Citigroup Sued for Fraud Over $1 Billion of CDOs -Loreley Financing v. Citigroup Complaint

8/3/2019 Citigroup Sued for Fraud Over $1 Billion of CDOs -Loreley Financing v. Citigroup Complaint

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SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK

LORELEY FINANCING (JERSEY) NO. 3 LTD.;

LORELEY FINANCING (JERSEY) NO. 5 LTD.;LORELEY FINANCING (JERSEY) NO. 6 LTD.;



LORELEY FINANCING (JERSEY) NO. 27 LTD.;LORELEY FINANCING (JERSEY) NO. 29 LTD.;


and LORELEY FINANCING (JERSEY) NO. 32

LTD.,Plaintiffs,

-v-

CITIGROUP GLOBAL MARKETS INC.;

CITIBANK, N.A.; CITIGROUP GLOBAL

MARKETS LIMITED; LACERTA ABS CDO2006-1, LTD.; LACERTA ABS CDO 2006-1,

CORP.; USP SPC; COOKSON SPC; PINNACLE

PEAK CDO I, LTD.; PINNACLE PEAK CDO I,

LLC; CLOVERIE PLC; PLETTENBERG BAY

CDO LIMITED; and PLETTENBERG BAY CDOCORP.;

Defendants.

Index No.

Date Purchased: January 24, 2012

Plaintiffs designate New York

County as the place of trial

The basis of venue is CPLR Article 5,

including CPLR 501, 503, and 509

SUMMONS

TO THE ABOVE NAMED DEFENDANTS:

YOU ARE HEREBY SUMMONED to answer the Complaint in this action and to serve a

copy of your answer, or if the Complaint is not served with this summons, to serve a notice of

appearance on Plaintiffs attorneys within 20 days after the service of this summons, exclusive of

the day of service (or within 30 days after the service is complete if this summons is not

personally delivered to you within the State of New York); and in the case of your failure to

ILED: NEW YORK COUNTY CLERK 01/24/2012 INDEX NO. 650212/

YSCEF DOC. NO. 1 RECEIVED NYSCEF: 01/24/


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appear or answer, judgment will be taken against you by default for the relief demanded in the

Complaint.

Dated: New York, NY

January 24, 2012

KASOWITZ, BENSON, TORRES

& FRIEDMAN LLP

By: /s/ Marc E. Kasowitz

Marc E. Kasowitz ([email protected])

Sheron Korpus ([email protected])

1633 Broadway

New York, New York 10019(212) 506-1700

James M. Ringer

MEISTER SEELIG & FEIN LLP140 East 45th Street, 19th Floor

New York, NY 10017

(212) 655-3500

Stephen M. Plotnick

CARTER LEDYARD&MILBURNLLP

2 Wall StreetNew York, NY 10005-2072

(212) 732-3200

Attorneys for Plaintiffs Loreley Financing (Jersey) No.

3 Ltd.; Loreley Financing (Jersey) No. 5 Ltd.; Loreley

Financing (Jersey) No. 6 Ltd.; Loreley Financing

(Jersey) No. 7 Ltd.; Loreley Financing (Jersey) No. 25

Ltd.; Loreley Financing (Jersey) No. 27 Ltd.; Loreley

Financing (Jersey) No. 29 Ltd.; Loreley Financing

(Jersey) No. 31 Ltd. and Loreley Financing (Jersey)

No. 32 Ltd.


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Defendants Addresses:

Citigroup Global Markets Inc.

390 Greenwich Street

New York, New York 10013

Citibank, N.A.

399 Park Avenue

New York, New York, 10043

Citigroup Global Markets Limited

Citigroup Centre33 Canada Square

Canary Wharf, London

E14 5LB

United Kingdom

Lacerta ABS CDO 2006-1, Ltd.

c/o Maples Finance LimitedQueensgate House

P.O. Box 1093 GT

South Church Street, George Town

Grand Cayman, Cayman Islands

Lacerta ABS CDO 2006-1, Corp.

c/o Donald J. Puglisi850 Library Avenue, Suite 204

Newark, Delaware 19711

USP SPCc/o Maples Finance Limited

P.O. Box 1093 GT

Queensgate HouseSouth Church Street, George Town


Cookson SPC

c/o Maples Finance Limited

P.O. Box 1093 GT

Queensgate HouseSouth Church Street, George Town


Pinnacle Peak CDO I, Ltd.c/o Maples Finance Limited

P.O. Box 1093 GT

Queensgate House


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South Church Street, George Town


Pinnacle Peak CDO I, LLC

c/o Puglisi & Associates

850 Library Avenue, Suite 204Newark, Delaware 19711

Cloverie Plc1 North Wall Quay

International Financial Services Centre

Dublin 1Ireland

Plettenberg Bay CDO Limited

c/o AIB Financial Services Limited

AIB International CentreIFSC, Dublin 1

Ireland

Plettenberg Bay CDO Corp.

c/o Puglisi & Associates

850 Library Avenue, Suite 204Newark, Delaware 19711


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SUPREME COURT OF THE STATE OF NEW YORKCOUNTY OF NEW YORK

LORELEY FINANCING (JERSEY) NO. 3 LTD.;LORELEY FINANCING (JERSEY) NO. 5 LTD.;LORELEY FINANCING (JERSEY) NO. 6 LTD.;LORELEY FINANCING (JERSEY) NO. 7 LTD.;LORELEY FINANCING (JERSEY) NO. 25 LTD.;LORELEY FINANCING (JERSEY) NO. 27 LTD.;LORELEY FINANCING (JERSEY) NO. 29 LTD.;LORELEY FINANCING (JERSEY) NO. 31 LTD.;and LORELEY FINANCING (JERSEY) NO. 32 LTD.,

Index No. ______________

Plaintiffs, COMPLAINT

-v-

CITIGROUP GLOBAL MARKETS INC.; CITIBANK,N.A.; CITIGROUP GLOBAL MARKETS LIMITED;LACERTA ABS CDO 2006-1, LTD.; LACERTA ABSCDO 2006-1, CORP.; USP SPC; COOKSON SPC;PINNACLE PEAK CDO I, LTD.; PINNACLE PEAKCDO I, LLC; CLOVERIE PLC; PLETTENBERG BAYCDO LIMITED; and PLETTENBERG BAY CDOCORP.

Defendants.


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TABLE OF CONTENTS

Page

SUMMARY OF THE ACTION ..................................................................................................... 1THE PARTIES................................................................................................................................ 7

A. The Plaintiffs ............................................................................................................... 7B. The Defendants ............................................................................................................ 8

JURISDICTION AND VENUE ................................................................................................... 11FACTUAL ALLEGATIONS ....................................................................................................... 12

I. Background on Plaintiffs and Their Investment Advisor ..................................................12A. Plaintiffs Decision to Invest in CDOs ...................................................................... 12B. Plaintiffs Reliance on Citigroup ............................................................................... 15

II. Citigroups Decision to Profit from the Collapse of the Subprime HousingMarket on the Backs of Unsuspecting Long Investors like Plaintiffs ...............................16

A. Citigroups Access to Specialized Information, Unavailable to Plaintiffs,Concerning Subprime Mortgages, RMBS, and CDOs .............................................. 16

B. Citigroups Inside Knowledge of the Deterioration and Imminent Collapse of theSubprime Capital Markets ......................................................................................... 18

C. Citigroups Inside Knowledge that the Collateral in CDOs It Was Arranging WasToxic .......................................................................................................................... 23

D. Citigroups Inside Knowledge of Impending Downgrades in the RMBS and CDOMarkets ...................................................................................................................... 27

III. Through Material Misrepresentations and Omissions, Defendants InducedPlaintiffs into Investing Nearly $1 Billion in CDOs Designed to Fail ..............................29

A. The Lacerta CDO ....................................................................................................... 30B. The Jackson CDOs .................................................................................................... 37C. The Cookson CDOs ................................................................................................... 42D. The Pinnacle Peak CDO ............................................................................................ 48E. The ABSynth CDOs .................................................................................................. 54


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F. The Plettenberg Bay CDO ......................................................................................... 58IV. Defendants Selected Collateral That Was Not Fair Consideration for the

Obligations Undertaken by the CDOs, Leaving Them Insolvent ......................................61CAUSES OF ACTION ................................................................................................................. 62


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Plaintiffs Loreley Financing (Jersey) Nos. 3, 5, 6, 7, 25, 27, 29, 31, and 32 (each, LFJ

followed by the applicable number, and collectively, the Loreley Companies or Plaintiffs),

as and for their complaint against defendants Citigroup Global Markets Inc. (CGMI),

Citigroup Global Markets Limited (CGML, and together with CGMI, CGM), and Citibank,

N.A. (Citi, and together with CGM, Citigroup); Lacerta ABS CDO 2006-1, Ltd. (Lacerta

Ltd.) and Lacerta ABS CDO 2006-1, Corp. (Lacerta Corp., and together with Lacerta Ltd.,

Lacerta); USP SPC (USP or Jackson); Cookson SPC (Cookson); Pinnacle Peak CDO I,

Ltd. (Pinnacle Peak Ltd.) and Pinnacle Peak CDO I, LLC (Pinnacle Peak LLC, and together

with Pinnacle Peak Ltd., Pinnacle Peak); Cloverie Plc (Cloverieor ABSynth); Plettenberg

Bay CDO Limited (Plettenberg Bay Ltd.) and Plettenberg Bay CDO Corp. (Plettenberg Bay

Corp., and together with Plettenberg Bay Ltd., Plettenberg Bay; together with Lacerta,

Jackson, Cookson, ABSynth and Pinnacle Peak, the Issuers, and with Citigroup, collectively,

Defendants), respectfully allege on knowledge as to themselves and their own actions, and on

information and belief as to all other matters, as follows:

SUMMARY OF THE ACTION

1. This action arises out of Defendants false and misleading misrepresentations andomissions in arranging, marketing, and inducing Plaintiffs, a group of affiliated investment

companies, to invest nearly $1 billion in a series of fraudulent collateralized debt obligations

(CDOs). Each of these CDOs Lacerta, Jackson, Cookson, Pinnacle Peak, ABSynth, and

Plettenberg Bay was in reality a fraudulent investment vehicle created and exploited by

Defendants for their own benefit.

