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IN RE CITIGROUP

August 10, 2004.

IN RE CITIGROUP, INC. SECURITIES LITIGATION.


The opinion of the court was delivered by: LAURA TAYLOR SWAIN, District Judge

OPINION AND ORDER

Pompano Beach Police & Firefighters Retirement System ("Plaintiff"), which has been designated as lead plaintiff pursuant to 15 U.S.C. § 78u-4, brings this putative class action on behalf of purchasers or those who otherwise acquired securities of Citigroup, Inc. ("Citigroup"), from July 24, 1999, to December 11, 2002, asserting claims under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against: Citigroup; its chairman and chief executive officer, Sanford I. Weill ("Weill"); its chief financial officer, Todd S. Thomson ("Thomson"); its wholly-owned investment banking subsidiary, Salomon Smith Barney Holdings, Inc. ("SSB"); the former chairman and chief executive officer of SSB and of Citigroup's Global Corporate & Investment Bank, Michael A. Carpenter ("Carpenter"); and former SSB stock analyst Jack Grubman ("Grubman" and, collectively, "Defendants"). Plaintiff also asserts claims under section 20(a) of the 1934 Act, 15 U.S.C. § 78t(a), against Weill, Thomson, and Carpenter. The Court has jurisdiction of this action pursuant to 28 U.S.C. § 1331 and 15 U.S.C. § 78aa.

Plaintiff claims that, with respect to transactions with Enron Corporation ("Enron"), Dynegy Inc. ("Dynegy"), and Worldcom Inc. ("Worldcom"), Defendants failed to conduct Citigroup's business in accordance with the risk management policies detailed in its public disclosures and omitted certain financial information or made affirmative misrepresentations relating to Citigroup, and that Defendants thereby violated the antifraud provisions of the securities laws in connection with the purchase and sale of Citigroup securities. Defendants move, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss the Complaint*fn1 for failure to state a claim and, pursuant to Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b), on the grounds that fraud is not adequately pleaded in the Complaint. The Court has considered thoroughly the arguments and submissions of the parties in connection with this motion. For the reasons that follow, Defendants' motion to dismiss is granted.

  BACKGROUND

  Plaintiff's principal material allegations can be summarized as follows. The summary takes as true Plaintiff's allegations and undisputed factual assertions, but does not in any way constitute factual findings by the Court. Lead Plaintiff Pompano Beach Police & Firefighters' Retirement System is an investor that purchased shares of Citigroup stock during the class period; Plaintiff claims that the stock was priced artificially high during the relevant period. (Compl. ¶ 32.) Defendant Citigroup is a publicly-traded financial services institution that provides, through its subsidiaries and divisions, commercial and investment banking and brokerage services. (Id. ¶ 33.) Defendants Weill, Thomson, and Carpenter were directors and officers of Citigroup at all relevant times. (Id. ¶¶ 34, 35, 37.) Weill and Thomson signed Citigroup's Report on Form 10-K for 1999, 2000, and 2001. (Id. ¶¶ 34, 35.) Thomson also signed Citigroup's Reports on Form 10-Q for the periods ending March 2000, June 2000, September 2000, March 2001, June 2001, and September 2001. (Id. ¶ 35.) Carpenter signed SSB's Reports on Form 10-K for 1999, 2000, and 2001. (Id. ¶ 37.) Defendant SSB, a wholly-owned subsidiary of Citigroup, is a retail brokerage, investment banking, and asset management firm. (Id. ¶ 36.) Defendant Grubman was a stock analyst at SSB during the relevant period and resigned in August 2002. (Id. ¶ 38.)

