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Citigroup Halts Investor Withdrawals

The largest U.S. bank, Citigroup, has barred investors in one of its hedge funds from withdrawing their money. According to a front-page story in the Feb. 15 edition of the Wall Street Journal, Citigroup suspended redemptions in CSO Partners, a hedge fund that specializes in corporate debt.

CSO was closed for withdrawals after investors tried to pull more than 30 percent of the fund's roughly $500 million in assets. Last month, Citigroup injected $100 million to stabilize the fund, which lost 11 percent last year.

The hedge fund's former manager, John Pickett, parted ways with Citigroup in December 2007, following a clash with senior management and complaints that he committed more than half of the fund's assets to buy leveraged loans offered by a consortium of banks on behalf of a German media company. Reportedly, the size of the investment exceeded Citigroup's internal trading protocols.

The banks behind the consortium provided CSO with loans totaling more than $730 million. During the course of the deal, Pickett tried to renege, charging that the consortium had altered the loan terms once he submitted his bid. At the same time, the credit crisis began its assault on the markets, and the value of the loans started to erode. If CSO could not cancel the deal, its performance ultimately would suffer.

Picket felt it was his fiduciary obligation on behalf of investors to back out of the order. He also believed the fund should take legal action against the banks responsible for arranging the transaction.

The matter was settled in December 2007. In addition to paying the banks' legal fees, Citigroup agreed to a settlement proposal by Morgan Stanley whereby CSO would buy $746 million of the loans at face value, even though the loans were trading at 86 percent to 93 percent of face value.

As for Pickett, he resigned on December 12 — a week following the settlement. If CSO had not settled, it would have posted a year-end profit instead of an 11-percent loss.

The story is troubling on several fronts. What does it say about the internal controls and risk management practices of companies like Citigroup if the John Picketts of the world can invest more than half of any fund's assets into a single deal? Moreover, what does it say to investors if Morgan Stanley did, in fact, alter the loan terms?

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