Citigroup to Pay $285 Million to Settle Fraud Charges
By JEAN EAGLESHAM And SUZANNE KAPNERWall Street's total price tag on settlements with U.S. securities regulators for allegedly misleading investors about mortgage bonds churned out ahead of the financial crisis surged past $1 billion with a deal by Citigroup Inc. to pay $285 million.
The New York company agreed to the payment to end civil-fraud charges by the Securities and Exchange Commission related to a 2007 deal called Class V Funding III. The SEC claimed Citigroup sold slices of the $1 billion mortgage-bond deal without disclosing to investors that the bank was shorting $500 million of the deal, or betting its assets would lose value.
Several Wall Street firms have settled similar claims by the SEC, which has generally stuck to the strategy used by the agency to get a $550 million settlement last year with Goldman Sachs Group Inc. over a collateralized debt obligation called Abacus 2007-AC1.
And the SEC's investigation of the Wall Street mortgage machine isn't over yet. Lorin Reisner, deputy enforcement director at the SEC, said civil mortgage-related cases against Goldman, J.P. Morgan Chase & Co., Countrywide Financial Corp., New Century Financial Corp. and other companies "read like an index to unlawful conduct in connection with the financial crisis." He added in an email: "Our work in this space is continuing."
As a result of the deal with Citigroup announced Wednesday, the SEC has collected a total of $1.03 billion through mortgage-bond-deal settlements. In addition to Citigroup, the total includes Goldman, J.P. Morgan, Royal Bank of Canada, Wells Fargo & Co. and Credit Suisse Group AG.
Citigroup said Wednesday that it suffered some losses on more than $100 million invested by the company in Class V Funding III, while profiting from its bet against $500 million of the portfolio. Citigroup added that it had "very substantial losses" on investments in other CDOs.
The companies neither admitted nor denied wrongdoing.According to the SEC, Citigroup helped to rig the bet on Class V Funding III in its favor by exercising "significant influence" over the selection of $500 million of the assets, according to the agency's civil complaint. The agency said investors were assured that the assets were selected by the deal's collateral manager, a unit of Credit Suisse.The assets in the deal, a CDO, were linked largely to other CDOs that in turn invested in pools of subprime mortgages. The SEC complaint quoted one unnamed, experienced CDO trader outside Citi who described the portfolio as "a collection of "dogs—" and "possibly the best short EVER!"The deal became largely worthless within months of its creation, the SEC said. As a result, about 15 hedge funds, investment managers and other firms that invested in the deal lost hundreds of millions of dollars, while Citigroup made $160 million in fees and trading profits, the SEC said.The biggest loser, with a $500 million stake from guarantees sold on the deal, was insurer Ambac, part of Ambac Financial Group Inc., which collapsed because of its exposure to billions of dollars of mortgage-linked investments that went sour, according to the SEC.The assets that Citigroup helped to select performed "significantly worse" than others in the CDO, according to the SEC's complaint.
Citigroup said it was pleased to resolve the matter. The SEC also filed civil charges of negligence against Brian Stoker, referred to by the agency as the Citigroup employee primarily responsible for structuring the CDO. The SEC alleged that Mr. Stoker described Class V Funding III as a "prop," or proprietary deal, meaning a trade undertaken for the firm's own account, rather than to benefit its customers.
The SEC complaint quoted from an email Mr. Stoker allegedly sent to his supervisor as the deal was being discussed in November 2006, writing that Credit Suisse "agreed to terms even though they don't get to pick the assets."
Mr. Stoker's lawyer, Fraser Hunter of law firm Wilmer Hale Cutler Pickering Hale Dorr LLP, said there was "no basis for the SEC to blame" his client for the alleged disclosure failures to investors. "He was not responsible for any alleged wrongdoing, he did not control or trade the position, did not prepare the disclosures and did not select the assets," Mr. Hunter said. "We will vigorously defend this lawsuit."
If it goes to trial, Mr. Hunter's case is due to be heard by U.S. District Judge Jed Rakoff. Judge Rakoff, who also must approve the Citigroup agreement, has previously criticized the SEC's approach to certain enforcement actions.
Credit Suisse agreed to pay a total of $2.5 million to settle civil charges in relation to the CDO. It didn't admit or deny wrongdoing. The Swiss bank doesn't expect to face enforcement action from the SEC in relation to CDOs that it created or marketed, according to a person familiar with the matter. A spokesman for Credit Suisse declined to comment.
The SEC also filed civil-fraud charges against Samir Bhatt, a former Credit Suisse employee. Mr. Bhatt agreed to a six-month suspension from associating with any investment adviser, as part of an agreement to settle the charges. He didn't admit or deny wrongdoing. Mr. Bhatt's lawyer, James Masella of law firm Blank Rome LLP, declined to comment.