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Citigroup Ex-Manager Islam Has No Regrets From Hedge-Fund Crash

Business Week

Reaz Islam, who ran Citigroup Inc. (C) hedge funds that lost most of their value in 2008, has “no regrets” about his performance and said “ambulance-chasing” lawyers are behind claims that he and the bank misled clients.

Investors in the ASTA/MAT municipal bond funds knew how volatile they were, Islam said in interviews and e-mails that broke his four-year silence on the matter. Those claiming otherwise are either “engaged in fraud or highly irresponsible,” said Islam, who left New York-based Citigroup in 2008 and works in Dhaka, Bangladesh.

The funds, now defunct, placed Citigroup at the center of a regulatory probe and a wave of litigation when they crashed four years ago. The Financial Industry Regulatory Authority, or Finra, has ordered the bank to pay at least $60 million to some of the funds’ investors, who said that Citigroup pitched them a safe, more profitable alternative to other fixed-income investments. There are 69 claims remaining, according to a Beverly Hills based lawyer for plaintiffs.

“This was a high-volatility, high-return strategy and never a safe and riskless investment as claimed by a few rogue, ambulance-chasing attorneys,” Islam said in an e-mail. “I have no regrets and obviously learned a lot from the crisis, notably to expect the unexpected at all times and how people change color in times of crisis.”

The ASTA/MAT funds attracted Citigroup clients, who were pitched the investment by the lender’s private bankers and financial advisers. Investors included Ronald Beard, chairman of Callaway Golf Co. (ELY), Jerry Murdock, the founder of a $5 billion venture-capital firm and Bruce Spector, a senior adviser to buyout firm Apollo Global Management LLC.

Borrowed Billions

Islam, 45, sought to exploit differences between yields on U.S. government debt and municipal bonds. He borrowed billions of dollars from banks to amplify the bets, according to Citigroup documents filed in U.S. District Court in Denver.

The funds swooned when investors fled the credit markets in 2008 and lenders requested repayment. As a group, the ASTA/MAT funds had raised $1.92 billion from investors, the court documents show. As of Feb. 29, 2008, they held $303 million, an 84 percent decline.

“Unfortunately, like many things in life, the strategies no longer worked after the material and sustained change in correlation in early 2008, breaking 15-plus years of strong history of correlation, the key driver of the strategy,” Islam wrote. “Every manager in the space had the same fate, with no exceptions.”

Biggest Award

Murdock and Gerald Hosier, who live in Aspen, Colorado, won $54.1 million from the bank through a Finra arbitration claim last April, including $17 million in punitive damages, after alleging that Citigroup misled them about the funds’ risk. Their award is the fifth-biggest of its kind, Finra records show.

Citigroup’s defense in the arbitration was that investors knew of the risks and signed agreements saying they understood that the funds could lose money, according to court records. A three-person Finra panel ruled against the bank, and the federal court in Denver dismissed an appeal in December.

The bank intends to appeal the latest decision, according to its annual filing last month. Citigroup’s legal team didn’t contact Islam about the case, he said.

‘Accurate and Complete’

“Citi acted appropriately at all times in connection with the development, sales and marketing of ASTA/MAT,” Danielle Romero-Apsilos, a spokeswoman for the bank, said in an e-mail. “Our disclosures were accurate and complete and detailed the risks associated with investing in these products.”

Islam is now a managing partner with LR Global Partners LP, a New York-based investment firm with operations in Bangladesh, Singapore, Vietnam and Sri Lanka, according to its website. The company manages about $250 million, much of which he oversees in Bangladesh, Islam said.

He said he never marketed the ASTA/MAT funds to investors. That was done by Citigroup’s private bankers, he said. The sales documents they gave to potential investors were clear about the risks, Islam said. He provided Bloomberg News with a marketing brochure for one of the funds that targeted “traditional municipal-bond investors” who were looking for more profit — and more risk.

“We talked about every risk in the prospectus,” Islam said. “The marketing materials, including the term sheet risk disclosures, were comprehensive, written in plain English and idiot-proof.”

‘Traditional’ Investors

Investors disagree. Citigroup pitched the funds as “conservative,” Hosier and Murdock claimed. Internal documents show that Citigroup sought clients who otherwise invested in more conventional fixed-income securities.

“To be clear, our goal is NOT to target hedge-fund clients who are willing to accept an unrestricted risk profile,” Citigroup wrote in one of the documents. Instead, the lender sought “larger traditional fixed-income investors who are seeking alternatives and customized solutions without materially altering their risk characteristics.”

Richard Zinman, an adviser then working for Citigroup, pitched one of the funds in a Jan. 6, 2006, e-mail to Murdock as “a muni substitute” that took “virtually no credit risk,” court documents show. Zinman, now at Credit Suisse Group AG (CSGN), referred questions to David Walker, a spokesman for the Zurich- based bank, who declined to comment.

‘Slap Him’

Michael Piuze, an attorney in Los Angeles, said the ASTA/MAT fund managers took more risks than they said they would. He won $766,000 from Citigroup on a May 2010 Finra claim.