2. From 2000 to 2006, Citigroup earned increasingly large returns from originatingsubprime mortgages, securitizing them into residential mortgage- backed securities (RMBS),


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arranging CDOs, and underwriting other structured finance transactions derived from subprime

mortgages. When the overheated housing market began to cool in 2006, the market for

subprime-based financial products began to decline. Yet Citigroup was accustomed to these

profits. In now infamous words, Citigroups then-CEO Chuck Prince said in July 2007, literally

days before the subprime market collapse, As long as the music is playing, youve got to get up

and dance,and added, Were still dancing.1

3. By early 2007, Citigroup knew that even the most senior tranches of CDOs werefar more risky than their ratings suggested. Citigroups peculiar knowledge was based on

information on individual loan performance that was available only to financial institutions that,

like Citigroup, originated subprime mortgages and securitized them into RMBS. As a result of

its insiders knowledge, Citigroup knew that the RMBS it and other major banks were packaging

into CDOs included a significant percentage of subprime mortgages that violated basic

underwriting standards and were likely to defaultmaking the RMBS assets and the CDOs that

rested on them far less secure than portrayed by their ratings. Rather than disclosing these

material facts to investors in the deals it arranged, Citigroup concealed them so that it could

offload some of the massive exposure to subprime RMBS that Citigroup carried on its own

balance sheet to unsuspecting investorswhile at the same time continuing to earn lucrative fees

from generating CDOs and used its position to transfer its risk to Plaintiffs and other long

investors in Citigroup CDOs.2

1Michiyo Nakamoto & David Wighton, Citigroup Chief Stays Bullish on Buy-Outs, Financial

Times, July 9, 2007, http://www.ft.com/cms/s/0/80e2987a-2e50-11dc-821c-0000779fd2ac.html#axzz1jdQ16vwk.

2An investor who takes a long position in a security stands to gain when the security performsor increases in value; by contrast, an investor who stands to profit when the security fails toperform or falls in value is referred to as having a short position or to be short that security.


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4. Indeed, to continue generating outsized profits in a market that it knew, as aninsider, was doomed to collapse sooner rather than later, Citigroup began arranging fraudulent

CDOs for its own benefit and for the benefit of certain preferred clients who wanted to short

the housing market (i.e., to bet that subprime securities would fail). Citigroup also used these

CDOs to offload the risk of toxic RMBS and CDO assets that Citigroup carried on its own books

by concealing key facts that were peculiarly within its knowledge, while at the same time

knowingly misrepresenting to unsuspecting long investors that these assets were of high quality.

5. For example, Citigroup colluded secretly with a now-notorious hedge fund knownas Magnetar Capital LLC (Magnetar) to create six of Magnetars infamous Constellation

CDO deals in which Magnetar secretly controlled, undisclosed to investors, critical deal features

(including the choice of collateral) to further its scheme to profit from short bets against the

housing market. Citigroup benefited from this deceptive scheme by reaping tens of millions of

dollars in fees. Working closely with Citigroup, Magnetar purchased the hard-to-sell equity

tranches of these CDOs (which carried the most risk) at discounted prices, while using the

returns to finance inexpensive short bets against those same CDOs by secretly buying credit

protection via credit default swaps (CDS) on those reference portfolios, as well as CDS

contracts referencing tranches of the CDOs themselves. As Magnetar and Citigroup expected,

the CDS contracts generated substantial net profits for Magnetar when the CDOs failed.

6. Citigroup marketed Lacerta, a Constellation CDO, to Plaintiffs as a legitimatelong investment opportunity meeting Plaintiffs stringent investment requirements, representing

that its portfolio was selected solely to create a long investment for equity and mezzanine

investors. Citigroup did not disclose the material fact that Magnetara party that stood to reap

massive profits from the collapse of the housing market was actually dictating the collateral


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selection criteria and deal structure of Lacertabehind the scenes. Magnetars economic interests

as a net-short investor were directly adverse to those of long investors like Plaintiffs. Moreover,

also unbeknownst to Plaintiffs, Citigroup caused the Lacerta CDO to, in effect, sell CDS

contracts to Magnetar at below-market prices. In short, Citigroup helped Magnetar stack the

deck in its favor so that Magnetar would win no matter what cards were dealt. None of this was

disclosed to Plaintiffs.

7. Lacerta was not the only CDO that Citigroup arranged at the behest of a shortinvestor. Like Citigroup, Morgan Stanley & Co., Inc. (Morgan Stanley) purchased subprime

loans that it packaged into RMBS for sale to unsuspecting investors. Also like Citigroup,

Morgan Stanley learned through non-public due diligence reports that a substantial percentage of

these loans did not conform to applicable underwriting guidelines, thus rendering the RMBS it

was selling much riskier than their credit ratings suggested. Because Morgan Stanley had been

unable to sell many of its RMBS directly and needed to offload its exposure to them, it colluded

with Citigroup to create the Jackson CDOswhich were purportedly arranged by Citigroup, but

were actually constructed by Morgan Stanley to permit it to buy protection on the very toxic

securities it had created and could not sell. Citigroup participated in this deception in order to

earn lucrative fees for arranging the transaction.

8. Although it was obviously material information, Citigroup never disclosed toPlaintiffsand indeed affirmatively misrepresentedthe fact that Morgan Stanley had not only

selected the reference assets in Jackson from its own toxic portfolio, but was betting on the

failure of those same assets. Before making this investment, Plaintiffs investment advisor asked

Citigroup point-blank who was on the other side of this transaction, and Citigroup lied, falsely

claiming that its CDS customer was a hedge fund that wanted to hedge its exposure to certain


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investments, not an investment bank that wanted to unload risk it was unable to sell in the

market. If Plaintiffs had known the truththat one investment bank was paying a competitor to

arrange CDOs for itPlaintiffs would not have purchased $100 million in Jackson notes.

9. Citigroup also sold Plaintiffs $600 million of notes in a series of synthetic CDOsknown as Cookson. Via CDS contracts, the Cookson CDOs sold credit protection to a

Citigroup affiliate on a pool of 80 referenced CDOs in which Citigroup owned senior positions,

thereby shifting the risk of losses on those positions from Citigroup to Plaintiffs. If just five of

the referenced CDOs failed, the Citigroup affiliate would cash in on its CDS while Plaintiffs

would lose their entire investment. In fact, based on its peculiar knowledge of the performance

(or lack thereof) of its subprime mortgages, Citigroup knew that these positions which were

highly rated and appeared outwardly to investors like Plaintiffs to be risk-remote were in

reality facing a heightened risk of imminent collapse.

10. Citigroup deliberately concealed this material information from Plaintiffs,intentionally misleading them into believing that the referenced assets and thus Plaintiffs

investment in the Cookson deals were risk-remote. In its marketing materials, Citigroup

described the Cookson notes as among the most secure investments imaginable a 1 on a scale

of 1 to 10,000.

11. In reality, nearly 19% of the Cookson portfolios referenced other CDOs thatCitigroup itself had arranged. Citigroup knew that those CDOs were composed of Citigroup-

securitized RMBS containing high percentages of non-conforming subprime loans. Further,

almost 23% of the referenced CDOs in the Cookson portfolios were tranches of Constellation

CDOs. Citigroup knew, based upon its experience as an arranger of several Constellation CDOs,

that the portfolios of those CDOs had been constructed to the specifications of Magnetar a


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short trader whose economic interests were diametrically opposed to those of Plaintiffs.

Citigroup knewbut did not disclose to Plaintiffsthat these toxic reference assets rendered the

protections that were supposed to be underlying Plaintiffs notes illusory, and that Plaintiffs were

likely to lose their entire investment. In short, Citigroup used the Cookson CDOs to shift its

exposure and anticipated losses from its own balance sheet to Plaintiffs.

