FILED: NEW YORK COUNTY CLERK 01/24/2012NYSCEF DOC. NO. 1 INDEX NO. 650212/2012 RECEIVED NYSCEF: 01/24/2012 SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK LORELEY FINANCING (JERSEY) NO. 3 LTD.; LORELEY FINANCING (JERSEY) NO. 5 LTD.; LORELEY FINANCING (JERSEY) NO. 6 LTD.; LORELEY FINANCING (JERSEY) NO. 7 LTD.; LORELEY FINANCING (JERSEY) NO. 25 LTD.; LORELEY FINANCING (JERSEY) NO. 27 LTD.; LORELEY FINANCING (JERSEY) NO. 29 LTD.; LORELEY FINANCING (JERSEY) NO. 31 LTD.; and LORELEY FINANCING (JERSEY) NO. 32 LTD., Plaintiffs, -vCITIGROUP GLOBAL MARKETS INC.; CITIBANK, N.A.; CITIGROUP GLOBAL MARKETS LIMITED; LACERTA ABS CDO 2006-1, LTD.; LACERTA ABS CDO 2006-1, CORP.; USP SPC; COOKSON SPC; PINNACLE PEAK CDO I, LTD.; PINNACLE PEAK CDO I, LLC; CLOVERIE PLC; PLETTENBERG BAY CDO LIMITED; and PLETTENBERG BAY CDO CORP.; Defendants. Index No. Date Purchased: January 24, 2012 Plaintiffs designate New York County as the place of trial The basis of venue is CPLR Article 5, including CPLR 501, 503, and 509 SUMMONS TO THE ABOVE NAMED DEFENDANTS: YOU ARE HEREBY SUMMONED to answer the Complaint in this action and to serve a copy of your answer, or if the Complaint is not served with this summons, to serve a notice of appearance on Plaintiffs’ attorneys within 20 days after the service of this summons, exclusive of the day of service (or within 30 days after the service is complete if this summons is not personally delivered to you within the State of New York); and in the case of your failure to appear or answer, judgment will be taken against you by default for the relief demanded in the Complaint. Dated: New York, NY January 24, 2012 KASOWITZ, BENSON, TORRES & FRIEDMAN LLP By: /s/ Marc E. Kasowitz Marc E. Kasowitz (
[email protected]) Sheron Korpus (
[email protected]) 1633 Broadway New York, New York 10019 (212) 506-1700 James M. Ringer MEISTER SEELIG & FEIN LLP 140 East 45th Street, 19th Floor New York, NY 10017 (212) 655-3500 Stephen M. Plotnick CARTER LEDYARD & MILBURN LLP 2 Wall Street New York, NY 10005-2072 (212) 732-3200 Attorneys for Plaintiffs Loreley Financing (Jersey) No. 3 Ltd.; Loreley Financing (Jersey) No. 5 Ltd.; Loreley Financing (Jersey) No. 6 Ltd.; Loreley Financing (Jersey) No. 7 Ltd.; Loreley Financing (Jersey) No. 25 Ltd.; Loreley Financing (Jersey) No. 27 Ltd.; Loreley Financing (Jersey) No. 29 Ltd.; Loreley Financing (Jersey) No. 31 Ltd. and Loreley Financing (Jersey) No. 32 Ltd. 2 Defendants’ Addresses: Citigroup Global Markets Inc. 390 Greenwich Street New York, New York 10013 Citibank, N.A. 399 Park Avenue New York, New York, 10043 Citigroup Global Markets Limited Citigroup Centre 33 Canada Square Canary Wharf, London E14 5LB United Kingdom Lacerta ABS CDO 2006-1, Ltd. c/o Maples Finance Limited Queensgate House P.O. Box 1093 GT South Church Street, George Town Grand Cayman, Cayman Islands Lacerta ABS CDO 2006-1, Corp. c/o Donald J. Puglisi 850 Library Avenue, Suite 204 Newark, Delaware 19711 USP SPC c/o Maples Finance Limited P.O. Box 1093 GT Queensgate House South Church Street, George Town Grand Cayman, Cayman Islands Cookson SPC c/o Maples Finance Limited P.O. Box 1093 GT Queensgate House South Church Street, George Town Grand Cayman, Cayman Islands Pinnacle Peak CDO I, Ltd. c/o Maples Finance Limited P.O. Box 1093 GT Queensgate House 3 South Church Street, George Town Grand Cayman, Cayman Islands Pinnacle Peak CDO I, LLC c/o Puglisi & Associates 850 Library Avenue, Suite 204 Newark, Delaware 19711 Cloverie Plc 1 North Wall Quay International Financial Services Centre Dublin 1 Ireland Plettenberg Bay CDO Limited c/o AIB Financial Services Limited AIB International Centre IFSC, Dublin 1 Ireland Plettenberg Bay CDO Corp. c/o Puglisi & Associates 850 Library Avenue, Suite 204 Newark, Delaware 19711 4 SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK LORELEY FINANCING (JERSEY) NO. 3 LTD.; LORELEY FINANCING (JERSEY) NO. 5 LTD.; LORELEY FINANCING (JERSEY) NO. 6 LTD.; LORELEY FINANCING (JERSEY) NO. 7 LTD.; LORELEY FINANCING (JERSEY) NO. 25 LTD.; LORELEY FINANCING (JERSEY) NO. 27 LTD.; LORELEY FINANCING (JERSEY) NO. 29 LTD.; LORELEY FINANCING (JERSEY) NO. 31 LTD.; and LORELEY FINANCING (JERSEY) NO. 32 LTD., Plaintiffs, -vCITIGROUP GLOBAL MARKETS INC.; CITIBANK, N.A.; CITIGROUP GLOBAL MARKETS LIMITED; LACERTA ABS CDO 2006-1, LTD.; LACERTA ABS CDO 2006-1, CORP.; USP SPC; COOKSON SPC; PINNACLE PEAK CDO I, LTD.; PINNACLE PEAK CDO I, LLC; CLOVERIE PLC; PLETTENBERG BAY CDO LIMITED; and PLETTENBERG BAY CDO CORP. Defendants. Index No. ______________ COMPLAINT TABLE OF CONTENTS Page SUMMARY OF THE ACTION ..................................................................................................... 1 THE PARTIES................................................................................................................................ 7 A. B. The Plaintiffs ............................................................................................................... 7 The Defendants ............................................................................................................ 8 JURISDICTION AND VENUE ................................................................................................... 11 FACTUAL ALLEGATIONS ....................................................................................................... 12 I. A. B. II. A. B. C. D. Background on Plaintiffs and Their Investment Advisor ..................................................12 Plaintiffs‟ Decision to Invest in CDOs ...................................................................... 12 Plaintiffs‟ Reliance on Citigroup ............................................................................... 15 Citigroup‟s Decision to Profit from the Collapse of the Subprime Housing Market on the Backs of Unsuspecting Long Investors like Plaintiffs ...............................16 Citigroup‟s Access to Specialized Information, Unavailable to Plaintiffs, Concerning Subprime Mortgages, RMBS, and CDOs .............................................. 16 Citigroup‟s Inside Knowledge of the Deterioration and Imminent Collapse of the Subprime Capital Markets ......................................................................................... 18 Citigroup‟s Inside Knowledge that the Collateral in CDOs It Was Arranging Was Toxic .......................................................................................................................... 23 Citigroup‟s Inside Knowledge of Impending Downgrades in the RMBS and CDO Markets ...................................................................................................................... 27 III. Through Material Misrepresentations and Omissions, Defendants Induced Plaintiffs into Investing Nearly $1 Billion in CDOs Designed to Fail ..............................29 A. B. C. D. E. The Lacerta CDO ....................................................................................................... 30 The Jackson CDOs .................................................................................................... 37 The Cookson CDOs ................................................................................................... 42 The Pinnacle Peak CDO ............................................................................................ 48 The ABSynth CDOs .................................................................................................. 54 F. The Plettenberg Bay CDO ......................................................................................... 58 IV. Defendants Selected Collateral That Was Not Fair Consideration for the Obligations Undertaken by the CDOs, Leaving Them Insolvent ......................................61 CAUSES OF ACTION ................................................................................................................. 62 Plaintiffs Loreley Financing (Jersey) Nos. 3, 5, 6, 7, 25, 27, 29, 31, and 32 (each, “LFJ” followed by the applicable number, and collectively, the “Loreley Companies” or “Plaintiffs”), as and for their complaint against defendants Citigroup Global Markets Inc. (“CGMI”), Citigroup Global Markets Limited (“CGML,” and together with CGMI, “CGM”), and Citibank, N.A. (“Citi,” and together with CGM, “Citigroup”); Lacerta ABS CDO 2006-1, Ltd. (“Lacerta Ltd.”) and Lacerta ABS CDO 2006-1, Corp. (“Lacerta Corp.,” and together with Lacerta Ltd., “Lacerta”); USP SPC (“USP” or “Jackson”); Cookson SPC (“Cookson”); Pinnacle Peak CDO I, Ltd. (“Pinnacle Peak Ltd.”) and Pinnacle Peak CDO I, LLC (“Pinnacle Peak LLC,” and together with Pinnacle Peak Ltd., “Pinnacle Peak”); Cloverie Plc (“Cloverie” or “ABSynth”); Plettenberg Bay CDO Limited (“Plettenberg Bay Ltd.”) and Plettenberg Bay CDO Corp. (“Plettenberg Bay Corp.,” and together with Plettenberg Bay Ltd., “Plettenberg Bay;” together with Lacerta, Jackson, Cookson, ABSynth and Pinnacle Peak, the “Issuers,” and with Citigroup, collectively, “Defendants”), respectfully allege on knowledge as to themselves and their own actions, and on information and belief as to all other matters, as follows: SUMMARY OF THE ACTION 1. This action arises out of Defendants‟ false and misleading misrepresentations and omissions in arranging, marketing, and inducing Plaintiffs, a group of affiliated investment companies, to invest nearly $1 billion in a series of fraudulent collateralized debt obligations (“CDOs”). Each of these CDOs – Lacerta, Jackson, Cookson, Pinnacle Peak, ABSynth, and Plettenberg Bay – was in reality a fraudulent investment vehicle created and exploited by Defendants for their own benefit. 2. From 2000 to 2006, Citigroup earned increasingly large returns from originating subprime mortgages, securitizing them into residential mortgage-backed securities (“RMBS”), arranging CDOs, and underwriting other structured finance transactions derived from subprime mortgages. When the overheated housing market began to cool in 2006, the market for subprime-based financial products began to decline. Yet Citigroup was accustomed to these profits. In now infamous words, Citigroup‟s then-CEO Chuck Prince said in July 2007, literally days before the subprime market collapse, “As long as the music is playing, you‟ve got to get up and dance,” and added, “We‟re still dancing.”1 3. By early 2007, Citigroup knew that even the most senior tranches of CDOs were far more risky than their ratings suggested. Citigroup‟s peculiar knowledge was based on information on individual loan performance that was available only to financial institutions that, like Citigroup, originated subprime mortgages and securitized them into RMBS. As a result of its insider‟s knowledge, Citigroup knew that the RMBS it and other major banks were packaging into CDOs included a significant percentage of subprime mortgages that violated basic underwriting standards and were likely to default – making the RMBS assets and the CDOs that rested on them far less secure than portrayed by their ratings. Rather than disclosing these material facts to investors in the deals it arranged, Citigroup concealed them so that it could offload some of the massive exposure to subprime RMBS that Citigroup carried on its own balance sheet to unsuspecting investors – while at the same time continuing to earn lucrative fees from generating CDOs – and used its position to transfer its risk to Plaintiffs and other long investors in Citigroup CDOs.2 1 Michiyo Nakamoto & David Wighton, Citigroup Chief Stays Bullish on Buy-Outs, Financial Times, July 9, 2007, http://www.ft.com/cms/s/0/80e2987a-2e50-11dc-821c0000779fd2ac.html#axzz1jdQ16vwk. 2 An investor who takes a “long” position in a security stands to gain when the security performs or increases in value; by contrast, an investor who stands to profit when the security fails to perform or falls in value is referred to as having a “short” position or to be “short” that security. 2 4. Indeed, to continue generating outsized profits in a market that it knew, as an insider, was doomed to collapse sooner rather than later, Citigroup began arranging fraudulent CDOs for its own benefit and for the benefit of certain preferred clients who wanted to “short” the housing market (i.e., to bet that subprime securities would fail). Citigroup also used these CDOs to offload the risk of toxic RMBS and CDO assets that Citigroup carried on its own books by concealing key facts that were peculiarly within its knowledge, while at the same time knowingly misrepresenting to unsuspecting long investors that these assets were of high quality. 5. For example, Citigroup colluded secretly with a now-notorious hedge fund known as Magnetar Capital LLC (“Magnetar”) to create six of Magnetar‟s infamous “Constellation” CDO deals in which Magnetar secretly controlled, undisclosed to investors, critical deal features (including the choice of collateral) to further its scheme to profit from short bets against the housing market. Citigroup benefited from this deceptive scheme by reaping tens of millions of dollars in fees. Working closely with Citigroup, Magnetar purchased the hard-to-sell equity tranches of these CDOs (which carried the most risk) at discounted prices, while using the returns to finance inexpensive short bets against those same CDOs by secretly buying credit protection via credit default swaps (“CDS”) on those reference portfolios, as well as CDS contracts referencing tranches of the CDOs themselves. As Magnetar and Citigroup expected, the CDS contracts generated substantial net profits for Magnetar when the CDOs failed. 6. Citigroup marketed Lacerta, a Constellation CDO, to Plaintiffs as a legitimate long investment opportunity meeting Plaintiffs‟ stringent investment requirements, representing that its portfolio was selected “solely to create a long investment for equity and mezzanine investors.” Citigroup did not disclose the material fact that Magnetar – a party that stood to reap massive profits from the collapse of the housing market – was actually dictating the collateral 3 selection criteria and deal structure of Lacerta behind the scenes. Magnetar‟s economic interests as a net-short investor were directly adverse to those of long investors like Plaintiffs. Moreover, also unbeknownst to Plaintiffs, Citigroup caused the Lacerta CDO to, in effect, sell CDS contracts to Magnetar at below-market prices. In short, Citigroup helped Magnetar stack the deck in its favor so that Magnetar would win no matter what cards were dealt. None of this was disclosed to Plaintiffs. 7. Lacerta was not the only CDO that Citigroup arranged at the behest of a short investor. Like Citigroup, Morgan Stanley & Co., Inc. (“Morgan Stanley”) purchased subprime loans that it packaged into RMBS for sale to unsuspecting investors. Also like Citigroup, Morgan Stanley learned through non-public due diligence reports that a substantial percentage of these loans did not conform to applicable underwriting guidelines, thus rendering the RMBS it was selling much riskier than their credit ratings suggested. Because Morgan Stanley had been unable to sell many of its RMBS directly and needed to offload its exposure to them, it colluded with Citigroup to create the Jackson CDOs – which were purportedly arranged by Citigroup, but were actually constructed by Morgan Stanley to permit it to buy protection on the very toxic securities it had created and could not sell. Citigroup participated in this deception in order to earn lucrative fees for arranging the transaction. 8. Although it was obviously material information, Citigroup never disclosed to Plaintiffs – and indeed affirmatively misrepresented – the fact that Morgan Stanley had not only selected the reference assets in Jackson from its own toxic portfolio, but was betting on the failure of those same assets. Before making this investment, Plaintiffs‟ investment advisor asked Citigroup point-blank who was on the other side of this transaction, and Citigroup lied, falsely claiming that its CDS customer was a hedge fund that wanted to hedge its exposure to certain 4 investments, not an investment bank that wanted to unload risk it was unable to sell in the market. If Plaintiffs had known the truth – that one investment bank was paying a competitor to arrange CDOs for it – Plaintiffs would not have purchased $100 million in Jackson notes. 9. Citigroup also sold Plaintiffs $600 million of notes in a series of synthetic CDOs Via CDS contracts, the Cookson CDOs sold credit protection to a known as “Cookson.” Citigroup affiliate on a pool of 80 referenced CDOs in which Citigroup owned senior positions, thereby shifting the risk of losses on those positions from Citigroup to Plaintiffs. If just five of the referenced CDOs failed, the Citigroup affiliate would cash in on its CDS while Plaintiffs would lose their entire investment. In fact, based on its peculiar knowledge of the performance (or lack thereof) of its subprime mortgages, Citigroup knew that these positions – which were highly rated and appeared outwardly to investors like Plaintiffs to be risk-remote – were in reality facing a heightened risk of imminent collapse. 10. Citigroup deliberately concealed this material information from Plaintiffs, intentionally misleading them into believing that the referenced assets – and thus Plaintiffs‟ investment in the Cookson deals – were risk-remote. In its marketing materials, Citigroup described the Cookson notes as among the most secure investments imaginable – a “1” on a scale of 1 to 10,000. 11. In reality, nearly 19% of the Cookson portfolios referenced other CDOs that Citigroup itself had arranged. Citigroup knew that those CDOs were composed of Citigroupsecuritized RMBS containing high percentages of non-conforming subprime loans. Further, almost 23% of the referenced CDOs in the Cookson portfolios were tranches of Constellation CDOs. Citigroup knew, based upon its experience as an arranger of several Constellation CDOs, that the portfolios of those CDOs had been constructed to the specifications of Magnetar – a 5 short trader whose economic interests were diametrically opposed to those of Plaintiffs. Citigroup knew – but did not disclose to Plaintiffs – that these toxic reference assets rendered the protections that were supposed to be underlying Plaintiffs‟ notes illusory, and that Plaintiffs were likely to lose their entire investment. In short, Citigroup used the Cookson CDOs to shift its exposure and anticipated losses from its own balance sheet to Plaintiffs. 