March 1, 2005
If you want to make a lot of money, sell “short” a security that you
know is going to go down and buy it back at a lower price. Your profit
will be the difference between your selling price and your cost of
buying it back. To make even a higher return on your money, leverage
(margin) the sales. A still better deal is to make the price of the
security plummet by selling so much of it that the market makers cannot
make an orderly market with their stabilizing purchases and are forced
to capitulate because of their rapidly increasing and unsustainable
losses. By doing this you can reap colossal profits on your sales and
knock your competitors out of business at the same time. Note: This
strategy is not usually an option for individual investors.
On August 2, 2004 Citigroup’s London government bond traders
sold “just” $15.6 billion ($15,600,000,000) of cash bonds in less than
two minutes before the MTS - the European electronic trading system
where dealers must provide continuous quotes in order to maintain
orderly markets - broke down. That’s more than most people make in a
lifetime. It’s more than the sale of 624,000,000 shares of Microsoft at
25.
Apparently the trade did not represent a long-term investment decision
as the bank bought back $5.2 billion of the bonds 30 minutes later
making a profit of more than $22.1 million covering a portion of the
sale.
If the market had turned and gone the “wrong” way before the traders had
covered their short position, losses for the bank could have been
massive. In other words, don’t try this at home. Also, keep in mind that
the Citigroup traders were not using their own money; they were using
the bank’s money, i.e. the bank’s shareholders’ money.
Quoting from the February 2nd Financial Times: “In a memorandum
dated two weeks before the trades and published by the Financial Times
on Tuesday, a Citigroup employee outlined a strategy that `may help kill
off some of the smaller dealers’ in the competitive eurozone government
bond market.”
The Europeans did not view the world’s largest financial institution’s
actions to intentionally destabilize the Eurex futures market with a
sense of humor. German prosecutors in Frankfurt are conducting an
ongoing criminal investigation into suspected market manipulation by six
of Citigroup’s traders, including the head trader, on the bank’s
European government bond trading desk. We understand the UK authorities
and the Italians are also conducting investigations. Chuck Prince,
Citigroup’s chief executive, described the trade as “knuckle-headed.”
The above is an impressive example of how to spread American capitalism.
Seriously, we are disappointed, but hardly surprised, that once again
the ethics of Citigroup’s traders show that people think and act on the
premise that it’s permissible to do anything that is not specifically
prohibited by regulators or by law. If you cannot find a statute
expressly stating that an action is illegal, go ahead even though you
know it’s wrong. Chances are that you’ll get away with it most of the
time. That’s how huge bonuses are earned in Wall Street.
WorldCom was an example starring Salomon Smith Barney’s celebrity
telecom analyst Jack Grubman and his boss, Sanford I. Weill, Citigroup’s
chairman. Salomon Smith Barney was/is Citigroup’s brokerage subsidiary.
We have a Smith Barney - Jack Grubman - research report in our files
dated November 2, 2000 in which WorldCom, Inc. (symbol WCOM) was rated
1M - “Buy, Medium risk” - when the stock was $18.94. The stock had
fallen from its 52 week high of $61.31, but its 2.922 billion shares
still had a market value of $55.342 billion.
Grubman had WCOM’s previous target price at $87.00 but now reduced the
target price to $45 with the stock falling to $19 after the company
reduced its 2001 consolidated cash estimated share earnings to $1.60
from $2.40.
The following is a portion of the Summary of the Smith Barney - Jack
Grubman - November 2, 2000 WorldCom report:
“WCOM is setting realistic but achievable goals for fin’l perform. in a
tough industry. They have the best set of assets and strong balance
sheet for high growth off a very large WorldCom Group base. We think
this is the bottom, & would be massively aggressive buyers of the
stock.” (Our emphasis.)
It was not too long until the unthinkable happened. Humpty Dumpty fell
off the Wall as a result of an $11 billion accounting fraud – until that
time the largest in US history - and the subsequent collapse of the
company.
As of this writing Bernie Ebbers, formerly a milkman, basketball coach,
motel operator and later WorldCom’s fearless leader, is being tried in a
criminal fraud trial. He could get up to 85 years on fraud and
conspiracy charges if convicted, but that does not get money back to
those whose WCOM shares became worthless. And, by the way, Ebbers was
not the only alleged criminal in the WorldCom debacle.