  Risk Management

  As a financial institution, Citigroup depends on its reputation for risk management. Citigroup made several policy statements concerning its approach to risk management in its Reports on Form 10-K. (Id. ¶¶ 55-60.) For example, Citigroup declared that:
Risk management is the cornerstone of Citigroup's business. Risks arise from lending, underwriting, trading, insurance and other activities routinely undertaken on behalf of customers around the world . . .
The review of the risk profile covers . . . Credit risk ratings, including trends in client creditworthiness. . . . Limits assigned to relationship concentrations . . . Distribution and underwriting risk, capturing the risk that arises when Citigroup commits to purchase an instrument from an issuer for subsequent resale; Corporate Control and Risk Assessment, evaluating and measuring defects in our business processes; . . . Legal, evaluating vulnerability and business implications of legal issues . . .
(Id. ¶ 57 (quoting Citigroup's 1998 Report on Form 10-K, filed March 8, 1999)) (emphasis in Complaint). Similar statements were included in Citigroup's public filings in 2000, 2001, and 2002. In the 10-K Reports, Citigroup also described various risk management-related procedures, such as those governing extensions of credit. (Id. ¶¶ 63-65.)

  Enron

  Enron is an energy company formed in 1985 through the merger of two pipeline companies. (Id. ¶¶ 70-71.) Before Enron declared bankruptcy in December 2001, it accounted for 25 percent of all United States energy trades and was a major Citigroup client. (Id. ¶ 70.) Enron's revenues climbed steadily in the late 1990's and reached a year-end high in 2000 of $100 billion. (Id. ¶ 72.) Because Enron consistently reported earnings that surpassed expectations, it had an investment-grade credit rating, and its share prices remained high throughout that period. (Id.) Enron's high credit rating allowed it to borrow billions of dollars in the commercial paper market and to sell debt securities to the public. (Id. ¶ 73.) In 2001, Enron began to reveal that its accounting reports were fraudulent; in October 2001, Enron announced that it intended to take a charge of $1 billion and reduce shareholders' equity by $1.2 billion.

  Citigroup entered into a variety of lending and investment transactions with Enron, and, according to Plaintiff, was aware that Enron's financial statements were inflated because Citigroup was the originator of several of the investment schemes and structures. (Id. ¶¶ 113-14.) Citigroup was also aware of Enron's finances because, as a lender and an underwriter of Enron securities, Citigroup was required to perform credit analyses. (Id. ¶¶ 115, 116, 247.) Moreover, because Citigroup was competing with other banks to provide Enron with off-balance sheet financing, Citigroup was aware of Enron's off-balance sheet liabilities. (Id. ¶ 119.)

  Special Purpose Entities

  One major facet of Citigroup's relationship with Enron was Citigroup's assistance to Enron in establishing special purpose entities ("SPEs"), Enron subsidiaries whose finances Enron omitted from its balance sheets through a series of fraudulent accounting procedures. Citigroup's assistance included, among other things, structuring the subsidiaries and providing loans to fund them. (Id. ¶¶ 122-129.) Plaintiff asserts that the SPEs allowed Enron to avoid listing various debts on its balance sheets and thus enabled Enron to report inflated earnings figures. The Complaint identifies several iterations of such SPEs, all of which are alleged to have constituted mechanisms by which Citigroup assisted Enron in staving off its burgeoning debt. Disguised Loans

  Plaintiff further alleges that Citigroup also acted in the role of lender to Enron, in certain transactions exceeding the internal limits Citigroup usually applied to a "buyer" [sic] with Enron's triple-B credit rating; for instance, as of the first quarter of 1999, although Citigroup had an internal limit for Enron of $375 million, Citigroup allegedly had outstanding credit exposure with Enron of $1.668 billion. (Id. ¶¶ 148-49.) During the relevant period, Citigroup provided to Enron at least an additional $4.8 billion in what Plaintiff refers to as "disguised loans". (Id. ¶¶ 149, 153.) In so doing, Citigroup was able to charge Enron substantial fees for Citigroup services and at the same time encourage investments in Enron that would generate funds with which Enron could pay off its debt to Citigroup. (Id.) Citigroup's disguised loans to Enron were often misreported in Citigroup's financial statements, creating a situation in which Citigroup's outstanding loans were understated in public filings and interest income was not properly classified. (Id. ¶ 156.) Loans also were not properly reported in Federal Reserve filings; the Federal Reserve has initiated investigations into various Citigroup transactions with Enron. (Id.)

