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Citigroup Loses Municipal Bond Case

Wall Street Journal

Citigroup Inc. has been ordered to pay $54.1 million to two wealthy investors for losses they suffered on a series of risky municipal bond funds that lost 77% of their value in the midst of the financial crisis.

The award by an industry arbitration panel is the largest ever levied against a major Wall Street brokerage in favor of individual investors, according to the Securities Arbitration Commentator Inc., a newsletter in Maplewood, N.J.

As is customary, the arbitration panel, which is under the auspices of the Financial Industry Regulatory Authority, didn’t explain its reasoning for the award. But the penalty was aggressive, including an order for Citi to pay $17 million in punitive damages and $3 million in legal fees, among other expenses.

The payments were awarded to investors Jerry Murdock Jr., 52, a venture capital investor, and Gerald D. Hosier, 69, a retired patent attorney.

Citigroup said in a statement, “We are disappointed with the decision, which we believe is not supported by the facts or law.” It also said it is reviewing its options, which include going to the courts with an appeal.

The award is just the latest problem to spring from Citigroup’s municipal bond funds. The bond funds are also the subject of Securities and Exchange Commission probe, according to people familiar with the matter. The SEC is investigating whether the bank misled investors by failing to disclose the funds’ risks.

With a minimum investment of $500,000, the bond funds aimed to deliver returns a few percentage points higher than municipal bonds by borrowing as much as $7 for every $1 invested, putting the proceeds in municipal bonds and mortgage debt. But they plummeted in value when the mortgage market crumbled starting in mid-2007.

Thomas Stipanowich, a law professor at Pepperdine University law school in Malibu, Calif., called the panel’s action “a significant statement, a bold use of a variety of remedial tools to vindicate the rights of an individual investor.” Citigroup, for example, must pay $21,600 for the entire hearing fee expense, which panels typically split between parties.

Messrs. Hosier and Murdock, who are neighbors in the Aspen, Colo., had the same broker at Citi’s former Smith Barney unit. The broker, Richard Zinman, left the firm shortly after the funds blew up.

Mr. Zinman testified for his former clients during the arbitration hearing in Denver last month that the funds, which were designed for wealthy investors, proved to be more volatile and risky than Citi officials had told its brokers, according to Philip M. Aidikoff, the investors’ lawyer.

Mr. Zinman referred calls to a spokesman for Credit Suisse Group, where he now works. The spokesman declined to comment.

After a storm of protest by Citi brokers, Citi officials offered share buybacks that reduced investors’ losses to about 61%.

The largest previous award to individuals under arbitration procedures, which are mandatory in most Wall Street customer agreements, was a $20.2 million award to a group of individuals against Ameriprise Financial Inc. in 2006 related to the sale of variable annuities and mutual funds.

Big brokerage firms have been ordered to pay out larger sums to corporate investors, such as a $406.6 million award in 2009 against Credit Suisse in favor of STMicroelectronics NV in a case involving losses on auction-rate securities. Credit Suisse is appealing that award.

Mr. Aidikoff estimated that investors have prevailed in three quarters of the roughly 20 claims against the Citigroup funds that arbitration panels have decided. The largest previous award to a Citi bond-fund claimant was for $6.4 million.