[New York Times] January 12, 2003 Putting All the Eggs in a One-Stop Basket Can Be Messy By GRETCHEN MORGENSON
TO the architects who build them, integrated financial services empires have the allure of immense profits. But for the customers of these one-stop financial entities, perils often result.
The laws separating commercial banks from investment firms have only recently been undone, so clients of financial services behemoths are just beginning to see how the inherent conflicts can affect them. Consider a case filed against Citibank by SNS Bank N.V., a midsize commercial bank in the Netherlands and a Citibank client.
In June 1996, SNS invested $15 million in Captiva Finance Ltd., an offshore investment vehicle designed and set up by Citibank to invest in debt obligations. SNS wanted its investment, roughly 1 percent of its portfolio, to be placed conservatively.
At the time, Captiva's portfolio manager was Chancellor Senior Secured Management Inc., an independent firm. In February 1998, Captiva replaced Chancellor with another independent firm, Stanfield Capital Partners. But by August 1999, Strategic Debt Portfolio Management, a unit of Citibank, was hired to run Captiva.
In its letter to Captiva investors explaining the change, Citibank, a Citigroup unit, said it was obliged to identify managers "with the capacity for future growth." Stanfield had stumbled.
SNS never had the opportunity to vote on the change, even though both the Captiva offering memorandum and the financial management agreement between Captiva and Stanfield stated that such a vote would be part of a termination.
Soon after the Citibank unit took over the Captiva portfolio, it incurred significant losses, according to the lawsuit. SNS asked Citibank to sell its interest in Captiva several times, but Citibank did not.
Frank 't Hart, general counsel to SNS, said that when the bank confronted Citibank with its poor performance, it was assured that the portfolio would not fall much further. But by late 2001, SNS had lost three-quarters of its $15 million investment. Now it is worth $3 million. "With respect to this kind of investment, Citibank had a certain expertise we did not have," Mr. 't Hart said. "We hired Citibank because we believed them to have a certain level of professionalism and integrity and they have violated the trust we had in them."
Mr. 't Hart also noted that, while Citibank recommended that Captiva remove Stanfield for performance reasons, it did not apply the same standard to its own abysmal performance by removing itself.
Of the seven debt issues in the Captiva portfolio that have defaulted, five were bought by the Citibank manager. These include obligations of 360networks, a manager of fiber optic networks; Big V Supermarkets, a privately held food retailer; ICG Communications and Winstar Communications, both defunct; and the LTV Corporation, the steel maker. The LTV bond was underwritten by Salomon Smith Barney, another Citigroup unit.
In response to the suit, Citibank said it was not required to put the change in Captiva's money manager to a vote of its noteholders. It said SNS was told of the change, did not object and is now trying to recoup its losses through a lawsuit.
But the potential for conflicts in such an arrangement looms large. "Where the financial manager is an arm of the promoter, any semblance of independence is lost," said Michael J. Sullivan, partner at McElroy, Deutsch & Mulvaney in Morristown, N.J., who represents SNS. "Because of the high leverage, the promoter takes profits while the equity investors take all the risk."
Once again: Buyer beware.