The SEC has subpoenaed former Citigroup brokers as it investigates whether the bank misled investors about how risky its debts funds were, particularly from mid-2007 until March 2008 when those funds shed 77% of their values.  At the time, a storm of protest from brokers and clients ensued, and Citigroup, following an internal debate, offered share buybacks that reduced investor losses to about 61%.

Three brokers who worked in California for Smith Barney, then a Citigroup unit, reportedly concluded the bank hadn't adequately disclosed the funds' risks and also mismanaged them. It was these RR's who received SEC subpoenas, and spoke to the SEC in 2009, and spoke again this past summer.  Another former Smith Barney broker from Texas met with the SEC in September.  The California brokers resigned in 2008 and filed an arbitration claim charging Citigroup with having "constructively" dismissed them.  They lost the case. 

    The SEC Investigation.   If the SEC finds that Citigroup misled investors about the funds' risks and levies a penalty, the California brokers may stand to claim 10% to 30% of certain penalties under Dodd-Frank's "whistleblower" provisions.  Citigroup denies having misled investors, saying its disclosure was adequate because investors had been put on notice the funds were more volatile than the stock market and that they could lose their entire investment. 

• The MAT ("Municipal Arbitrage Trust") Finance LLC fund series borrowed at low short-term rates and invested in longer-term bonds that paid higher rates.  Some marketing materials called it "an attractive alternative" to a bond index, while other disclosures said it was riskier than the stock market and 3 times as risky as a bond index.  Although bonds are generally less volatile than stocks, the MAT funds eventually borrowed more than $8 for every $1 invested, magnifying the risk from even small changes in the bonds' value.
• The Falcon fund series contained muni bonds, MBS's and bank loans.  S&P's gave the fund a rating of "low to moderate sensitivity to changing market conditions," equivalent to safe, medium-term government bonds, a rating that sales materials highlighted.

The funds raised $2.8 billion from investors between 2002 and 2007 - each investor had to have at least $5mn in investible assets - i.e., sophisticated investors, thus exempting Citi from registration requirements.  A Newport Beach, CA team of Smith Barney RR's put $91mn, or 4%, of their clients' assets into the funds.  The particular funds they put their clients in fell 80% to 97% from May 2007 to March 2008, by the brokers' calculation.

    Sallie Krawcheck Expressed Concerns.  Sallie Krawcheck, then head of Citigroup's wealth-management division, spoke to several brokers and soon advocated that the bank cover part of the losses on the ground that the funds were less stable than billed.  Other Citigroup executives balked, with #2 executive John Havens saying that a bailout might cost "hundreds of millions more" than other execs believed.  Citigroup, which had poured in cash to stabilize the funds when they received collateral demands from lenders, eventually decided to spend $250 million to cover about one-eighth of clients' losses.  Clients who accepted had to give up the right to pursue further claims.   [WSJournal, 11/8]