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SEC and Citigroup Agree to $285 Million Settlement; Agency Claims Bank Misled Investors About CDO

Bruce Carton | October 19, 2011

The SEC Enforcement Division's Structured and New Products Unit filed its latest case related to the financial crisis today. The agency filed a settled an enforcement action against Citigroup Global Markets (Citigroup's principal U.S. broker-dealer subsidiary) alleging that it misled investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market. 

According to the SEC, CGM structured and marketed a CDO called Class V Funding III, exercised significant influence over the selection of $500 million of the assets included in the CDO portfolio, and then "took a proprietary short position against those mortgage-related assets from which it would profit if the assets declined in value. Citigroup did not disclose to investors its role in the asset selection process or that it took a short position against the assets it helped select." Citigroup has agreed to settle the SEC's charges by paying a total of $285 million--$160 million in disgorgement, $30 million in prejudgment interest and a $95 million penalty. The $285 million will be returned to investors through a Fair Fund distribution. 

Announcing the case today, Enforcement Director Robert Khuzami emphasized that the securities laws required CGM to provide "more care and candor" to investors in the CDO. These investors "were not informed that Citgroup had decided to bet against them and had helped choose the assets that would determine who won or lost,” he said. When the CDO defaulted within months, its 15 investors lost virtually their entire investments.

According to an article in the NY Times, the case is quite similar to the case the high-profile SEC brought in April 2010 against Goldman Sachs concerning a failed financial product tied to subprime mortgages. In the Goldman Sachs case, however, the portfolio at issue was selected by an outside hedge fund manager. In the Citigroup case, the bank itself allegedly chose the assets for the portfolio that it then bet against without disclosing that fact to investors.

A detailed list of SEC monetary recoveries in "enforcement actions against companies whose misconduct occurred leading up to or during the financial crisis" is available here.