Citigroup Coughs Up $285 Million To Settle Fraud Claims Over Derivatives and Real Estate Case

Citigroup, one of the banks bailed out under the TARP program, has settled a civil suit with the SEC for $285 million. The suit contended that Citigroup misled investors in a $1 billion derivatives deal tied to the United States housing market, then bet against the investors as the housing market began to show signs of distress.

The securities fraud complaint was similar to one the S.E.C. brought against Goldman Sachs last year, with one significant difference. Goldman Sachs was accused of misleading investors about who was picking the investments in a mortgage-related derivative.

It told investors that the bonds would be chosen by an independent manager, when in fact many of them were chosen by John A. Paulson, a hedge fund manager who chose assets that he believed were most likely to lose value, according to the S.E.C.’s complaint in that case. Goldman later settled the case by paying $550 million.

In the Citigroup case, however, it was the bank itself that chose assets for the portfolio that it then bet against. Investors were not told of its role or that Citigroup had an interest that was adverse to the interests of investors.

“The securities laws demand that investors receive more care and candor than Citigroup provided to these C.D.O. investors,” said Robert Khuzami, director of the S.E.C.’s division of enforcement. “Investors were not informed that Citigroup had decided to bet against them and had helped choose the assets that would determine who won or lost.”

The S.E.C. said that the $285 million would be returned to investors in the deal, a collateralized debt obligation known as Class V Funding III. The commission said that Citigroup exercised significant influence over the selection of $500 million of assets in the deal’s portfolio.

Citigroup then took a short position against those mortgage-related assets, an investment in which Citigroup would profit if the assets declined in value. The company did not disclose to the investors to whom it sold the collateralized debt obligation that it had helped to select the assets or that it was betting against them.

Essentially, the bank put together a security, touted it to its investors, and then took a contrary position and bet against the investors who just bought into the investment Citigroup touted.

It's yet another reason for regulatory actions to insure transparency so that investment houses don't tout securities or other paper and then bet against those same securities. Trying to profit from either way a security swings is something everyone would like to do - but these investors weren't told that Citi, the one providing the security, was doing it to them.