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Citigroup, Morgan Stanley & Jackson Segregated CDO

Citigroup and Morgan Stanley appear to be taking a lead from Goldman Sachs when it comes to collateralized debt obligations (CDOs). As reported in a May 21 article by Bloomberg, Citigroup is the focus of several inquiries for allegedly selling a series of mortgage-linked securities – known as the Jackson Segregated Portfolio – to investors without disclosing the fact that Morgan Stanley helped shape the investments while also betting they would fail.

According to the Bloomberg article, marketing documents for the products – which were underwritten by Citigroup in 2006 – failed to provide information on the entity responsible for selecting the underlying mortgage bonds. Sources close to the deal contend that the entity was a Morgan Stanley unit. Six of the seven series of Jackson bonds later defaulted, costing investors more than $150 million of losses, according to Bloomberg data.

So far, Citigroup hasn’t been publicly accused of any violations tied to the Jackson deals.

In a similar situation last month, the Securities and Exchange Commission (SEC) accused Goldman Sachs of misleading investors by failing to disclose that the hedge fund, Paulson & Company, had a role in picking securities it then bet against.

As in the Goldman Sachs case, the Jackson Segregated investments involved a synthetic CDO. Derivatives linked to mortgage bonds were pooled together, packaged into new bonds and then sold investors. On the other end of the Jackson derivatives was a “short” investor. Profits were made when the underlying bonds failed.

“To get the deals done, most underwriters of synthetic CDOs initially took the short positions, sometimes with a plan to sell them off later. When Citigroup set up Jackson, it arranged with Morgan Stanley to take over the short positions once the deal closed . . . Citigroup allowed the firm to help select the bonds linked to the derivatives because Morgan Stanley would have a stake in the performance of the securities,” the Bloomberg article reports

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