court Funding II. Completed in June 2007, this $3 billion deal contained a
mysterious $750 million position in a CDO index. Experts believe that such
positions were included for the purposes of shorting the market. Did Citi
disclose why it included these assets to the investors in this CDO? As much as
30 percent of the assets in the deal were from unsold Citi CDOs. Was this a
dumping ground for decaying assets the bank could not unload, as a lawsuit by Ambac, which was settled, charged? - Armitage. This $3 billion March 2007 CDO looked a lot like
Ridgeway II. It had a large portion of other CDOs, much of which came from
other Citi deals, including $260 million from Adams Square Funding II. Did Citi
adequately disclose to investors what they were buying? - Class
V Funding IV. A $2 billion June 2007 deal, Citi appears to have done this
directly with Ambac. The SEC complaint about Class V
Funding III makes it clear that Ambac was unaware of
Citi’s position in that deal. Did the bank disclose more to Ambac
in this deal? - Octonion. This $1 billion
March 2007 CDO bought some of Adams Square Funding II. Adams Square II bought a
piece of Octonion. A third CDO, Class V Funding III,
also bought some of Octonion. Octonion,
in turn, bought a piece of Class V Funding III. How did Citi and the collateral
managers involved in these deals justify this daisy chain of buying?
