You don’t have to be Everett Dirksen to wonder what the hell is going on at Citigroup:
Citigroup Inc. (C.N), the world’s largest financial services company, on Friday said it will pay $2 billion to Enron Corp. investors who accused it of helping engineer a massive accounting fraud at the energy trader.
The class-action settlement is one of the largest in corporate history, though it is less than the $2.58 billion that Citigroup agreed to pay WorldCom Inc. investors in 2004.
The settlement may put pressure on a series of other major banks to settle with Enron investors.
Skip to next paragraph Citigroup did not admit wrongdoing in agreeing to settle. It said the pre-tax payment is fully covered by its existing litigation reserves and that it does not plan to adjust its remaining reserves.
Could someone who knows more than me (I would ask my cat if he could talk) about corporate finance and corporate law explain a few things:
1.) When a company has to pay $4 billion in fines in a 2 year period, is it not a sign that something is horribly corrupt? Has anyone paid a price at Citigroup?
2.) How does a company have $4 billion in ‘existing litigation reserves?’ Why was that money not passed on to shareholders?
3.) What is the menatlity behind having $4 billion in ‘litigation reserves.’ Is this a legal requirement that you must have a certain amount of litigiation insurance or cash on hand in case you get sued, or is it just a tacit admission that we know we are engaging in some shady business, so let’s set aside some loot to mitigate the fall-out.
4.) Does anyone on the planet think that just because they did not admit guilt in the settlement, they are not guilty? If that is the case, and they are just tossing around cash, how do I get some?
And while these are snarky questions, I am actually really curious.
Hokie
Is this a legal requirement that you must have a certain amount of litigiation insurance or cash on hand in case you get sued, or is it just a tacit admission that we know we are engaging in some shady business, so let’s set aside some loot to mitigate the fall-out.
To be fair, while Citigroup is pretty scummy, most large companies do keep cash on hand in case you get sued, and I don’t think it’s a legal requirement. It’s because quite often, suits are going to happen, and it’s better PR just to settle rather than go through a long trial.
Brian
Getting sued constantly is routine for any big corporation. (Usually by other corporations). They’d be foolish not to have a pile of money lying around to deal with it.
Pretty much all the big banks have been handing out .com crash cash the last 5 years. They all played a part in hyping crap companies like Enron and Worldcom, bringing IPOs that probably should never have been brought, etc. A billion here, a few 100 million there. Actually not that much money in the great scheme of things. You make $100 billion and give out $10 billion in settlements and fines. You’re still ahead quite nicely.
Aaron
I would point out to you the scene in “Fight Club” where Edward Norton explains his job. If the cost of litigation is less than the cost of a corporation being ethical, doing the right thing or anything else that hurts the bottom line, they go with litigation and settlement. In that kind of environment, having four billion or so on hand to settle claims seems pretty logical.
Aaron
jcricket
Aaron hits the nail on the head. This is a classic example of the limits of free, unregulated market forces to reign in unethical corporate behavior.
Unfortunately, the largest penalties that can be imposed can be “small potatoes” for some of these big corporations.
Microsoft & Citigroup make enough in profits that it’s simply cheaper to just keep settling lawsuits than it is to fix whatever behavior gets them into trouble.
So Microsoft, for example, ultimately retains (let’s say) 90% of the benefits from being an illegal monopoly, and litigation is just a “cost of doing business”.
So whenever I hear the libertarian argument that the “free market” will correct all wrongs, I have to laugh.
Existing regulations need to be strengthened to make it more costly for companies to destroy pension plans, operate as illegal monopolies, or otherwise skirt the law. Maybe then there’d be an actual change in behavior.
Steven
Under GAAP accounting rules, whenever a company believes that recovery against it on a claim is probable and the amount is “reasonably estimable”, then it must take a charge to earnings and establish a reserve. What Citi did was take the earnings hit earlier and establish the reserve. Thus, when they settle, they pay the cash but it doesn’t have an effect on earnings, because that effect occurred in an earlier period. There is clearly more art than science to the establishment and timing of these reserves.