In July 2002 Jack Grubman testified that WorldCom paid $80 million in
underwriting and advisory fees to Citigroup’s Smith Barney.
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Stephen Labaton wrote in the April 28, 2003 New York Times:
“Prosecutors announced a settlement today with the nation’s biggest
investment firms that bars the head of the largest bank from talking to
his analysts, details a far greater range of conflicts of interest than
previously disclosed, and leaves the industry exposed both to further
regulation and costly litigation.
“The $1.4 billion settlement by 10 firms and 2 well-known analysts
reached tentatively last December but completed in the last few days,
resolved accusations that the firms lured millions of investors to buy
billions of dollars worth of shares in companies they knew were troubled
and which ultimately either collapsed or sharply declined.
“The Securities and Exchange Commission, state prosecutors and market
regulators accused three firms in particular --- Citigroup’s Salomon
Smith Barney, Merrill Lynch, and Credit Suisse First Boston --- of
fraud.
“In a reflection of regulators’ concerns about the prospect for the
conflicts of interest at Citigroup, Wall Street’s biggest bank, the
settlement bars its chairman and chief executive, Sanford I. Weill, from
communicating with his firm’s stock analysts about the companies they
cover, unless a lawyer is present.
“As part of the agreement, two analysts whose fortunes rose with the
markets, Jack B. Grubman of Salomon Smith Barney and Henry Blodget of
Merrill Lynch, agreed to lifetime bans from the industry, along with
significant fines.
“The singling out of Mr. Weill stemmed in part from his efforts to try
to influence Mr. Grubman to change his view of AT&T – a Citigroup client
that had Mr. Weill on its board – to positive from negative…”
Citigroup’s share of the $1.4 billion fine was $400 million paid by
shareholders in 2003.
***************************
Citigroup’s London trading abuse happened in August 2004. On October 26,
2004 the Financial Times reported: “Citigroup apologized
publicly yesterday for the worst breakdown of corporate behaviour in
more than 100 years of doing business in Japan and announced plans to
win back public and regulatory trust.”
Also in 2004 - the bank settled a $2.5 billion lawsuit and set aside $10
billion to cover lawsuits including WorldCom and Enron. The head of
investment banking in China, Ms. Margaret Ren and her colleague, were
removed in June after presenting “false information to the company and
its regulators.”
March 1, 2005: “Italian Prosecutors Probe Citigroup.” The eurozone bond
scandal is widening with Italian authorities; and, in addition, a US
judge told Parmalat, the collapsed Italian milk company, that it could
pursue a fraud claim for $10 billion against Citigroup for its actions
in disguising Parmalat’s bankruptcy.
On February 28, 2005 from the Financial Times: “Weill calls for
more company philanthropy. Mr. Weill, who is chairman of the Committee
to Encourage Corporate Philanthropy, said there was a growing need for
companies to be seen to be giving back to the community. `With the
problems they have suffered with corporate governance it has become more
important that they be seen as human and institutions that really care,’
he told the FT. Weill `was speaking ahead of today’s Excellence in
Corporate Philanthropy awards.’”
The purpose of our comments is to highlight just a few of multitudes of
activities that resulted in immeasurable harm to investors.
Measures have now been put in place with the hope of stopping similar
activities in the future. But now the business world is bitterly
complaining that its biggest business problem is too much regulation.
Part of the legislation to curb the corporate abuses is Sarbanes-Oxley
commonly referred to as “Sarbox.” The February 21st FT headlines were:
“Burden of regulation rated as the biggest risk facing world’s banks.”
The biggest “risk” last year was derivatives while regulation came in
sixth.
We have never been accused of desiring more government in any form.
However, the previous system led to catastrophic results, especially in
the last five years, and despite new rules, major new scandals are
surfacing daily. Are the new safeguards working? You are the investing
public. You be the judge.
Maybe corporate philanthropy really is the answer.
MEANWHILE, WHO’S LOOKING OUT FOR YOU? WE ARE.
John W. Hamilton
March 1, 2005