12. Other CDOs that Citigroup arranged, marketed, and sold to Plaintiffs followedsimilar patterns. For instance, Plaintiffs were induced to invest $70 million in the Pinnacle Peak

CDO, a managed deal whose asset portfolio was falsely represented to have been selected by an

independent collateral manager that would conduct substantial analytical review of the collateral

and act in the best interests of investors. In reality, Citigroup used Pinnacle Peak to offload

tranches of other Constellation CDOs that Citigroup knew had been arranged at the behest of a

short-trader, to dump otherwise unsellable CDOs that had been arranged by Citigroup, and to

dispose of toxic RMBS. Contrary to its false and misleading representations, Citigroup knew but

failed to disclose to Plaintiffs that the assets underlying the Pinnacle Peak CDO were so poor that

Plaintiffs investment was effectively doomed to fail and was worthless from inception.

13. In truth, Citigroup arranged CDOs like Pinnacle Peak to serve as buyers fortranches of other CDOs that Citigroup had previously arranged and retained on its own books.

Thus, Citigroup was essentially running a shell game, creating the false appearance of a market

whereby Citigroup-arranged CDOs acted as buyers and sellers of each others tranches.

Plaintiffs did not know, nor could they have known, that they were victims of this scheme.

14. To recover the almost $1 billion they paid for these and other fraudulentinvestments which are now worthless, Plaintiffs assert claims seeking damages and rescission

based on fraud, fraudulent conveyance, and unjust enrichment.


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THE PARTIES

A. The Plaintiffs15. Plaintiff LFJ 3 is a company organized and existing under the laws of Jersey,

Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff

LFJ 3 invested in and is the owner of $150 million Class A notes issued in connection with the

Cookson I CDO.

16. Plaintiff LFJ 5 is a company organized and existing under the laws of Jersey,Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff


Cookson IV CDO.



Cookson IV CDO and $25 million Class A-1 notes issued in connection with the Plettenberg Bay

CDOs.



Cookson IV CDO.


LFJ 25 invested in and is the owner of $50 million Class IA and $50 million Class IIA notes

issued in connection with the Jackson CDOs.


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LFJ 27 invested in and is the owner of $70 million Class A-1 notes issued in connection with the

Lacerta CDO.


LFJ 29 invested in and is the owner of $80 million Class B notes and $20 million Class C notes

issued by Cloverie in connection with the ABSynth CDOs.

22.

Plaintiff LFJ 31 is a company organized and existing under the laws of Jersey,

Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff


Cookson II CDO and $150 million Class A notes issued in connection with the Cookson III

CDO.


LFJ 32 invested in and is the owner of $70 million Class A3 notes issued in connection with the

Pinnacle Peak CDO.

B. The Defendants

24. Defendant Lacerta Ltd. is a Cayman Islands limited liability company located atc/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South Church Street,

George Town, Grand Cayman, Cayman Islands. Lacerta Ltd. is the issuer of the Lacerta notes

owned by Plaintiff LFJ 27.


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25. Defendant Lacerta Corp. is a Delaware corporation located at c/o Donald J.Puglisi, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Lacerta Corp. is the co-issuer

of the Lacerta notes owned by Plaintiff LFJ 27.

26. Defendant USP is a Cayman Islands limited liability segregated portfoliocompany located at c/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South

Church Street, Grand Cayman, Cayman Islands. USP is the issuer of the Jackson notes owned

by Plaintiff LFJ 25.

27. Defendant Cookson is a Cayman Islands limited liability segregated portfoliocompany located at c/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South

Church Street, George Town, Grand Cayman, Cayman Islands. Cookson is the issuer of the

Cookson I notes owned by Plaintiff LFJ 3, the Cookson II notes and the Cookson III notes

owned by Plaintiff LFJ 31, and the Cookson IV notes owned by Plaintiffs LFJ 5, LFJ 6, and LFJ

7.

28. Defendant Pinnacle Peak Ltd. is a Cayman Islands limited liability companylocated at P.O. Box 1093 GT, Queensgate House, South Church Street, George Town, Grand

Cayman, Cayman Islands. Pinnacle Peak Ltd. is the issuer of the Pinnacle Peak notes owned by

Plaintiff LFJ 32.

29. Defendant Pinnacle Peak LLC is a Delaware limited liability company located atc/o Puglisi & Associates, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Pinnacle

Peak LLC is the co-issuer of the Pinnacle Peak notes owned by Plaintiff LFJ 32.

30. Defendant Cloverie is an Irish limited liability company located at 1 North WallQuay, International Financial Services Centre, Dublin 1, Ireland. Cloverie is the issuer of the

ABSynth notes owned by Plaintiff LFJ 29.


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31. Defendant Plettenberg Bay Ltd. is an Irish limited liability company located at c/oAIB Financial Services Limited, AIB International Centre, IFSC, Dublin 1, Ireland. Plettenberg

Bay Ltd. is the issuer of the Plettenberg Bay notes owned by Plaintiff LFJ 6.

32. Defendant Plettenberg Bay Corp. is a Delaware corporation located at c/o Puglisi& Associates, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Plettenberg Bay Corp.

is the co-issuer of the Plettenberg Bay notes owned by Plaintiff LFJ 6.

33. Collectively, Defendants Lacerta, Cookson, USP, Pinnacle Peak, Cloverie andPlettenberg Bay are referred to as the Issuers.

34.

Defendant CGMI is a New York corporation located at 390 Greenwich Street,

New York, New York 10013. CGMI is a registered broker-dealer and serves as a brokerage and

securities arm of Citigroup Inc. CGMI was the arranger of the Lacerta, Jackson, Cookson,

Pinnacle Peak and Plettenberg Bay CDOs.

35. Defendant CGML is a United Kingdom limited-liability company located atCitigroup Centre, 33 Canada Square, Canary Wharf, London E14 5LB, United Kingdom.

CGML was the arranger for the ABSynth CDOs. CGML was also the counterparty to the Class

S swap in the Plettenberg Bay CDO and on the CDS in the ABSynth CDOs. CGML worked

with Defendant CGMI to perpetrate the ABSynth fraud described herein by selecting CDOs and

RMBS that CGMI had arranged as referenced assets for the ABSynth notes.

36. CGMI and CGML were the underwriters and direct sellers of the Lacerta, JacksonCookson, Pinnacle Peak, ABSynth, and Plettenberg Bay notes purchased by Plaintiffs.

37. Defendant Citi is a chartered national banking association located at 399 ParkAvenue, New York, New York 10043. Citi also has a London-based affiliate, which is a foreign

registered commercial banking institution located at Citigroup Centre, 33 Canada Square, Canary


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Wharf, London E14 5LB, United Kingdom. Citi was the counterparty to the CDS issued by the

Lacerta, Jackson, Cookson, Pinnacle Peak and Plettenberg Bay CDOs.

JURISDICTION AND VENUE

38. This Court has jurisdiction over Defendants pursuant to CPLR 301 and 302.Defendants CGMI and Citi maintain offices and regularly conduct business in New York, and

orchestrated the fraudulent schemes at issue in and from New York. All Defendants transacted

business within New York that gives rise to Plaintiffs causes of action. Defendants committed

the wrongful acts alleged herein in New York. All Defendants regularly transact business within

New York and contract to provide services within New York.

39. Moreover, the relevant documents governing the Lacerta, Jackson, Cookson,Pinnacle Peak, and Plettenberg Bay CDOs each provide for an express submission to jurisdiction

in the State of New York, County of New York.

40. Venue in New York County is proper pursuant to CPLR 501, 503 and 509.CGMI and Citi reside in this county. The relevant documents governing the Lacerta, Jackson,

Cookson, Pinnacle Peak and Plettenberg Bay CDOs each provide for venue in the State of New

York, County of New York. Additionally, Defendants committed many of the alleged wrongful

acts at issue in and from the County of New York.

41. This action is appropriately assigned to the Commercial Division of the SupremeCourt of the State of New York, County of New York, pursuant to the Rules of the Commercial

Division of the Supreme Court, including 202.70 of the Uniform Rules for New York State

Trial Courts.


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FACTUAL ALLEGATIONS

I. Background on Plaintiffs and Their Investment Advisor

A. Plaintiffs Decision to Invest in CDOs

42. Plaintiffs are special purpose entities formed to invest in CDOs on a long-term,buy-and-hold basis.

43. A CDO is an investment vehicle that typically includes the formation of a specialpurpose entity, commonly referred to as the issuer, that raises money by issuing securities to

investors. Generally, an arranging bank creates the issuer in order to acquire a portfolio of

investment assets whose cash flow is the expected source of income for various classes, or

tranches, of debt securities that are marketed and sold to investors.3

44. The investors in the CDO, which include noteholders and equity investors, arepaid from the proceeds generated by the collateral. Amounts are paid out to investors according

to a defined priority (known as a waterfall). The most senior tranches of notes, which have the

lowest risk of loss and highest credit rating, typically receive principal and interest first. The

junior tranches have the highest risk of loss and lowest credit rating (with the exception of the

equity tranche, which typically is not rated).