12. Other CDOs that Citigroup arranged, marketed, and sold to Plaintiffs followed similar patterns. For instance, Plaintiffs were induced to invest $70 million in the Pinnacle Peak CDO, a managed deal whose asset portfolio was falsely represented to have been selected by an independent collateral manager that would conduct substantial analytical review of the collateral and act in the best interests of investors. In reality, Citigroup used Pinnacle Peak to offload tranches of other Constellation CDOs that Citigroup knew had been arranged at the behest of a short-trader, to dump otherwise unsellable CDOs that had been arranged by Citigroup, and to dispose of toxic RMBS. Contrary to its false and misleading representations, Citigroup knew but failed to disclose to Plaintiffs that the assets underlying the Pinnacle Peak CDO were so poor that Plaintiffs‟ investment was effectively doomed to fail and was worthless from inception. 13. In truth, Citigroup arranged CDOs like Pinnacle Peak to serve as buyers for tranches of other CDOs that Citigroup had previously arranged and retained on its own books. Thus, Citigroup was essentially running a shell game, creating the false appearance of a market whereby Citigroup-arranged CDOs acted as buyers and sellers of each other‟s tranches. Plaintiffs did not know, nor could they have known, that they were victims of this scheme. 14. To recover the almost $1 billion they paid for these and other fraudulent investments which are now worthless, Plaintiffs assert claims seeking damages and rescission based on fraud, fraudulent conveyance, and unjust enrichment. 6 THE PARTIES A. 15. The Plaintiffs Plaintiff LFJ 3 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 3 invested in and is the owner of $150 million Class A notes issued in connection with the Cookson I CDO. 16. Plaintiff LFJ 5 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 5 invested in and is the owner of $90 million Class A notes issued in connection with the Cookson IV CDO. 17. Plaintiff LFJ 6 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 6 invested in and is the owner of $30 million Class A notes issued in connection with the Cookson IV CDO and $25 million Class A-1 notes issued in connection with the Plettenberg Bay CDOs. 18. Plaintiff LFJ 7 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 7 invested in and is the owner of $30 million Class A notes issued in connection with the Cookson IV CDO. 19. Plaintiff LFJ 25 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 25 invested in and is the owner of $50 million Class IA and $50 million Class IIA notes issued in connection with the Jackson CDOs. 7 20. Plaintiff LFJ 27 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 27 invested in and is the owner of $70 million Class A-1 notes issued in connection with the Lacerta CDO. 21. Plaintiff LFJ 29 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 29 invested in and is the owner of $80 million Class B notes and $20 million Class C notes issued by Cloverie in connection with the ABSynth CDOs. 22. Plaintiff LFJ 31 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 31 invested in and is the owner of $150 million Class A notes issued in connection with the Cookson II CDO and $150 million Class A notes issued in connection with the Cookson III CDO. 23. Plaintiff LFJ 32 is a company organized and existing under the laws of Jersey, Channel Islands, located at 26 New Street, St. Helier, Jersey JE2 3RA, Channel Islands. Plaintiff LFJ 32 invested in and is the owner of $70 million Class A3 notes issued in connection with the Pinnacle Peak CDO. B. 24. The Defendants Defendant Lacerta Ltd. is a Cayman Islands limited liability company located at c/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South Church Street, George Town, Grand Cayman, Cayman Islands. Lacerta Ltd. is the issuer of the Lacerta notes owned by Plaintiff LFJ 27. 8 25. Defendant Lacerta Corp. is a Delaware corporation located at c/o Donald J. Puglisi, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Lacerta Corp. is the co-issuer of the Lacerta notes owned by Plaintiff LFJ 27. 26. Defendant USP is a Cayman Islands limited liability segregated portfolio company located at c/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South Church Street, Grand Cayman, Cayman Islands. USP is the issuer of the Jackson notes owned by Plaintiff LFJ 25. 27. Defendant Cookson is a Cayman Islands limited liability segregated portfolio company located at c/o Maples Finance Limited, P.O. Box 1093 GT, Queensgate House, South Church Street, George Town, Grand Cayman, Cayman Islands. Cookson is the issuer of the Cookson I notes owned by Plaintiff LFJ 3, the Cookson II notes and the Cookson III notes owned by Plaintiff LFJ 31, and the Cookson IV notes owned by Plaintiffs LFJ 5, LFJ 6, and LFJ 7. 28. Defendant Pinnacle Peak Ltd. is a Cayman Islands limited liability company located at P.O. Box 1093 GT, Queensgate House, South Church Street, George Town, Grand Cayman, Cayman Islands. Pinnacle Peak Ltd. is the issuer of the Pinnacle Peak notes owned by Plaintiff LFJ 32. 29. Defendant Pinnacle Peak LLC is a Delaware limited liability company located at c/o Puglisi & Associates, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Pinnacle Peak LLC is the co-issuer of the Pinnacle Peak notes owned by Plaintiff LFJ 32. 30. Defendant Cloverie is an Irish limited liability company located at 1 North Wall Quay, International Financial Services Centre, Dublin 1, Ireland. Cloverie is the issuer of the ABSynth notes owned by Plaintiff LFJ 29. 9 31. Defendant Plettenberg Bay Ltd. is an Irish limited liability company located at c/o AIB Financial Services Limited, AIB International Centre, IFSC, Dublin 1, Ireland. Plettenberg Bay Ltd. is the issuer of the Plettenberg Bay notes owned by Plaintiff LFJ 6. 32. Defendant Plettenberg Bay Corp. is a Delaware corporation located at c/o Puglisi & Associates, 850 Library Avenue, Suite 204, Newark, Delaware 19711. Plettenberg Bay Corp. is the co-issuer of the Plettenberg Bay notes owned by Plaintiff LFJ 6. 33. Collectively, Defendants Lacerta, Cookson, USP, Pinnacle Peak, Cloverie and Plettenberg Bay are referred to as the “Issuers.” 34. Defendant CGMI is a New York corporation located at 390 Greenwich Street, New York, New York 10013. CGMI is a registered broker-dealer and serves as a brokerage and securities arm of Citigroup Inc. CGMI was the arranger of the Lacerta, Jackson, Cookson, Pinnacle Peak and Plettenberg Bay CDOs. 35. Defendant CGML is a United Kingdom limited-liability company located at Citigroup Centre, 33 Canada Square, Canary Wharf, London E14 5LB, United Kingdom. CGML was the arranger for the ABSynth CDOs. CGML was also the counterparty to the Class S swap in the Plettenberg Bay CDO and on the CDS in the ABSynth CDOs. CGML worked with Defendant CGMI to perpetrate the ABSynth fraud described herein by selecting CDOs and RMBS that CGMI had arranged as referenced assets for the ABSynth notes. 36. CGMI and CGML were the underwriters and direct sellers of the Lacerta, Jackson Cookson, Pinnacle Peak, ABSynth, and Plettenberg Bay notes purchased by Plaintiffs. 37. Defendant Citi is a chartered national banking association located at 399 Park Avenue, New York, New York 10043. Citi also has a London-based affiliate, which is a foreign registered commercial banking institution located at Citigroup Centre, 33 Canada Square, Canary 10 Wharf, London E14 5LB, United Kingdom. Citi was the counterparty to the CDS issued by the Lacerta, Jackson, Cookson, Pinnacle Peak and Plettenberg Bay CDOs. JURISDICTION AND VENUE 38. This Court has jurisdiction over Defendants pursuant to CPLR §§ 301 and 302. Defendants CGMI and Citi maintain offices and regularly conduct business in New York, and orchestrated the fraudulent schemes at issue in and from New York. All Defendants transacted business within New York that gives rise to Plaintiffs‟ causes of action. Defendants committed the wrongful acts alleged herein in New York. All Defendants regularly transact business within New York and contract to provide services within New York. 39. Moreover, the relevant documents governing the Lacerta, Jackson, Cookson, Pinnacle Peak, and Plettenberg Bay CDOs each provide for an express submission to jurisdiction in the State of New York, County of New York. 40. Venue in New York County is proper pursuant to CPLR §§ 501, 503 and 509. CGMI and Citi reside in this county. The relevant documents governing the Lacerta, Jackson, Cookson, Pinnacle Peak and Plettenberg Bay CDOs each provide for venue in the State of New York, County of New York. Additionally, Defendants committed many of the alleged wrongful acts at issue in and from the County of New York. 41. This action is appropriately assigned to the Commercial Division of the Supreme Court of the State of New York, County of New York, pursuant to the Rules of the Commercial Division of the Supreme Court, including § 202.70 of the Uniform Rules for New York State Trial Courts. 11 FACTUAL ALLEGATIONS I. Background on Plaintiffs and Their Investment Advisor A. 42. Plaintiffs’ Decision to Invest in CDOs Plaintiffs are special purpose entities formed to invest in CDOs on a long-term, buy-and-hold basis. 43. A CDO is an investment vehicle that typically includes the formation of a special purpose entity, commonly referred to as the “issuer,” that raises money by issuing securities to investors. Generally, an arranging bank creates the issuer in order to acquire a portfolio of investment assets whose cash flow is the expected source of income for various classes, or “tranches,” of debt securities that are marketed and sold to investors.3 44. The investors in the CDO, which include noteholders and equity investors, are paid from the proceeds generated by the collateral. Amounts are paid out to investors according to a defined priority (known as a “waterfall”). The most senior tranches of notes, which have the lowest risk of loss and highest credit rating, typically receive principal and interest first. The junior tranches have the highest risk of loss and lowest credit rating (with the exception of the equity tranche, which typically is not rated). 45. Banks that arrange CDOs typically perform multiple roles, including: (a) structuring and modeling the CDOs; (b) marketing and selling them to investors; (c) interfacing with ratings agencies to achieve the targeted ratings for the CDOs‟ tranches; (d) financing and 3 The assets in a CDO‟s portfolio can be comprised of cash assets (such as RMBS), synthetic assets, or both. Synthetic assets include CDS contracts, transactions resembling an insurance contract whereby a “protection buyer” pays a “protection seller” periodic “premiums” (similar to insurance premiums) in return for the protection seller‟s promise to pay the protection buyer should certain “credit events” occur, such as events of payment default, loss, write-down, or a deterioration in ratings. A CDO containing both cash and synthetic assets is referred to as a “hybrid” CDO. 12 facilitating the purchases of the cash collateral and holding that collateral on their own books prior to closing; and (e) facilitating hybrid structures by acting as the initial protection buyer for CDS included in the synthetic collateral pool. Moreover, because the special purpose vehicle that serves as the deal‟s issuer does not have any employees of its own, the arranging banks usually act for the issuer and serve as the “initial purchasers,” buying all of the notes from the issuer at closing and then selling them to investors. For performing these functions, arranging banks typically receive millions of dollars in fees at closing. 46. IKB Deutsche Industriebank AG, along with its former affiliate IKB Credit Asset Management GmbH (collectively, “IKB”), was contractually appointed as investment advisor to Plaintiffs. Plaintiffs‟ investment advisor identified potential investments in CDOs and performed due diligence on behalf of Plaintiffs prior to making investment recommendations to them. 47. At all relevant times, Defendants knew that IKB served as Plaintiffs‟ investment advisor and that IKB performed due diligence on and recommended CDO investments – including the investments at issue in this lawsuit – to Plaintiffs. 48. Citigroup and the other Defendants represented to Plaintiffs that independent and experienced collateral managers would select and manage the collateral portfolios for the Pinnacle Peak and Plettenberg Bay CDOs for the benefit of long investors such as Plaintiffs, whose profits are dependent on the success of the CDO. The long investors typically pay the collateral manager a percentage of the notional value of the transaction (i.e., the total deal issuance) as a fee. 49. The collateral manager‟s role is material to a long investor‟s investment decision because the collateral manager is supposed to be responsible for the CDO‟s risk profile and performance through its selection of collateral. For that reason, Plaintiffs‟ investment advisor 13 conducted extensive due diligence on collateral managers. The collateral manager has a duty to analyze and select collateral with the best risk/return profile and which fits the investors‟ eligibility criteria, to monitor the credit status of the individual underlying assets, to reinvest payment proceeds from maturing underlying assets, and to make allowed substitutions in the collateral to maximize long investors‟ profits. 50. The performance of the collateral selected for a CDO is critical to the deal‟s success. As Defendants were aware, neither Plaintiffs nor their investment advisor had close relationships with loan servicers or originators, or access to the loan-level information for the mortgages underlying the CDO deals in which Plaintiffs invested, and therefore could not conduct due diligence on a loan-by-loan basis, which was essential to valuing a CDO‟s collateral. Therefore, the involvement of a qualified, independent collateral manager committed to identifying and selecting the highest quality and best mix of eligible collateral in the best interests of the CDO‟s long investors was a material factor in Plaintiffs‟ investment decisions and the recommendations of their investment advisor. For managed deals, Plaintiffs sought out experienced and independent collateral managers who were committed to selecting and managing the collateral for the benefit of investors and the CDO‟s success. 51. Plaintiffs‟ investment decisions also were based on the ratings assigned to prospective CDO investments and their underlying collateral as indicators of the risks associated with potential investments.4 Like many other CDO investors, Plaintiffs focused on highly-rated tranches (primarily AAA and AA).5 4 Ratings agencies typically assign credit ratings to the various tranches of a CDO (except for the equity tranche). For the purposes of this complaint, and unless stated otherwise, any reference to a particular rating refers to the Standard & Poor‟s ratings categories. 5 According to Standard & Poor‟s, a rating of “AAA” signifies an “[e]xtremely strong capacity to meet financial commitments,” and a rating of “AA” signifies a “[v]ery strong capacity to meet 14 B. 52. Plaintiffs’ Reliance on Citigroup Citigroup had a longstanding business relationship with Plaintiffs through their investment advisor. Citigroup promoted itself to Plaintiffs‟ investment advisor as a leader in structured finance CDOs, listing its track record with billions of dollars in structured credit transactions that either had already closed or were in the pipeline. 53. Plaintiffs‟ investment advisor specifically reviewed Plaintiffs‟ investment strategy and guidelines with Citigroup, in detail, during meetings, phone conversations and in various emails. Citigroup was also intimately familiar with Plaintiffs‟ investment program and criteria, as well as IKB‟s role as investment advisor to the Plaintiffs. 54. Between 2005 and 2007, Plaintiffs‟ investment advisor recommended to Plaintiffs, and other related special-purpose entities, investments in 20 Citigroup-arranged CDOs totaling approximately $1.8 billion. Citigroup was among the largest and most trusted arrangers of CDO investments for Plaintiffs. 55. Based on its deep and lengthy business relationship with Plaintiffs‟ investment advisor and detailed knowledge of Plaintiffs‟ investment program and objectives, Citigroup knew that over the course of 2006 and 2007, Plaintiffs had become increasingly interested in highly-rated CDOs with the most secure structures. 56. Plaintiffs and their investment advisor reasonably relied on Citigroup to present only those CDOs that met Plaintiffs‟ stringent standards. financial commitments.” See Credit Ratings Definitions & FAQs, Standard & Poor‟s, http://www.standardandpoors.com/ ratings/definitions-and-faqs/en/us. 15 II. Citigroup’s Decision to Profit from the Collapse of the Subprime Housing Market on the Backs of Unsuspecting Long Investors like Plaintiffs A. 57. Citigroup’s Access to Specialized Information, Unavailable to Plaintiffs, Concerning Subprime Mortgages, RMBS, and CDOs Citigroup was a major player at multiple levels of the subprime capital market: it acted as a mortgage originator, an underwriter of subprime RMBS, and an arranger of structured finance products, like CDOs, that invested in RMBS. Because of these multiple roles, Citigroup gained a unique perspective and obtained peculiar knowledge – unavailable to Plaintiffs and their investment advisor – concerning the deteriorating condition and imminent collapse of the subprime market and the quality of the CDOs it was promoting. 