U. S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 22134 / October 19, 2011
Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-Civ.-7387 (Rakoff, J.) (S.D.N.Y. filed Oct. 19, 2011)
Securities and Exchange Commission v. Brian H. Stoker, 11-Civ.-7388 (S.D.N.Y. filed Oct. 19, 2011)
Citigroup To Pay $285 Million to Settle SEC Charges For Misleading Investors About CDO Company Profited From Proprietary Short Position Former Citigroup Employee Sued For His Role In Transaction
The Securities and Exchange Commission (SEC) today charged Citigroup Global Markets Inc. (Citigroup), the principal U.S. broker-dealer subsidiary of Citigroup Inc., with misleading investors about a $1 billion collateralized debt obligation (CDO) called Class V Funding III (Class V III). At a time when the U.S. housing market was showing signs of distress, Citigroup structured and marketed Class V III and exercised significant influence over the selection of $500 million of the assets included in the CDO. Citigroup then took a proprietary short position with respect to those $500 million of assets. That short position would provide profits to Citigroup in the event of a downturn in the United States housing market and gave Citigroup economic interests in the Class V III transaction that were adverse to the interests of investors. Citigroup did not disclose to investors the role that it played in the asset selection process or the short position that it took with respect to the assets that it helped select. Without admitting or denying the SEC’s allegations, Citigroup has consented to settle the Commission’s action.
The SEC today also brought a litigated civil action against Brian Stoker (Stoker) and instituted settled administrative proceedings against Credit Suisse Asset Alternative Capital, LLC (formerly known as Credit Suisse Alternative Capital, Inc.) (CSAC), Credit Suisse Asset Management, LLC (CSAM), and Samir H. Bhatt (Bhatt), based on their conduct in the Class V III transaction. Stoker was the Citigroup employee primarily responsible for structuring the Class V III transaction. CSAM is the successor in interest to CSAC, which was the collateral manager for the Class V III transaction, and Bhatt was the portfolio manager at CSAC primarily responsible for the Class V III transaction. Without admitting or denying the Commission’s findings, CSAM, CSAC, and Bhatt have agreed to settle the Commission’s proceedings.
Citigroup Global Markets and Brian Stoker
According to the SEC's complaints, filed in the U.S. District Court for the Southern District of New York (SDNY), in or around October 2006, personnel from Citigroup’s CDO trading and structuring desks had discussions about possibly having the trading desk establish a short position in a specific group of assets by using credit default swaps (CDS) to buy protection on those assets from a CDO that Citigroup would structure and market. Following the institution of discussions with CSAC about having CSAC act as the collateral manager for a proposed CDO transaction, Stoker sent an e-mail to his supervisor in which he stated that he hoped that the transaction would go forward and described the transaction as the Citigroup trading desk head’s “prop trade (don’t tell CSAC). CSAC agreed to terms even though they don’t get to pick the assets.”
As further set forth in the complaints, Citigroup and CSAC agreed to proceed with the Class V III transaction. During the time when the transaction was being structured, CSAC allowed Citigroup to exercise significant influence over the selection of assets included in the Class V III portfolio. The Class V III transaction marketed primarily through a pitch book and an offering circular. Stoker was primarily responsible for these documents. Both the pitch book and the offering circular included disclosures that CSAC, the collateral manager, had selected the collateral for the Class V III portfolio and that Citigroup would act as the initial CDS counterparty. The disclosures, however, did not provide any information about the extent of Citigroup’s interest in the negative performance of the Class V III collateral or that, by the times when the pitch book and the offering circular were prepared, Citigroup already had short positions in $500 million of the collateral. The pitch book and the offering circular were materially misleading because they failed to disclose that Citigroup had played a substantial role in selecting the assets for Class V III, Citigroup had taken a $500 million short position in the Class V III collateral for its own account, and Citigroup’s short position was comprised of names it had been allowed to select, while Citigroup did not short names that it had no role in selecting. Nothing in the disclosures put investors on notice Citigroup had interests that were adverse to the interests of investors.
According to the complaints, the Class V III transaction closed on February 28, 2007. One experienced CDO trader characterized the Class V III portfolio as “dogsh!t” and “possibly the best short EVER!” and an experienced collateral manager commented that “the portfolio is horrible.” On November 7, 2007, a credit rating agency downgraded every tranche of Class V III, and on November 19, 2007, Class V III was declared to be in an Event of Default. The approximately 15 investors in the Class V III transaction lost their entire investments in Class V III. Citigroup received fees of approximately $34 million for structuring and marketing the transaction and realized net profits of at least $160 million from its short position on $500 million of the collateral.
As a result of their conduct, the Commission has alleged that Citigroup and Stoker each violated Sections 17(a)(2) and (3) of the Securities Act of 1933. Without admitting or denying the allegations in the Commission’s complaint, Citigroup has agreed to settle by consenting to the entry of a final judgment that (i) enjoins it from violating these provisions, (ii) requires it to pay $160 million in disgorgement, plus $30 million in prejudgment interest, and $95 million as a penalty, for a total of $285 million, which will be returned to investors through a Fair Fund distribution, and (iii) requires remedial action by Citigroup in its review and approval of offerings of certain mortgage-related securities. The settlement is subject to Court approval. With respect to Stoker, the SEC is seeking an injunction, disgorgement with prejudgment interest, and a civil money penalty.
CSAM, CSAC, and Bhatt
In the related administrative proceedings instituted against CSAM, CSAC, and Bhatt, the SEC found that, as a result of the roles that they played in the asset selection process and the preparation of the pitch book and the offering circular for the Class V III transaction, CSAM and CSAC violated Section 206(2) of the Investment Advisers Act of 1940 (Advisers Act) and Section 17(a)(2) of the Securities Act and that Bhatt violated Section 17(a)(2) of the Securities Act and caused the violations of Section 206(2) of the Advisers Act by CSAC. Without admitting or denying the SEC’s findings, CSAM and CSAC consented to the issuance of an order directing each of them to cease and desist from committing or causing any violations, or future violations, of Section 206(2) of the Advisers Act and Section 17(a)(2) of the Securities Act and requiring them to pay disgorgement of $1 million in fees that it received from the Class V III transaction plus $250,000 in prejudgment interest, and requiring them to pay a penalty of $1,250,000. Without admitting or denying the SEC’s findings, Bhatt consented to the issuance of an order directing him to cease and desist from committing or causing any violations, or future violations, of Section 206(2) of the Advisers Act and Section 17(a)(2) of the Securities Act and suspending him from association with any investment adviser for a period of 6 months.
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The SEC investigation that led to these enforcement proceedings was conducted by Andrew H. Feller and Thomas D. Silverstein of the Enforcement Division's Structured and New Products Unit (SNPU). Steven Rawlings, Brenda Chang and Elizabeth Goot, SNPU attorneys in the New York Regional Office, also participated in the matter. The SEC trial attorney who will lead the litigation against Stoker is Jeffrey Infelise.