“He should either have his mouth washed out with soap or have someone slap him a couple of times,” Piuze said of Islam.

Piuze won millions of dollars in damages for families of smokers who sued Altria Group Inc. (MO), the maker of Marlboro cigarettes, claiming the firm misrepresented the risk. Spector, the Apollo Global Management adviser and founder of the Private Bank of California, won a Finra claim for $383,000.

Citigroup pitched the investment to Beard, the Callaway chairman, as a standard municipal-bond investment fund that offered “slightly better” returns, he said in a phone interview. Beard, who said his money is now managed by Wells Fargo & Co. (WFC), won a Finra claim for $336,000 in December 2010.

The Securities and Exchange Commission is examining how Citigroup managed and marketed the ASTA/MAT funds, the bank said in its annual filing. Citigroup disclosed the inquiry in August 2008 and is cooperating with regulators, according to the filing. John Nester, an SEC spokesman, declined to comment.

Borrowed Billions

Islam’s funds borrowed billions of dollars to buy both municipal securities and derivatives designed to minimize losses should the bonds decline in value. The funds borrowed eight to nine times the amount gathered from investors, Citigroup documents show, and controlled about $18 billion of assets because of that leverage, Islam said.

The bank pitched the ASTA/MAT funds to clients in its private bank and at the Smith Barney brokerage, according to a Citigroup document that became public in the Hosier case. The minimum investment in each fund was $500,000, according to the document. All of the money in ASTA/MAT came from Citigroup’s clients, said Steven Caruso, a lawyer for Murdock and Hosier.

Murdock founded Insight Venture Partners, a New York-based investment firm that has raised more than $5 billion, according to its website. Former Treasury Secretary Robert Rubin and ex- Goldman Sachs Group Inc. Chairman Stephen Friedman are listed as special limited partners at the firm.

Lemelson’s Attorney

Hosier, a patent attorney, worked for Jerome Lemelson, an inventor who obtained more than 600 patents on ideas from bar- code readers to soft-tipped darts. Lemelson, who died in 1997, and a foundation he started sued hundreds of businesses for infringement. Companies often settled by paying license fees.

The ASTA/MAT funds were popular among such clients because they promised higher returns than what they could get on other fixed-income investments, Islam said. They also were tax-free because they came from owning municipal bonds, the debt securities issued by U.S. cities and counties, he said.

Islam started the funds in 2002. They returned 14 percent on average each year, including tax savings, until early 2007 when he started the MAT Five fund, he said.

“There were never any complaints prior to the crisis in 2007 and 2008,” Islam said.

Concern about the safety of corporate and asset-backed bonds in the second half of 2007 led to declines in municipal debt, too. U.S. Treasuries, a haven for investors, rallied. The moves pushed the yield on municipal bonds to their highest compared with Treasuries since 2003, and the ratio became more volatile, buffeting the ASTA/MAT funds. The MAT Five fund lost 17 percent in the fourth quarter of 2007.


A “dislocation between tax-exempt and taxable yields” caused the loss, according to a report to investors.

Markets worsened in 2008, and Islam’s lenders demanded repayment of the loans he used to leverage his municipal-bond purchases, according to Caruso. One of the banks making a margin call was Citigroup itself, Caruso said. Citigroup subsequently loaned the funds $660 million to keep them solvent, he said.

Funds that raised money last suffered most because they hadn’t been around long enough to collect interest payments from the municipal bonds they held, Caruso said. MAT Five held $19 million on Feb. 29, 2008, after raising $632 million in 2007, court records show.

Citigroup offered MAT Five investors 23 cents on the dollar for their stakes, Caruso said. All of the funds shut down in 2011, he said.

‘Psychological Capital’

“Despite all odds, until the final days we did everything we could to protect the investments but failed, given the speed and magnitude of the dislocation that no one predicted,” said Islam, who said he lost about $2 million, including deferred compensation. “As a percentage of my net worth at that time, I do not believe anyone lost more money in these strategies as I did, not including loss of my psychological capital.”

Islam’s didn’t just suffer from bad luck, investors say. He and his team took more risk and borrowed too much money because of “powerful economic incentives,” Hosier and Murdock claimed. This included a fee structure that delivered 20 percent of all income earned by the funds, shared by Citigroup and the fund managers, once the funds produced returns exceeding 5.5 percent.

Islam left Citigroup in August 2008. He kept his account of the ASTA/MAT collapse to himself until contacted by Bloomberg News. Nothing could have saved the funds in the end, he said.

The fallout for the bank isn’t over, the plaintiffs’ attorney, said the 69 households with pending Finra cases put more than $125 million into ASTA/MAT.

“The written evidence produced by Citi in these cases tells a different story” than Islam’s characterization of plaintiffs’ lawyers. “His arrogance in the face of recorded conversations and broker e-mails is remarkable, but not unexpected.”

In Dhaka, almost 8,000 miles (12,900 kilometers) from Citigroup’s New York headquarters, Islam said he’s trying to move on with his life.

“I still think about, given all the facts at that time, if we could have done anything differently,” Islam wrote in an e- mail. “The answer is consistently NO.”