I have more than a passing knowledge of securities law and corporate finance. Given the complexities and vagaries of GAAP accounting and tax law, and the market impertive to meet earnings expectations, most companies in the financial servies industries have been involved in transactions that fall in the gray zone. Occasionally execs get greedy and these deals become fraud (Enron being the classic example; WorldCom is not a good example of this, since it was fraud from the outset.) Remember, an organization like Citi is vast and its business is structuring these types of transactions. This goes to your point of whether they are guilty and whether they knew they were guilty. My guess is that as time went on, the execs at Citi knew these deals were getting riskier and closer to the edge of legality. They also probably believed that this wasn’t their concern—they were the intermediary and as long as the lawyers and accountants were assuring everyone that these deals weren’t illegal, then from Citi’s point of view they could proceed.
In this respect, Citi is no different than any other investment bank. These guys are paid a lot of money to create structures that reduce risk and increase earnings by threading your way through tax and accounting rules. Frankly, many of these structures don’t have much economic substance, but they provide a tax or accounting result that is beneficial. Consequently, when the deals go bad or a company collapses and investors lose a lot of money, it is reasonably easy for a prosecutor to allege violations of securities laws or mail fraud. That’s not to say the bank isn’t guilty, but another way to look at it is that the accounting and tax rules drive this behavior and the economic performance of many companies depends on the use of these techniques. A guilty plea and a fine here and there is just the price of doing business in this kind of regulatory environment.
Bob Munck
So is Citibank anything more than a giant vacuum pump that hoovers money from its customers (all kinds of people, but mostly the poor and middle classes) and spews it into the accounts of its investors and executives (again, all kinds of people, but mostly the rich and well-connected)?
wufnik
Steven is right–this was all tax driven by Enron, with Citi (and a lot of other investment banks) helping out. Some people involved no longer work at Citi, but not all. There is a deeper issue, here, though, which arises from Steven’s comment that the tax or accounging result is “beneficial.” To whom, exactly? Enron was able to take advantage of a lot of stuff that was specifically intorduced (or blocked) once republicans took over the Senate. My favorite example (which is not related to what Citi did to get fined, but is more symptomatic of the kind of corruption that has become insidious)–Wendy Gramm, wife of former Senator Phil Gramm of Texas, used to head up the Cmmodity Futures Trading Commission under Reagan and Bush 1. When Clinton came in, she lifted government oversight on the trading of energy contracts, which, of coure, was one of the major profit centers for Enron. This was under the guise of “deregulation.” Remember the california energy fiasco–that turned out to have been caused and manipulated by Enron traders? No oversight, greedy traders, crisis–big surprise. Not beneficial to California consumers, that’s for sure. Five weeks after Wendy left the government, Enron appointed her to its board of directors, where she pulled down lots of money. And Enron, of course, gave a bunch to Phil in his campaigns. Phil, to show his gratitude, was responsible for the Commodity Futures Modernization Act (catchy title, no?), which took Wendy’s administrative exemption and turned it into law. (If I remember correctly, Clinton vetoed this, and then the republican Congress overrode the veto–but my memory may not have this right.) Wendy, for her part, went on Enron’s audit committee, which was responsible for approving all those “partnerships” that let Enron hide tons of debt until the house of cards collapsed. Certainly most Enron empolyees did not benefit from this collapse. Lay, by the way, was chairman of Gramm’s unsuccessful presidential bid in 1996.
The $4 billion reserve, by the way, was taken out of profits the years it was created. So Citi shareholders paid some price here–and if you look at the crappy performance of its stock the past couple of years, they still are.
ed in texas
Citi And Enron were linked up big time; it was Reich’s (at Citi) decision not to extend further credit that started the big landslide. Yes they maintain large litigation reserves. If they keep doing stupid things like losing tapes with my mortgage records on them they’ll need them. If you want to see a horror story on litigation reserves, go over to law.com (American Lawyer mag, March issue) and look up the Fen-Phen Follies. $10B in the hole and sinking.