58. For example, in its consumer lending business unit, Citigroup held prime and subprime mortgages that it had originated itself or purchased from third parties through the Citigroup mortgage lending subsidiary, CitiFinancial Mortgage (“CitiFinancial”). Citigroup securitized these mortgages into RMBS, which it either sold to institutional investors directly or placed into CDOs and other structured finance products that it arranged. 59. Within the investment banking business unit, Citigroup held subprime mortgages for securitization and trading, subprime RMBS that Citigroup warehoused, and tranches of CDOs that Citigroup had previously arranged but had not sold.6 60. From 2005 to 2007, Citigroup arranged nearly $110 billion of CDOs. During that period, Citigroup rose from the world‟s fourth-largest arranger of mortgage-backed CDOs to the 6 See Subprime Lending and Securitization and Government Sponsored Enterprises: Hearing Before the Financial Crisis Inquiry Commission, 127:16-25 to 128:1-17 (Apr. 7, 2010) (testimony of Susan Mills, Managing Director of Mortgage Finance, Citi Markets & Banking, Global Securitized Markets), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/20100407-Transcript.pdf. 16 largest – and received hundreds of millions of dollars in associated fees. Citigroup reaped over $347 million in fees from CDO transactions in 2007 alone. Collateralized Debt Obligations Issuances (2007)* Rank 1 2 3 4 5 Bank Citigroup Merrill Lynch Deutsche Bank Barclays Wachovia 2007 Issuance ($Mil.) $41,975.10 38,055.10 31,495.70 28,004.90 23,210.10 No. of Deals 60 55 51 29 48 Market Share (%) 10.0 9.0 7.5 6.7 5.5 *Includes CDOs of CMBS Source: Bookrunners of Worldwide Collateralized Debt Obligations in 2008, AssetBacked Alert (Dec. 31, 2008), http://www.abalert.com/ranking.php?rid=1756. 61. Although it sold the equity, mezzanine, and some of the senior tranches of these CDOs, Citigroup retained other senior tranches, typically known as “super-senior” tranches, which were considered extremely safe and secure.7 62. In a continuously rising housing market and healthy economy, Citigroup‟s subprime-related businesses appeared to be nearly risk-free. Citigroup could make increasingly aggressive mortgages to subprime borrowers, but see default rates remain manageable. Citigroup could package those mortgages into RMBS, and quickly sell those RMBS to third 7 Subprime Lending and Securitization and Government Sponsored Enterprises: Hearing Before the Fin. Crisis Inquiry Comm’n.. 261:18-24 (Apr. 7, 2010) (testimony of Nestor Dominguez, Former Co-Head of Global CDOs, Citigroup), http://fcic-static.law.stanford.edu/cdn_media/fcictestimony/2010-0407-Transcript.pdf (hereinafter, “Dominguez Testimony Transcript”) (“Our CDO business model called for distributing all the securities that resulted from our CDO structuring activities except the most senior tranches of specific transactions that were structured to be held on Citi‟s balance sheet. These retained positions were referred to in the market as „super senior‟ . . . .”). As recounted by the FCIC, there were at least two additional reasons for retaining these tranches. First, the favorable capital treatment of AAA rated securities required banks to hold relatively less capital against them. See Fin. Crisis Inquiry Comm‟n.., The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States 196 (2011) (hereinafter, “FCIC Report”). Second, the super-senior and triple-A tranches were reported “at values for which they could not be sold” and as a consequence the “finances for creating the deal” improved. Id. In essence, “[i]t was a hidden subsidy of the CDO business by mispricing.” Id. 17 parties without taking any risk of decline. And Citigroup could also package the RMBS into CDOs and sell those CDOs on to investors. At each step in the chain, Citigroup could pocket additional fees while minimizing the exposure to risks from subprime RMBS on its own balance sheet. B. 63. Citigroup’s Inside Knowledge of the Deterioration and Imminent Collapse of the Subprime Capital Markets In 2005 and 2006, Citigroup became aware that the economic foundation of its Because of its insider‟s subprime CDO and RMBS businesses were beginning to crack. perspective, Citigroup became aware that subprime borrowers were missing increasing numbers of payments, causing higher delinquency and default rates. In some instances, those missed payments occurred within the first three months of the mortgage loan being made, suggesting that increasing numbers of mortgages were the product of fraudulent loan applications or otherwise had not met lenders‟ original underwriting guidelines. The escalating incidence of non-conforming loans also led to heightened requests by securities issuers and intermediaries that the loan originators take back mortgages that did not conform to underwriting criteria specified in the loan purchase agreement (known as “put backs”). These factors raised the specter of meaningful losses not just on the mortgages themselves, but on all products composed of them. The markets for subprime RMBS and CDOs began to soften. 64. balance sheet. Citigroup was keenly aware of the risks that these developments posed to its As a mortgage originator and RMBS securitizer, Citigroup knew that the subprime mortgage industry had become a house of cards teetering on the brink of collapse. 65. By early 2006, Citigroup knew that substantial volumes of the subprime (and even prime) loans that it was purchasing from mortgage originators for securitization did not conform to applicable underwriting standards. 18 66. Richard Bowen, the former Business Chief Underwriter for Citigroup‟s Consumer Lending Group, testified before the Financial Crisis Inquiry Commission (“FCIC”) that through extensive due diligence of the mortgages Citigroup acquired – information that was not available to investors like Plaintiffs – he discovered that significant portions of these mortgages were defective and failed to meet Citigroup‟s underwriting and quality assurance standards. 67. Mr. Bowen observed that, by mid-2006, more than 60% of the prime mortgages Citigroup purchased from originators failed to comply with Citigroup‟s guidelines, and that the number of defective mortgages increased to over 80% during 2007.8 Despite knowing these mortgages were toxic, Citigroup securitized approximately 80% of them into RMBS and CDOs and sold them to investors without disclosure of these material facts.9 68. The situation Mr. Bowen observed with respect to the subprime loans Citigroup Citigroup‟s policy dictated that pools of was acquiring and securitizing was just as dire. subprime mortgages could only be purchased if underwriters applying Citigroup‟s policy guidelines for subprime mortgages approved a minimum of 90% of loans in the pool (or, if the pool was extremely large, in a statistically significant sample of the pool).10 Mr. Bowen testified that in the third quarter of 2006, the subprime loan Chief Risk Officer was changing 8 See Subprime Lending and Securitization and Government Sponsored Enterprises: Hearing Before the Fin. Crisis Inquiry Comm’n. 134:24-25 to 135:1-19 (Apr. 7, 2010) (testimony of Richard M. Bowen III, former Business Chief Underwriter, Citigroup Consumer Lending Group), http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0407-Transcript.pdf (hereinafter, “Bowen Testimony Transcript”). 9 See Written Testimony of Richard M. Bowen III, former Business Chief Underwriter, Citigroup Consumer Lending Group, Presented to the Fin. Crisis Inquiry Comm‟n. at the Hearing on Subprime Lending and Securitization and Government Sponsored Enterprises 6 (Apr. 7, 2010), http://fcic-static.law.stanford.edu/ cdn_media/fcic-docs/2010-0407%20Richard%20Bowen%20Written%20Testimony.pdf (hereinafter, “Bowen Written Testimony”). 10 See id. at 9. 19 underwriters‟ recommendations from “turn down” to “approve” in order to ensure that the loan pool would pass the 90% approval threshold.11 Mr. Bowen further testified that, on other occasions, Citigroup purchased subprime loan pools where only 70% of the constituent loans met Citigroup‟s underwriting guidelines.12 Still on other occasions, the Chief Risk Officer instructed underwriters to assess loan pools using the originators‟ more lenient underwriting guidelines rather than Citigroup‟s more stringent standards.13 69. Mr. Bowen repeatedly raised these concerns with his superiors, including the Chairman of the company‟s Executive Committee, its Senior Risk Officer, its Chief Financial Officer, and its Chief Auditor.14 And if the company required any further confirmation of the red flags its Chief Underwriter was raising, Citigroup received such confirmation from Clayton Holdings (“Clayton”), the due diligence consultant Citigroup retained to examine samples of the mortgage pools that Citigroup was purchasing in order to determine whether the sampled mortgages conformed to applicable underwriting standards. 70. Starting in late 2005 or early 2006, Clayton reported to Citigroup that a large percentage of the loans Citigroup had acquired for securitization were non-conforming.15 Of the 11 12 13 14 See id; see also Bowen Testimony Transcript, supra note 8, at 136:14-18. See Bowen Written Testimony, supra note 9, at 10. See id. See id. at 2, 7, 13-14; see also Bowen Testimony Transcript, supra note 8, at 133:14-25, 134:1-7, 135:9-19, 136:19-21, 154:16-19, 155:1-3, 175:3:18. 15 Letter from Paul T. Bossidy, Chief Executive Officer, Clayton, to Phil Angelides, Chairman, Fin. Crisis Inquiry Comm‟n. 3 (Sept. 30, 2010), http://graphics8.nytimes.com/packages/pdf/opinion/Clayton-FCIC.pdf (“Clayton rolled out this system and its Exception Reports to our clients beginning in late 2005 and continuing throughout 2006.”) 20 6,205 loans it reviewed for Citigroup from 2006 to the first half of 2007, Clayton flagged 42% as failing to conform to underwriting standards.16 71. Faced with this information, basic business ethics required Citigroup do one of two things. First, given that at least two out of every five loans in the sample reviewed by Clayton were defective, Citigroup should have examined the entire loan pool to identify and remove all of the other defective loans. Indeed, Citigroup had a contractual right to “put back” these non-conforming loans to the originator, requiring the original lender to repurchase such loans from Citigroup. Alternatively, Citigroup should have disclosed – both to the ratings agencies and to potential investors – that the RMBS it was underwriting were substantially tainted with non-conforming and highly risky loans. 72. But Citigroup did neither of these things. Instead of taking steps to protect investors, or at least disclose these key material facts to them, Citigroup acted for its own benefit. Rather than use the Clayton analysis to improve the quality of the RMBS it was marketing, Citigroup instead used it to negotiate lower prices from the originators of these bad loans and pocketed the discount for itself. 73. To make matters worse, Citigroup ignored Clayton‟s recommendations that the bank should reject these non-conforming loans. Citigroup allowed 31% of the defective loans Clayton found in its sample back into the loan pools, meaning that one out of every three of these bad loans made their way into RMBS. More importantly, Citigroup made no effort to examine any of the loans that Clayton did not review (in other words, the vast majority of loans in the 16 See FCIC Report, supra note 7, at 167; see also All Clayton Trending Reports: 1st Quarter 2006 – 2nd Quarter 2007 (Sept. 23, 2010), http://fcic-static.law.stanford.edu/cdn_media/fcictestimony/2010-0923-Clayton-All-Trending-Report.pdf (hereinafter, “Clayton Trending Report”). 21 pool17), meaning that all of the bad loans buried in the unreviewed majority of the pool – 100% of them – made their way into RMBS and, inevitably, into CDOs of RMBS. 74. The Federal Housing Finance Agency (the “FHFA”)18 sued Citigroup in connection with its subprime RMBS operations in a complaint recently filed in the Southern District of New York.19 The FHFA alleged that Citigroup falsely represented the quality and nature of the loans underlying over $3.5 billion worth of RMBS that Citigroup securitized and sold to Fannie Mae and Freddie Mac. After those securities began to fail at an alarming rate, Fannie Mae and Freddie Mac discovered massive discrepancies between the actual owneroccupancy rates and loan-to-value ratios and what was represented by the loan originators in prospectus supplements and other marketing and registration materials. 75. Citigroup knew but never disclosed to Plaintiffs that a substantial proportion of the loans underlying the RMBS assets of the CDOs it was arranging were non-conforming and 17 According to testimony provided to the FCIC by Clayton personnel, the size of the loan samples was a subject of contention between Clayton and the banks for whom it was performing due diligence, with the banks constantly pushing for smaller sample sizes. The typical sample size banks allowed Clayton to review was 10%, dipping as low as 5% during the height of the subprime mortgage boom. See, e.g., Financial Crisis at the Community Level – Sacramento, CA: Hearing Before the Fin. Crisis Inquiry Comm’n. 156:7-9, 177:15-23 (Sept. 23, 2010) (testimony of Vicki Beal, Senior Vice President, Clayton Holdings), http://fcicstatic.law.stanford.edu/cdn_media/fcic-testimony/2010-0923-transcript.pdf (hereinafter, “Beal Testimony Transcript”). 18 The FHFA is a federal agency that was created pursuant to the Housing and Economic Recovery Act of 2008 (“HERA”) to oversee the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the Federal Home Loan Banks. On September 6, 2008, FHFA was appointed conservator of Fannie Mae and Freddie Mac and in that capacity is authorized under HERA to bring suits on behalf of those entities. See 12 U.S.C. § 4617(b)(2). 19 See Complaint, Fed. Hous. Fin. Agency v. Citigroup, Inc. et al., No. 11-Civ-6196, 2011 WL 3873301 (S.D.N.Y. Sept. 2, 2011). 22 that Citigroup had negotiated a discount from the loans‟ originators based on this defect and pocketed the reduction as profit.20 C. 76. Citigroup’s Inside Knowledge that the Collateral in CDOs It Was Arranging Was Toxic Citigroup knew but never disclosed that the RMBS underlying its CDOs were composed largely of toxic mortgages that were likely to default and were not worthy of the credit ratings given to them by the ratings agencies. In the rare instances where Citigroup experienced push-back from the ratings agencies, Citigroup pressed for exceptions to ensure that its deals received higher ratings than they deserved.21 77. Equally important, based on communications with Clayton, with originators, and with other market participants, Citigroup knew or had reason to suspect that the RMBS securitized by other underwriters that it was packing into its CDOs were similarly flawed. Indeed, as Citigroup‟s former CEO, Charles Prince, explained in testimony before the FCIC, within the major investment banks – including Citigroup itself – the securitization of subprime RMBS had become “a factory line…. As more and more of these subprime mortgages were created as raw materials for the securitization process … more and more of it was of lower and 20 See Beal Testimony Transcript, supra note 17, at 155:24-25 to 156:1-4 (“[O]ur clients use Clayton‟s due diligence to identify issues with loans, negotiate better prices on pools of loans they are considering for purchase, and negotiate expanded representations and warranties in purchase and sale agreements from sellers.”); Jonathan R. Laing, Banks Face Another Mortgage Crisis, Barron’s, Nov. 20, 2010, http://online.barrons.com/article/SB50001424052970203676504575618621671054514.html#articl eTabs_panel_ article%3D1 (“Apparently the Clayton data were merely employed by the securitizers to negotiate lower prices on the mortgages from the originators without passing any price discount or higher yield on to the investors.”) 21 See S. Permanent Subcomm. on Investigations of the S. Comm. on Homeland Sec. and Governmental Affairs, 112th Cong., Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, 279 & n.1079 (Apr. 13, 2011) (hereinafter, “Levin Report”) (quoting February 2006 e-mail from Citigroup to S&P, pressuring the agency not to apply a more accurate rating model or to grant an exception); id. at 282 & n.1087 (June 2007 e-mail from Moody‟s to Citigroup agreeing to grant an exception). 23 lower quality. And at the end of the process, the raw material [i.e., the mortgages themselves] going into it was actually bad quality, it was toxic quality, and that is what ended up coming out the other end of the pipeline.”22 78. In contrast to a multifaceted market participant such as Citigroup, Plaintiffs and their investment advisor lacked access to the above-described information. They did not know and could not have known the truth about the non-conforming mortgages and other issues underlying the RMBS in the collateral portfolios of the CDOs Citigroup was arranging. 79. Citigroup‟s exposure to the toxic mortgage securities on its books was massive. Citigroup had over $20 billion in super-senior exposure from the CDOs that it arranged between 2004 and 2007. To make matters worse, Citigroup had issued “liquidity puts” on an additional $25 billion in super-senior tranches of other CDOs, thereby incurring the risk of losses on them as well.23 80. By no later than April 2007, Citigroup recognized internally that continued softening of housing prices would consume the subordination supposedly protecting even the super-senior tranches of CDOs,24 and therefore knew that its super-senior tranches, which had 22 23 FCIC Report, supra note 7, at 102-03. See Written Testimony of Nestor Dominguez, former Co-Head of Global CDOs, Citigroup, Presented to the Fin. Crisis Inquiry Comm‟n. at the Hearing on the Impact of the Financial Crisis (Apr. 7, 2010), http://www.fcic.gov/hearings/pdfs/2010-0407-Dominguez.pdf (noting that Citi‟s put options were “a fall-back source of financing, in case of either a significant widening of credit spreads or a temporary inability to issue commercial paper); see also Dominguez Testimony Transcript, supra note 7, at 262:25 to 263:1-3. 