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.
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 behavior 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