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SEC: Citi designed bad security for investors, bet against it

October 19, 2011 | 10:10 am

Citigroup is paying hundreds of millions to settle a lawsuit accusing it of betting against its own clients on a mortgage-backed security that the bank had designed to fail.

Citi will pay $287 million to settle the lawsuit filed Wednesday by the Securities and Exchange Commission. The complaint involves a security that derived its value from subprime mortgages -– known as a collateralized debt obligation -- that Citi helped structure and sell to clients just as the mortgage meltdown was beginning in early 2007.

Without telling the clients who were buying the $1 billion security, which carried the name Class V Funding III, Citi packed it with credit default swaps that were likely to fall in value as the mortgage market collapsed, according to the complaint. Citi traders then bet against the security, or shorted it, eventually making money at the expense of its clients, the complaint says.

One industry expert said at the time that it was “possibly the best short EVER!” according to the complaint.

The case recalls a previous case brought against Goldman Sachs for the now infamous Abacus security. While Citi is paying less than Goldman to settle its case, Citi was more integrally involved in the wrongdoing alleged in its case.

Whereas in the Goldman case, the Abacus security was designed by an outside hedge fund investor who wanted to bet against it, in the Citi case, it was Citi employees who designed the security, marketed it to investors and bet against it, eventually making $160 million from the deal.

Citi told clients that Credit Suisse had been responsible for choosing the components of Class V Funding and did not acknowledge that Citi employees had chosen half of the components itself, the complaint says. When the Citi employee responsible for the deal was putting it through he wrote that Credit Suisse "agreed to terms even though they don’t get to pick the assets."

Class V Funding defaulted in November 2007, about eight months after it was marketed to investors. The 15 clients who bought it lost most of their investment, the SEC said.

In addition to the lawsuit against Citi, the SEC filed suit against the Citi employee who oversaw Class V Funding, Brian Stoker. Stoker, who left Citi in 2008, did not settle and the suit will move forward.

Stoker’s lawyer Fraser Hunter, said they would "vigorously defend this lawsuit."

"There is no basis for the SEC to blame Brian Stoker for these alleged disclosure violations," Stoker said. "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."

In a statement, Citi acknowledged that it made money from Class V Funding, but noted that it had lost money on other collateralized debt obligations –- debts that nearly helped bring Citi down as the crisis reached its heights in 2008.

“We are pleased to put this matter behind us and are focused on contributing to the economic recovery, serving our clients and growing responsibly,” Citi said in the statement.

The SEC also filed suit and settled with Credit Suisse. Credit Suisse paid $2.5 million to settle the case.

RELATED:

JPMorgan pays $153.6 million to settle fraud

Goldman agrees to settle fraud case with SEC, will

-- Nathaniel Popper

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