24 Presentation by Alberto Agrest, Citigroup Global Markets Inc., Credit Derivatives: Products and Markets (Nov. 2007). The presentation includes a chart from an April 11, 2007 Citigroup report titled ABS CDOs in a Mezz, which shows CDO loss estimates based on various subprime scenarios. 24 already lost substantial value, were at risk of plummeting further. Nevertheless, Citigroup deliberately reported inflated values for the super-senior positions it kept on its books.25 81. At the same time, beginning in or around 2006, Citigroup was finding it progressively more difficult to drum up investors for the senior and junior tranches of its CDOs, and was increasingly being forced to hold these positions on its own books – and thus bear the risk – after the deals closed. To minimize its own exposure (while keeping its CDO machine running), Citigroup decided to manufacture the appearance of a market for these otherwise unsellable tranches by placing them into new Citigroup-arranged CDOs that it controlled. 82. As reported by the independent, non-profit newsroom ProPublica, “[b]y 2007, 67 percent of [CDO securities] were purchased by other CDOs” and “[t]he banks often orchestrated these purchases.” ProPublica found “85 instances during 2006 and 2007 where two CDOs bought pieces of each other‟s unsold inventory.”26 The arranging banks induced collateral managers to go along by threatening to cut them off from future CDO management business if they did not agree to purchase CDO notes for the CDOs they were managing.27 83. According to one analysis, Citigroup incestuously placed over 30% of the tranches of the CDOs it arranged into other Citigroup-arranged CDOs, making Citigroup‟s CDOs their own largest customers. Not surprisingly, Citigroup-arranged CDOs that crossinvested in other Citigroup-arranged CDOs performed particularly poorly, demonstrating that Citigroup included the worst of its own CDO tranches in subsequent CDOs. 25 26 See FCIC Report, supra note 7, at 196. See Jake Bernstein and & Jesse Eisinger, Banks‟ Self-Dealing Super Charged Financial Crisis, ProPublica (Aug. 26, 2010), http://www.propublica.org/article/banks-self-dealing-supercharged-financial-crisis. 27 See id. 25 84. Recognizing this pattern, in October 2011, the U.S. Securities and Exchange The SEC alleged that in or about October 2006, Commission (“SEC”) sued Citigroup.28 Citigroup‟s CDO trading desk and its CDO structuring desk devised a plan to allow the bank to place a massive short bet against A-rated tranches of specific mezzanine CDOs that they believed were at heightened risk of defaulting. To carry out this plan, Citigroup arranged Class V Funding III (“Class V Funding”), a hybrid “CDO-squared” (so-called because its collateral consisted of tranches of other CDOs) with a notional portfolio valued at $1 billion. 85. Unknown to investors, Citigroup used Class V Funding to take a $500 million naked short position29 on specific CDO tranches that Citigroup clandestinely selected for Class V Funding‟s synthetic portfolio. Citigroup hid its involvement in portfolio selection from potential investors by falsely representing in the deal‟s marketing materials that Credit Suisse Alternative Capital, Inc. (“CSAC”), the deal‟s putative collateral manager, would independently select Class V Funding‟s portfolio. Ultimately, Citigroup selected nearly 60% of Class V Funding‟s reference assets, which it shorted through CDS contracts. 86. In addition to concealing its involvement in selecting collateral for Class V Funding, Citigroup also misrepresented that its true economic interests in this CDO were directly opposed to those of the long investors to whom Citigroup was marketing the deal. From the outset, Citigroup had intended to use Class V Funding as a vehicle for making a proprietary short trade (i.e., one made for the bank‟s own benefit and not on behalf of a client) on $500 million – fully half – of the deal‟s portfolio. Citigroup did not disclose this material fact in its marketing materials. 28 See Complaint, SEC v. Citigroup Global Markets, Inc., No. 11-Civ-7387 (S.D.N.Y. Oct. 19, 2011). 29 A “naked short” position is one that is not being used to hedge or offset a long position. 26 87. Citigroup‟s undisclosed short-trading scheme soon paid off. Less than nine months after the deal closed, all of Class V Funding‟s tranches were downgraded; 12 days later, the CDO experienced an event of default. Class V Funding‟s long investors suffered catastrophic losses on their investments, yet Citigroup pocketed approximately $160 million of net profit on its venture, including $34 million in fees for structuring the deal. 88. Citigroup reached a settlement with the SEC on October 19, 2011, pursuant to which it agreed, without admitting or denying liability, to disgorge its entire $160 million profit from Class V Funding plus an additional $125 million in penalties and prejudgment interest.30 The judge, however, refused to approve the proposed settlement, stating that Citigroup was a “recidivist” and should not be permitted to escape liability for relative “pocket change” and without admitting wrongdoing.31 The settlement was rejected by the District Court, and is currently on appeal. D. 89. Citigroup’s Inside Knowledge of Impending Downgrades in the RMBS and CDO Markets In or about May 2007, Citigroup received highly material, non-public information that Moody‟s would soon change the methodology used to rate RMBS and RMBS CDOs, which would result in downgrades and defaults on a massive scale. 90. Documents produced in litigation brought against another financial institution involved in arranging and selling CDOs show that Moody‟s conducted meetings in May 2007 30 See Press Release, Sec. & Exchange Comm‟n., Citigroup to Pay $285 Million to Settle SEC Charges for Misleading Investors About CDO Tied to Housing Market (Oct. 19, 2011), www.sec.gov/news/press/2011/2011-214.htm. 31 See United States SEC v. Citigroup Global Markets Inc., 11 Civ. 7387 (JSR), 2011 U.S. Dist. LEXIS 135914, *14-15 (S.D.N.Y. Nov. 28, 2011). 27 with investment banks – including, on information and belief, Citigroup – concerning the timing of these downgrades.32 91. As a major player in the CDO and RMBS markets, Citigroup knew that these downgrades would have particularly severe effects on CDO-squared products – such as Cookson, ABSynth, and Pinnacle Peak – because downgrades in the referenced CDO assets would trigger an event of default in the CDO-squared. 92. By June 2007, the head of Citigroup‟s mortgage desk had come to the conclusion that the “CDO market is dead” as a result of the subprime “contagion.”33 93. Citigroup withheld this obviously material information from investors, including Plaintiffs, and continued to market CDOs to them fully aware of the disastrous effect the impending downgrades would have on the value of these investments. Indeed, Citigroup continued to represent that the Cookson, ABSynth, and Pinnacle Peak CDOs were extremely safe and consistent with Plaintiffs‟ conservative buy-and-hold investment strategy. 94. Against this backdrop, Citigroup devised and implemented several fraudulent schemes through which it was able to mitigate its exposure to the impending collapse of the subprime market even as it continued to earn lucrative fees securitizing subprime RMBS and arranging and marketing CDOs stocked with these increasingly toxic assets to unsuspecting investors such as Plaintiffs. 32 See Pursuit Partners, LLC v. UBS AG, No. X05-CV-08-4013452-S, 2009 WL 3286011, at *12 n.17 (Conn. Super Ct. Sept. 8, 2009). 33 See Levin Report, supra note 21, at 481, n.2022. 28 III. Through Material Misrepresentations and Omissions, Defendants Induced Plaintiffs into Investing Nearly $1 Billion in CDOs Designed to Fail 95. Between September 2006 and July 2007, Defendants fraudulently procured Plaintiffs‟ investments in $965 million (face value) of notes in eleven CDOs that Citigroup had arranged and marketed: Transaction Name Lacerta Transaction Description Synthetic CDO referencing mostly RMBS CDOs referencing a synthetic, static portfolio of RMBS and CMBS Plaintiff LFJ27 Tranche Purchased Lacerta ABS CDO 2006-1, Class A-1 Total Jackson 2006-IA Jackson 2006-IIA Total Cookson 2007-16, Class A Cookson 2007-19, Class A Cookson 2007-35, Class A Cookson 2007-38, Class A Cookson 2007-38, Class A Cookson 2007-38, Class A Total Pinnacle Peak CDO I, Class A3 Total ABSynth I ABSynth II Synthetic CDOs, each referencing a static portfolio of CDOs, RMBS, CMBS, student loan, and credit card debt Hybrid, managed CDO referencing RMBS and CDOs Cloverie Series 2007-32, Class B Cloverie Series 2007-33, Class C Total Plettenberg Bay LFJ 6 Plettenberg Bay CDO Ltd., Class A-1 Total TOTAL – ALL DEALS Amount Paid $70,000,000 $70,000,000 $50,000,000 $50,000,000 $100,000,000 $150,000,000 $150,000,000 $150,000,000 $90,000,000 $30,000,000 $30,000,000 $600,000,000 $70,000,000 $70,000,000 $80,000,000 $20,000,000 $100,000,000 $25,000,000 $25,000,000 $965,000,000 Jackson I Jackson II Cookson I Cookson II Cookson III Cookson IV LFJ 25 Synthetic CDOs each referencing a separate, static portfolio of 20 CDOs LFJ 3 LFJ 31 LFJ 31 LFJ 5 LFJ 6 LFJ 7 Pinnacle Peak Hybrid, managed CDO referencing RMBS, CDOs and other assets LFJ 32 LFJ 29 96. As detailed below, Defendants falsely marketed these deals to Plaintiffs as safe long investment opportunities built on high-quality collateral portfolios. 29 A. The Lacerta CDO 1. Citigroup’s Misrepresentations and Omissions Concerning Lacerta 97. On or around October 4, 2006 and October 12, 2006, Citigroup provided a term sheet and a revised term sheet (collectively, the “Lacerta Term Sheets”) for the Lacerta CDO to Plaintiffs‟ investment advisor, knowing that their contents would be conveyed to Plaintiff LFJ 27. Each page of the Lacerta Term Sheets bore Citigroup‟s logo in the top right corner. 98. These term sheets indicated that the initial collateral portfolio for Lacerta had already been selected in consultation with a third-party investor who had made a “lead order” for the equity tranche of that deal. See Lacerta Term Sheets at 1. The Lacerta Term Sheets further represented that, “[i]n order to minimize costs, a third-party asset manager is not involved in the transaction” and that “[t]he transaction‟s low cost base allows for a portfolio of higher credit quality than the portfolio that would be required to deliver the same return to investors when included in a higher cost structure.” Id. 99. Citigroup also specifically represented in the Lacerta Term Sheets that “[t]he strong initial portfolio has been selected and ramped solely to create a long investment for equity and mezzanine investors.” Id. (emphasis added). 2. In Reality, Lacerta Was Designed to Fail by a Now-Notorious Short Investor: Magnetar a. 100. Magnetar’s “Constellation CDO” Scheme Citigroup‟s representations were materially false and misleading because they concealed a crucial fact: that Magnetar selected Lacerta‟s collateral to support its undisclosed short-trading strategy. The portfolio had not been “selected and ramped solely to create a long investment for equity and mezzanine investors.” In reality, Lacerta was one of approximately 27 30 designed-to-fail Constellation CDOs that Magnetar sponsored as vehicles for massive short bets against the subprime RMBS market. 101. In exchange for Magnetar‟s agreement to purchase the equity tranches of these Constellation CDOs,34 the arranging banks allowed Magnetar to clandestinely set the criteria used to select the deals‟ portfolio of cash and synthetic assets.35 102. Unknown to long investors – but known to the arranging banks – the parameters Magnetar established for the deals were designed for Magnetar‟s specific criteria and trading strategy. Magnetar would sponsor the Constellation CDOs by buying the equity tranche at a discounted price, while simultaneously taking a short position that was at least double (or far more) its long position in the equity tranche by buying CDS contracts that would pay off when the CDOs failed. 103. To maximize the likelihood that its short-trading strategy would succeed, Magnetar dictated a mix of assets for the Constellation CDOs that was likely to generate several large cash distributions to its equity holding (i.e., the long position) at the beginning that Magnetar used to pay its CDS premiums before events of default entitled Magnetar to claim massive payments under the CDS contracts it secretly executed with respect to the Constellation CDOs‟ synthetic collateral (i.e., the short position), as well as CDS referencing tranches of the Constellation CDOs themselves. In deference to Magnetar, arranging banks caused the Constellation CDOs to sell both the equity and the CDS contracts to Magnetar at a discount. The 34 The equity tranche of a CDO is subordinated (or “junior”) to all other tranches. The available funds are distributed in order of seniority and, because it is the most junior tranche, the equity tranche traditionally bears the most risk since it is usually the first tranche that will experience losses if the CDO‟s assets do not perform as expected. For this reason, CDOs‟ equity tranches are generally the hardest to place. If a purchaser for the equity tranche cannot be found, then the deal‟s arranger must either purchase the equity itself (and bear the attendant risk) or cancel the deal (and lose tens of millions of dollars in arranging and warehousing fees). 35 See FCIC Report, supra note 7, at 192; Levin Report, supra note 21, at 372-73. 31 net result was that – unlike the investments of purely long investors, such as Plaintiffs, that would succeed only if the CDOs themselves succeeded – Magnetar‟s trade would yield huge profits if the deals collapsed. 104. As recounted by the FCIC and in the Levin Report, as well as a number of recent lawsuits and other public reports, Magnetar‟s influence over collateral selection took various forms. In some cases, Magnetar provided lists of pre-approved assets for the collateral manager to choose from. In others, Magnetar was granted a “veto” right over any asset selected for the CDO.36 In others still, Magnetar simply exercised trades in the name of the collateral manager. 37 In all cases, however, Magnetar‟s agreement to act as equity sponsor in these deals was contingent on the constitution of portfolios that would advance Magnetar‟s undisclosed shorttrading strategy. 105. In addition to allowing Magnetar to dictate asset selection, arranging banks also deferred to Magnetar‟s demand that the Constellation CDOs contain structural features designed to facilitate – and pay for – Magnetar‟s undisclosed short positions. Whereas CDOs traditionally contained tests for overcollateralization and interest coverage (known as the “OC test” and “IC test”),38 the banks that arranged the Constellation CDOs structured those deals – at Magnetar‟s behest – to suspend or delay the implementation of these tests. The concealed purpose of this “triggerless” deal feature was to ensure that Magnetar would continue to receive cash payments 36 See Amended Declaration of Conrad Walker Pursuant to 28 U.S.C. § 1746 in Support of Application for Order to Conduct Discovery Pursuant to 28 U.S.C. § 1782 for Use in Foreign Legal Proceedings, Ex. H, In re Application of IKB Industriebank AG, Civ. No. 11-0237 (N.D.N.Y. Apr. 4, 2011). Indeed, documents produced in other litigation show that Magnetar insisted that its veto right be recorded “behind the scenes and outside of the docs.” Id. at Ex. I. 37 38 See FCIC Report, supra note 7, at 192. The purpose of these tests is to protect senior tranches. When the CDO‟s collateral does not generate sufficient cash flow to meet those tests, payments to junior and equity tranches are suspended. 32 on its equity investment which it could use to fund its larger short positions – via CDS contracts – on the Constellation CDOs‟ synthetic collateral. 106. In short, the Constellation CDOs were constructed for the benefit of a specific short investor (Magnetar) with a specific trading strategy at the expense of all other investors. When the CDOs collapsed, as they were designed to do, the hundreds of millions of dollars invested by noteholders would be used to pay out Magnetar‟s short bet against the CDOs it had created. 107. Over the course of 2006 and 2007, Magnetar implemented this scheme in approximately 27 Constellation CDOs, effectively creating a market for the express purpose of shorting it. In the nine-month period between July 2006 and March 2007, Citigroup collaborated with Magnetar in the creation and marketing of six of these deals, totaling nearly $3 billion (collectively, the “Citigroup-Arranged Constellation CDOs”): Deal Name Cetus ABS CDO 2006-1 Cetus ABS CDO 2006-2 Cetus ABS CDO 2006-4 Lacerta ABS CDO 2006-1 Octans III CDO Octonion I CDO Trade Date July 21, 2006 September 27, 2006 November 15, 2006 November 29, 2006 December 6, 2006 March 6, 2007 Total 108. Total Deal Size $300,000,000 $300,000,000 $450,000,000 $600,000,000 $300,000,000 $1,040,000,000 $2,990,000,000 In exchange for collaborating with Magnetar, Citigroup reaped tens of millions of dollars in fees on the Citigroup-Arranged Constellation CDOs in its roles as, inter alia, arranger, initial purchaser, and placement agent for each CDO. 33 b. In Light of Magnetar’s Undisclosed Short-Trading Scheme, Citigroup’s Representations That the Lacerta Portfolio Had Been Selected for the Benefit of Long Investors Were Materially False and Misleading 109. By representing to LFJ 27‟s investment advisor that the Lacerta portfolio had been selected in consultation with a third-party investor “solely to create a long investment opportunity for equity and mezzanine investors,” Citigroup intended to and caused LFJ 27 and its investment advisor to believe that Lacerta was a safe investment for long investors looking to invest in highly-rated senior notes benefitting from high levels of subordination. 