45. Banks that arrange CDOs typically perform multiple roles, including: (a)structuring and modeling the CDOs; (b) marketing and selling them to investors; (c) interfacing

with ratings agencies to achieve the targeted ratings for the CDOs tranches; (d) financing and

3The assets in a CDOs portfolio can be comprised of cash assets (such as RMBS), syntheticassets, or both. Synthetic assets include CDS contracts, transactions resembling an insurancecontract whereby a protection buyer pays a protection seller periodic premiums (similar toinsurance premiums) in return for the protection sellers promise to pay the protection buyershould certain credit events occur, such as events of payment default, loss, write-down, or adeterioration in ratings. A CDO containing both cash and synthetic assets is referred to as ahybrid CDO.


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facilitating the purchases of the cash collateral and holding that collateral on their own books

prior to closing; and (e) facilitating hybrid structures by acting as the initial protection buyer for

CDS included in the synthetic collateral pool. Moreover, because the special purpose vehicle

that serves as the deals issuer does not have any employees of its own, the arranging banks

usually act for the issuer and serve as the initial purchasers, buying all of the notes from the

issuer at closing and then selling them to investors. For performing these functions, arranging

banks typically receive millions of dollars in fees at closing.

46. IKB Deutsche Industriebank AG, along with its former affiliate IKB Credit AssetManagement GmbH (collectively, IKB), was contractually appointed as investment advisor to

Plaintiffs. Plaintiffs investment advisor identified potential investments in CDOs and performed

due diligence on behalf of Plaintiffs prior to making investment recommendations to them.

47. At all relevant times, Defendants knew that IKB served as Plaintiffs investmentadvisor and that IKB performed due diligence on and recommended CDO investments

including the investments at issue in this lawsuitto Plaintiffs.

48. Citigroup and the other Defendants represented to Plaintiffs that independent andexperienced collateral managers would select and manage the collateral portfolios for the

Pinnacle Peak and Plettenberg Bay CDOs for the benefit of long investors such as Plaintiffs,

whose profits are dependent on the success of the CDO. The long investors typically pay the

collateral manager a percentage of the notional value of the transaction (i.e., the total deal

issuance) as a fee.

49. The collateral managers role is material to a long investors investment decisionbecause the collateral manager is supposed to be responsible for the CDOs risk profile and

performance through its selection of collateral. For that reason, Plaintiffs investment advisor


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conducted extensive due diligence on collateral managers. The collateral manager has a duty to

analyze and select collateral with the best risk/return profile and which fits the investors

eligibility criteria, to monitor the credit status of the individual underlying assets, to reinvest

payment proceeds from maturing underlying assets, and to make allowed substitutions in the

collateral to maximize long investors profits.

50. The performance of the collateral selected for a CDO is critical to the dealssuccess. As Defendants were aware, neither Plaintiffs nor their investment advisor had close

relationships with loan servicers or originators, or access to the loan-level information for the

mortgages underlying the CDO deals in which Plaintiffs invested, and therefore could not

conduct due diligence on a loan-by-loan basis, which was essential to valuing a CDOs

collateral. Therefore, the involvement of a qualified, independent collateral manager committed

to identifying and selecting the highest quality and best mix of eligible collateral in the best

interests of the CDOs long investors was a material factor in Plaintiffs investment decisions

and the recommendations of their investment advisor. For managed deals, Plaintiffs sought out

experienced and independent collateral managers who were committed to selecting and

managing the collateral for the benefit of investors and the CDOs success.

51. Plaintiffs investment decisions also were based on the ratings assigned toprospective CDO investments and their underlying collateral as indicators of the risks associated

with potential investments.4

Like many other CDO investors, Plaintiffs focused on highly-rated

tranches (primarily AAA and AA).5

4Ratings agencies typically assign credit ratings to the various tranches of a CDO (except for the

equity tranche). For the purposes of this complaint, and unless stated otherwise, any reference toa particular rating refers to the Standard & Poors ratings categories.

5According to Standard & Poors, arating of AAA signifies an [e]xtremely strong capacity tomeet financial commitments, and a rating of AA signifies a [v]ery strong capacity to meet


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B. Plaintiffs Reliance on Citigroup

52. Citigroup had a longstanding business relationship with Plaintiffs through theirinvestment advisor. Citigroup promoted itself to Plaintiffs investment advisor as a leader in

structured finance CDOs, listing its track record with billions of dollars in structured credit

transactions that either had already closed or were in the pipeline.

53. Plaintiffs investment advisor specifically reviewed Plaintiffs investment strategyand guidelines with Citigroup, in detail, during meetings, phone conversations and in various e-

mails. Citigroup was also intimately familiar with Plaintiffs investment program and criteria, as

well as IKBs role as investment advisor to the Plaintiffs.

54. Between 2005 and 2007, Plaintiffs investment advisor recommended toPlaintiffs, and other related special-purpose entities, investments in 20 Citigroup-arranged CDOs

totaling approximately $1.8 billion. Citigroup was among the largest and most trusted arrangers

of CDO investments for Plaintiffs.

55. Based on its deep and lengthy business relationship with Plaintiffs investmentadvisor and detailed knowledge of Plaintiffs investment program and objectives, Citigroup

knew that over the course of 2006 and 2007, Plaintiffs had become increasingly interested in

highly-rated CDOs with the most secure structures.

56. Plaintiffs and their investment advisor reasonably relied on Citigroup to presentonly those CDOs that met Plaintiffs stringent standards.

financial commitments. See Credit Ratings Definitions & FAQs, Standard & Poors,http://www.standardandpoors.com/ ratings/definitions-and-faqs/en/us.


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II. Citigroups Decision to Profit from the Collapse of the Subprime HousingMarket on the Backs of Unsuspecting Long Investors like Plaintiffs

A. Citigroups Access to Specialized Information, Unavailableto Plaintiffs, Concerning Subprime Mortgages, RMBS, and CDOs

57. Citigroup was a major player at multiple levels of the subprime capital market: itacted as a mortgage originator, an underwriter of subprime RMBS, and an arranger of structured

finance products, like CDOs, that invested in RMBS. Because of these multiple roles, Citigroup

gained a unique perspective and obtained peculiar knowledgeunavailable to Plaintiffs and their

investment advisor concerning the deteriorating condition and imminent collapse of the

subprime market and the quality of the CDOs it was promoting.

58. For example, in its consumer lending business unit, Citigroup held prime andsubprime mortgages that it had originated itself or purchased from third parties through the

Citigroup mortgage lending subsidiary, CitiFinancial Mortgage (CitiFinancial). Citigroup

securitized these mortgages into RMBS, which it either sold to institutional investors directly or

placed into CDOs and other structured finance products that it arranged.

59. Within the investment banking business unit, Citigroup held subprime mortgagesfor securitization and trading, subprime RMBS that Citigroup warehoused, and tranches of

CDOs that Citigroup had previously arranged but had not sold.6

60. From 2005 to 2007, Citigroup arranged nearly $110 billion of CDOs. During thatperiod, Citigroup rose from the worlds fourth-largest arranger of mortgage-backed CDOs to the

6SeeSubprime Lending and Securitization and Government Sponsored Enterprises: Hearing

Before the Financial Crisis Inquiry Commission,127:16-25 to 128:1-17 (Apr. 7, 2010)(testimony of Susan Mills, Managing Director of Mortgage Finance, Citi Markets & Banking,Global Securitized Markets), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdf.


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largestand received hundreds of millions of dollars in associated fees. Citigroup reaped over

$347 million in fees from CDO transactions in 2007 alone.

Collateralized Debt Obligations Issuances (2007)*

Rank Bank 2007 Issuance ($Mil.) No. of Deals Market Share (%)

1 Citigroup $41,975.10 60 10.0

2 Merrill Lynch 38,055.10 55 9.0

3 Deutsche Bank 31,495.70 51 7.5

4 Barclays 28,004.90 29 6.7

5 Wachovia 23,210.10 48 5.5

*Includes CDOs of CMBS

Source:Bookrunners of Worldwide Collateralized Debt Obligations in 2008,Asset-Backed Alert(Dec. 31, 2008),http://www.abalert.com/ranking.php?rid=1756.

61. Although it sold the equity, mezzanine, and some of the senior tranches of theseCDOs, Citigroup retained other senior tranches, typically known as super-senior tranches,

which were considered extremely safe and secure.7

62. In a continuously rising housing market and healthy economy, Citigroupssubprime-related businesses appeared to be nearly risk-free. Citigroup could make increasingly

aggressive mortgages to subprime borrowers, but see default rates remain manageable.

