Citigroup’s tab for reimbursing clients who said the financial giant misled them into investing in risky hedge funds marketed as the safety equivalent of municipal bonds has soared to at least $85 million.
The payments, awarded since 2008 in 59 arbitrations or settlements, represent just part of a continuing legacy of the nation’s financial collapse. At least 39 additional clients with similar claims reached confidential settlements before their arbitrations, conducted through the Financial Industry Regulatory Authority (FINRA), were decided.
The embarrassing total could climb even higher as dozens more cases are set for arbitration through 2013. One California law firm says it represents about 65 clients with claims that total “north of $50 million.” A Florida firm has roughly 25 cases seeking “tens of millions of dollars.”
Burned investors who recovered all or part of their Citigroup losses include the Callaway Golf board chairman, a Florida cable television developer and a New York entrepreneur who earned riches from Internet ventures.
“I had an investment adviser at Citi who was supposed to look out for my best interests, and he never warned me how risky this investment was,” said Alex Zhardanovsky, co-founder of PetFlow.com, an online food and supply delivery service for pets. He lost roughly $350,000.
The Securities and Exchange Commission has been investigating Citigroup’s management and marketing of the investments for nearly four years, according to a copy of a May 2008 request for documents the agency sent to the financial giant.
Citigroup’s SEC filings have disclosed arbitrations and lawsuits over the investments without providing financial details. That information isn’t required to be disclosed because it isn’t material to the firm’s bottom line. USA TODAY compiled the most current total by searching public arbitration awards, examining court filings and interviewing former Citigroup clients and their lawyers. Investors often must pursue arbitration rather than lawsuits if they have disputes with financial brokers.
The review came as Citigroup failed a government stress test in which the Federal Reserve estimated the losses banks could bear in a steep recession. It also comes as the resignation of a Goldman Sachs executive who accused that company of favoring profits over clients has stoked consumer concerns about how Wall Street works.
“Citi acted appropriately at all times in connection with the development, sales and marketing of ASTA/MAT,” the company said. “Our disclosures were accurate and complete and detailed the risks associated with investing in these products. The products were sold only to highly sophisticated, high-net-worth investors ($5 million-plus in investable assets), all of whom signed subscription agreements in which they expressly acknowledged the risks associated with this investment.”
Citigroup spokeswoman Danielle Romero-Apsilos said the company declined to answer questions about arbitrations regarding the funds.
The investments included a series of six fixed-income hedge funds or alternative investment funds known as ASTA or MAT. Part of Citigroup Global Markets, the investments were retail funds marketed to high-net-worth clients with minimum investments ranging from $250,000 to $1 million. They ultimately held billions of dollars in investor money.
Former customers said Citigroup financial advisers told them the funds would generate returns of 6% to 8% on managed investments in municipal bonds. That would produce slightly higher returns than could be attained via investments in the bonds themselves. Ex-clients said marketers told them a hedging strategy would nonetheless keep risk low.
That interested Ronald Beard, a former managing partner of Gibson Dunn & Crutcher, a global law firm with more than 1,000 attorneys. Beard, a California resident who’s now a law firm adviser and Callaway’s board chairman, said he and his family invested $400,000 in MAT/ASTA in 2007 on the recommendation of a longtime adviser at Citigroup’s private banking arm.
They lost almost the entire investment.
“I wasn’t looking for any vast return. It was simply moving from one muni fund to another, and I didn’t really think that much about it,” said Beard, explaining that he relied on his adviser’s advice.
“We felt betrayed, and we were shocked,” he added.
Christopher Puglisi, a commodities and stocks trader from New Jersey, said he, too, invested during 2007 through an account at Citigroup’s Smith Barney division. But only after he was satisfied the money he invested from the sale of his trading business would be safe.
“I certainly wasn’t going to risk losing capital for a 6% to 8% return,” said Puglisi, who lost more than $700,000.
Puglisi, Beard and other MAT/ASTA investors said they were never told the funds were highly leveraged, borrowing roughly $8 for every $1 invested. When the U.S. municipal bond market fell into turmoil in 2008, the Citigroup investments plunged.
A separate group of Citigroup hedge funds sold to top investment clients, called Falcon Strategies, similarly nose-dived on losing mortgage investments in 2007.
Citigroup put a $661 million infusion into MAT/ASTA in a bid to stabilize the funds. But the move still left the investments down as much as 80%. By Sept. 30, 2008, total assets had dropped to about $1.5 billion, a Citigroup SEC filing shows.
Falcon Strategies fell by more than 50% in the fourth quarter of 2007. The following year, its total assets dropped from an estimated $4 billion in March to $1.3 billion in September, a Citigroup SEC filing shows.