110. This representation was materially false and misleading because Magnetar‟s As interests were fundamentally misaligned with those of Lacerta‟s other long investors. Citigroup well knew, Magnetar designed the Lacerta CDO – like the other Constellation CDOs – as a vehicle for implementing its secret short-trading scheme. When Magnetar‟s undisclosed short bet against Lacerta via the CDS contracts paid off, the deal‟s long investors – including LFJ 27 – footed the bill. 111. Magnetar‟s investment strategy and criteria were materially different than those of LFJ 27 and other long-only investors. Magnetar believed it could create an arbitrage profit by buying the CDO equity tranches at a discount and by buying CDS contracts for a fraction of their nominal value, thereby massively shorting the more expensive senior CDO tranches. Magnetar would purchase protection on CDS contracts referencing the assets in the CDO‟s collateral pool, as well as CDS referencing tranches of the Constellation CDOs themselves. Thus, whereas Magnetar stood to reap huge profits if the CDO cratered, LFJ 27 and other long investors could only profit if the CDO performed well. 112. LFJ 27 invested in Lacerta in reliance on Citigroup‟s representations that the CDO‟s portfolio had been selected “solely to create a long investment opportunity for equity and 34 mezzanine investors.” In reality, Citigroup allowed Magnetar to set the parameters for Lacerta in furtherance of its short-trading strategy because Magnetar‟s agreement to purchase the CDO‟s hard-to-sell equity (absent which there would be no CDO at all) was conditioned on the collateral portfolio meeting Magnetar‟s investment criteria. 113. By the time Lacerta closed, Citigroup was well acquainted with Magnetar‟s investment strategy, having already collaborated with it in the creation of three prior Constellation CDOs. Moreover, as alleged above, in or about October 2006 – the very period in which Citigroup was marketing Lacerta to LFJ 27 – Citigroup was designing Class V Funding as a vehicle to pursue its own undisclosed short-trading strategy. 114. As alleged above, Citigroup‟s role at virtually every level of the subprime market gave it access to detailed information, unavailable to the public, about the deterioration of the RMBS and the CDOs of RMBS, which constituted the collateral of the Lacerta CDO. Thus, Citigroup independently knew that the asset selection criterion dictated by Magnetar resulted in RMBS containing significant portions of non-conforming loans being included in Lacerta‟s portfolio. 115. Further, Citigroup acceded to Magnetar‟s demand that Lacerta – like the other Constellation CDOs – be structured so as to ensure that Magnetar could finance its short position (via CDS contracts issued by Lacerta referencing its synthetic assets) with distributions from its investment in Lacerta‟s equity tranche. Citigroup structured Lacerta to delay the implementation of the OC and IC tests for the first five years of the CDO‟s life to ensure that Magnetar would continue to receive cash from its equity position with which it could fund the premiums on its CDS contracts while waiting for the subprime market to collapse and its short positions to pay off. 35 116. In short, Citigroup‟s representations to LFJ 27 and its investment advisor that Lacerta was a sound investment opportunity for long investors were materially false and misleading. The CDO that Citigroup constructed – using a blueprint provided by Magnetar – was not designed to benefit long investors, but was instead designed to benefit Magnetar‟s undisclosed short bet against Lacerta‟s synthetic portfolio and to fund that bet with cash flows diverted from noteholders to Magnetar‟s equity holding. 3. 117. LFJ 27’s Detrimental Reliance on Citigroup’s Misrepresentations and Omissions In justifiable and reasonable reliance on Citigroup‟s false representations and material omissions, on or around November 29, 2006, LFJ 27 bought $70 million in Lacerta Class A-1 notes from Citigroup, in its capacity as initial purchaser for Lacerta. As of that date, the Lacerta Class A-1 notes were rated AAA. 118. LFJ 27 did not know, and could not have known that, contrary to Citigroup‟s express representations that Lacerta‟s portfolio had been selected by a long investor “solely” for the benefit of other long investors, Citigroup tailored Lacerta to the specifications of a short investor, Magnetar. 119. As Citigroup and Magnetar anticipated, Lacerta experienced an event of default long before its approximate five-year reinvestment period expired. Specifically, on or around February 8, 2008, Lacerta experienced an event of default, which affected all tranches of the deal, including the Class A-1 notes purchased by Plaintiff LFJ 27. Less than three weeks later, on or around February 26, 2008, S&P downgraded the Class A-1 notes to a junk rating of B-. Less than 15 months after purchasing them for $70 million, LFJ 27‟s Class A-1 Lacerta notes had become virtually worthless. 36 120. Had Citigroup disclosed to Plaintiff LFJ 27 or its investment advisor the truth about Magnetar‟s role and conflicting interests in selecting collateral for Lacerta, Plaintiff LFJ 27 would not have invested in the Lacerta CDO. 121. Citigroup improperly benefited from the sale of the Lacerta notes to LFJ 27, including by fraudulently obtaining the $70 million purchase price for the notes as well as fees and expense account payments totaling as much as $29.7 million, in connection with its fraudulent sale of the Lacerta CDO. B. The Jackson CDOs 1. 122. Plaintiff LFJ 25’s Detrimental Reliance on Defendants’ Representations Concerning the Jackson CDOs Also in 2006, Citigroup marketed and sold credit-linked notes in two transactions – Jackson 2006-IA (“Jackson I”) and Jackson 2006-IIA (“Jackson II”) – referencing a static portfolio of synthetic assets. Citigroup arranged the Jackson CDOs and was the initial purchaser of the Jackson notes, which were issued by Defendant USP, the special purpose vehicle established to act for the account of the Jackson CDOs. 123. On or about July 7, 2006, Citigroup provided the Loreley Companies‟ investment advisor with a Marketing Book concerning the Jackson transactions (the “Jackson Marketing Book”), knowing that its contents would be conveyed to Plaintiff LFJ 25. Citigroup‟s logo appeared in the lower right hand corner of the presentation. 124. The Jackson Marketing Book described a “non-amortization” feature, which See Jackson Marketing Book at 16-17. The Jackson increased the risk to noteholders. Marketing Book also represented vaguely that “CGM or one of its Affiliates selected the Reference Obligations included in the initial proposed Reference Portfolio. In making these 37 selections, CGM or such Affiliate may have taken into account certain factors and interests that could be inconsistent with or adverse to the interests of the Noteholders.” Id. at 17. 125. After noting this unusual disclosure in the Jackson Marketing Book, as well as the presence of the non-amortization feature, Plaintiff LFJ 25‟s investment advisor contacted Citigroup to assure itself that, notwithstanding the Jackson Marketing Book‟s “adverse interest” risk factor disclosure, the portfolio was not in fact adversely selected against the interests of noteholders. 126. Citigroup assured Plaintiff LFJ 25‟s investment advisor that the Jackson collateral had not been adversely selected. In communications with Plaintiff LFJ 25‟s investment advisor, Citigroup represented that the reference portfolio had been “pre-selected” by a “hedge fund” that was “looking for protection” to hedge its existing exposure to residuals of RMBS. Consistent with that representation, Citigroup and USP omitted this “adverse interests” risk factor from the draft and final Offering Circular – prepared by Citigroup and USP – for the Jackson CDOs. 127. Based on Citigroup‟s assurances and the representations in the Offering Circular and otherwise, Plaintiff LFJ 25 and its investment advisor reasonably believed that the Jackson collateral had not been adversely selected, but had instead been selected to correspond to a portfolio in which a hedge fund investor had taken a long investment but wished to hedge. Thus, Citigroup assuaged the concerns that Plaintiff LFJ 25 and its investment advisor had as a result of the “adverse interests” disclosure in the Jackson Marketing Book and the non-amortization feature. 128. In justifiable and reasonable reliance on these representations, on or about September 21, 2006, LFJ 25 purchased $50 million in (AAA-rated) notes issued by Jackson 2006-IA and a further $50 million in (AA-rated) notes issued by Jackson 2006-IIA. 38 2. The Jackson CDOs Were a Sham Arranged by Defendants to Allow Morgan Stanley to Offload Risk From Otherwise Unsellable Toxic RMBS 129. Citigroup‟s representations were materially false and misleading. Unknown to LFJ 25 or its investment advisor, in arranging Jackson and marketing the deal under its own name, Citigroup was in reality acting as a “front” for Morgan Stanley, which secretly selected the portfolio to shift the risk of toxic RMBS assets from its own books to unsuspecting investors, such as LFJ 25.39 Citigroup further caused the Jackson CDOs to sell credit protection to Morgan Stanley (either directly or indirectly through back-to-back hedging transactions with intermediary banks) via CDS contracts issued by the Jackson CDOs. 130. Contrary to Citigroup‟s representations, neither Citigroup, nor a Citigroup affiliate, nor a “hedge fund” had selected the reference portfolio for the Jackson deals. In reality, Morgan Stanley dictated the selection of assets for that portfolio for the very purpose of shorting them, as a hedge against subprime RMBS exposure that Morgan Stanley held on its books. 131. It is extremely unusual for one investment bank to ask a competing investment bank to arrange a transaction that the first investment bank could have arranged by itself. By using Citigroup to arrange the Jackson CDOs, Morgan Stanley agreed to pay Citigroup several millions of dollars that it could have earned for itself. But Morgan Stanley needed Citigroup so that it could hide its involvement from the Plaintiffs and other investors. 132. Morgan Stanley hid behind Citigroup, and Citigroup concealed Morgan Stanley‟s involvement, because both Morgan Stanley and Citigroup knew that potential investors, such as 39 The Jackson CDOs were reportedly part of a program, known as the “Dead Presidents” deals, designed by Morgan Stanley with the intent of betting against them, but which Morgan Stanley “didn‟t market [] to clients.” See Amir Efrati, Susan Pulliam, Serena Ng & Aaron Lucchetti, U.S. Probes Morgan Stanley, Wall St. J., May 11, 2010. These deals have been reported to be the focus of civil and criminal investigations. See id. 39 LFJ 25, would not have invested in the Jackson deal if they had known the truth. Morgan Stanley was in the business of securitizing and trading RMBS, but it was not a long-term investor in RMBS. If investors had known that Morgan Stanley had selected these assets, they might have suspected that Morgan Stanley was taking a short position in the assets, and considered them to be particularly undesirable. 133. Morgan Stanley‟s involvement in Jackson would have been of particular importance to Plaintiff LFJ 25 because the non-amortization feature potentially increased the return that could be earned by a short investor on the other side of the transaction. 134. Moreover, a very high proportion – 20% – of the RMBS referenced in the Jackson CDOs had been securitized by Morgan Stanley itself. Morgan Stanley needed to hedge those RMBS assets because it was holding them on its books involuntarily after failing to sell them. As the underwriter of those assets, Morgan Stanley had first-hand knowledge that those assets were particularly risky, and thus likely to produce a credit protection payment to Morgan Stanley as the protection-buyer. By not disclosing Morgan Stanley‟s involvement, Citigroup created the impression that Citigroup, not Morgan Stanley, had selected the RMBS securitized by Morgan Stanley. 135. Thus, Morgan Stanley‟s objective in selecting the assets was very different from that of a hedge fund investor that had a “long” investment position in those assets. Morgan Stanley was not seeking to hedge its exposure to assets in which it had invested purposefully. 136. While engaging in this adverse selection, Morgan Stanley also possessed peculiar knowledge of information it received from Clayton that it, like Citigroup, obtained as the underwriter of the RMBS, but which was not available to investors such as LFJ 25. In 20062007, roughly one-third of all loans purchased by Morgan Stanley were in violation of 40 underwriting standards.40 As Morgan Stanley admitted as part of a settlement with the Massachusetts Attorney General, in the last three quarters of 2006, Morgan Stanley “waived more than half of all material exceptions found by Clayton” and continued to purchase these low-quality loans.41 Thus, Morgan Stanley, like Citigroup, knew that a substantial percentage of subprime loans it was purchasing and securitizing did not meet the originator‟s basic underwriting standards, making the RMBS assets securitized by Morgan Stanley far less secure, and far less valuable, than they were represented to be. 137. If Citigroup had disclosed to Plaintiff LFJ 25 or its investment advisor that Morgan Stanley had selected the collateral, let alone that Morgan Stanley had selected the collateral because it had peculiar knowledge that the collateral was unsellable or tainted by underwriting violations, LFJ 25 would never have invested in the Jackson CDOs. 138. In reasonable and justifiable reliance on Citigroup‟s misrepresentations and omissions, on or about September 21, 2006, LFJ 25 purchased $100 million in notes in the Jackson CDOs. On or around March 19, 2008, S&P downgraded the Jackson 2006-IA notes to a junk rating of CCC-. On or about December 20, 2007, S&P downgraded the Jackson 2006-IIA notes to a junk rating of BB+. At present, these notes are virtually worthless. 139. Citigroup improperly benefited from the sale of the Jackson notes to LFJ 25, including by fraudulently obtaining the $100 million purchase price for the notes and, on information and belief, the substantial fees Citigroup earned in connection with its fraudulent sale of the Jackson CDOs. 40 41 See Clayton Trending Report, supra note 16. See Assurance of Discontinuance at 10, In re Morgan Stanley & Co. Inc., No. 10-2538 (Mass. Super. Ct. June 24, 2010). 41 C. The Cookson CDOs 1. The Structure of the Cookson Notes 140. In early 2007, Citigroup solicited Plaintiffs, via their investment advisor, to invest $150 million in each of a series of four bespoke synthetic CDOs known as “Cookson.” 141. The first three deals – Cookson I, Cookson II, and Cookson III – each referenced a portfolio of 20 super-senior tranches of ABS CDO securities equally weighted at $250 million. The fourth deal – Cookson IV – referenced a portfolio of 20 AAA-rated tranches of ABS CDO securities, each equally weighted at $250 million. The total notional value of each Cookson portfolio was $5 billion. 142. The first three Cookson deals were structured with an “attachment point” of 1.5% This means that for each deal, if the 20 referenced and a “detachment point” of 4.5%. investments suffered losses equivalent to 1.5% of their aggregate value, any further losses would cause Plaintiffs to lose a portion of their $150 million investment. And if the tranches referenced in any of the deals‟ portfolios suffered losses rising to $225 million, Plaintiffs would suffer a complete loss of their investment. Given that the notional value of each asset referenced in the Cookson portfolios was $250 million, if any single reference asset lost all of its value, Plaintiffs would lose their entire investment. 143. The fourth Cookson deal had an “attachment point” of 6% (equivalent to $300 million) and a “detachment point” of 9% (equivalent to $450 million). As a result, if any two of the 20 assets referenced in the Cookson IV portfolio defaulted, then Plaintiffs would suffer a complete loss of their investment. 144. Citigroup selected each of the 80 assets referenced in the portfolios of the four Cookson CDOs. Defendant Citi purchased $600 million in credit protection on these same 80 assets via CDS contracts issued by the Cookson CDOs. All of the assets referenced in the 42 Cookson portfolios were super-senior or AAA-rated securities that Citigroup had either purchased or, in the case of Citigroup-arranged CDOs, retained. As a result, Citigroup stood to lose hundreds of millions – or even billions – of dollars if those tranches incurred losses. 2. 145. Citigroup’s Misrepresentations and Omissions Concerning the Cookson Deals In April 2007, Citigroup provided Plaintiffs‟ investment advisor with a “preliminary term sheet” for Cookson I, knowing that its terms would be conveyed to Plaintiffs. 146. The Cookson I term sheet included a table summarizing the 20 CDO tranches the deal would reference, along with a summary of key information regarding each CDO. See Cookson I term sheet at 1. The term sheet represented that each of the 20 referenced CDOs had a collateral manager and a AAA rating or was superior to tranches with a AAA rating. In May and June 2007, Citigroup provided Plaintiffs‟ investment advisor with preliminary term sheets concerning the Cookson II, III, and IV deals knowing that their terms would be conveyed to Plaintiffs. These term sheets contained similar representations. 147. In these term sheets, Citigroup represented that the notes offered to Plaintiffs would be AAA-rated and that the deal had a Moody‟s “Weighted Average Rating Factor” (“WARF”) score of 1 on a scale of 1 to 10,000, indicating the lowest possible likelihood of default. See, e.g., Cookson I, II, III and IV term sheets at 1. 148. This representation omitted material facts, namely that Citigroup did not design the Cookson deals to be investments meriting a “1” rating on the WARF scale. In reality, Citigroup deliberately used these deals to transfer to Plaintiffs Citigroup‟s own exposure to subprime investments that Citigroup knew to be toxic. 