Citi’s Hedge Fund Litigation Problem

I’m no expert on public relations, but I’d expect the flacks at Citigroup (C) would go to great lengths to avoid maligning the firm’s Smith Barney brokers. But the financial giant’s public defense for peddling risky proprietary hedge funds to wealthy clients seeking conservative investments implicitly undermines either the integrity or the competency of the firm’s brokers.

“Our disclosures and marketing material sufficiently outlined the inherent risk in the funds and their leveraged strategies,” an unnamed spokesman said in a statement issued to the Wall Street Journal regarding the firm’s Falcon and ASTA/MAT hedge funds, which have lost about 75 percent of their value in the past year.

Oh really? Well if the disclosures were so sufficiently outlined, then how come I’m getting calls from outraged clients who vehemently insist they bought into the hedge funds because they were repeatedly assured by their brokers that the funds were extremely low-risk investments? Smith Barney brokers themselves apparently are even willing to acknowledge that these assurances were given. I quote verbatim here from the Wall Street Journal:

Citigroup brokers and fund managers assured prospective investors that the new hedge funds were low-risk, with Falcon likely to post losses of no more than 5% a year in the worst-case scenario, according to people familiar with the situation.

“That’s why they bought it,” says a Smith Barney broker whose clients, many of them wealthy retirees, invested in the Falcon Funds. “These kinds of clients weren’t looking for a home run.”

Investors rely on the overtures of their brokers, who fashion themselves as financial consultants or advisors, not highly compensated salespeople. “We make money the old-fashioned way. We earn it” – as Smith Barney used to say.

Unfortunately, most brokers don’t have the training or the acumen to understand highly complex and sophisticated financial instruments. So they dutifully rely on the representations given to them by their superiors, who are richly compensated for moving the products out the door.

Herein lies the vicious circle: Citigroup concocts inherently risky funds for its brokers to sell to their wealthy clients that generate handsome fees for the firm and commissions for its brokers. The brokers are told to market the fund as a “conservative” investment, notwithstanding that fact that the funds are so levered that a few ticks the wrong way causes the house-of-cards to collapse. The brokers mimicked the company’s recommended sales pitch to their clients and successfully wrangled hundreds of millions of lucrative assets.

Citigroup, understanding that it has a significant legal liability on its hands, publicly insists that company sufficient disclosed the risks when it marketed the funds. If that was truly the case, the brokers who marketed the funds will deservedly be held legally accountable for failing to educate their clients about the obvious risks.

But more than likely, many of the Smith Barney brokers who marketed the funds themselves were likely led to believe the funds were in fact “low risk.” At a minimum, there was a lack of due diligence. Now that markets are under pressure, Citigroup wants to shift the onus of blame to its brokerage force, rather than hold its wealth management executives accountable. Blaming the folks who followed orders - rather than the ones who gave them - is the way Wall Street works.

Disclosure: No positions

Comments

[Sedan]

I'm a Mat 5 NY investor (stupid me). No question that these funds were marketed as low risk. Full serivce brokers, stuctured investments, high fees...........consume... value is suspect.

[Healthy]

Citigroup and Smith Barney are places no person should put his/her money. Smith Barney has been proven over and over again to be deadly to the financial health of people who buy their proprietary products or who follow their research analysts. Anyone who holds accounts at Smith Barney must be out of his/her mind. I would never be caught doing business with such a self-defamed financial company when there are so many other reputable places to invest through, such as LPL, the largest independent firm where you can be assured of little or no conflict.

[Healthy]

Here's the problem: Financial advisors are required to learn thorough information they're rigorously tested on, covering traditional financial instruments such as fixed income, stocks and mutual funds. The SEC has not adequately required advisors to have adequate knowledge on structured products, hedge funds, and other non-traditional products. The SEC should also prohibit the sales of these products to any customer unless he first passes a test himself demonstrating a deep understanding of the product. We've seen time and time again how Smith Barney and Citigroup aggressively sell products to people who lose money on them because they didn't realize how disasterously risky the products are. And nothing's changed since this was uncovered years ago. Smith Barney/Citigroup is still feeding a bunch of crap to their customers. Ever wonder why Smith Barney's price targets on stocks are consistently higher than the other brokerage firm analysts' price targets? It's because they think they'll get more cients by provinding the highest price targets, obviously. DANGER, WILL SMITH, DANGER!!!

[Esoteric]

What happened to personal responsibility and common sense? Are we kidding ourselves with such generalities "no one should never invest with such and such," "they made me do it," and on and on. My 15 years of experience in the brokerage world has confirmed a hundred times that there are sleeze bags and pushy salespeople everywhere - from your local bank's "financial advisor" to the Merrills and Smith Barneys of the world. And to the contrary, there are also great, candid, "this is how it is, this is how you pay me, in this scenario maybe you'd be better off in an index fund" people at all the same establishments. Are they few and far between? Unfortunately, yes. But here's the thing: If each of us individually took the time to gain even a basic knowledge of how investments work, how "advisors" get paid, what the conflicts of interest may be, these calamities would soon become a thing of the past. Geez - if it sounds to good to be true, it probably is - REALLY? Could it really be that simple? Yes!

[Reed Vision]

If I' a SB broker and I know full well that management is forcing me to pedal a farce, are you telling me that I should be smart enough and moral enough not to? The SEC shouldn't be coming down on the sales folks, they should be slamming the corporate leaders with criminal convictions for concocting half-baked bullshit. In-fact, if it was really doing its doing it's job, the SEC wouldn't allow 9/10's of the investment products that is being and has been marketed or even transacted. The amount of global money wrapped up in credit swap derivatives is mind numbing. AND NO ONE KNOWS HOW TO VALUE IT? Blame begins with the referee of capital markets-the regulators. It then continues down the chain. There was no incentive for Mr. Islam's FALCON HEDGE FUND to par down the maniacal degree of leverage that his purportedly conservative investment carried. So what he's out. With a fat golden shower, I'm sure. You think that only the investors got hurt? Think about thousands of hard working Citi folk who don't work in the investment laboratory and their prospects being ripped apart by investment side. Reed's vision was about 20 over 1000 when Sandy put this offer in front of him, given SB had stopped earning the hard way when Sandy took them over year before.