A grand-slam judgment last month has emboldened the lawyers and investors seeking to recoup losses on $2 billion in municipal arbitrage funds run by Citigroup.
On Aug. 2, an arbitration panel convened in Boca Raton, Fla., by the Financial Industry Regulatory Authority
For two law firms in the South, the amount of the award was secondary to the logic underpinning the judgment.
The panel found Citi liable for “negligent supervision” and “negligent management” of the funds, which imploded during the financial crisis.
Until now, claims against Citi’s municipal arbitrage vehicles have typically accused the bank of downplaying the risks of investing in the funds — not of running them poorly.
This was the first time a panel explicitly found Citi mismanaged the funds, according to J. Boyd Page, a senior partner at law firm Page Perry, based in Atlanta.
The distinction could be pivotal.
Citi began offering the muni arbitrage vehicles in 2002.
The statute of limitations may have run out on an investor who felt deceived nine years ago and now wanted to allege material omission or misrepresentation, Page explained.
An investor alleging that Citi mismanaged the vehicles in 2007 or 2008, though, still has what Page calls “an actionable claim.”
One panel’s ruling does not establish precedent for another. Still, last month’s ruling opened up an opportunity for the earlier investors in these vehicles — who Page estimated represent $500 million to $700 million of the total $2 billion invested in the funds — to make claims many thought were no longer timely, he said.
“It tells a lot of people that there are still very viable claims,” Page said.
Last month’s Kamza ruling inspired Page Perry to establish a joint venture with Robert Wayne Pearce — the Boca Raton-based lawyer who won the award — devoted to pursuing these types of claims.
In a statement, a spokesman for Citi said: “Panels have reached inconsistent decisions on these claims, which we continue to believe are meritless.”
The description of inconsistency is true. Each panel has different members, panels never explain why they rule the way they do, and awards in these claims have ranged from zero to full recovery plus recuperation of fees.
FINRA panels have issued at least nine awards in disputes over the vehicles.
Three of the awards have been for zero. Six have been for a total of more than $5 million, with the great majority of the dollar value of these awards coming since May.
These proceedings concern a group of hedge funds Citigroup created to arbitrage the municipal yield curve.
A common structure last decade, muni arbitrage entails buying long-term municipal bonds and selling notes that pay a short-term municipal rate.
The idea is that the muni yield curve is too steep — a fund can profit by collecting a long-term municipal rate and paying a short-term one.
These structures were typically hedged using a taxable rate, such as the London Interbank Offered Rate. The hedges were designed to ensure the value of the position only changed because of shifts in the slope of the yield curve, not because of changes in the overall level of interest rates.
The hedges only worked if Libor moved in concert with municipal borrowing costs.
When the traditional correlation between Libor and municipal rates unmoored — as most traditional correlations did during the financial crisis — the arbitrage funds became insolvent.
Phil Aidikoff, a lawyer who has won more than $2 million for plaintiffs seeking redress from Citi municipal arbitrage vehicles, said clients in these cases typically allege the company depicted the investments inaccurately.
“Our claims are based on a failure to properly represent the true risk of the muni arbitrage strategy,” Aidikoff said.
Citi told brokers to push these vehicles as fixed-income products with slight volatility and little or no risk of loss of principal, Aidikoff said. In fact, their heavy leverage and reliance on traditional relationships between different types of interest rates made them vulnerable to slight dislocations.
Aidikoff’s firm has more than 40 more such cases pending before arbitration panels.
According to a report Page and Pearce distributed to clients, a new type of claim is now tenable. Rather than arguing Citi misled investors by papering over risks, they plan to argue Citi ran the funds badly.
Citi presented certain strategies for how it intended to run the funds, according to the report. This mostly entailed buying municipals when the ratio of muni yields to Treasury yields was high, and selling them when the ratio was low. In bond vernacular, that means buying when munis were “cheap” and selling when they were “rich.”
Page and Pearce claim Citi ignored this, buying when it should have been selling based on its own strategy.
Page said his firm has 30 to 40 cases pending before FINRA, Pearce has another 10, and the joint venture is working with six to eight investors on new claims.