149. As alleged above, Citigroup had peculiar knowledge from its involvement in arranging six Constellation CDOs that the collateral for those deals was not chosen by 43 independent collateral managers working for the benefit of long investors, but was instead selected by Magnetar in furtherance of its undisclosed short-trading scheme. Rather than disclosing this patently material information to Plaintiffs, Citigroup instead used it to buy protection and profit on the inevitable default of these reference securities. Citigroup packed the Cookson reference portfolios with tranches of 18 designed-to-fail Magnetar-sponsored CDOs, including all but one of the six Constellation CDOs that Citigroup itself had arranged: Deal Name Cookson I Constellation CDOs in Reference Portfolio 5 TOTAL Carina CDO Cetus ABS CDO 2006-1* LIBRA CDO Octans III CDO* Pyxis ABS CDO 2006-1* 8 TOTAL Auriga CDO Cetus ABS CDO 2006-2* Cetus ABS CDO 2006-4* Draco 2007-1 Octans II MKP Vela CBO Scorpius CDO Vertical Virgo 2006-1 Cookson III Cookson IV 1 TOTAL ACA Aquarius 2006-1 4 TOTAL Auriga CDO Cetus ABS CDO 2006-3 Octonion I CDO* Sagittarius CDO I Notional Value in Portfolio $1,250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $2,000,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $1,000,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 * Citigroup-arranged CDOs % of Total Deal Portfolio 25% 5% 5% 5% 5% 5% 40% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 20% 5% 5% 5% 5% Cookson II 150. Moreover, as alleged above, around the time it was marketing the Cookson deals to Plaintiffs‟ investment advisor, Citigroup had peculiar knowledge that the subprime RMBS it 44 was securitizing contained substantial percentages of risky, non-conforming loans, and it was encountering increasing difficulty in selling the CDOs it was arranging in the market. Citigroup nevertheless caused the Cookson deals to reference a substantial number of Citigroup-arranged CDOs as well as CDOs containing Citigroup-securitized RMBS without disclosing this material information to Plaintiffs‟ investment advisor. Deal Name Cookson I Citigroup-arranged CDOs in Reference Portfolio 6 TOTAL Cetus ABS CDO 2006-1* GSC ABS CDO 2006-1c Mugello ABS CDO 2006-1 Octans III CDO* Palmer ABS CDO Stack 2007-1 Cookson II 2 TOTAL Cetus ABS CDO 2006-2* Cetus ABS CDO 2006-4* Cookson III 4 TOTAL AVANTI Funding 2006-1 Ivy Lane CDO Neptune CDO III Plettenberg Bay CDO Cookson IV 3 TOTAL Adams Square Funding II Coldwater CDO Octonion I CDO* Notional Value in Portfolio $1,500,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $500,000,000 $250,000,000 $250,000,000 $1,000,000,000 $250,000,000 $250,000,000 $250,000,000 $250,000,000 $750,000,000 $250,000,000 $250,000,000 $250,000,000 * Constellation CDOs % of Total Deal Portfolio 30% 5% 5% 5% 5% 5% 5% 10% 5% 5% 20% 5% 5% 5% 5% 15% 5% 5% 5% 151. The Cookson portfolios also contained at least one instance where two Citigroup- arranged CDOs had cross-invested in each other (i.e., each owned notes issued by the other). The Octonion I CDO owned tranches of the Adams Square Funding II CDO, and vice versa. Cookson IV referenced both of these CDOs. Ten percent of the notional value of the Cookson 45 IV portfolio was tainted by this cross-investment. Thus, Plaintiffs‟ 6% detachment point on Cookson IV would be triggered if these two CDOs defaulted. Significantly, Octonion I also owned parts of Class V Funding, the Citigroup-arranged CDO-squared that, as the SEC claims, Citigroup used as a vehicle for secretly shorting specific CDO assets it believed would fail. All three of these Citigroup-arranged CDOs – Octonion I, Adams Square Funding II, and Class V Funding – closed within nine days of each other, between February 28 and March 8, 2007. 152. Given that the failure of a single referenced asset in the portfolios of Cookson I, Cookson II, or Cookson III – or the failure of just two referenced assets in the portfolio of Cookson IV – would be sufficient to wipe out Plaintiffs‟ entire investment in those deals, Citigroup‟s decision to stock the Cookson CDOs with garbage assets that it knew had either been designed or were likely to fail would have been material to Plaintiffs and any economically rational investor in deciding whether to invest in these deals. information, they would not have invested in the Cookson CDOs. 153. Citigroup also failed to disclose the material information it had concerning the Had Plaintiffs known this impending changes to Moody‟s rating methodology, changes it knew would lead to default events in subprime RMBS CDOs, including those referenced in the Cookson collateral pool, with disastrous results for the value of Plaintiffs‟ investments. Citigroup caused the Cookson entities to sell credit protection via the CDS to Citigroup‟s affiliate, Citi, at below-market rates that failed to reflect this undisclosed risk. As a result, the Cookson CDOs received less cash in return for the sale of protection than they would have obtained in an open-market bona fide CDS trade if that risk had been fully disclosed. 154. In short, to protect itself from these imminent downgrades and defaults, Citigroup deliberately stocked the Cookson reference portfolios with assets on Citigroup‟s books that it 46 knew were poised to experience downgrades and defaults, marketed these investments to Plaintiffs as super-safe investments, and then purchased credit protection via CDS contracts on the Cookson portfolios equaling the precise amount – $600 million – of Plaintiffs‟ investment. Through this scheme, Citigroup insured itself against losses it would suffer on the tranches it had on its books, and transferred such risk to Plaintiffs. 155. Had Citigroup disclosed to Plaintiffs or their investment advisor the truth about the imminent change to Moody‟s rating methodology and the impact it would have on the Cookson CDOs‟ reference portfolios, Plaintiffs would not have invested in the Cookson CDOs. 3. 156. Plaintiffs’ Detrimental Reliance on Citigroup’s Misrepresentations and Omissions In reasonable and justifiable reliance on these representations, Plaintiffs invested a total of $600 million in the four Cookson deals. On or about June 6, 2007, Plaintiff LFJ 3 purchased $150 million of credit-linked notes in Cookson I, and Plaintiff LFJ 31 purchased $150 million of credit-linked notes in Cookson II. On or about June 22, 2007, Plaintiff LFJ 31 purchased $150 million of credit-linked notes in Cookson III. On or about July 13, 2007, Plaintiff LFJ 5 purchased $90 million of credit-linked notes in Cookson IV, and Plaintiffs LFJ 6 and 7 each purchased $30 million of credit-linked notes in Cookson IV. 157. Within a year of closing, the Cookson CDOs failed. Between January and June 2008, Defendant Citi gave notice to Plaintiffs that certain reference assets in the Cookson CDOs had been liquidated and claimed $600 million in credit protection payments under the CDS contracts it had purchased, wiping out Plaintiffs‟ $600 million Cookson investment in its entirety. 158. Defendant Citigroup improperly benefited from the sale of the Cookson notes to LFJ 3, LFJ 5, LFJ 6, LFJ 7, and LFJ 31, including by fraudulently obtaining the $600 million 47 purchase price for the notes and, on information and belief, the substantial fees Citigroup earned, in connection with its fraudulent sale of the Cookson CDOs. D. The Pinnacle Peak CDO 1. 159. Defendants’ Misrepresentations Concerning the Pinnacle Peak CDO LFJ 32 invested $70 million in Pinnacle Peak, a managed, hybrid CDO arranged and marketed by Citigroup with a portfolio consisting of approximately 97.7% cash assets and 2.3% synthetic assets. 160. On or about May 3, 2007, Citigroup sent Plaintiff LFJ 32‟s investment advisor the preliminary Pinnacle Peak term sheet and Pinnacle Peak pitch book (the “Pinnacle Peak Pitch Book”), knowing that their terms would be conveyed to Plaintiff LFJ 32. The Pinnacle Peak Pitch Book stated that Pinnacle Peak was a “high grade” asset-backed security CDO transaction that would be managed by Koch Global Capital, LLC (“KGC”), a firm with “over 100 years of combined experience within fixed income capital markets.” See Pinnacle Peak Pitch Book at 5. Emphasizing KGC‟s role as collateral manager, the Pinnacle Peak Pitch Book represented that: “KGC‟s goal is a consistently applied, risk-managed approach to portfolio management. This includes using internally generated risk measurements, and fundamental credit research applied to portfolios by an experienced investment management team.” A “key area[] of focus at KGC” is “maintaining an efficient infrastructure and well documented procedures [which] assists its accumulation of a conservative portfolio.” “Every asset is expected to be approved by the investment committee prior to purchase.” “Risk management is central to KGC‟s philosophy[.]” “KGC utilizes a proprietary system and risk management tools,” and follows “primarily a Quantitative asset selection approach.” “KGC applies advanced financial engineering technology to structure, issue and manage assets within its CDOs in a manner designed with a goal of maximizing risk adjusted returns.” 48 “Assets pass through multiple levels of scrutiny before being included in the portfolio.” “Credit discipline and ongoing surveillance is [sic] the foundation of portfolio selection and buy/hold/sell decisions.” KGC‟s “Key Credit Principles” include “identify[ing] undervalued credits without generating excess risk” and applying “a relative value asset score for validation and verification purposes.” “Securities purchased for the CDO are monitored through the Koch Investment Management („KIM‟) System in conjunction with the warehouse provider/trustee. The portfolio is reviewed regularly to check portfolio compliance and identify early warning credit issues....” See id. at 16, 22-23, 25. 161. The Pinnacle Peak Pitch Book also emphasized the expertise and careful process that KGC would apply in selecting CDOs to be included in the Pinnacle Peak portfolio: “KGC focuses on CDO sectors where it has internal credit and structural expertise.” As part of its “[t]ypical CDO Investment Process,” KGC would “[r]eview every asset within the portfolio; stress run portfolios for breaks to yield/principal; [and] compliance check triggers/measures.” And to analyze the “structural integrity” of candidate CDO assets, the Pinnacle Peak Pitch Book represented that “CDOs are stress modeled utilizing KGC proprietary scenarios,” and that it conducted “detailed analysis of any focus or questionable assets within the portfolio and appl[ied] additional stress.” See id. at 33. 162. On May 25, 2007, Citigroup sent Plaintiffs‟ investment advisor the preliminary draft of the offering circular for the Pinnacle Peak deal (“Pinnacle Peak Offering Circular”). The Pinnacle Peak Offering Circular represented, among other things, that KGC‟s “objective in investing ... is to minimize the possibility of principal loss while enhancing return through limited portfolio management, subject to the limitations in the Indenture.... The Manager will 49 invest in assets that it believes are appropriately priced, properly structured and able to be adequately serviced.” See Pinnacle Peak Offering Circular at 96. 163. Additionally, the Pinnacle Peak Offering Circular explicitly represented that all purchases of collateral on behalf of the Pinnacle Peak CDO would be made for “fair market value” and at “arm‟s length”: “[A]ll purchases of such Eligible Collateral Debt Securities from any third party (including the Manager, and their respective clients and affiliates, and Citi or any of its affiliates) will be … at fair market value … and otherwise on an ‘arm’s length basis’ or, if effected with the Manager, the Issuer, the Trustee or any Affiliate of any of the foregoing or any account or portfolio managed or advised by the Manager or any of its Affiliates, on terms as favorable to the Issuer as would be the case if such person were not so affiliated.” … “Any purchase or disposition of an Eligible Collateral Debt Security…. will be conducted on an “arm‟s length basis” for fair market value[.]” Id. at 50, 86 (emphasis added). 164. In reasonable and justifiable reliance on Defendants‟ representations, on or about July 3, 2007, Plaintiff LFJ 32 purchased $70 million in Pinnacle Peak Class A-3 notes, rated AAA at closing. 2. 165. Defendants Used Pinnacle Peak as a Dumping Ground for Weak Citigroup-arranged CDOs and Citigroup-securitized RMBS Citigroup‟s representations to Plaintiff LJF 32‟s investment advisor were materially false and misleading. Just as Citigroup had used CSAC as a “beard” to mask its influence over asset selection in connection with Class V Funding, so too did Citigroup use KGC to lure Plaintiffs‟ into investing in Pinnacle Peak. Citigroup did not act in the traditional role of an arranging bank of a managed CDO as Plaintiffs were led to believe. Rather, Citigroup 50 exercised significant influence over the selection of collateral for the Pinnacle Peak deal and used it as a dumping ground to offload the risks it knew, based on its insider‟s knowledge, were posed by assets it held on its own books. 166. For example, Citigroup caused Pinnacle Peak to include a disproportionately high proportion of Citigroup-arranged CDOs in the deal‟s portfolio. Out of the 45 CDO tranches in Pinnacle Peak‟s portfolio, 17 were arranged by Citigroup, and three were tranches of Citigrouparranged Constellation CDOs: Citigroup-arranged CDOs in the Pinnacle Peak Portfolio 17 TOTAL Armitage ABS CDO A3 Armitage ABS CDO A4 Bonifacius Class V Funding III Cookson 2007-10A Cookson 2007-10B 888 Tactical Fund Lacerta 2006-1 A2* Lacerta 2006-1 B* Laguna Seca Funding I Octonion I CDO* Raffles Place II Funding A3 Raffles Place II Funding A4 Ridgeway Court Funding II A5 Ridgeway Court Funding II C Singa Funding Stack 2007-1 Notional Value in Portfolio $233,470,454 $12,000,000 $10,000,000 $17,500,000 $7,500,000 $25,000,000 $5,000,000 $12,500,000 $15,000,000 $15,000,000 $20,000,000 $15,000,000 $8,993,041 $19,984,536 $7,000,000 $15,000,000 $7,992,877 $20,000,000 % of Total Deal Portfolio 45% 2% 2% 3% 1% 5% 1% 2% 3% 3% 4% 3% 2% 4% 1% 3% 2% 4% *Citigroup-Arranged Constellation CDOs 167. Citigroup included these Citigroup-arranged CDOs in the Pinnacle Peak portfolio because Citigroup had been unable to place them with real investors. By placing these CDOs in the Pinnacle Peak portfolio, Citigroup offloaded onto long investors, including Plaintiff LFJ 32, a 51 sizeable chunk of Citigroup‟s exposure to over $230 million in Citigroup-arranged CDO notes. These Citigroup-arranged CDO notes represented 15.6% of the deal‟s total portfolio. To place these figures in context, full losses on the Citigroup-arranged CDO notes alone – even if the rest of the portfolio performed perfectly – were sufficient to wipe out the entire value of LFJ 32‟s investment. 168. The Citigroup-arranged CDOs included in Pinnacle Peak were particularly toxic. For example, as alleged above, Class V Funding was a vehicle designed by Citigroup to allow it to place a half-billion dollar short bet against mezzanine CDOs that it believed were poised to default. That CDO is now the subject of an enforcement action by the SEC. Class V Funding was to a large extent collateralized by other CDOs that Citigroup had previously underwritten, including four Citigroup-arranged Constellation CDOs and notes from the Jackson CDOs, which were, as explained above, a vehicle created to enable Morgan Stanley to short assets. 169. Pinnacle Peak‟s portfolio also included notes from two Citigroup-arranged CDOs – Octonion I (a Constellation CDO) and 888 Tactical Fund – that owned notes from Class V Funding, as well as a Citigroup-arranged CDO known as Armitage that had sold notes to 888 Tactical Fund. These CDOs were part of a web of cross-ownership of other Citigroup-arranged CDOs. 170. By placing notes from these CDOs in the Pinnacle Peak portfolio, investors, including LFJ 32, were exposed to layers upon layers of toxic Citigroup-arranged CDOs that Citigroup knew, or should have known, were likely to fail. 171. Citigroup also stocked the Pinnacle Peak portfolio with low-quality assets, including RMBS securitized by Citigroup itself. As alleged above, Citigroup was well aware of rampant departures from underwriting guidelines in the loans that it and other arranging banks 52 were purchasing for securitization, yet Citigroup did not disclose this material information to LFJ 32 or the deal‟s other investors. 172. Given that Citigroup – and not, as had been represented, KGC – was dictating collateral selection for this deal, Pinnacle Peak‟s purchases of Citigroup-arranged RMBS and CDOs were certainly not at “arm‟s length,” contrary to the explicit representations in the Pinnacle Peak Offering Circular. Moreover, on information and belief, Citigroup caused Pinnacle Peak to acquire these assets at above-market prices unilaterally dictated by Citigroup, contrary to the Pinnacle Peak Offering Circular‟s representation that all of the CDO‟s assets would be purchased at “fair market value.” 173. Further, Citigroup failed to disclose the material information it had concerning the impending changes to Moody‟s rating methodology, changes it knew would lead to default events with disastrous results for the value of Plaintiffs‟ investments. Citigroup caused the Pinnacle Peak CDO to sell credit protection via the Pinnacle Peak CDS to Citigroup‟s affiliate, Citi, at below-market rates. As alleged above, Citigroup knew that impending changes to Moody‟s rating methodology would likely trigger downgrades and defaults in subprime RMBS CDOs, including those referenced in the Pinnacle Peak CDO‟s collateral pool. Yet the rates at which Citi purchased credit protection via the CDS failed to reflect this undisclosed risk. As a result, the Pinnacle Peak CDO received less cash in return for the sale of protection than it would have obtained in an open-market bona fide CDS trade if that risk had been fully disclosed. 