Investors in the MAT Municipal Arbitrage Funds sold by Citigroup/Smith Barney recently won a total of $2.1 million in separate arbitration proceedings and these awards may just be the tip of the iceberg. In fact, Wall Street brokerage firms are being ordered to pay millions to investors who incurred significant losses on what they thought were low-risk investments, but were, in fact, leveraged municipal arbitrage hedge funds, according to a Wall Street Journal article by Randall Smith (“Crisis-Era Munis Haunt Wall Street,” July 27, 2010).
Citigroup and Smith Barney marketed municipal arbitrage funds under the names MAT and ASTA. The funds issued tax-exempt short-term debt and used the proceeds to buy longer-term municipal bonds that offered higher tax-exempt yields. Derivatives such as interest-rate swaps were used purportedly to hedge against adverse moves in both short- and long-term interest rates. Investors were promised higher yields than municipal bonds, according to the article.
Citigroup indicated in marketing materials that its funds could borrow 7/8 of the amounts invest with only 1/8 coming from fund investors. The plan was to borrow at a short-term rate of 3.3 percent and invest in long-term bonds that paid 4.2 percent. The marketing materials claimed this strategy could boost investor returns to 8%,.
The strategy was riskier than a stock-market index and three times as risky as a bond-market index, but Citigroup marketed MAT and ASTA as “fixed income alternatives.”
The Securities and Exchange Commission and federal prosecutors are reportedly examining Citigroup’s risk disclosures, which understated the funds’ risk, according to the article.
One series of Citigroup funds raised $1.9 billion from investors between 2002 and 2007, invested in an estimated $15 billion in bonds and lost between 70% and 97% of their asset value by the end of February 2008, according to the article. Investors lost between 15% and 72% through March 2009, net of quarterly distributions, according to the article.
One such investor, Bob Selan, a California magazine publisher, invested $1 million in a Citigroup fund in 2006 through Smith Barney. Mr. Selan said it was presented as “a safe alternative” to bonds. “The way it was explained to me, they were going to buy triple-A bonds and you were going to get a couple of extra percentage points,” Mr. Selan was quoted as saying.
However, in February 2008, as municipal-bond prices plummeted, leveraged municipal bond funds had to post more collateral against the falling bond prices, and some funds were forced to liquidate.
Mr. Selan lost over 50% of his investment. In May, an arbitration panel awarded him $550,504.96 (100% of his loss) plus interest.
Mr. Selan’s legal team includes the firms of Page Perry, of Atlanta, Georgia, Maddox, Hargett and Caruso, P.C., of New York, New York and Indianapolis, Indiana, and David R. Meyer & Associates of Columbus, Ohio. The law firms are handling more than three dozen MAT/ASTA cases involving more than $100 million in losses. The firms continue to investigate and pursue FINRA arbitrations on behalf of Citigroup/Smith Barney customers who suffered losses in fixed income alternative investments, including MAT, ASTA and Falcon.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. For further information, please contact us.