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Citigroup settles SEC fraud charges for $285 million

Citigroup Inc. [corporate website] on Wednesday announced a $285 million settlement to resolve charges [complaint, PDF; press release] brought by the Securities and Exchange Commission (SEC) [official website] that a subsidiary of the global financial services firm defrauded investors who bought toxic housing-related debt during the housing crisis. Citigroup Global Markets Inc. (CGMI), Citigroup's principal US broker-dealer, marketed and sold in 2007 a $1 billion collateralized debt obligation (CDO) that defaulted fewer than nine months after it closed. CGMI allegedly misled investors [Reuters report] about the strength of the the CDO, named Class V Funding III, and failed to reveal that the company "had exercised significant influence over the selection of $500 million of the assets" in the CDO portfolio, and that it had taken a short position in those assets, essentially meaning it had placed bets elsewhere in the financial markets that the CDO would fail. The SEC summarized in its complaint:

By taking a short position with respect to the assets that it had helped select, Citigroup profited from the poor performance of those assets, while investors in Class V III suffered losses. The CDO securities on which Citigroup bought protection had a notional value of approximately $500 million, representing half of the Class V III investment portfolio. The marketing materials Citigroup prepared and distributed to investors did not disclose Citigroup's role in selecting assets for Class V III and did not accurately disclose to investors Citigroup’s short position on those assets. ... By engaging in the conduct described herein, [CGMI] violated Sections 17(a)(2) and (3) of the Securities Act of 1933 ... by negligently misrepresenting key deal terms.
Citigroup allegedly represented that the collateral manager of the CDO, a unit at Credit Suisse Group AG [corporate website], had independently selected the assets, while in reality about half had actually been selected by CGMI with the intention of taking the short position. Upon default Class V Funding III left the investors with losses even though Citigroup netted $160 million in fees and profits. Under the terms of the settlement, which still requires approval from US District Judge Jed Rakoff in Manhattan, Citigroup will disgorge the $160 million of alleged improper fees and profits, plus $30 million of interest, and pay a $95 million fine. Credit Suisse has agreed to settle with the SEC for $2.5 million. Citigroup settled without admitting wrongdoing.

Citigroup's settlement is the third between the SEC and a major bank accused of marketing a CDO without disclosing a short position or allowing investors to take one. In June JPMorgan Chase & Co [corporate website] settled similar fraud charges [JURIST report] for $153.6 million. The settlement included a $133 million fine and $20.6 million representing fraudulent profits and interest. In July 2010, Goldman Sachs [corporate website; JURIST news archive] agreed to a $550 million settlement with the SEC to resolve charges [JURIST report] that the firm marketed a subprime mortgage product and made misleading statements and omissions to investors in early 2007. Of the $550 million settlement, $300 million was to be paid to the US Treasury and $250 million disgorged to harmed investors. The penalty was the largest against a financial company in SEC history. Additionally, in December 2010 Bank of America (BOA) [corporate website] settled with the SEC [JURIST report] for $137 million, although the case did not involve investor fraud charges. There BOA was charged with using anti-competitive transactions with 20 state municipalities, putting at risk the tax-exempt status of municipal securities by establishing fraudulent fair market values using "improper bidding practices" between 1998 and 2002.

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