174. If Defendants had disclosed to Plaintiff LFJ 32 or its investment advisor that Pinnacle Peak‟s portfolio had not been selected by an experienced collateral manager for the benefit of long investors, but had instead been selected by Citigroup to transfer its exposure to the toxic CDOs and RMBS it had arranged, LFJ 32 would not have invested in the Pinnacle Peak 53 CDO. Likewise, had Citigroup disclosed to Plaintiff LFJ 32 or its investment advisor the truth about the imminent change to Moody‟s rating methodology and the impact it would have on the Pinnacle Peak CDO‟s reference portfolios, LFJ 32 would not have invested in the Pinnacle Peak CDO. 175. On or about January 17, 2008, Pinnacle Peak experienced an event of default. On or about February 27, 2008, the Class A-3 notes that Plaintiff LFJ 32 had purchased just eight months earlier were downgraded by Moody‟s to a junk rating of Ca. Plaintiff LFJ 32‟s $70 million investment in Pinnacle Peak is now worthless. 176. Citigroup improperly benefited from the sale of the Pinnacle Peak notes to LFJ 32, including by fraudulently obtaining the $70 million purchase price for the notes, and the $6.325 million in fees and expense account payments Citigroup received in connection with their fraudulent sale of the Pinnacle Peak CDO. E. The ABSynth CDOs 1. 177. Plaintiff LFJ 29’s Detrimental Reliance on Citigroup’s Representations Concerning the ABSynth CDOs In early 2007, Citigroup pitched an investment in two bespoke CDOs – Cloverie Series 2007-32 (known as “ABSynth I”) and Cloverie Series 2007-33 (known as “ABSynth II”) – to Plaintiff LFJ 29 via LFJ 29‟s advisor. 178. The ABSynth deals referenced the same static, synthetic portfolio – selected by Citigroup – of RMBS, CDOs, commercial mortgage-backed securities, student loan, and credit card securities. The ABSynth portfolios referenced 115 total assets, ten of which were CDOs. Although the ABSynth deals were themselves static, all ten of the CDOs referenced in the ABSynth portfolios were managed. 54 179. In April 2007, Citigroup provided Plaintiff LFJ 29‟s investment advisor with preliminary term sheets for the ABSynth CDOs knowing that they would be conveyed to LFJ 29. Each page of each term sheet bore the logo of Citigroup. Citigroup represented that the ABSynth I credit-linked notes it was offering were AAA-rated securities and the ABSynth II credit-linked notes were AA-rated securities, both with favorable subordination characteristics. 180. In reasonable and justifiable reliance on these representations, on June 21, 2007, LFJ 29 purchased $80 million in ABSynth I Class B credit-linked notes and $20 million in ABSynth II Class C credit-linked notes. 2. 181. Citigroup Concealed Material Information Concerning the Collateral Referenced in the ABSynth Portfolios Unknown to Plaintiff LFJ 29 or its investment advisor, Citigroup included assets in the ABSynth CDOs‟ reference portfolios that it knew, based on its insider‟s knowledge, were likely to default and cause LFJ 29 to lose its investment. Fully 30% of the CDOs referenced in the ABSynth portfolios were arranged by Citigroup itself, including Octans III (another designed-to-fail, Magnetar-sponsored Constellation CDO) and Adams Square Funding II (a CDO with considerable levels of highly suspicious cross-ownership with other Citigrouparranged CDOs): 55 Deal Name ABSynth I Citigroup-Arranged CDOs in Reference Portfolio 3 TOTAL Adams Square Funding II Neptune CDO III Octans III CDO* Notional Value in Portfolio $65,217,390 $21,739,130 $21,739,130 $21,739,130 $15,667,842 $5,222,614 $5,222,614 $5,222,614 % of Total Deal Portfolio 30% 10% 10% 10% 30% 10% 10% 10% ABSynth II 3 TOTAL Adams Square Funding II Neptune CDO III Octans III CDO* * Constellation CDO 182. These underlying CDOs were the largest contributor to the ABSynth CDOs‟ subsequent failure. For example, when a total write-down later occurred on the ABSynth I notes, nine of the ten referenced CDOs had full write-downs, contributing more than two-thirds of the losses necessary to cause a total loss of LFJ 29‟s investment. 183. Like the underlying CDO assets, the RMBS assets selected for inclusion by Citigroup in June 2007 were also selected for the benefit of the “short” position – i.e., Citigroup, as counterparty to the ABSynth CDS – in the deals. By taking a short position with respect to the assets it selected based on its insider‟s knowledge, Citigroup profited from the poor performance of those assets – while investors without the same knowledge, including LFJ 29, suffered losses. 184. Citigroup did not disclose to Plaintiff LFJ 29‟s investment advisor Magnetar‟s role in the structuring and selection of the collateral for the Constellation CDO included in the ABSynth collateral. Nor did it disclose that other Citigroup-arranged CDOs were included in the collateral because Citigroup could not sell those tranches in the market, or that Citigroup had included tainted RMBS, including RMBS out of its own portfolio, in the collateral. 56 185. Further, Citigroup failed to disclose the private information it had concerning the imminent changes to Moody‟s rating methodology, changes it knew would lead to default events with disastrous results for the value of Plaintiffs‟ investments. Citigroup caused ABSynth to sell credit protection via the CDS to Citigroup, at below-market rates. As alleged above, Citigroup knew that changes to Moody‟s methodology would likely trigger downgrades and defaults in subprime RMBS CDOs, including those referenced in ABSynth‟s collateral pool. Yet the rates at which Citigroup purchased credit protection via the ABSynth CDS failed to reflect this undisclosed risk. As a result, ABSynth received less cash in return for the sale of protection than it would have obtained in an open-market bona fide CDS trade if that risk had been fully disclosed. 186. If Citigroup had disclosed to Plaintiff LFJ 29 or its investment advisor that it had knowingly stocked the ABSynth portfolio with CDOs and RMBS that it expected to fail, LFJ 29 would not have invested in the ABSynth CDOs. Similarly, had Citigroup disclosed to Plaintiff LFJ 29 or its investment advisor the truth about the imminent change to Moody‟s rating methodology and the impact it would have on ABSynth‟s reference portfolio, Plaintiff LFJ 29 would not have invested in the ABSynth deals. 187. On or about December 2, 2008, LFJ 29 lost the entire value of its $80 million investment in the ABSynth I notes and its $20 million investment in the ABSynth II notes. 188. Defendant Citigroup improperly benefited from the sale of the ABSynth notes to LFJ 29, including by fraudulently obtaining the $100 million purchase price for the notes and, on information and belief, the substantial fees Citigroup earned in connection with its fraudulent sale of the ABSynth CDOs. 57 F. The Plettenberg Bay CDO 1. Plaintiff LFJ 6’s Detrimental Reliance on Defendants’ Representations Concerning Plettenberg Bay 189. Plettenberg Bay was marketed and sold by Citigroup as a managed hybrid CDO with a portfolio comprised of $75 million in cash securities and $425 million in synthetic securities. 190. Citigroup represented that Investec Bank (UK), Ltd. (“Investec”) would be the collateral manager for this deal, ostensibly to select and manage the reference portfolio in the interest of the deal‟s success and to protect and enhance the investments of the deal‟s long investors. 191. In or around January 2007, Citigroup provided Plaintiffs‟ investment advisor with a presentation outlining the mechanics and terms of the Plettenberg Bay CDO (the “Plettenberg Bay Pitch Book”), knowing that its terms would be conveyed to LFJ 6, for the purpose of inducing LFJ 6 to invest in Plettenberg Bay. Each page of the Plettenberg Bay Pitch Book bore the logo of Citigroup. The Plettenberg Bay Pitch Book stated that due to Investec‟s “[e]xtensive activities across the capital structure in carefully selected asset classes in the structured credit markets” and its “[r]elationships with both sell-side broker dealer banks and buy-side managers and investors” that it had “greater insights into the relative value of potential investments; increased access to information related to the performance of underlying assets and market information related to deal flows and transaction pipelines; and [a]n improved ability to source collateral efficiently and at attractive prices.” Plettenberg Bay Pitch Book at 33. In addition, the Plettenberg Bay Pitch Book stated that the assets selected would have a “[l]ow probability of default (e.g., ABS)” or “[l]ow expected loss (e.g., US leveraged loans).” Id. at 39. 58 192. Additionally, the Offering Memorandum for Plettenberg Bay (“Plettenberg Bay Offering Memorandum”) explicitly represented that all purchases of collateral on behalf of the Plettenberg Bay CDO would be made for fair value and at “arm‟s length”: Any and all sales of Collateral Debt Assets and reinvestments of Sale Proceeds in Substitute Collateral Debt Assets shall be conducted on „arm‟s length‟ terms, and the Collateral Manager shall seek the best commercially reasonable price and execution in accordance with the Collateral Management Agreement. Plettenberg Bay Offering Memorandum, at 88. 193. In justifiable and reasonable reliance on these representations, on or about March 7, 2007, Plaintiff LFJ 6 purchased $25 million in Plettenberg Bay Class A-1 notes, rated AAA. 2. 194. Defendants’ Representations Concerning Plettenberg Bay Were False These representations were materially false and misleading when made. Citigroup used Investec to lure LFJ 6 into investing in Plettenberg Bay. Citigroup did not act in the traditional role of an arranging bank of a managed CDO, as LFJ 6 and its investment advisor were led to believe. Rather, Citigroup exercised significant influence over the selection of collateral for the Plettenberg Bay deal – and used it as a dumping ground to offload the risks it knew, based on its insider‟s knowledge, were posed by assets held by Citigroup on its own books. 195. Contrary to Citigroup‟s representations, Citigroup ensured that the Plettenberg Bay reference collateral would consist of assets that Citigroup knew had much greater risk than disclosed. For example, approximately 9% of the Plettenberg Bay portfolio consisted of Citigroup-securitized RMBS assets, a high proportion relative to Citigroup‟s share of the market. Citigroup failed to disclose its insider‟s knowledge that these RMBS included a high percentage of non-conforming loans, and were thus substantially weaker and more likely to default than 59 their credit ratings suggested. Moreover, Plettenberg Bay‟s portfolio referenced Pyxis 2006-1, a Constellation CDO, and Citigroup failed to disclose the true facts behind the deal – i.e., that Magnetar had designed the Constellation CDOs to fail by stocking them with weak, defaultprone assets in furtherance of its short-trading scheme. 196. Once again, Citigroup did not disclose any of the operative material facts concerning these assets, but instead misrepresented that Investec had selected underlying assets that it believed had a “low probability of default” and other favorable characteristics for investors. Citigroup knew those representations to be false and misleading. 197. Moreover, contrary to the explicit representations in the Plettenberg Bay Offering Memorandum, these purchases of Citigroup-arranged RMBS were certainly not at “arm‟s length.” Citigroup caused Plettenberg Bay to purchase these assets at above-market prices unilaterally dictated by Citigroup, contrary to the Plettenberg Bay Offering Memorandum‟s representation that all assets would be acquired for the “best commercially reasonable price.” 198. If Citigroup had disclosed to Plaintiff LFJ 6 or its investment advisor that it had knowingly stocked the Plettenberg Bay portfolio with RMBS that it expected to fail, LFJ 6 would not have invested in the deal. 199. On or about March 4, 2008, Plettenberg Bay experienced an event of default, and LFJ 6‟s Class A-1 notes were downgraded to a junk rating about a month later. 200. The entire value of Plaintiff LFJ 6‟s $25 million investment in Plettenberg Bay has been wiped out. 201. Citigroup improperly benefited from the sale of the Plettenberg Bay notes to LFJ 6, including by fraudulently obtaining the $25 million purchase price for the notes and the $6.6 60 million in fees Citigroup earned in connection with the fraudulent sale of the Plettenberg Bay CDO. IV. Defendants Selected Collateral That Was Not Fair Consideration for the Obligations Undertaken by the CDOs, Leaving Them Insolvent 202. As stated above, Defendants knew but concealed from the market and potential investors that the subprime RMBS and CDOs of RMBS that they placed into the Pinnacle Peak and Plettenberg Bay CDOs‟ cash portfolios were significantly more risky, and thus more likely to default, than suggested by their credit ratings. Yet, Defendants caused those CDOs to pay above-market rates for those assets. 203. Similarly, Defendants were aware, but did not disclose to the market and potential investors, that the assets referenced in the synthetic portfolios of the Lacerta, Jackson, Cookson, Pinnacle Peak, ABSynth and Plettenberg Bay CDOs were substantially weaker, and thus more likely to default, than suggested by their credit ratings. Yet Defendants caused the CDOs to sell credit protection on these synthetic assets via CDS contracts for premiums that were not commensurate to such elevated risk levels and thus did not reflect fair market value. 204. Moreover, by early 2007, Citigroup was aware – based on its peculiar knowledge of the subprime market through its activities securitizing RMBS and arranging CDOs, as well as the non-public information it received from the analysis of Clayton Holdings – that the market for residential mortgages and RMBS was severely impaired. As a result, the cash assets transferred to the hybrid CDOs Pinnacle Peak and Plettenberg Bay were only worth a fraction of the “par value” paid by the CDOs for these assets. Similarly, the pool of synthetic assets referenced in the portfolios of the Cookson, Jackson, Pinnacle Peak, ABSynth, and Plettenberg Bay CDOs had also experienced substantial impairment, yet Defendants caused the CDOs to 61 accept CDS premium payments that did not account for the deterioration (and elevated risk) of these reference assets. 205. For example, one particular tranche (the 1.5% to 4.5% tranche, in which LFJ 31 invested) of the Cookson III CDO received a spread of only 115 basis points per annum (i.e., a return of 1.15%), whereas the “fair market spread” of the same tranche as of June 22, 2007, would have been 1,827 basis points (i.e., 18.27%). The return to the CDO was, therefore, less than one-fifteenth the fair market rate. 206. Thus, the CDOs at issue in this lawsuit paid more for their cash collateral and received less for the credit protection they sold via CDS contracts than they would have in openmarket bona fide trades. 207. Because the Lacerta, Jackson, Cookson, Pinnacle Peak, ABSynth and Plettenberg Bay CDOs did not receive fair consideration in these conveyances, these CDOs were rendered insolvent, as they lacked sufficient assets to meet their obligations to investors. Additionally, the conveyances left these CDOs with insufficient capital to carry on business, and to meet obligations as they arose. CAUSES OF ACTION FIRST CAUSE OF ACTION (Common Law Fraud Against CGMI and CGML) 208. herein. 209. CGMI, as arranger of the Lacerta, Jackson, Cookson, Pinnacle Peak and Plaintiffs repeat and re-allege all of the foregoing paragraphs as if fully set forth Plettenberg Bay CDOs (collectively, the “CGMI-arranged CDOs”), and CGML, as arranger of the ABSynth CDOs (the “CGML-arranged CDOs”), made representations to Plaintiffs and to the 62 rating agencies concerning the RMBS and CDO collateral for the CGMI-arranged CDOs and the CGML-arranged CDOs. 210. These oral and written misrepresentations and omissions, all as described in the preceding allegations, included representations concerning the safety and security of the Plaintiffs‟ investments; the identity and interests of the parties who selected the RMBS and CDO collateral for these investments; the identity and interests of the parties who selected the assets underlying the CDO collateral for these CDOs; the role of the CDOs‟ collateral managers; the undisclosed role of Magnetar in the CDOs; the undisclosed role of non-party Morgan Stanley in the Jackson CDO; the quality of the mortgage loans underlying the collateral for these CDOs; the representation that collateral would be acquired at “arm‟s length” and for “fair market value,” when in reality collateral comprised risky assets transferred to the CDOs at above-market prices; the value, credit quality and risk of loss for the notes purchased by Plaintiffs in these CDOs; and the likelihood that impending changes in rating methodologies, and resulting downgrades, would result in the collapse of CDOs investing in subprime RMBS. 211. Citigroup‟s representations were materially false and misleading when made. These representations were made intentionally or with reckless disregard for the truth. 212. Citigroup made these misrepresentations and omissions to Plaintiffs directly or via Plaintiffs‟ investment advisor with the knowledge that Plaintiffs would rely on them. 213. Citigroup made these misrepresentations and omissions to the ratings agencies with the knowledge that the ratings agencies would rely on them and give the CGMI-arranged and CGML-arranged CDOs inflated ratings, and with the intention and expectation that Plaintiffs would rely upon these ratings in purchasing notes. 63 214. CGMI and CGML had an affirmative duty to provide complete and accurate disclosures of the material facts about the CGMI-arranged and CGML-arranged CDOs that lay peculiarly within their knowledge. CGMI and CGML intentionally or recklessly failed to provide full, complete, and accurate disclosures of these material facts. 215. By orchestrating the sale of notes of Citigroup-arranged CDOs to other Citigroup- arranged CDOs, Citigroup created and perpetuated the false impression that the market for Citigroup-arranged CDOs was robust, and that the prices the CDOs were paying for the referenced CDOs were fair prices. 