The Securities and Exchange Commission is investigating Citigroup’s involvement in a $1 billion collateralized debt obligation (CDO) deal that the bank created and completed in 2007. The agency is investigating whether Citigroup improperly pressured an independent manager to put specific assets into the deal, according to an article by Jake Bernstein and Jesse Eisinger in Pro Publica entitled “SEC Investigating Citigroup Mortgage Deal.”
The SEC has been conducting a broad investigation into Wall Street’s CDO business, including whether investment banks created deals in order to get rid of distressed assets by dumping them on unsuspecting buyers. That appears to be the focus of the SEC’s investigation of Citigroup’s CDO deals.
The Citigroup CDO is named Class V Funding III and was composed of pieces of other CDOs that were themselves backed by risky slices of subprime mortgages. Citigroup marketed and sold the deal to investors. The Credit Suisse Alternative Capital was the “independent manager” that was supposed to select the best assets for the CDO.
Among the assets purchased by Class V Funding III were portions of, or sidebets involving, at least 15 CDOs that the Illinois-based hedge fund Magnetar helped to create. Citigroup also underwrote four of those CDOs. In April, ProPublica and others described how Magnetar created $40 billion of CDOs as part of its bet against the housing market.
Citigroup insured $500 million of Class V Funding III through Ambac, thereby hedging its exposure. Rating agencies downgraded Class V Funding III eight months after its completion. Ambac filed for bankruptcy in November 2010, largely due to its exposure to CDOs like Class V Funding III.
Ultimately, however, Citigoup failed to hedge against losses from most of the CDOs in which it invested. Citigroup lost nearly $34 billion on its mortgage CDO business, according to the article.
A federal class action brought by Citigroup shareholders against Citigroup accuses it using Class V Funding III and other CDO as a way to “clean out its warehouse” while downplaying the risk of its exposure to CDOs. This case is apparently going forward on the allegation, among others, that Citigroup misrepresented its exposure to CDOs.
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