  Citigroup also engaged in prepaid swaps, a particular type of disguised loan in which transactions that were essentially loans were recorded as commodity trades for accounting purposes in violation of generally accepted accounting principles ("GAAP"). (Id. ¶¶ 157-66, 170.) By 2001, Citigroup had outstanding prepaid swaps with Enron amounting to at least $2.4 billion. (Id. ¶ 174.) One such transaction, known as Yosemite, was created to lend $800 million to Delta, an Enron SPE; although booked as a trade in Citigroup's accounting, Yosemite was structured to maximize interest payments to Citigroup and was essentially a loan to Enron. (Id. ¶¶ 160-166.) The accounting practices underlying these transactions, as with other prepaid swaps, were not disclosed to investors. (Id. ¶ 172.) In addition, because Citigroup itself held several Yosemite bonds, Citigroup was left with unsecured exposure to Enron's debt. (Id. ¶ 183.) Citigroup further violated its risk management policies by creating inadequate loan loss reserves to compensate for Enron's debt levels. (Id. ¶ 176.)

  This scheme of prepaid swaps and other disguised loans violated Enron's borrowing limits with Citigroup and exposed Citigroup to potential regulatory action from the Securities and Exchange Commission ("SEC"), the Department of Justice, and the Federal Reserve, as well as to lawsuits from investors claiming to have been defrauded by the Yosemite bond offerings. (Id. ¶ 186.) Citigroup did not disclose the prepaid swaps as outstanding loans in its SEC filings or its Annual Reports to Shareholders. (Id. ¶ 187.)

  Various Citigroup officials were aware of the Delta/Yosemite transactions, and Citigroup's Investment Grade Debt Committee reviewed the terms of the transactions. (Id. ¶¶ 189-90.) In fact, Weill promoted the Yosemite deals and their structure as a symbol of the success of the SSB/Citicorp merger, although he later claimed in a Senate investigation that he had no "personal knowledge" of transactions like Delta. (Id. ¶¶ 191, 194.) Similarly, a communication from Weill to Citigroup executives, known as the "Weil Memo," referred to the "Bacchus" series of transactions (a series of loans disguised as sales of Enron assets) and explained how they were created to act as protective measures to safeguard Citigroup's investment in Enron. (Id. ¶¶ 197-209.)

  In addition to disguised loans, Citigroup, in tandem with Chase, created syndicated loans whereby Citigroup and Chase guaranteed loans to Enron, and other banks purchased portions of Enron's credit risk from Citigroup. (Id. ¶ 236.) Through syndicated and other types of loans, and in violation of its internal loan limits, Citigroup loaned Enron and/or its affiliates over $4 billion in 1999, $5.5 billion in 2000, and almost $4 billion in 2001. (Id. ¶ 223.) Throughout this period, Citigroup failed to disclose to its investors that Enron's balance sheets were grossly inflated. (Id. ¶¶ 237-41.)

  In November 2001, Citigroup and Chase also provided improperly secured loans, of which Citigroup contributed approximately $600 million, to Enron subsidiaries. (Id. ¶ 242.) The loans to the subsidiaries were secured by interests in the subsidiaries' gas pipelines; the subsidiaries then lent the money to Enron in exchange for an uncollateralized "I.O.U." (Id.) Enron also transferred back to the subsidiaries $250 million, which was applied to retire an earlier unsecured loan from Citigroup to Enron. (Id. ¶ 244.) Enron declared bankruptcy a few days after these loan transactions were completed. (Id. ¶ 243.) The timing and structure of the transactions exposed Citigroup to the risk of forced disgorgement of the $250 million and avoidance of the security interest in bankruptcy court. (Id. ¶ 243.) Citigroup announced in January 2002 that its exposure to Enron debt was $1.1 billion, including ...


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