“The fund we invested in literally imploded, almost all the way” to zero, Beard said of his family’s MAT stake.
He and other investors were surprised by discoveries after they filed arbitration challenges that accused Citigroup of breach of fiduciary duty, recommending unsuitable investments, fraud and other charges. A sales memo the company disclosed for the proceedings stated that the funds were tailored not for those willing to take on big financial risks but for “larger traditional fixed-income investors who are seeking alternatives” without adding higher risk.
But company e-mails showed that Citigroup’s internal rating of credit risk listed MAT/ASTA as a 5, the highest and most volatile level. Falcon Strategies was right behind, with a 4 rating. Citigroup’s financial advisers said they had not been told that, so they hadn’t been able to relay that information to investment clients and guide them adequately.
“I am stunned at the complete arrogance and misinformation that we have been receiving,” Arestoula Drakatos, a director of Citi Private Bank wrote in a March 11, 2008, e-mail to several superiors. “The most important point is that it is imperative that we do whatever it takes to make our clients whole.”
“Wow. Even the bankers are turning mean,” wrote Sallie Krawcheck, the executive who at the time ran Citigroup’s global wealth management division, which administered the funds.
Weeks later, a presentation Krawcheck prepared for Citigroup’s director board warned of a potential $1.5 billion financial hit for the company if it didn’t move to keep angry investment clients from closing their accounts and financial advisers from departing.
But Krawcheck instead left Citigroup in late 2008 amid a rift with CEO Vikram Pandit. She declined to comment on the hedge funds episode.
Reaz Islam, the portfolio manager who led Citigroup’s management of the doomed investments, told company executives during an internal December 2007 meeting — a session he recorded and later became part of a federal court case — that he was satisfied with the performance of his staff.
“Really,” responded Jonathan Dorfman, one of the executives. “They’ve lost over half a billion dollars of other people’s money. If this were Morgan Stanley or Goldman Sachs, they would have been fired immediately.”
Islam, who left Citigroup in 2008, repeatedly denied any wrongdoing in formal responses filed with many of the arbitration proceedings. Islam did not respond to a written message left in New York and e-mails sent to Bangladesh, where he now works for New York-based LR Global Partners.
Philip Aidikoff, a California attorney whose law firm has won the bulk of the arbitration awards decided against Citigroup, said he advised clients to pursue the actions in part because the firm offered burned investors 22 cents on the dollar.
During arbitration proceedings, Citigroup argued that the angry clients were sophisticated and wealthy investors who had been alerted to the potential risks in legal disclosures included with the fund offerings.
“I used to write some of these things, and I know what’s in them. But I don’t read them,” said Beard. “I expect them (financial advisers) to tell me what’s relevant.”
Attorneys for Beard and other former Citigroup investors argued that the financial giant misled customers about funds it knew were risky.
“The biggest surprise is the damaging internal e-mails and the extent to which (Citigroup) people committed to writing that these were defective (investment) products,” said Steven Caruso, a New York lawyer whose firm has worked with Aidikoff’s firm on the arbitrations.
After considering the Citigroup records and weighing arguments from both sides, arbitrators repeatedly sided with the angry investors.
Zhardanovsky said he got back nearly 80% of his loss. Beard recovered his entire investment, though a third of the total went to pay his lawyers. Arbitrators awarded Puglisi most of what he lost, but the battle took three years and cost him roughly $300,000 in legal fees and other expenses.
USA TODAY’s review found that the annual arbitration award totals increased as plaintiff lawyers gained access to internal Citigroup records and e-mails about the funds. In 2009, 15 awards or settlements totaled $4.8 million. Last year, 23 awards or settlements totaled $68.8 million.
The 2011 cases included one of the largest FINRA awards, more than $54.1 million in compensatory and punitive damages, plus attorney fees, to a venture capitalist and an intellectual property attorney from Colorado. Citigroup, which lost a federal district court appeal of the award, is now challenging that decision in federal appeals court.
Aidikoff said his law firm is 17-0 in representing households that pursued arbitration over the funds. Describing that winning string, plus 41 settlements, he said, “I’ve never seen the statistics so stark.”
In contrast, FINRA statistics show that among customers who had filed for arbitration against brokers for any financial matter, roughly 52% recovered some monetary damages or non-monetary relief from 2007 through 2012 to date.
Despite the arbitration victories, Puglisi and others question the absence of any government regulatory action against Citigroup. “Until the SEC steps up and holds people accountable, this is never going to stop,” he said.
The SEC declined to comment on its investigation.
“We’ve handed these cases to them on a silver platter,” said Robert Pearce, whose Boca Raton, Fla., law firm has handled many of the winning arbitrations. “I’m somewhat surprised.”