Citigroup Inc. sold a series of mortgage-linked securities without disclosing that Morgan Stanley helped shape them while betting they would fail, two people with knowledge of the matter said.
Marketing documents for the $205 million Jackson Segregated Portfolio, underwritten by Citigroup in 2006, do not say who picked the underlying mortgage bonds. A Morgan Stanley unit helped select the bonds, the people said, speaking anonymously because the deal was private. Six of the seven series of Jackson bonds later defaulted, costing investors more than $150 million, data compiled by Bloomberg shows.
"Failure to identify that there was a third party participating who would take a short position would have been extremely relevant to the purchaser of this product," Duke University law professor James Cox said.
Regulators have been scrutinizing Wall Street firms' sales of subprime mortgage securities that later defaulted, contributing to the worst credit crisis since the Great Depression. They include some of the more than $500 billion of collateralized debt obligations created by pooling mortgage bonds and other debt and packaging them into new securities sold by Wall Street from 2005 through 2007. Citi did say in the Jackson marketing documents that its interests in the deal "may be adverse" to those of investors in the CDO's bonds.
"We expressly disclosed in marketing the Jackson CDOs that the collateral selection may have included factors adverse to investors," said Citigroup spokeswoman Danielle Romero-Apsilos. "Having said that, we remain committed to enhancing the transparency of all financial transactions in which we are involved." Morgan Stanley spokesman Mark Lake said he could not comment. Both banks are based in New York.
The Securities and Exchange Commission last month accused Goldman Sachs Group Inc. of misleading investors by failing to disclose the role of the hedge fund Paulson & Co.in picking collateral it bet against. Goldman Sachs calls the claims unfounded.
Citigroup has not been publicly accused of any violation tied to the Jackson deals. In a quarterly filing this month, it said it is cooperating with "various formal and informal inquiries" into subprime-mortgage-related activities and is in talks to resolve some of them.
It sold $59.3 billion of CDOs from 2005 to 2007, according to a November 2008 report by Sanford C. Bernstein analyst Brad Hintz. In late 2008, the banking company had to get a $45 billion government bailout, partly because of losses on mortgage-backed securities it kept on its books. Citigroup lost almost $30 billion in 2008 and 2009 before reporting a $4.43 billion profit in the first quarter.
Citigroup sold the Jackson CDOs in August-September 2006, according to Bloomberg data, just as U.S. subprime mortgage delinquency rates began rising.
When Citigroup set up Jackson, it arranged with Morgan Stanley to take over the short positions once the deal closed, the people said. Citigroup allowed the investment bank to help select the bonds linked to the derivatives because Morgan Stanley would have a stake in the securities' performance, they said.
The Jackson marketing documents said Citigroup might have information about the bonds or business relationships "that may or may not be publicly available or known to the other parties to the transaction" but that it had no obligation to disclose "any such relationship or information."