A new lawsuit accuses Citigroup of employing "shamelessly fraudulent schemes" to disguise the risks it was taking with mortgage debt
An extensive new complaint in a lawsuit against Citigroup (C) charges that the banking giant misled investors about the size and risk of its housing-market wagers, raising questions about how early the bank knew it faced serious trouble from the assets that have plagued its balance sheet and stock price.
Laying out its arguments in detail over 500 pages, including a variety of charts, graphs, and tables, the lawsuit accuses Citi of "shamelessly fraudulent schemes" to hide the risk the company was taking on as it bought, repackaged, and sold mortgage debt and related securities. Among other allegations, the lawsuit says Citigroup ignored market indexes when pricing some securities, using instead a variety of methods that the company had called unreliable in valuation guides.
Citigroup believes the suit "is without merit," a spokesman said. "We will defend against it vigorously."
The filing in U.S. District Court in Manhattan on Dec. 1 updates an earlier lawsuit seeking class-action status and covers stock losses through Feb. 22 of this year, well before this fall's acute financial crisis. The lead plaintiffs are former directors and employees of Automated Trading Desk, which was sold to Citigroup for shares in the big bank in 2007, shortly before Citigroup's stock price began falling steeply over housing-market concerns.
A Steady Decline
Citigroup, like many banks and other financial companies, saw its stock begin to slide last fall as concerns mounted about the losses they would suffer as the housing market ground to a halt and home prices began to drop; many investors also began to question the values financial firms had put on esoteric and potentially volatile financial instruments. Citi's share price fell to just more than $25 in late February from a high of more than $55 in May 2007; lately the shares have traded under $7.75. In late November the federal government stepped in (BusinessWeek.com, 11/24/08) with more than $300 billion to stabilize Citi.
Much of the lawsuit centers on complex securities called collateralized debt obligations, which combine and divvy up income streams from numerous loans, often mortgages. In the lawsuit, the plaintiffs argue that Citigroup often couldn't sell substantial slices, or tranches, of the CDOs it created, and instead repackaged the tranches into new CDOs, often disguising how much risk the company itself retained. In some cases, the lawsuit says, Citigroup sold the securities but guaranteed the buyers against losses.
"They knew they had a lot of exposure," said Ira Press, a partner at Kirby McInerney, the plaintiffs' lead firm, in an interview. "They just tried to keep the ball rolling so they could maintain this fiction that they had passed the risk on to others."
Hiding the Risks?
Citing a former employee, the lawsuit says the company didn't bother to vet mortgages it bought from correspondent lenders—mortgage originators that sell their loans to financial companies like Citigroup—and didn't take appropriate steps to monitor early indicators, such as defaults on first payments, that those mortgages were riskier than advertised.
Citigroup also delayed suing its correspondent lenders over patterns of misrepresented mortgages for nearly two years in some cases, the lawsuit alleges. "Delay of litigation allowed Citigroup to delay writing down the assets that were the subject of the litigation," it says, essentially enabling the bank to pretend it hadn't discovered the assets were worth less than it originally believed.
Even after it was clear that some correspondent lenders were repeatedly misrepresenting underperforming and low-quality loans, Citigroup continued doing business with them, the lawsuit says.
Press said the suit doesn't argue that Citigroup should have foreseen the housing meltdown, or that it simply made bad business decisions. Rather, Citigroup intentionally hid the risks it knew it was taking, he said. "Citigroup was aware of the exposure earlier, they just weren't disclosing it to the public."