Citigroup could package those mortgages into RMBS, and quickly sell those RMBS to third

7Subprime Lending and Securitization and Government Sponsored Enterprises: Hearing Before

the Fin. Crisis Inquiry Commn.. 261:18-24 (Apr. 7, 2010) (testimony of Nestor Dominguez,Former Co-Head of Global CDOs, Citigroup), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdf (hereinafter, Dominguez Testimony Transcript) (OurCDO business model called for distributing all the securities that resulted from our CDOstructuring activities except the most senior tranches of specific transactions that were structuredto be held on Citis balance sheet. These retained positions were referred to in the market as

super senior . . . .). As recounted by the FCIC, there were at least two additional reasons forretaining these tranches. First, the favorable capital treatment of AAA rated securities requiredbanks to hold relatively less capital against them. SeeFin. Crisis Inquiry Commn.., TheFinancial Crisis Inquiry Report: Final Report of the National Commission on the Causes of theFinancial and Economic Crisis in the United States196 (2011) (hereinafter, FCIC Report).Second, the super-senior and triple-A tranches were reported at values for which they could notbe sold and as a consequence the finances for creating the deal improved. Id. In essence,[i]t was a hidden subsidy of the CDO business by mispricing. Id.
http://www.abalert.com/ranking.php?rid=1756http://www.abalert.com/ranking.php?rid=1756http://www.abalert.com/ranking.php?rid=1756


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parties without taking any risk of decline. And Citigroup could also package the RMBS into

CDOs and sell those CDOs on to investors. At each step in the chain, Citigroup could pocket

additional fees while minimizing the exposure to risks from subprime RMBS on its own balance

sheet.

B. Citigroups Inside Knowledge of the Deteriorationand Imminent Collapse of the Subprime Capital Markets

63. In 2005 and 2006, Citigroup became aware that the economic foundation of itssubprime CDO and RMBS businesses were beginning to crack. Because of its insiders

perspective, Citigroup became aware that subprime borrowers were missing increasing numbers

of payments, causing higher delinquency and default rates. In some instances, those missed

payments occurred within the first three months of the mortgage loan being made, suggesting

that increasing numbers of mortgages were the product of fraudulent loan applications or

otherwise had not met lenders original underwriting guidelines. The escalating incidence of

non-conforming loans also led to heightened requests by securities issuers and intermediaries

that the loan originators take back mortgages that did not conform to underwriting criteria

specified in the loan purchase agreement (known as put backs). These factors raised the

specter of meaningful losses not just on the mortgages themselves, but on all products composed

of them. The markets for subprime RMBS and CDOs began to soften.

64. Citigroup was keenly aware of the risks that these developments posed to itsbalance sheet. As a mortgage originator and RMBS securitizer, Citigroup knew that the

subprime mortgage industry had become a house of cards teetering on the brink of collapse.

65. By early 2006, Citigroup knew that substantial volumes of the subprime (andeven prime) loans that it was purchasing from mortgage originators for securitization did not

conform to applicable underwriting standards.


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66. Richard Bowen, the former Business Chief Underwriter for Citigroups ConsumerLending Group, testified before the Financial Crisis Inquiry Commission (FCIC) that through

extensive due diligence of the mortgages Citigroup acquiredinformation that was not available

to investors like Plaintiffs he discovered that significant portions of these mortgages were

defective and failed to meet Citigroups underwriting and quality assurance standards.

67. Mr. Bowen observed that, by mid-2006, more than 60% of the prime mortgagesCitigroup purchased from originators failed to comply with Citigroups guidelines, and that the

number of defective mortgages increased to over 80% during 2007.8 Despite knowing these

mortgages were toxic, Citigroup securitized approximately 80% of them into RMBS and CDOs

and sold them to investors without disclosure of these material facts.9

68. The situation Mr. Bowen observed with respect to the subprime loans Citigroupwas acquiring and securitizing was just as dire. Citigroups policy dictated that pools of

subprime mortgages could only be purchased if underwriters applying Citigroups policy

guidelines for subprime mortgages approved a minimum of 90% of loans in the pool (or, if the

pool was extremely large, in a statistically significant sample of the pool).10 Mr. Bowen testified

that in the third quarter of 2006, the subprime loan Chief Risk Officer was changing

8SeeSubprime Lending and Securitization and Government Sponsored Enterprises: HearingBefore the Fin. Crisis Inquiry Commn. 134:24-25 to 135:1-19 (Apr. 7, 2010) (testimony ofRichard M. Bowen III, former Business Chief Underwriter, Citigroup Consumer LendingGroup),http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdf(hereinafter, Bowen Testimony Transcript).

9 See Written Testimony of Richard M. Bowen III, former Business Chief Underwriter,Citigroup Consumer Lending Group, Presented to the Fin. Crisis Inquiry Commn. at theHearing on Subprime Lending and Securitization and Government Sponsored Enterprises 6(Apr. 7, 2010), http://fcic-static.law.stanford.edu/ cdn_media/fcic-docs/2010-04-07%20Richard%20Bowen%20Written%20Testimony.pdf (hereinafter, Bowen WrittenTestimony).10Seeid. at 9.
http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdfhttp://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdfhttp://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdfhttp://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdf


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underwriters recommendations from turn down to approve in order to ensure that the loan

pool would pass the 90% approval threshold.11

Mr. Bowen further testified that, on other

occasions, Citigroup purchased subprime loan pools where only 70% of the constituent loans met

Citigroups underwriting guidelines.12

Still on other occasions, the Chief Risk Officer instructed

underwriters to assess loan pools using the originators more lenient underwriting guidelines

rather than Citigroups more stringent standards.13

69. Mr. Bowen repeatedly raised these concerns with his superiors, including theChairman of the companys Executive Committee, its Senior Risk Officer, its Chief Financial

Officer, and its Chief Auditor.

14

And if the company required any further confirmation of the red

flags its Chief Underwriter was raising, Citigroup received such confirmation from Clayton

Holdings (Clayton), the due diligence consultant Citigroup retained to examine samples of the

mortgage pools that Citigroup was purchasing in order to determine whether the sampled

mortgages conformed to applicable underwriting standards.

70. Starting in late 2005 or early 2006, Clayton reported to Citigroup that a largepercentage of the loans Citigroup had acquired for securitization were non-conforming.15 Of the

11Seeid; see also Bowen Testimony Transcript, supra note 8, at 136:14-18.

12See Bowen Written Testimony, supra note 9, at 10.

13See id.

14Seeid. at 2, 7, 13-14; see also Bowen Testimony Transcript, supra note 8, at 133:14-25,134:1-7, 135:9-19, 136:19-21, 154:16-19, 155:1-3, 175:3:18.15

Letter from Paul T. Bossidy, Chief Executive Officer, Clayton, to Phil Angelides, Chairman,Fin. Crisis Inquiry Commn. 3 (Sept. 30, 2010),http://graphics8.nytimes.com/packages/pdf/opinion/Clayton-FCIC.pdf (Clayton rolled out thissystem and its Exception Reports to our clients beginning in late 2005 and continuing throughout2006.)


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6,205 loans it reviewed for Citigroup from 2006 to the first half of 2007, Clayton flagged 42% as

failing to conform to underwriting standards.16

71. Faced with this information, basic business ethics required Citigroup do one oftwo things. First, given that at least two out of every five loans in the sample reviewed by

Clayton were defective, Citigroup should have examined the entire loan pool to identify and

remove all of the other defective loans. Indeed, Citigroup had a contractual right to put back

these non-conforming loans to the originator, requiring the original lender to repurchase such

loans from Citigroup. Alternatively, Citigroup should have disclosed both to the ratings

agencies and to potential investors that the RMBS it was underwriting were substantially

tainted with non-conforming and highly risky loans.

72. But Citigroup did neither of these things. Instead of taking steps to protectinvestors, or at least disclose these key material facts to them, Citigroup acted for its own benefit.

Rather than use the Clayton analysis to improve the quality of the RMBS it was marketing,

Citigroup instead used it to negotiate lower prices from the originators of these bad loans and

pocketed the discount for itself.

73. To make matters worse, Citigroup ignored Claytons recommendations that thebank should reject these non-conforming loans. Citigroup allowed 31% of the defective loans

Clayton found in its sample back into the loan pools, meaning that one out of every three of these

bad loans made their way into RMBS. More importantly, Citigroup made no effort to examine

any of the loans that Clayton did not review (in other words, the vast majority of loans in the

16 See FCIC Report, supra note 7, at 167; see also All Clayton Trending Reports: 1st Quarter

2006 2nd Quarter 2007 (Sept. 23, 2010), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0923-Clayton-All-Trending-Report.pdf (hereinafter, Clayton TrendingReport).


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pool17), meaning thatallof the bad loans buried in the unreviewed majority of the pool 100%

of themmade their way into RMBS and, inevitably, into CDOs of RMBS.

74. The Federal Housing Finance Agency (the FHFA)18 sued Citigroup inconnection with its subprime RMBS operations in a complaint recently filed in the Southern

District of New York.19 The FHFA alleged that Citigroup falsely represented the quality and

nature of the loans underlying over $3.5 billion worth of RMBS that Citigroup securitized and

sold to Fannie Mae and Freddie Mac. After those securities began to fail at an alarming rate,

Fannie Mae and Freddie Mac discovered massive discrepancies between the actual owner-

occupancy rates and loan-to-value ratios and what was represented by the loan originators in

prospectus supplements and other marketing and registration materials.

