Skip to main content

Secrets of a Sales Machine

New York Times

BACK in 1940, a popular book about Wall Street asked, “Where are the customers’ yachts?” Investment firms, it lamented, always seemed to win, even when their customers lost.

True then and, all too often, true now – with rare exceptions. One of them was the case of Gerald D. Hosier and Jerry Murdock Jr., who invested millions with Citigroup, lost big – and came back swinging.

Documents related to the case show how Citigroup pushed exotic investments as safe alternatives to humdrum municipal bonds. The paperwork, which was unsealed recently, makes for fascinating, if disheartening reading.

First, some background. Mr. Hosier and Mr. Murdock are the kind of customers everyone in the investment business covets. Which is to say, they’re prosperous. The two were clients of Citigroup’s wealth management business, which, like its counterparts at other investment firms, takes a particular interest in high-net-worth people.

But Mr. Hosier and Mr. Murdock were not happy customers. They accused Citigroup of fraud and breach of fiduciary duty, saying they had been misled about complex, risky investments that Citigroup had held out as safe and sound.

Last April, a securities arbitration panel agreed with them. The men won the largest sum ever awarded to individuals in such a proceeding – a total of $54.1 million. Most of that was compensation for their losses. But some $17 million consisted of punitive damages. An additional $3 million went to cover legal fees.

Given that harsh judgment, something about this case clearly disturbed the arbitrators. But because such proceedings are confidential, outsiders didn’t know the details – until, that is, Citigroup asked a United States district court to overturn the award.

Now almost all of the documents the arbitrators saw have been unsealed. In late December, Judge Christine M. Arguello, in the District of Colorado, ruled against Citigroup and affirmed the award. So what do the documents show? Among other things, that Citigroup itself viewed these investments as risky. On its internal scale of 1 to 5 – 1 being the safest, 5 the riskiest – this stuff was rated 5. The filings also show how Citigroup tried to deflect problems when the investments began to sour.

Danielle Romero-Apsilos, a spokeswoman for Citigroup, said in a statement that the bank acted appropriately in creating and selling the investments, municipal arbitrage portfolios known as ASTA/MAT.

“Our disclosures were accurate and complete and detailed the risks associated with investing in these products,” Ms. Romero-Apsilos said. Clients who bought the instruments “signed subscription agreements in which they expressly acknowledged the risks associated with this investment.”

Only high-net-worth customers could participate, and they had to put up at least $500,000. In cases like this, banks typically argue that such wealthy, sophisticated investors know a gamble when they see one.

This time, that argument failed, and it’s not hard to see why. The lawyer for the investors, Philip M. Aidikoff, of Aidikoff, Uhl & Bakhtiari,  has won numerous cases against Citi involving these strategies and represents investors in scores of others yet to be decided.

Internal sales memos produced in the arbitration describe the ASTA/MAT as ideal for customers seeking alternatives to fixed-income investments.

“Our goal is NOT to target hedge fund clients who are willing to accept an unrestricted risk profile,” one internal document said, “but larger traditional fixed-income investors who are seeking alternatives and customized solutions without materially altering their risk characteristics.”

But internal Citigroup e-mails were far clearer about potential risks. In early 2008, a few days after the investments started plummeting, Sallie Krawcheck, then head of wealth management at Citigroup, sent an e-mail asking for the risk rating of MAT, part of a family of investments know as “alternatives.”

“Alternatives are always in 3-5,” came the response. A rating of 5 was usually reserved for potentially volatile products that carried the risk that clients could lose their entire investment, or more.

Customers might have known what they were getting into if they’d known about that 5 rating. But it was not disclosed to them. Transcripts of conversations between Citigroup management and the portfolio manager handling the investments also point to a disconnect between what investors were told and what Citigroup actually did.

As Citigroup executives prepared for a conference call with brokers whose customers had been burned, the portfolio manager was advised not to talk about his internal guidelines, which differed from the prospectus sent to investors. This document is known as a private placement memorandum.

“You have internal guidelines that are different from what’s in the P.P.M., correct?” one executive asked.

“Yep, we do,” the manager replied.

“Yeah, so we focus on what’s in the docs, rather than, you know … ,” the executive said, trailing off.

When Citigroup realized its strategy had gone toes-up, it tried to contain the damage. It offered to repurchase the instruments at steep discounts to the purchase price. But that was contingent upon customers signing a form promising not to sue the bank.

Perhaps anticipating objections, Citigroup produced a memo for its brokers, titled “Fund Rescue Options,” outlining answers to various questions about the offer. It included commentary that some brokers read as a veiled threat.

One question, for instance, was whether a client’s decision to accept the offer would show up on a broker’s regulatory record, known as a U-5. The answer was no. If a customer did not sign the legal release but pursued an individual complaint, the complaint and any settlement could appear on the U-5, Citi told its brokers.

E-mails from angry brokers who had, knowingly or not, sandbagged their best clients were also among the documents filed with the court.

“I’m sure a great deal of time and energy went into the ASTA/MAT solution,” one broker wrote. “But my clients and I don’t see it as a solution. From our simplistic perspective, the product was defective, management inept, risk controls nonexistent and the effect was ruinous. If one drives their car into another, they are responsible; they have no option but to take responsibility for their actions.”

Come to think of it, that’s kind of a good metaphor for the entire credit meltdown. Except for the taking responsibility part, that is.