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Citigroup To Pay $285 Million to Settle SEC Charges For Misleading Investors About CDO Company

The Securities and Exchange Commission (SEC) today charged Citigroup Global Markets Inc. (Citigroup), the principal U.S. broker-dealer subsidiary of Citigroup Inc., with misleading investors about a $1 billion collateralized debt obligation (CDO) called Class V Funding III (Class V III). At a time when the U.S. housing market was showing signs of distress, Citigroup structured and marketed Class V III and exercised significant influence over the selection of $500 million of the assets included in the CDO. Citigroup then took a proprietary short position with respect to those $500 million of assets. That short position would provide profits to Citigroup in the event of a downturn in the United States housing market and gave Citigroup economic interests in the Class V III transaction that were adverse to the interests of investors. Citigroup did not disclose to investors the role that it played in the asset selection process or the short position that it took with respect to the assets that it helped select. Without admitting or denying the SEC’s allegations, Citigroup has consented to settle the Commission’s action.

The SEC today also brought a litigated civil action against Brian Stoker (Stoker) and instituted settled administrative proceedings against Credit Suisse Asset Alternative Capital, LLC (formerly known as Credit Suisse Alternative Capital, Inc.) (CSAC), Credit Suisse Asset Management, LLC (CSAM), and Samir H. Bhatt (Bhatt), based on their conduct in the Class V III transaction. Stoker was the Citigroup employee primarily responsible for structuring the Class V III transaction. CSAM is the successor in interest to CSAC, which was the collateral manager for the Class V III transaction, and Bhatt was the portfolio manager at CSAC primarily responsible for the Class V III transaction. Without admitting or denying the Commission’s findings, CSAM, CSAC, and Bhatt have agreed to settle the Commission’s proceedings.

Citigroup Global Markets and Brian Stoker


 According to the SEC’s complaints, filed in the U.S. District Court for the Southern District of New York (SDNY), in or around October 2006, personnel from Citigroup’s CDO trading and structuring desks had discussions about possibly having the trading desk establish 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. Following the institution of discussions with CSAC about having CSAC act as the collateral manager for a proposed CDO transaction, Stoker sent an e-mail to his supervisor in which he stated that he hoped that the transaction would go forward and described the transaction 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.”

As further set forth in the complaints, Citigroup and CSAC agreed to proceed with the Class V III transaction. 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 Class V III transaction marketed primarily through a pitch book and an offering circular. Stoker was primarily responsible for these documents. Both the pitch book and the offering circular included disclosures that CSAC, the collateral manager, had selected the collateral for the Class V III portfolio and that Citigroup would act as the initial CDS counterparty. The disclosures, however, did not provide any information about the extent of Citigroup’s interest in the negative performance of the Class V III collateral or that, by the times when the pitch book and the offering circular were prepared, Citigroup already had short positions in $500 million of the collateral. 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 for Class V III, Citigroup had taken a $500 million short position in the Class V III collateral for its own account, and Citigroup’s short position was comprised of names it had been allowed to select, while Citigroup did not short names that it had no role in selecting. Nothing in the disclosures put investors on notice Citigroup had interests that were adverse to the interests of investors.

According to the complaints, the Class V III transaction closed on February 28, 2007. One experienced CDO trader characterized the Class V III portfolio as “dogsh!t” and “possibly the best short EVER!” and an experienced collateral manager commented that “the portfolio is horrible.” On November 7, 2007, a credit rating agency downgraded every tranche of Class V III, and on November 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 their entire investments in Class V III. Citigroup received fees of approximately $34 million for structuring and marketing the transaction and realized net profits of at least $160 million from its short position on $500 million of the collateral.