75. Citigroup knew but never disclosed to Plaintiffs that a substantial proportion ofthe loans underlying the RMBS assets of the CDOs it was arranging were non-conforming and

17According to testimony provided to the FCIC by Clayton personnel, the size of the loan

samples was a subject of contention between Clayton and the banks for whom it was performingdue diligence, with the banks constantly pushing for smaller sample sizes. The typical samplesize banks allowed Clayton to review was 10%, dipping as low as 5% during the height of thesubprime mortgage boom. See, e.g., Financial Crisis at the Community LevelSacramento, CA:Hearing Before the Fin. Crisis Inquiry Commn. 156:7-9, 177:15-23 (Sept. 23, 2010) (testimonyof Vicki Beal, Senior Vice President, Clayton Holdings), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0923-transcript.pdf (hereinafter, BealTestimony Transcript).

18 The FHFA is a federal agency that was created pursuant to the Housing and EconomicRecovery Act of 2008 (HERA) to oversee the Federal National Mortgage Association (FannieMae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal HomeLoan Banks. On September 6, 2008, FHFA was appointed conservator of Fannie Mae andFreddie Mac and in that capacity is authorized under HERA to bring suits on behalf of thoseentities. See 12 U.S.C. 4617(b)(2).19

See Complaint, Fed. Hous. Fin. Agency v. Citigroup, Inc. et al., No. 11-Civ-6196, 2011 WL3873301 (S.D.N.Y. Sept. 2, 2011).


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that Citigroup had negotiated a discount from the loans originators based on this defect and

pocketed the reduction as profit.20

C. Citigroups Inside Knowledge thatthe Collateral in CDOs It Was Arranging Was Toxic

76. Citigroup knew but never disclosed that the RMBS underlying its CDOs werecomposed largely of toxic mortgages that were likely to default and were not worthy of the credit

ratings given to them by the ratings agencies. In the rare instances where Citigroup experienced

push-back from the ratings agencies, Citigroup pressed for exceptions to ensure that its deals

received higher ratings than they deserved.21

77. Equally important, based on communications with Clayton, with originators, andwith other market participants, Citigroup knew or had reason to suspect that the RMBS

securitized by other underwriters that it was packing into its CDOs were similarly flawed.

Indeed, as Citigroups former CEO, Charles Prince, explained in testimony before the FCIC,

within the major investment banks including Citigroup itself the securitization of subprime

RMBS had become a factory line. As more and more of these subprime mortgages were

created as raw materials for the securitization process more and more of it was of lower and

20 See Beal Testimony Transcript, supra note 17, at 155:24-25 to 156:1-4 ([O]ur clients useClaytons due diligence to identify issues with loans, negotiate better prices on pools of loansthey are considering for purchase, and negotiate expanded representations and warranties inpurchase and sale agreements from sellers.); Jonathan R. Laing, Banks Face Another MortgageCrisis,Barrons, Nov. 20, 2010,http://online.barrons.com/article/SB50001424052970203676504575618621671054514.html#articleTabs_panel_ article%3D1 (Apparently the Clayton data were merely employed by thesecuritizers to negotiate lower prices on the mortgages from the originators without passing anyprice discount or higher yield on to the investors.)

21See S. Permanent Subcomm. on Investigations of the S. Comm. on Homeland Sec. andGovernmental Affairs, 112th Cong., Wall Street and the Financial Crisis: Anatomy of aFinancial Collapse, 279 & n.1079 (Apr. 13, 2011) (hereinafter, Levin Report) (quotingFebruary 2006 e-mail from Citigroup to S&P, pressuring the agency not to apply a more accuraterating model or to grant an exception); id. at 282 & n.1087 (June 2007 e-mail from Moodys toCitigroup agreeing to grant an exception).


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lower quality. And at the end of the process, the raw material [i.e., the mortgages themselves]

going into it was actually bad quality, it was toxic quality, and that is what ended up coming out

the other end of the pipeline.22

78. In contrast to a multifaceted market participant such as Citigroup, Plaintiffs andtheir investment advisor lacked access to the above-described information. They did not know

and could not have known the truth about the non-conforming mortgages and other issues

underlying the RMBS in the collateralportfolios of the CDOs Citigroup was arranging.

79. Citigroups exposure to the toxic mortgage securities on its books was massive.Citigroup had over $20 billion in super-senior exposure from the CDOs that it arranged between

2004 and 2007. To make matters worse, Citigroup had issued liquidity puts on an additional

$25 billion in super-senior tranches of other CDOs, thereby incurring the risk of losses on them

as well.23

80. By no later than April 2007, Citigroup recognized internally that continuedsoftening of housing prices would consume the subordination supposedly protecting even the

super-senior tranches of CDOs,24 and therefore knew that its super-senior tranches, which had

22 FCIC Report, supra note 7, at 102-03.

23 See Written Testimony of Nestor Dominguez, former Co-Head of Global CDOs, Citigroup,Presented to the Fin. Crisis Inquiry Commn. at theHearing on the Impact of the Financial

Crisis (Apr. 7, 2010), http://www.fcic.gov/hearings/pdfs/2010-0407-Dominguez.pdf (noting thatCitis put options were a fall-back source of financing, in case of either a significant wideningof credit spreads or a temporary inability to issue commercial paper); see also DominguezTestimony Transcript, supra note 7, at 262:25 to 263:1-3.24

Presentation by Alberto Agrest, Citigroup Global Markets Inc., Credit Derivatives: Productsand Markets (Nov. 2007). The presentation includes a chart from an April 11, 2007 Citigroupreport titledABS CDOs in a Mezz, which shows CDO loss estimates based on various subprimescenarios.


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already lost substantial value, were at risk of plummeting further. Nevertheless, Citigroup

deliberately reported inflated values for the super-senior positions it kept on its books.25

81. At the same time, beginning in or around 2006, Citigroup was finding itprogressively more difficult to drum up investors for the senior and junior tranches of its CDOs,

and was increasingly being forced to hold these positions on its own books and thus bear the

riskafter the deals closed. To minimize its own exposure (while keeping its CDO machine

running), Citigroup decided to manufacture the appearance of a market for these otherwise

unsellable tranches by placing them into new Citigroup-arranged CDOs that it controlled.

82.

As reported by the independent, non-profit newsroom ProPublica, [b]y 2007, 67

percent of [CDO securities] were purchased by other CDOs and [t]he banks often orchestrated

these purchases. ProPublica found 85 instances during 2006 and 2007 where two CDOs

bought pieces of each others unsold inventory.26 The arranging banks induced collateral

managers to go along by threatening to cut them off from future CDO management business if

they did not agree to purchase CDO notes for the CDOs they were managing.27

83. According to one analysis, Citigroup incestuously placed over 30% of thetranches of the CDOs it arranged into other Citigroup-arranged CDOs, making Citigroups

CDOs their own largest customers. Not surprisingly, Citigroup-arranged CDOs that cross-

invested in other Citigroup-arranged CDOs performed particularly poorly, demonstrating that

Citigroup included the worst of its own CDO tranches in subsequent CDOs.

25See FCIC Report, supra note 7, at 196.

26See Jake Bernstein and & Jesse Eisinger, Banks Self-Dealing Super Charged Financial Crisis,ProPublica (Aug. 26, 2010), http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis.27 See id.


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84. Recognizing this pattern, in October 2011, the U.S. Securities and ExchangeCommission (SEC) sued Citigroup.

28The SEC alleged that in or about October 2006,

Citigroups CDO trading desk and its CDO structuring desk devised a plan to allow the bank to

place a massive short bet against A-rated tranches of specific mezzanine CDOs that they

believed were at heightened risk of defaulting. To carry out this plan, Citigroup arranged Class

V Funding III (Class V Funding), a hybrid CDO-squared (so-called because its collateral

consisted of tranches of other CDOs) with a notional portfolio valued at $1 billion.

85. Unknown to investors, Citigroup used Class V Funding to take a $500 millionnaked short position

29

on specific CDO tranches that Citigroup clandestinely selected for Class V

Fundings synthetic portfolio. Citigroup hid its involvement in portfolio selection from potential

investors by falsely representing in the deals marketing materials that Credit Suisse Alternative

Capital, Inc. (CSAC), the deals putative collateral manager, would independently select Class

V Fundings portfolio. Ultimately, Citigroup selected nearly 60% of Class V Fundings

reference assets, which it shorted through CDS contracts.

86. In addition to concealing its involvement in selecting collateral for Class VFunding, Citigroup also misrepresented that its true economic interests in this CDO were directly

opposed to those of the long investors to whom Citigroup was marketing the deal. From the

outset, Citigroup had intended to use Class V Funding as a vehicle for making a proprietary short

trade (i.e., one made for the banks own benefit and not on behalf of a client) on $500 million

fully halfof the deals portfolio. Citigroup did not disclose this material fact in its marketing

materials.

28See Complaint, SEC v. Citigroup Global Markets, Inc., No. 11-Civ-7387 (S.D.N.Y. Oct. 19,

2011).29A naked short position is one that is not being used to hedge or offset a long position.


