According to a Page One story by David Enrich in today’s Wall Street Journal, Citigroup has barred investors from withdrawing their money from a Citigroup hedge fund named CSO Partners.
CSO, which specializes in corporate debt, was closed to withdrawals after investors sought to withdraw 30% of the funds’ approximately $500 million in assets. The fund lost 11% last year and Citigroup injected an additional $100 million into the fund last month to stabilize it. John Pickett, the fund’s former manager, has left the firm amidst a bitter dispute with senior executives and a complaint that he put too much money into a single investment.
In June 2007, Pickett placed an order for several hundred million dollars of leveraged loans offered by a consortium of banks on behalf of a German media company. At the time, CSO had $700 million in assets ? so Pickett wanted to commit more than half of the fund’s assets to this one deal.
The size of this investment reportedly exceeded the internal trading limits in place at Citigroup. Some of the fund’s investors contend that Citigroup did not supervise Picket closely enough.
The seven banks running the consortium allocated CSO a bundle of loans with a face value of more than $730 million. Pickett tried to back out of the deal and claimed that the banks had changed the loan terms after he submitted his bid.
The credit crisis had started disrupting the markets in the summer of 2007, and the value of the loans was eroding. If CSO could not cancel the deal, its performance numbers would suffer. Picket argued that he owed a fiduciary duty to the investors to cancel the order. He also proposed that the fund sue the banks that were arranging the transaction.
Morgan Stanley complained directly to John Havens, the head of Citigroup’s alternative investment unit and Pickett’s superior. Havens was also the former head of global sales and distribution at Morgan Stanley. Havens and James O’Brien, another Morgan Stanley fixed-income veteran who had joined Citigroup, sided with Morgan Stanley. They instructed Pickett not to initiate any legal action and they also began negotiating a settlement with Morgan Stanley. Pickett accused Havens and O’Brien of ignoring the fund’s fiduciary duty and with having a possible conflict of interest because of their ties with Morgan Stanley.
After months of negotiation, Citigroup agreed in December 2007 to a Morgan Stanley settlement proposal under which CSO would purchase $746 million of the loans at face value, even though they were trading for 86% to 93% of their face value. CSO also agreed to pay the bank’s legal expenses.
Had COS not purchased the loans and paid Morgan Stanley’s legal bills, it would have shown a modest profit for 2007 instead of the 11% loss. Pickett resigned on December 12 ? one week after the settlement.
These developments are disturbing on many levels. First, for Pickett to invest more than half of the fund’s assets in one deal demonstrated either that Citigroup had no risk management and internal controls or that such controls were routinely ignored. Second, if the allegation that Morgan Stanley changed the terms of the loans is accurate, then the outcome here demonstrates that Wall Street’s old boy network is alive and well to the detriment of investors.