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Home > Cases > Citigroup > Citigroup Halts Hedge Fund Withdrawals

Citigroup Halts Hedge Fund Withdrawals

Citigroup has barred investors from withdrawing their money from a Citigroup hedge fund named CSO Partners.

According to a story by David Enrich in the Wall Street Journal, CSO was closed to withdrawals after investors tried to withdraw 30% of the funds' approximately $500 million in assets. CSO, which specializes in corporate debt, lost 11% last year, requiring Citigroup to inject an additional $100 million into the fund in January to stabilize it.

CSO's former manager, John Pickett, left the firm following a bitter dispute with senior executives about accusations he put too much money into a single investment.

Background

Last summer, 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. CSO had $700 million in assets at the time, and Pickett wanted to commit more than half of the fund's assets to the deal.

Reportedly, the size of this investment exceeded Citigroup's internal trading limits.

The seven banks running the consortium allocated CSO loans with a face value of more than $730 million. Pickett tried to back out of the buy, claiming the terms were changed on him.

In the summer of 2007, the credit crisis was in full force, and the value of the loans began to erode. If CSO was unable to cancel the deal, performance numbers would take a hit. Picket tried to cancel the order, and even suggested that the fund sue the banks attempting to arrange the transaction.

As a result, Morgan Stanley complained to John Havens, head of Citigroup's alternative investment unit and Pickett's superior. Havens also was the former head of global sales and distribution at Morgan Stanley. Both Havens and James O'Brien, also a Morgan Stanley fixed-income veteran who had joined Citigroup, sided with Morgan Stanley. They told Pickett not to initiate legal action and subsequently began negotiating a settlement with Morgan Stanley.

For his part, Pickett accused Havens and O'Brien of ignoring the fund's fiduciary duty and that both men had a possible conflict of interest because of their ties with Morgan Stanley.

In December 2007, after months of negotiation, Citigroup agreed to Morgan Stanley's settlement proposal. CSO would purchase $746 million of the loans at face value, even though they were trading for 86% to 93% of their face value. In addition, CSO agreed to pay the bank's legal fees.

If CSO had not purchased the loans and paid Morgan Stanley's legal bills, it would have shown a modest profit for 2007. Instead, it saw an 11% loss. One week following the settlement, Pickett resigned.

For many reasons, these developments are disturbing. To begin, if Pickett had free reign to invest more than half of the fund's assets into one deal, it demonstrates either a lack of risk management and internal controls at Citigroup or that such controls are routinely ignored. Second, if Morgan Stanley did, in fact, change the terms of the loans, then the outcome is one more example of how Wall Street's good old boy network is alive and well at investors' expense.

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