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87. Citigroups undisclosed short-trading scheme soon paid off. Less than ninemonths after the deal closed, all of Class V Fundings tranches were downgraded; 12 days later,

the CDO experienced an event of default. Class V Fundings long investors suffered

catastrophic losses on their investments, yet Citigroup pocketed approximately $160 million of

net profit on its venture, including $34 million in fees for structuring the deal.

88. Citigroup reached a settlement with the SEC on October 19, 2011, pursuant towhich it agreed, without admitting or denying liability, to disgorge its entire $160 million profit

from Class V Funding plus an additional $125 million in penalties and prejudgment interest.30

The judge, however, refused to approve the proposed settlement, stating that Citigroup was a

recidivist and should not be permitted to escape liability for relative pocket change and

without admitting wrongdoing.31

The settlement was rejected by the District Court, and is

currently on appeal.

D. Citigroups Inside Knowledge of ImpendingDowngrades in the RMBS and CDO Markets

89. In or about May 2007, Citigroup received highly material, non-public informationthat Moodys would soon change the methodology used to rate RMBS and RMBS CDOs, which

would result in downgrades and defaults on a massive scale.

90. Documents produced in litigation brought against another financial institutioninvolved in arranging and selling CDOs show that Moodys conducted meetings in May 2007

30SeePress Release, Sec. & Exchange Commn., Citigroup to Pay $285 Million to Settle SEC

Charges for Misleading Investors About CDO Tied to Housing Market (Oct. 19, 2011),www.sec.gov/news/press/2011/2011-214.htm.31

SeeUnited States SEC v. Citigroup Global Markets Inc., 11 Civ. 7387 (JSR), 2011 U.S. Dist.LEXIS 135914, *14-15 (S.D.N.Y. Nov. 28, 2011).


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with investment banksincluding, on information and belief, Citigroupconcerning the timing

of these downgrades.32

91. As a major player in the CDO and RMBS markets, Citigroup knew that thesedowngrades would have particularly severe effects on CDO-squared products such as

Cookson, ABSynth, and Pinnacle Peak because downgrades in the referenced CDO assets

would trigger an event of default in the CDO-squared.

92. By June 2007, the head of Citigroups mortgage desk had come to the conc lusionthat the CDO market is dead as a result of the subprime contagion.33

93.

Citigroup withheld this obviously material information from investors, including

Plaintiffs, and continued to market CDOs to them fully aware of the disastrous effect the

impending downgrades would have on the value of these investments. Indeed, Citigroup

continued to represent that the Cookson, ABSynth, and Pinnacle Peak CDOs were extremely

safe and consistent with Plaintiffs conservative buy-and-hold investment strategy.

94. Against this backdrop, Citigroup devised and implemented several fraudulentschemes through which it was able to mitigate its exposure to the impending collapse of the

subprime market even as it continued to earn lucrative fees securitizing subprime RMBS and

arranging and marketing CDOs stocked with these increasingly toxic assets to unsuspecting

investors such as Plaintiffs.

32See Pursuit Partners, LLC v. UBS AG, No. X05-CV-08-4013452-S, 2009 WL 3286011, at *12

n.17 (Conn. Super Ct. Sept. 8, 2009).33See Levin Report, supra note 21, at 481, n.2022.


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III. Through Material Misrepresentations and Omissions, Defendants InducedPlaintiffs into Investing Nearly $1 Billion in CDOs Designed to Fail

95. Between September 2006 and July 2007, Defendants fraudulently procuredPlaintiffs investments in $965 million (face value) of notes in eleven CDOs that Citigroup had

arranged and marketed:

TransactionName

Transaction Description Plaintiff Tranche Purchased Amount Paid

LacertaSynthetic CDOreferencing mostly RMBS

LFJ27Lacerta ABS CDO 2006-1,Class A-1

$70,000,000

Total $70,000,000

Jackson ICDOs referencing asynthetic, static portfolio

of RMBS and CMBS

LFJ 25 Jackson 2006-IA $50,000,000

Jackson II Jackson 2006-IIA $50,000,000

Total $100,000,000

Cookson I

Synthetic CDOs eachreferencing a separate,static portfolio of 20CDOs

LFJ 3 Cookson 2007-16, Class A $150,000,000Cookson II LFJ 31 Cookson 2007-19, Class A $150,000,000Cookson III LFJ 31 Cookson 2007-35, Class A $150,000,000

Cookson IV

LFJ 5 Cookson 2007-38, Class A $90,000,000



Total $600,000,000

Pinnacle PeakHybrid, managed CDOreferencing RMBS, CDOs

and other assets

LFJ 32Pinnacle Peak CDO I,

Class A3

$70,000,000

Total $70,000,000

ABSynth ISynthetic CDOs, eachreferencing a staticportfolio of CDOs,RMBS, CMBS, studentloan, and credit card debt

LFJ 29

Cloverie Series 2007-32,Class B

$80,000,000

ABSynth IICloverie Series 2007-33,Class C

$20,000,000

Total $100,000,000

PlettenbergBay

Hybrid, managed CDOreferencing RMBS andCDOs

LFJ 6Plettenberg Bay CDO Ltd.,Class A-1

$25,000,000

Total $25,000,000

TOTAL ALL DEALS $965,000,000

96. As detailed below, Defendants falsely marketed these deals to Plaintiffs as safelong investment opportunities built on high-quality collateral portfolios.


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A. The Lacerta CDO1. Citigroups Misrepresentations and Omissions Concerning Lacerta

97. On or around October 4, 2006 and October 12, 2006, Citigroup provided a termsheet and a revised term sheet (collectively, the Lacerta Term Sheets) for the Lacerta CDO to

Plaintiffs investment advisor, knowing that their contents would be conveyed to Plaintiff LFJ

27. Each page of the Lacerta Term Sheets bore Citigroups logo in the top right corner.

98. These term sheets indicated that the initial collateral portfolio for Lacerta hadalready been selected in consultation with a third-party investor who had made a lead order for

the equity tranche of that deal. See Lacerta Term Sheets at 1. The Lacerta Term Sheets further

represented that, [i]n order to minimize costs, a third-party asset manager is not involved in the

transaction and that [t]he transactions low cost base allows for a portfolio of higher credit

quality than the portfolio that would be required to deliver the same return to investors when

included in a higher cost structure. Id.

99. Citigroup also specifically represented in the Lacerta Term Sheets that [t]hestrong initial portfolio has been selected and rampedsolely to create a long investment for

equity and mezzanine investors.Id. (emphasis added).

2. In Reality, Lacerta Was Designed to Fail bya Now-Notorious Short Investor: Magnetar

a. Magnetars Constellation CDO Scheme

100. Citigroups representations were materially false and misleading because theyconcealed a crucial fact: that Magnetar selected Lacertas collateral to support its undisclosed

short-trading strategy. The portfolio had not been selected and ramped solely to create a long

investment for equity and mezzanine investors. In reality,Lacerta was one of approximately 27


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designed-to-fail Constellation CDOs that Magnetar sponsored as vehicles for massive short bets

against the subprime RMBS market.

101. In exchange for Magnetars agreement to purchase the equity tranches of theseConstellation CDOs,

34the arranging banks allowed Magnetar to clandestinely set the criteria

used to select the deals portfolio of cash and synthetic assets.35

102. Unknown to long investors but known to the arranging banks the parametersMagnetar established for the deals were designed for Magnetars specific criteria and trading

strategy. Magnetar would sponsor the Constellation CDOs by buying the equity tranche at a

discounted price, while simultaneously taking a short position that was at least double (or far

more) its long position in the equity tranche by buying CDS contracts that would pay off when

the CDOs failed.

103. To maximize the likelihood that its short-trading strategy would succeed,Magnetar dictated a mix of assets for the Constellation CDOs that was likely to generate several

large cash distributions to its equity holding (i.e., the long position) at the beginning that

Magnetar used to pay its CDS premiums before events of default entitled Magnetar to claim

massive payments under the CDS contracts it secretly executed with respect to the Constellation

CDOs synthetic collateral (i.e., the short position), as well as CDS referencing tranches of the

Constellation CDOs themselves. In deference to Magnetar, arranging banks caused the

Constellation CDOs to sell both the equity and the CDS contracts to Magnetar at a discount. The

34The equity tranche of a CDO is subordinated (or junior) to all other tranches. The availablefunds are distributed in order of seniority and, because it is the most junior tranche, the equitytranche traditionally bears the most risk since it is usually the first tranche that will experiencelosses if the CDOs assets do not perform as expected. For this reason, CDOs equity tranchesare generally the hardest to place. If a purchaser for the equity tranche cannot be found, then thedeals arranger must either purchase the equity itself (and bear the attendant risk) or cancel thedeal (and lose tens of millions of dollars in arranging and warehousing fees).35See FCIC Report, supra note 7, at 192; Levin Report, supra note 21, at 372-73.


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net result was that unlike the investments of purely long investors, such as Plaintiffs, that

would succeed only if the CDOs themselves succeeded Magnetars trade would yield huge

profits if the deals collapsed.