216. Plaintiffs reasonably and justifiably relied to their detriment on CGMI‟s and CGML‟s above-described misrepresentations and omissions, including CGMI‟s and CGML‟s affirmative duty to provide full, complete, and accurate disclosures to Plaintiffs. 217. Plaintiffs reasonably and justifiably relied to their detriment on the ratings of the CGMI-arranged CDOs and the CGML-arranged CDOs. 218. CGMI‟s and CGML‟s misrepresentations and omissions induced Plaintiffs to purchase the above-described notes from the CGMI-arranged and CGML-arranged CDOs. 219. As a direct and proximate result of CGMI‟s and CGML‟s fraud, Plaintiffs have suffered damages, and CGMI and CGML are liable to Plaintiffs in an amount in excess of $965 million plus interest. 220. trial. SECOND CAUSE OF ACTION (Rescission of Contract Based Upon Fraud Against CGMI and CGML) 221. herein. 64 Plaintiffs repeat and re-allege all of the foregoing paragraphs as if fully set forth Plaintiffs also are entitled to punitive damages in an amount to be determined at 222. Defendants CGMI‟s and CGML‟s representations with respect to the notes purchased by Plaintiffs were material, incomplete, misleading and false when made. These misrepresentations and omissions were made intentionally or with reckless disregard for the truth. 223. Defendant CGMI made materially misleading and incomplete statements to induce: Plaintiff LFJ 27 into investing $70 million in Lacerta CDO notes; Plaintiff LFJ 25 into investing $100 million in Jackson CDO notes; Plaintiff LFJ 3 into investing $150 million in Cookson I notes; Plaintiff LFJ 31 into investing $150 million in Cookson II notes and another $150 million in Cookson III notes; Plaintiffs LFJs 5 and 7 into investing $90 million and $30 million respectively in Cookson IV notes; Plaintiff LFJ 6 into investing $30 million in Cookson IV notes and $25 million in Plettenberg Bay CDO notes; and Plaintiff LFJ 32 into investing $70 million in Pinnacle Peak CDO notes. 224. Defendant CGML made materially misleading and incomplete statements to induce Plaintiff LFJ 29 into investing $100 million in ABSynth CDO notes. 225. As alleged above, these statements included representations concerning the safety and security of the Plaintiffs‟ investments; the identity and interests of the parties who selected the RMBS and CDO collateral for these investments; the identity and interests of the parties who selected the assets underlying the CDO collateral for these CDOs; the role of the CDOs‟ collateral managers; the undisclosed role of Magnetar in the CDOs; the undisclosed role of nonparty Morgan Stanley in the Jackson CDO; the quality of the mortgage loans underlying the collateral for these CDOs; the representation that collateral would be acquired at “arm‟s length” and for “fair market value,” when in reality collateral comprised risky assets transferred to the CDOs at above-market prices; the value, credit quality and risk of loss for the notes purchased by 65 Plaintiffs in these CDOs; and the likelihood that impending changes in rating methodologies, and resulting downgrades, would result in the collapse of CDOs investing in subprime RMBS. 226. CGMI‟s and CGML‟s misrepresentations and omissions were made to Plaintiffs directly or via Plaintiffs‟ investment advisor, with the knowledge that Plaintiffs would rely on such information when investing. In other words, CGMI and CGML intentionally, deliberately, and maliciously lured Plaintiffs into investing in the notes, knowing that they were selling something different than what they represented the CDOs to be. 227. Based upon their superior knowledge and expertise, their incomplete and misleading disclosures, and in light of the fact that Plaintiffs did not have access to material facts that were peculiarly within Citigroup‟s knowledge, CGMI and CGML had an affirmative duty to provide full, complete, and accurate disclosures of these material facts. Furthermore, based on their relationship with Plaintiffs‟ investment advisor in connection with CDO transactions, CGMI and CGML owed a duty to Plaintiffs‟ investment advisor, and Plaintiffs, to disclose material facts about the true risk of loss in connection with the purchase of the notes at issue. 228. Defendants were aware and intended that Plaintiffs were acting pursuant to Defendants‟ false and materially misleading statements, and Defendants failed to comply with their duty to clarify these statements and correct Plaintiffs‟ understanding regarding the CDO transactions. 229. As a result of the material misrepresentations detailed above, there was fraud in the inducement of the contract for the Lacerta notes; the Jackson notes; the Cookson notes; the Pinnacle Peak notes; the ABSynth note; and the Plettenberg Bay notes. 66 230. Plaintiffs reasonably and justifiably relied to their detriment on Defendants‟ misrepresentations and omissions, including Defendants‟ affirmative duty to provide full, complete and accurate disclosures to Plaintiffs. 231. But for Defendants‟ misrepresentations and omissions, Plaintiffs would never have agreed to invest in the CDO transactions at issue; Defendants‟ misrepresentations and omissions therefore fraudulently induced Plaintiffs to purchase the notes from Defendants. 232. The notes that Plaintiffs bargained for were different from what Plaintiffs received from Defendants. Plaintiffs lack an adequate remedy at law. 233. Consequently, Plaintiffs are entitled to: (1) a judgment rescinding the contract of sale and directing CGMI to return the $865 million purchase price for the Lacerta notes, Jackson notes, Cookson notes, Pinnacle Peak notes, and Plettenberg Bay notes, together with interest; and (2) a judgment rescinding the contracts of sale and directing CGML to return the $100 million purchase price for the ABSynth notes, together with interest. Rescission would restore each party to its original position through Defendants tendering the original purchase price plus interest, less any benefit, to Plaintiffs, and Plaintiffs tendering their notes to Defendants. THIRD CAUSE OF ACTION (Fraudulent Conveyance Against All Defendants) 234. herein. 235. Plaintiffs, as holders of the Lacerta notes, Jackson notes, Cookson notes, Pinnacle Plaintiffs repeat and re-allege all of the foregoing paragraphs as if fully set forth Peak notes, ABSynth notes and Plettenberg Bay notes are creditors of the various CDO Issuers pursuant to the terms of the governing indentures and offering circulars. 67 236. On information and belief, on or about November 27, 2006, Citigroup caused the Lacerta CDO to issue CDS to short investors, including Magnetar, for below-market premiums (the “Lacerta Conveyance”). 237. The Lacerta Conveyance rendered the Lacerta CDO “insolvent” within the meaning of § 271 of the New York Debtor and Creditor Law (“DCL”). By virtue of this insolvency, the Lacerta Conveyance was fraudulent as to creditors under § 273 of the DCL. 238. The Lacerta Conveyance was made without “fair consideration” within the meaning of § 272 of the DCL at a time when Lacerta was engaged, or was about to be engaged, in a business or transaction for which the property remaining available to Lacerta after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 239. The Lacerta Conveyance was fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 240. The Lacerta Conveyance was made with actual intent “to hinder, delay, or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set it aside pursuant to § 278(a) of the DCL. 241. On information and belief, on or about September 21, 2006, Citigroup caused the Jackson CDOs to issue CDS to short investors, including Morgan Stanley, for below-market premiums (the “Jackson Conveyance”). 242. The Jackson Conveyance rendered Jackson “insolvent” within the meaning of § 271 of the DCL. By virtue of this insolvency, the Jackson Conveyance was fraudulent as to creditors under § 273 of the DCL. 243. The Jackson Conveyance was made without “fair consideration” within the meaning of § 272 of the DCL at a time when Jackson was engaged, or was about to be engaged, 68 in a business or transaction for which the property remaining available to Jackson after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 244. The Jackson Conveyance was fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 245. The Jackson Conveyance was made with the actual intent “to hinder, delay or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set it aside pursuant to § 278(a) of the DCL. 246. On information and belief, in or about June and July, 2007, Citigroup caused the Cookson CDOs to issue CDS to short investors, including a Citigroup affiliate, for below-market premiums (the “Cookson Conveyances”). 247. The Cookson Conveyances rendered Cookson “insolvent” within the meaning of § 271 of the DCL. By virtue of this insolvency, the Cookson Conveyances were fraudulent as to creditors under § 273 of the DCL. 248. The Cookson Conveyances were made without “fair consideration” within the meaning of § 272 of the DCL at a time when Cookson was engaged, or was about to be engaged, in a business or transaction for which the property remaining available to Cookson after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 249. The Cookson Conveyances were fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 250. The Cookson Conveyances were made with actual intent “to hinder, delay, or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set them aside pursuant to § 278(a) of the DCL. 69 251. On information and belief, on or about June 27, 2007, Citigroup sold cash assets at above-market prices to the Pinnacle Peak CDO, and caused the Pinnacle Peak CDO to issue CDS to short investors for below-market premiums (the “Pinnacle Peak Conveyance”). 252. The Pinnacle Peak Conveyance rendered the Pinnacle Peak CDO “insolvent” within the meaning of § 271 of the DCL. By virtue of this insolvency, the Pinnacle Peak Conveyance was fraudulent as to creditors under § 273 of the DCL. 253. The Pinnacle Peak Conveyance was made without “fair consideration” within the meaning of § 272 of the DCL at a time when Pinnacle Peak was engaged, or was about to be engaged, in a business or transaction for which the property remaining available to Pinnacle Peak after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 254. The Pinnacle Peak Conveyance was fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 255. The Pinnacle Peak Conveyance was made with actual intent “to hinder, delay, or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set it aside pursuant to § 278(a) of the DCL. 256. On information and belief, in or about April, 2007, Citigroup caused the ABSynth I CDO and the ABSynth II CDO to issue CDS to short investors, including a Citigroup affiliate, for below-market premiums (the “ABSynth Conveyances”). 257. The ABSynth Conveyances rendered the ABSynth CDOs “insolvent” within the meaning of § 271 of the DCL. By virtue of this insolvency, the ABSynth Conveyances were fraudulent as to creditors under § 273 of the DCL. 70 258. The ABSynth Conveyances were made without “fair consideration” within the meaning of § 272 of the DCL at a time when ABSynth was engaged, or was about to be engaged, in a business or transaction for which the property remaining available to ABSynth after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 259. The ABSynth Conveyances were fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 260. The ABSynth Conveyances were made with actual intent “to hinder, delay, or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set them aside pursuant to § 278(a) of the DCL. 261. On information and belief, on or about March 8, 2007, Citigroup sold cash assets at above-market prices to the Plettenberg Bay CDO, and caused the Plettenberg Bay CDO to issue CDS to short investors for below-market premiums (the “Plettenberg Bay Conveyance”). 262. The Plettenberg Bay Conveyance rendered the Plettenberg Bay CDO “insolvent” within the meaning of § 271 of the DCL. By virtue of this insolvency, the Plettenberg Bay Conveyance was fraudulent as to creditors under § 273 of the DCL. 263. The Plettenberg Bay Conveyance was made without “fair consideration” within the meaning of § 272 of the DCL at a time when Plettenberg Bay was engaged, or was about to be engaged, in a business or transaction for which the property remaining available to Plettenberg Bay after the conveyance was “an unreasonably small capital” within the meaning of § 274 of the DCL. 264. The Plettenberg Bay Conveyance was fraudulent as to creditors (including Plaintiffs) under § 274 of the DCL. 71 265. The Plettenberg Bay Conveyance was made with actual intent “to hinder, delay, or defraud present or future creditors” and was fraudulent as to creditors under § 276 of the DCL. Plaintiffs are entitled to set it aside pursuant to § 278(a) of the DCL. 266. On information and belief, Defendants, and non-parties Magnetar and Morgan Stanley, knew that as a result of the conveyances, investors in the Lacerta and Jackson CDOs (including Plaintiffs) would fund short positions held by Citigroup‟s preferred short clients, including non-parties Magnetar and Morgan Stanley, that were intended to drain the CDOs of their assets and defraud creditors (including Plaintiffs). Knowing these facts, Defendants caused or induced the Lacerta and Jackson CDOs to make the conveyances. 267. With regard to the Lacerta Conveyance, Jackson Conveyance, Cookson Conveyances, Pinnacle Peak Conveyance, ABSynth Conveyances and Plettenberg Bay Conveyance, the Issuers, collateral managers, and Citigroup made these conveyances with the intent to hinder, delay, or defraud the Issuers‟ creditors, including Plaintiffs. 268. In the alternative, at the time of each conveyance noted above, (i) the Issuers were either insolvent or were rendered insolvent thereby, (ii) were left with unreasonably small capital, and/or (iii) the Issuers and/or Citigroup intended or believed that the Issuers would incur debts beyond their ability to pay as they matured. 269. As a result, the sales of credit protection by the Issuers to Citigroup and the sales of securities to the Plettenberg Bay and Pinnacle Peak CDOs were fraudulent conveyances pursuant to §§ 270-81 of the DCL. 270. Consequently, Plaintiffs are entitled to a judgment setting aside and voiding each of the property transfers described as fraudulent conveyances and directing that the property 72 transferred be made available to Plaintiffs for satisfaction of the judgment that will be rendered in this action, together with interest. FOURTH CAUSE OF ACTION (Unjust Enrichment Against All Defendants) 271. herein. 272. As a result of their wrongful conduct detailed above, Defendants have been Plaintiffs repeat and re-allege all of the foregoing paragraphs as if fully set forth unjustly enriched at Plaintiffs‟ expense, and Plaintiffs are entitled to judgment ordering Defendants disgorge all amounts they received as a result of their involvement in connection with the Lacerta CDO, Jackson CDOs, Cookson CDOs, Pinnacle Peak CDO, ABSynth CDOs, and Plettenberg Bay CDO, including without limitation: (i) the proceeds of the sales of the notes; (ii) amounts received by CGML and Citi as counterparties on credit default swaps created by CGMI and CGML; (iii) distributions of any type from the CDOs at issue; (iv) commissions or sales fees; and (v) amounts received from the CDOs at issue in transactions involving the purchase of collateral. WHEREFORE, Plaintiffs respectfully demand entry of judgment in their favor and against Defendants as follows: a. Rescinding in whole or in part each of the purchases of the notes by Plaintiffs as described above, and ordering that Defendants return to Plaintiffs the purchase prices paid for the Lacerta notes, Jackson notes, Cookson notes, Pinnacle Peak notes, ABSynth notes and Plettenberg Bay notes; b. In addition or in the alternative, awarding Plaintiffs: (i) damages from Defendants in an amount to be determined at trial, but in no event less than the $965 73 million paid by Plaintiffs for the notes they purchased in the Lacerta, Jackson, Cookson, Pinnacle Peak, ABSynth and Plettenberg Bay CDOs; and (ii) other damages sustained by Plaintiffs as a result of Defendants‟ conduct, as described above, in an amount to be determined at trial; c. Setting aside and voiding each of the property transfers described above as fraudulent conveyances, and directing that the property transferred be made available to Plaintiffs in satisfaction of the judgment rendered in this action, together with interest and other amounts awarded to Plaintiffs; d. Ordering disgorgement of Defendants‟ ill-gotten gains and unjustly obtained fees and profits, and ordering restitution of such gains to Plaintiffs as appropriate; e. Awarding Plaintiffs punitive damages as a result of Defendants‟ intentional, deliberate, malicious, willful, and wanton conduct, as detailed above; f. g. Awarding Plaintiffs pre-judgment and post-judgment interest; Awarding Plaintiffs their costs and fees, including, to the extent applicable, attorneys‟ fees and other costs incurred by Plaintiffs in bringing this action; and h. appropriate. Awarding Plaintiffs such other relief as this Court may deem just and Dated: January 24, 2012 New York, NY 74 KASOWITZ, BENSON, TORRES & FRIEDMAN LLP By: /s/ Marc E. Kasowitz Marc E. Kasowitz (
[email protected]) Sheron Korpus (
[email protected]) 1633 Broadway New York, New York 10019 (212) 506-1700 James M. Ringer MEISTER SEELIG & FEIN LLP 140 East 45th Street, 19th Floor New York, NY 10017 (212) 655-3500 Stephen M. Plotnick CARTER LEDYARD & MILBURN LLP 2 Wall Street New York, NY 10005-2072 (212) 732-3200 Attorneys for Plaintiffs Loreley Financing (Jersey) No. 3 Ltd.; Loreley Financing (Jersey) No. 5 Ltd.; Loreley Financing (Jersey) No. 6 Ltd.; Loreley Financing (Jersey) No. 7 Ltd.; Loreley Financing (Jersey) No. 25 Ltd.; Loreley Financing (Jersey) No. 27 Ltd.; Loreley Financing (Jersey) No. 29 Ltd.; Loreley Financing (Jersey) No. 31 Ltd. and Loreley Financing (Jersey) No. 32 Ltd. 75