104. As recounted by the FCIC and in the Levin Report, as well as a number of recentlawsuits and other public reports, Magnetars influence over collateral selection took various

forms. In some cases, Magnetar provided lists of pre-approved assets for the collateral manager

to choose from. In others, Magnetar was granted a veto right over any asset selected for the

CDO.36 In others still, Magnetar simply exercised trades in the name of the collateral manager.37

In all cases, however, Magnetars agreement to act as equity sponsor in these deals was

contingent on the constitution of portfolios that would advance Magnetars undisclosed short-

trading strategy.

105. In addition to allowing Magnetar to dictate asset selection, arranging banks alsodeferred to Magnetars demand that the Constellation CDOs contain structural features designed

to facilitateand pay forMagnetars undisclosed short positions. Whereas CDOs traditionally

contained tests for overcollateralization and interest coverage (known as the OC test and IC

test),38

the banks that arranged the Constellation CDOs structured those deals at Magnetars

behest to suspend or delay the implementation of these tests. The concealed purpose of this

triggerless deal feature was to ensure that Magnetar would continue to receive cash payments

36 See Amended Declaration of Conrad Walker Pursuant to 28 U.S.C. 1746 in Support ofApplication for Order to Conduct Discovery Pursuant to 28 U.S.C. 1782 for Use in Foreign

Legal Proceedings, Ex. H, In re Application of IKB Industriebank AG, Civ. No. 11-0237(N.D.N.Y. Apr. 4, 2011). Indeed, documents produced in other litigation show that Magnetarinsisted that its veto right be recorded behind the scenes and outside ofthe docs. Id. atEx. I.

37See FCIC Report, supra note 7, at 192.

38 The purpose of these tests is to protect senior tranches. When the CDOs collateral does notgenerate sufficient cash flow to meet those tests, payments to junior and equity tranches aresuspended.


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on its equity investment which it could use to fund its larger short positions via CDS contracts

on the Constellation CDOs synthetic collateral.

106. In short, the Constellation CDOs were constructed for the benefit of a specificshort investor (Magnetar) with a specific trading strategy at the expense of all other investors.

When the CDOs collapsed, as they were designed to do, the hundreds of millions of dollars

invested by noteholders would be used to pay out Magnetars short bet against the CDOs it had

created.

107. Over the course of 2006 and 2007, Magnetar implemented this scheme inapproximately 27 Constellation CDOs, effectively creating a market for the express purpose of

shorting it. In the nine-month period between July 2006 and March 2007, Citigroup collaborated

with Magnetar in the creation and marketing of six of these deals, totaling nearly $3 billion

(collectively, the Citigroup-Arranged Constellation CDOs):

Deal Name Trade Date Total Deal Size

Cetus ABS CDO 2006-1 July 21, 2006 $300,000,000Cetus ABS CDO 2006-2

September 27, 2006

$300,000,000

Cetus ABS CDO 2006-4 November 15, 2006 $450,000,000Lacerta ABS CDO 2006-1 November 29, 2006 $600,000,000Octans III CDO December 6, 2006 $300,000,000Octonion I CDO March 6, 2007 $1,040,000,000

Total $2,990,000,000108. In exchange for collaborating with Magnetar, Citigroup reaped tens of millions of

dollars in fees on the Citigroup-Arranged Constellation CDOs in its roles as, inter alia, arranger,

initial purchaser, and placement agent for each CDO.


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b. In Light of Magnetars Undisclosed Short-TradingScheme, Citigroups Representations That the LacertaPortfolio Had Been Selected for the Benefit of LongInvestors Were Materially False and Misleading

109. By representing to LFJ 27s investment advisor that the Lacerta portfolio hadbeen selected in consultation with a third- party investor solely to create a long investment

opportunity for equity and mezzanine investors, Citigroup intended to and caused LFJ 27 and

its investment advisor to believe that Lacerta was a safe investment for long investors looking to

invest in highly-rated senior notes benefitting from high levels of subordination.

110. This representation was materially false and misleading because Magnetarsinterests were fundamentally misaligned with those of Lacertas other long investors. As

Citigroup well knew, Magnetar designed the Lacerta CDOlike the other Constellation CDOs

as a vehicle for implementing its secret short-trading scheme. When Magnetars undisclosed

short bet against Lacerta via the CDS contracts paid off, the deals long investors including

LFJ 27footed the bill.

111. Magnetars investment strategy and criteria were materially different than those ofLFJ 27 and other long-only investors. Magnetar believed it could create an arbitrage profit by

buying the CDO equity tranches at a discount and by buying CDS contracts for a fraction of their

nominal value, thereby massively shorting the more expensive senior CDO tranches. Magnetar

would purchase protection on CDS contracts referencing the assets in the CDOs collateral pool,

as well as CDS referencing tranches of the Constellation CDOs themselves. Thus, whereas

Magnetar stood to reap huge profits if the CDO cratered, LFJ 27 and other long investors could

only profit if the CDO performed well.

112. LFJ 27 invested in Lacerta in reliance on Citigroups representations that theCDOsportfolio had been selected solely to create a long investment opportunity for equity and


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mezzanine investors. In reality, Citigroup allowed Magnetar to set the parameters for Lacerta in

furtherance of its short-trading strategy because Magnetars agreement to purchase the CDOs

hard-to-sell equity (absent which there would be no CDO at all) was conditioned on the

collateral portfolio meeting Magnetars investment criteria.

113. By the time Lacerta closed, Citigroup was well acquainted with Magnetarsinvestment strategy, having already collaborated with it in the creation of three prior

Constellation CDOs. Moreover, as alleged above, in or about October 2006the very period in

which Citigroup was marketing Lacerta to LFJ 27 Citigroup was designing Class V Funding as

a vehicle to pursue its own undisclosed short-trading strategy.

114. As alleged above, Citigroups role at virtually every level of the subprime marketgave it access to detailed information, unavailable to the public, about the deterioration of the

RMBS and the CDOs of RMBS, which constituted the collateral of the Lacerta CDO. Thus,

Citigroup independently knew that the asset selection criterion dictated by Magnetar resulted in

RMBS containing significant portions of non-conforming loans being included in Lacertas

portfolio.

115. Further, Citigroup acceded to Magnetars demand that Lacerta like the otherConstellation CDOsbe structured so as to ensure that Magnetar could finance its short position

(via CDS contracts issued by Lacerta referencing its synthetic assets) with distributions from its

investment in Lacertas equity tranche. Citigroup structured Lacerta to delay the implementation

of the OC and IC tests for the first five years of the CDOs life to ensure that Magnetar would

continue to receive cash from its equity position with which it could fund the premiums on its

CDS contracts while waiting for the subprime market to collapse and its short positions to pay

off.


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116. In short, Citigroups representations to LFJ 27 and its investment advisor thatLacerta was a sound investment opportunity for long investors were materially false and

misleading. The CDO that Citigroup constructed using a blueprint provided by Magnetar

was not designed to benefit long investors, but was instead designed to benefit Magnetars

undisclosed short bet against Lacertas synthetic portfolio and to fund that bet with cash flows

diverted from noteholders to Magnetars equity holding.

3. LFJ 27s Detrimental Reliance onCitigroups Misrepresentations and Omissions

117. In justifiable and reasonable reliance on Citigroups false representations andmaterial omissions, on or around November 29, 2006, LFJ 27 bought $70 million in Lacerta

Class A-1 notes from Citigroup, in its capacity as initial purchaser for Lacerta. As of that date,

the Lacerta Class A-1 notes were rated AAA.

118. LFJ 27 did not know, and could not have known that, contrary to Citigroupsexpress representations that Lacertas portfolio had been selected by a long investor solely for

the benefit of other long investors, Citigroup tailored Lacerta to the specifications of a short

investor, Magnetar.

119. As Citigroup and Magnetar anticipated, Lacerta experienced an event of defaultlong before its approximate five-year reinvestment period expired. Specifically, on or around

February 8, 2008, Lacerta experienced an event of default, which affected all tranches of the

deal, including the Class A-1 notes purchased by Plaintiff LFJ 27. Less than three weeks later,

on or around February 26, 2008, S&P downgraded the Class A-1 notes to a junk rating of B-.

Less than 15 months after purchasing them for $70 million, LFJ 27s Class A-1 Lacerta notes

had become virtually worthless.


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120. Had Citigroup disclosed to Plaintiff LFJ 27 or its investment advisor the truthabout Magnetars role and conflicting interests in selecting collateral for Lacerta, Plaintiff LFJ 27

would not have invested in the Lacerta CDO.

121. Citigroup improperly benefited from the sale of the Lacerta notes to LFJ 27,including by fraudulently obtaining the $70 million purchase price for the notes as well as fees

and expense account payments totaling as much as $29.7 million, in connection with its

fraudulent sale of the Lacerta CDO.

B. The Jackson CDOs

1. Plaintiff LFJ 25s Detrimental Reliance on DefendantsRepresentations Concerning the Jackson CDOs

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